The John M. Olin Center

Paper Abstract

Untitled Document

23. Yuval Procaccia, Contractual Accidents, 9/2008.

Abstract: I consider a unified framework for the problem of “contractual accidents," situations in which parties contract on the basis of a common misperception of reality. Several contract law doctrines pertain to such situations, including those of mutual mistake, frustration of purpose, impossibility, commercial impracticability and misunderstandings.
Existing economic analysis has so far been largely unsuccessful in providing a theoretical justification for these legal doctrines. I argue that this emanates not from the doctrine's incompatibility with principles of economic welfare, but rather from the inadequacy of the model used for their analysis. In particular, the standard model is premised on the assumption that the parties contemplate all potential eventualities from the outset. By maintaining that fundamental premise, the model assumes away the very problem it seeks to explain – that of a possibly incomplete perception of reality, which limits the parties’ ability to map their genuine wishes onto a set of binding contractual terms.   
I therefore consider an alternative framework that relaxes the assumption of perfect contemplation of the realized state. The parties in this modified model contemplate a set of potential states, but they know that the set is possibly incomplete. In turn, each contemplated state is assigned only a conditional probability, whereby the condition refers to the working assumption that the set is complete. Without further departing from standard assumptions, I show that – contrary to common wisdom – this modified framework explains the merits of the existing laws of contractual accidents.