Pre-Contractual Reliance

Abstract:     
During contractual negotiations, but before entering a contract, parties might make (reliance) expenditures that would increase the surplus should a contract be made but would be fully or partially wasted otherwise. This paper develops a model for analyzing parties' decisions to invest in pre-contractual reliance under alternative legal regimes. Whereas parties' investments in reliance will be socially suboptimal in the absence of any pre-contractual liability, they will be socially excessive under a regime of strict liability for all reliance expenditures. Given the results for the two polar cases, the analysis explores how "intermediate" liability rules could be designed to induce optimal reliance decisions, considers what information courts would need to implement such rules, and discusses implications for the doctrines governing pre-contractual liability. The case for liability is shown to be stronger when a party retracts from a preliminary understanding or from terms that it has proposed. Finally, the analysis shows that pre-contractual liability does not necessarily have an adverse overall effect on parties' decisions to enter into contractual negotiations.

Keywords: Contracts, Negotiations, Reliance

JEL Classifications: K12

Working Paper Series