Revisiting the Efficiency Theory of Non-Contemplated Contingencies in Contract Law

Abstract

In contract law, common mistake or frustration are grounds for relieving the promisor from the obligation to perform. Conventional economic theory justifies relief by appealing to its effect on the promisee’s incentives, namely, her incentives to act efficiently to prevent the unfavorable occurrence or its associated losses. The Article challenges this justification. While relief may indeed generate efficient incentives under certain conditions, these are not the conditions in which it is in fact granted. Consequently, the cases in which the conventional theory recommends that relief be provided and those in which it is actually awarded, are incompatible. Based upon this premise, the Article develops a new theory of the law of common mistake and frustration, bearing descriptive and prescriptive implications. Under the new theory, the purpose of relief is not to incentivize promisees, but rather to determine the legal consequences of non-contemplated events. Viewed in this light, the Article identifies a new set of efficiency rationales for the rule. Under specified conditions, relief allows contracting parties to (1) refrain from welfare-reducing trade in unquantifiable risk; (2) maintain control over the distribution of contractual gains; and (3) overcome disincentives to form efficient contracts. The Article analyzes the conditions under which these virtues are applicable, and finds that they generally correspond to those in which relief is actually awarded.