Mandatory Rules in Contract Law

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German Working Papers in Law and Economics

AUTHOR:
Attila Menyhárd, Károly Mike, and Ákos Szalai

TITLE:
Mandatory Rules in Contract Law

SUGGESTED CITATION:
Attila Menyhárd, Károly Mike, and Ákos Szalai (2007) "Mandatory Rules in Contract Law", German Working Papers in Law and Economics: Vol. 2007: Article 18.
http://www.bepress.com/gwp/default/vol2007/iss2/art18

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ABSTRACT:
Microeconomics and the economic analysis of criminal law have long argued that the prohibition of a certain activity does not eliminate it completely. Both disciplines treat prohibition as an institutional feature that raises the costs of the targeted activity. Our model attempts to incorporate the insight of microeconomics and the economic analysis of criminal law into the standard model of contract law. Contracts differ from criminal acts in one significant respect, however. Unlike the victim of a crime, the potential plaintiff is also interested ex ante in the realisation of the other party’s forbidden activity. This is not necessarily the case ex post, however. Our most important finding relies on the acknowledgement of this possibility: the law can use a number of measures to increase the willingness to litigate of that party who stands to gain if the court voids the illegal term and replaces it with the mandatory rule. One such measure is the enforcement of the compensation for the illegal term as defined ex ante. Another possibility is to reduce that party’s incentive to contract who gains from inserting the illegal term in the contract (i.e. the potential defendant). The law can accomplish this by either increasing the costs of protecting the contract from litigation, or manipulating the probability of voiding the illegal term. The terms that are certain to be voided by a court will very probably be protected with a defence mechanism that ensures that the contract will not be litigated and will therefore be performed. Standards or general clauses, which lay down certain principles to be applied by courts, can be relatively much more efficient than substantive rules, which prohibit specific contractual terms.