Contract Formation and Interpretation

Abstract

Much research in law and economics, following Coase's insight that the effects of a legal rule depend on the ability of those whom it governs to bargain around it, has undertaken to explain how substantive entitlements such as property rights influence the bargaining process. Perhaps more important than any substantive rights or duties in this regard, however, is the extensive body of contract doctrine that governs the procedural mechanics of exchange. The formal rules of contract formation, by attaching consequences to the various acts and omissions that bargainers can choose from in a negotiation, affect the parties' incentives to make and to respond to offers, to delay, to bluff, and to communicate in the first place. Similarly, the law of contract interpretation - ranging from default rules to irrebuttable presumptions - determines the costs of bargaining into and around particular contract terms. Both sets of rules thus influence which contracts get formed and the terms on which they get formed. For these reasons, contract formation and interpretation can fairly be said to be logically prior to every other issue in law and economics. This essay surveys the economic effects of the doctrinal rules of contract formation and interpretation, focusing specially on the incentives such rules provide for strategic behavior in negotiation. Each of its individual sections discusses a particular aspect of such incentives.