Jacobia and Weissa, ‘Allocation of fault in contract law’

In this paper we consider situations in which the parties are in disagreement about the allocation of a certain risk, and either party could have acted ex-ante to prevent breach, to lower its probability or to insure against it (“least-cost avoidance” in tort law), but neither did so. When the state-of-the-world is revealed there remain steps the parties can take to prevent breach or mitigate damages. We consider strict liability and other regimes such as negligence and comparative fault, and show that the first-best solution is not achieved in those regimes because they incentivize the parties to consult the court in order to determine the identity of the obligor, and this is done only after the contract has collapsed.

We design a mechanism that yields the first-best solution without the need for court intervention, thereby allowing the parties to move forward and fulfill efficient contracts. In this mechanism, the court announces that any party that invests half the optimal level of precautionary costs as determined jointly by the parties is off-the-hook, and that if each party invests this amount the total costs and damages will be split. We demonstrate that this achieves optimality by leading the parties to jointly determine the optimal level of precautionary costs and to allocate the desired steps to the low-cost bearer. In addition, the mechanism leads to revelation of private information. Finally, we discuss the possibility of making the rule mandatory. By predetermining the equal split, the suggested mechanism brings renegotiation costs to a minimum because the parties only have to allocate the physical tasks between them.

Osnat Jacobia, Avi Weissa, Allocation of fault in contract law. International Review of Law and Economics, Volume 36, October 2013, Pages 1–11.

First posted 2014-02-27 07:03:59

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