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The color of law: an economic theory of legal boundaries

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Abstract

This paper presents an economic theory of property, tort, and contract law based on the goal of efficiently governing economic exchange relationships. In the theory, legal boundaries emerge endogenously in response to exogenous differences in the nature of the underlying transaction concerning the possible existence of unforeseen or non-contractible contingencies, and/or the desire of one of the parties to make non-salvageable investments prior to trade. The analysis asks whether, in this context, the transaction is best governed by property, tort, or contract principles. The conclusions are illustrated by a discussion of several cases that occupy the “boundaries” between the various areas.

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Notes

  1. On this distinction, also see Polinsky (1980), Ayres and Talley (1995), and Kaplow and Shavell (1996).

  2. Of course, it is possible that both parties might want to make preparatory investments [see, for example Bolton and Dewatripont (2005, pp. 560–563)]. I adopt the simpler unilateral investment formulation here to keep the model simple.

  3. See, for example, Fischel (1995a), Knetsch and Borcherding (1979), and Miceli (2011a, Chapter 3).

  4. In practice, money damage is the preferred remedy, with specific performance being limited to cases involving land, or other goods for which money damages is not a good substitute for performance.

  5. On impossibility in contract law, see Posner and Rosenfield (1977) and White (1988).

  6. See also Ulen (1984) and Friedmann (1989).

  7. Economists have used similar logic to argue for general enforcement of liquidated damage clauses, which are breach remedies explicitly included in the contract (Goetz and Scott 1977).

  8. For simplicity, we will treat the entitlement in question (the right to pollute) as a single item that is independent of the scale of the buyer’s activity. For example, the right to pollute is unrestricted rather than being dependent on the size of the plant. This assumption, while somewhat limiting, simplifies the model without affecting the qualitative conclusions.

  9. For general discussions of the holdup problem, see Williamson (1975), Klein, Crawford and Alchian (1978), Goldberg (1985), and Miceli and Segerson (2012a, b).

  10. As noted above, the model abstracts from litigation costs, but if included, they would reinforce the fact that φ < 1, assuming litigants pay their own costs.

  11. As under tort law, uncompensated litigation costs will tend to amplify the fact that φ < 1.

  12. Under the contractual doctrines of impossibility, commercial impracticability, and frustration of purpose, the promisor is excused from performance without penalty—in effect, φ = 0 (Posner and Rosenfield 1977; White 1988). This will clearly lead to excessive breach unless the excuse is limited to situations in which breach is efficient anyway (as argued, for example, by Sykes (1990)).

  13. The moral hazard problem can be eliminated while still ensuring efficient breach if the court employs a “limited” expectation damage remedy that has the form D* = V(x*)–P 0 (Cooter 1985; Craswell 1989). Such a rule, however, places even more informational demands on the court because, in addition to knowing V(·) it must compute x*.

  14. Note that the non-enforceability of penalty clauses would possibly increase the inefficiency by disallowing P 1 > V(x).

  15. Obviously, property law prevails for all α > .5.

  16. 26 N.Y.2d 219, 257 N.E.2d 870 (1970).

  17. See, for example, Goldberg (1985). On a more general comparison of trespass and nuisance law, see Merrill (1985).

  18. The total value of the factory may have been $45 million, but the proper measure of the cost of shutting it down would have been the difference between this amount and the value of the plant and equipment in its best non-polluting use, which presumably was not zero.

  19. 494 P.2d 701 (Ariz. 1972).

  20. The court’s assignment of the right in this case illustrates the arbitrariness within the current framework of the labels victim and injurer. This reflects the reciprocal nature of externalities, as first pointed out by Coase (1960).

  21. See Coleman (1988, Ch. 2, fn. 5), who makes a similar point.

  22. Based on this distinction, notice that the Boomer case can actually been characterized as either a holdout or a holdup problem because there were a large number of plaintiffs, all of whose consent would have been required to allow the factory to operate if an injunction (property rule) had been invoked. (Indeed, Fischel (1995b, pp. 75–77) characterized the Boomer case as involving a holdout problem). In contrast, Spur only involved two parties—a single buyer and a single seller—and so involved a pure holdup threat (albeit a small one, as I have argued).

  23. 545 U.S. 469 (2005).

  24. See, for example, Lopez et al. (2009). The controversy over this case, however, turned on the “public use” question—that is, whether the use of eminent domain was appropriate given that the planned use of the assembled land was largely for economic development rather than for provision of a public good. From an economic perspective, however, that issue turns out to be beside the point (see, for example, Miceli (2011b)).

  25. One-on-one transactions can still result in inefficiencies due to bilateral monopoly, but the wide granting of takings power in such cases runs the risk of over inclusiveness (Miceli 2011a, pp. 34–35).

  26. This perspective reflects Epstein’s (1985) view that takings law should mirror nuisance principles based on the argument that the government, when it acquires or regulates property, should not stand in a superior position to individual citizens when they similarly infringe on other citizens’ property.

  27. 382 P.2d 109, cert. denied, 375 U.S. 906 (Okla. 1962).

  28. See, for example, Cooter and Ulen (1988, pp. 320–322).

  29. Also see Posner (1977) and Aivazian et al. (1984).

  30. 117 F. 99 (9th. Cir. 1902).

  31. 47 Mich. 489, 11 N.W. 284 (1882).

  32. Note in contrast that application of the traditional rule in this case would have involved non-enforcement of the renegotiated price because no new consideration was offered in support of it.

  33. See, generally, Cribbet (1975) and Friedman (1990). On the law and economics of leases, see Miceli et al. (2001).

  34. One contractual response to this problem that avoided the risk of breach by the tenant for non-payment of rent was the use of sharecropping contracts, which entitled the landlord to a fixed share of the harvest (Allen and Lueck (1993), and Eswaran and Kotwol (1985)).

  35. See, for example, Javins v. First Nat’l Realty Corp. 428 F.2d 1071 (1970).

  36. See, for example, Epstein (1980) and Landes and Posner (1987, Ch. 10).

  37. See, for example, Spence (1977), Polinsky and Rogerson (1983), Landes and Posner (1987, p. 281), and Viscusi (1991, pp. 64–65).

  38. It is interesting to note that for product failures not involving personal injury, contractual allocation of responsibility for the costs of such failure in the form of optional warranties is allowed. This possibly reflects the view that product failures not involving injuries are sufficiently familiar to consumers that contractual allocation would result in efficient decisions (Landes and Posner 1987, p. 281).

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I acknowledge the helpful comments of two reviewers.

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Correspondence to Thomas J. Miceli.

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Miceli, T.J. The color of law: an economic theory of legal boundaries. Eur J Law Econ 38, 185–209 (2014). https://doi.org/10.1007/s10657-014-9452-1

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