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Hastings Law Journal

Abstract

Traditionally, courts have refused to compensate disappointed bargainers for reliance costs incurred prior to the formation of a bargained-for contract. Although these results could be justified under the economic assumptions that prevailed in the late nineteenth and early twentieth centuries, they are wholly inapposite to the structure of modem contracting. Negotiations for complex or long-term transactions often proceed incrementally today, with each party learning more at successive stages before making a final decision whether to commit. Under current law, a promisor may require a promisee to make significant, transaction-specific precontractual investments (sunk costs), profit from the information produced by those investments, and yet avoid all liability should the projected deal fall through.

In this Article, Professor Kostritsky proposes a new approach to this problem. Drawing from a model of bargaining behavior based on transaction cost economics, relational theories of contracting, and other economic insights, she argues that courts should impose a new default rule, enforcing the substance of an implicit bargain under which the promisor bears liability for the promisee's sunk costs. She demonstrates that most parties themselves would prefer such a rule because its total costs are lower than the costs of its alternatives: various private devices and alternate legal rules fail to encourage optimal prebargain reliance investments, and thus provide less efficient results. The proposed default rule, Professor Kostritsky concludes, provides a more sound and determinate justification for prebargain liability than do other approaches, would lead courts to reach better results, and would allow parties in negotiation to structure their relationships at a minimum total cost.

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