A Revised Economic Theory of Disclosure Duties and Break-Up Fees in Contract Law

39 Pages Posted: 6 Oct 2006

See all articles by Ofer Grosskopf

Ofer Grosskopf

Tel-Aviv University Faculty of Law

Barak Medina

Hebrew University of Jerusalem - Faculty of Law

Date Written: September 1, 2006

Abstract

Economic analysis of contract law offers an influential argument against imposing a duty to disclose information and in support of guaranteeing reimbursement (break-up fees) for pre-contractual investments in acquiring information. According to the conventional wisdom, a negotiating party invests resources in information gathering on the basis of its expectation to extract the contractual surplus that the investment may generate. As a result, it is arguably essential to protect the investing party's ability to benefit from its investment in gathering information. Such protection can be provided either by allowing non-disclosure of relevant information that was discovered through a deliberate effort, or by strengthening its bargaining position through break-up fees. This article presents a revised theory, which substantially narrows the economic case against disclosure duties and in support of break-up fees.

This paper's basic insight is that a negotiating party invests resources in acquiring information not only — and often not even primarily — to strengthen her bargaining position vis-à-vis her counterpart, but rather to achieve an advantage vis-à-vis her competitors (e.g., other traders who are interested in the same contract). A trader that acquires private information about the transaction's actual value can adjust her offer to reflect this information, and will thus have a greater likelihood of winning valuable contracts. Assuming that parties receive some benefit from contracting according to the price that reflects the transaction's actual value, a negotiating party has a competitive incentive to acquire information even if she knows ex-ante that her price offer will fully reflect her ex-post private information. Accordingly, forcing a negotiating party to disclose private information to her counterpart would not necessarily impede the ex-ante incentive to invest in acquiring such information. The upshot of this argument is that the mind-set of the existing literature, which argues against imposing a duty to disclose deliberately acquired private information and in favor of reimbursement provisions, cannot be substantiated without a careful inquiry into competition-based motivations to gather information.

Keywords: contract law, disclosue duties, termination fees, breakup fees, precontractual liability, reliance

JEL Classification: D82, D83, G14, K12, K22

Suggested Citation

Grosskopf, Ofer and Medina, Barak, A Revised Economic Theory of Disclosure Duties and Break-Up Fees in Contract Law (September 1, 2006). Available at SSRN: https://ssrn.com/abstract=935165 or http://dx.doi.org/10.2139/ssrn.935165

Ofer Grosskopf (Contact Author)

Tel-Aviv University Faculty of Law ( email )

Ramat Aviv
Tel Aviv, 69978
Israel

Barak Medina

Hebrew University of Jerusalem - Faculty of Law ( email )

Mount Scopus
Mount Scopus, IL 91905
Israel

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