Contract Law & HomoEconomius by Ali Bugra Gokagacli

PRELIMARY WORDS

The most significant provisions of the Turkish Code of Obligations (TCB) are probably set out between the article 112 and 126. These articles, by introducing the sanctions against the breach of contract, give meaning to the concept of “binding contracts” and secure the interest of the creditor. The security of the creditor’s interest, however, is realized through a series of sanctions, or contractual remedies, such as compensation, performance in kind, and rescindment of the contract depending on the nature of the breach. Therefore, the remedy applicable to a real breach will ultimately be determined by the creditor and the kind of the breach which inhibits her contractual interests. The purpose of this study is to discover which remedy should a wronged party employ under such circumstances. Within that context, we are going to explore the answer for the questions like when it is beneficial to resort to performance in kind instead of demanding positive compensation, or whether rescinding the contract is more beneficial.

Obviously, to decide which remedy is more advantageous takes a normative approach. In that sense, the writer is going to utilize the criteria of economic efficiency. This approach, determines the suitability of the remedies by taking the remedies effect on the social welfare into consideration. If a remedy, within the necessities of any given concrete case, costs less in terms of social costs and generates better surplus it is, at least normatively, more convenient. In addition, the writer advocates that the approach of economic efficiency is not merely expedient for the contractual remedies but for the contract law in general and thus needed to be taken under consideration when it comes to the interpretation of the contract law provisions.

It must be stressed that when determining the criteria of economic efficiency, the economy and law doctrines have also been addressed. Both the economy and law doctrines put emphasis on the fact that the rationale behaviour theory, developed by the economists, must be applied to the legal rules to understand their real life implications. That approach, naturally, presumes that all individuals will behave in a responsible manner that is going to maximize their profit and.[1]  

Author: Ali Gokagacli

1. The Notion of Contract

1. Contracts in Economics

Neo-classical economics argues that under ceteris paribus circumstances, the goods and services will be outstanding in the market and under full reach of everyone who is trying to obtain them. A buyer, hat has full-knowledge can acquire any good or service from the market without any real hustle. Therefore there is no need for negotiating a contract nor regulating its performance. In fact, for neo-classics there is no need for contracts at all because at the end of the day all actors of the market will exchange goods and services to maximize their interests anyway.

How contracts, exchanges, realize the social welfare is understood as their effectiveness in allocating resources. It is usually accepted that via contracts, the resources are allocated in a much better way by making contracts because, hence the contracts are results of mutual will each party, while entering into a contract, is going to receive something out of the contract which then she can use for generating surplus from another activity.  In other word, from an economic perspective the contracts are not zero sum games. The surplus that is generated by the supplier is called the producer surplus and the surplus generated by the demand owner is called the consumer surplus. These surpluses can be measured by simply deducting the maximum value of the sources used by the parties from their maximum willingness to pay for the same good or service. The sum of these two, will give the total surplus and reflect how much social welfare is created by the parties.

1. BASICS OF THE NOTION OF CONTRACTS

It is obvious that two parties will only enter into a contract, if only it serves both of their interests. For that, the nature of the contract needs to provide a margin of surplus to both parties. This interest, on the other hand, can be bot pecuniary or impecuniary.

Additionally, the interest arising from a contract can be bifurcated as ex ante and ex post interests. Naturally, for a valid contract to exist there needs to be and ex ante interest otherwise the parties would not form a contract in the first place.

Moreover, the very basic economic motive that urges parties to form a contract is the division of total surplus generated. Therefore the price of the contract is not relevant when it comes to determine how fair the contract provisions are. Under different market circumstances such division can and should be different. To give an example, in a fully competitive market the consumer surplus realized out of a contract out to be greater than the producer surplus because the consumer would be in a position make wider choices thus, pushing the producer’s hand. In a monopoly market thing would be vice a versa. As a result, normatively, when if the consumer / obligator is in breach of its performance for objective ex post reasons it is more beneficial to revise the contract then rescinding it.

1. The Economical Functions of the Contract Law

From a neo-classic economics point of view there is actually no reason for the contract law to exist due to the fact that the parties by themselves are presumed to be fully capable of maximizing their profits out of a contract in a fully cooperating market environment.

However, such presumption falls far afar from the realities of the markets. In most cases, the parties to a contract would not be in a position to fully maximize their contractual interests because there is going to be an information asymmetry between them. Another, handicap for parties is that not every good or service would be ready for instant exchange at the moment of the contract’s conclusion. In the absence of a binding and enforceable contract that poses a serious challenge to the future foreseeability; because parties cannot trust in one another for their future performance which in turn would  force parties to closely monitor each other to make themselves certain of the other parties performance.

Hence the reasons for contract law to exist can be summarized as information asymmetry, transaction costs, and the prevention of opportunistic behaviour.  

1. Prevention of Opportunistic Behaviours

When parties simultaneously perform their respective performance there is usually no need for a binding contract. However, if one party is supposed to perform her own obligation before the other party does then there is a very good incentive to other party not to perform his performance and retain both the consumer and producer surplus of the contract. This is called the opportunistic behaviour.

A better explanation for opportunistic behaviour can be made as the behaviour which one party shows to maximize his interests by resorting to fraudulent and cunning manners. This can be done by hiding information or actions.

Opportunistic behaviour arises as a problem especially when there is a specific investment by one party to the contract. To urge the specificly investing party there need to be an incentive otherwise she would probably not enter into the contract in first place.

This problem is solved by the contract law by making contracts binding. That way, in the event that one party does not full fill its contractual obligations the other party can, by using the State’s coercive force, receive her credit with the relevant interest.

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[1] TN: Behavioural economics shows that this is not always the case.