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11 research outputs found

Why Do We Know What We Know? Reevaluating the Economic Case against Pre-Contractual Disclosure Duties and for Break-Up Fees

Author: Grosskopf Ofer
Medina Barak
Publication venue: bepress Legal Repository
Publication date: 25/08/2006
Field of study

The economic analysis of contract law offers influential arguments against pre-contractual disclosure duties and for break-up fees, based on the presumption that pre-contractual duties are (or should be) set to provide sufficient incentives to optimally invest in acquiring information at the negotiation stage. We suggest, however, that the existing analysis is flawed, since it overlooks an important incentive for investing in information gathering. According to the conventional wisdom, a negotiating party will be motivated to invest resources in information gathering only on the basis of its expectation to extract the contractual surplus that the investment may generate. As a result, it is arguably essential to protect the investing party’s ability to benefit from its investment (by allowing non-disclosure) or to strengthen its bargaining position by guaranteeing reimbursement for the investment (break-up fees). However, contracting parties (e.g., the purchaser) invest resources in acquiring information not only—and probably not even primarily—to strengthen its bargaining position vis-à-vis its counterpart (e.g., the seller). Rather, the investment in acquiring information is often aimed at achieving an advantage vis-à-vis its competitors (e.g., other potential purchasers of the same asset), endeavoring to increase the investing party’s likelihood of forming a contract. Thus, even if the seller is able to extract all the contractual surplus generated by the investment, potential purchasers may well find it beneficial to invest in acquiring information to gain a competitive edge toward sealing a deal. In layman’s terms: a negotiator may invest in gathering information not only for the hope of sweetening the deal for herself, but also for the prospect of being able to submit a better offer to the other party. As a result, the argument of the existing literature against imposing a duty to disclose information and in favor of reimbursement provisions cannot be substantiated without a careful inquiry into competition-based motivations to gather information. Specifically, the analysis yields that, among other things, the exemption from disclosure cannot be justified on efficiency grounds in case of information that players in the relevant market regularly collect (e.g., examining the property that is offered for sale or interviewing potential job candidates). The competition-based motivation is insufficient, and legal protection is justified, only in the case of “exceptional” deliberately acquired information (e.g., searching for oil reserves or conducting a thorough job-screening through an extensive training program)

bepress Legal Repository

Regulating Contract Formation: Precontractual Reliance, Sunk Costs, and Market Structure

Author: Grosskopf Ofer
Medina Barak
Publication venue: bepress Legal Repository
Publication date: 12/02/2006
Field of study

This Article challenges the plausibility of the prospect of underinvestment in precontractual reliance (PCR). We argue that a negotiating party is motivated to invest in PCR not only through her expectation to extract the benefits that the investment yields (Added-Value Motivation), but also through the effect of the investment on her position vis-à-vis her competitors (Competition-Based Motivation). We demonstrate that under plausible assumptions, when a negotiating party operates in a relatively competitive market, the Competition-Based Motivation is frequently sufficient to induce optimal PCR, even without appropriate contractual provisions or legal intervention. We suggest several normative implications. First, legal intervention that is aimed at encouraging PCR is generally unwarranted. The forces of competition provide adequate investment incentives, and the regulation of contract formation should only facilitate their operation. We thus justify the reluctance of both positive law and commercial parties from imposing precontractual liability in cases of failed negotiations. Second, the analysis demonstrates that when one party (e.g., the supplier) operates in a competitive market of “professional” repeating players, the other party (e.g., the purchaser) is better off limiting the number of bidders (suppliers) with whom he negotiates. This result suggests that in such cases, from an efficiency perspective, a party (including a public authority) should be allowed to limit the number of suppliers with whom he conducts negotiations. By contrast, when suppliers operate in a competitive market of accidental, one-time players, the purchaser has an interest in encouraging excessive entry of suppliers into the negotiations, and legal intervention aimed at regulating the purchaser’s behavior can be justified. This result may justify, for instance, imposing a duty on employers to pay for training periods of potential employees. Third, legal intervention is justified in order to prevent manipulation of bidder’s assessment of their prospects to receive the contract. The analysis supports a rule that prohibits an auctioneer from receiving an offer that was submitted outside of the auction’s procedures, and a rule that disallows changing “the rules of the game” after the bidders already invested in PCR. Fourth, we show that when legal intervention is justified in the negotiation stage, the appropriate measure of damages that should be awarded is the plaintiff’s expectation interest. We also demonstrate that the difficulty in assessing this value when a contract is not formed can be resolved by approximating this value according to the sum of PCR for all bidders. Finally, we offer a new rationale for imposing disclosure duties (as well as other mandatory requirements to invest in PCR). We show that, in certain cases, such investment is allocated to the party who operates in a competitive market, even if it is efficient for the other party to bear this cost. Legal intervention is essential in such cases to resolve this inefficiency in the allocation of PCR. We refer in this respect to the case of Laidlaw v. Organ, and demonstrate why imposing a duty to disclose information is not expected to adversely affect a party’s incentive to invest in acquiring information

bepress Legal Repository