Pre-Contractual Reliance

Abstract:     
During contractual negotiation, parties often make (reliance) expenditures that would increase the surplus should a contract be made. This paper analyzes decisions to invest in pre-contractual reliance under alternative legal regimes. Investments in reliance will be socially suboptimal in the absence of any pre-contractual liability - and will be socially excessive under strict liability for all reliance expenditures. Given the results for these polar cases, we focus on exploring how "intermediate" liability rules could be best designed to induce efficient reliance decisions. One of our results indicates that the case for liability is shown to be stronger when a party retracts from terms that it has proposed or from preliminary understandings reached by the parties. Our results have implications, which we discuss, for various contract doctrines and debates. Finally, we show that pre-contractual liability does not necessarily have an overall adverse effect on parties' decisions to enter into contractual negotiations.

Keywords: Contracts, bargaining, negotiations, reliance

JEL Classifications: C78, D23, K12

Accepted Paper Series