The Dog That Didn't Bark: Private Investment Funds and Relational Contracts in the Wake of the Great Recession

Abstract

In the aftermath of the subprime mortgage crisis, the contract rights of numerous hedge funds and venture capital funds were breached. These contracts were complex and sophisticated and had been negotiated at great time and expense. Yet despite all of the assumptions of neo-classical contracts theory, nothing happened. Practically none of these injured parties sued to enforce their rights. Professor Illig uses this dearth of litigation to conduct a form of natural experiment as to the value of contract law. Discrete market participants contracted before the crash and then pursued their rights in court afterwards, while relational market participants contracted but refrained from suing. Given this bifurcated response to the identical stimulus, Professor Illig queries: why did the relational parties bother to contract in the first place? If they could have predicted the likelihood of their ex post inertia, then as rational economic actors they must have valued contracting for something other than as insurer of their reasonable expectations. For them, a contract must provide significant symbolic and ceremonial value. Based on this finding—as well as on complementary research from the field of behavioral economics—Professor Illig concludes by arguing against a universalist approach to contract law. Instead, he recommends that contract doctrine be evolved to reflect its dual nature—as insurer of expectations in the context of discrete exchanges and as a source of imagery and ritual in the context of relational affiliations. Doing so would enhance the impact of social norms as a mechanism for avoiding and resolving disputes.