Installment Contracts and Material Breach

Supreme Court Economic Review, Volume 26, pp. 1-46, 2018

43 Pages Posted: 2 Oct 2009 Last revised: 21 Oct 2019

See all articles by Bernhard Ganglmair

Bernhard Ganglmair

ZEW – Leibniz Centre for European Economic Research - Junior Research Group Competition and Innovation; University of Mannheim - Department of Economics; Mannheim Centre for Competition and Innovation (MaCCI)

Date Written: 2018

Abstract

Default rules in contract law grant a buyer the right to terminate an installment contract (i.e., a contract over the recurrent delivery in multiple periods) and cancel future deliveries if, and only if, past deliveries by the seller are sufficiently defective (putting the seller in "material breach"). This form of endogenous reversibility of the contract introduces memory and renders the installment contract non-divisible. Using an incomplete contracts framework with buyer's relationship-specific investment, I show that absent other contractual solutions an installment contract with endogenous reversibility can solve the buyer's holdup problem and implement the first-best outcome. Multiple independent contracts over one delivery each, installment contracts without the right to terminate, or installment contracts with exogenous reversibility cannot solve the buyer's holdup problem. I further show that the optimal termination right is not too buyer-friendly when the buyer has low bargaining power in ex post renegotiations. This result serves as an economic rationale for the restriction of termination rights to cases of material breach of contract.

Keywords: contingent control rights; default rules; expectation damages; holdup; installment contracts; material breach; non-divisible contracts; endogenous reversibility

JEL Classification: D23, D86, K12, L42

Suggested Citation

Ganglmair, Bernhard, Installment Contracts and Material Breach (2018). Supreme Court Economic Review, Volume 26, pp. 1-46, 2018, Available at SSRN: https://ssrn.com/abstract=983040 or http://dx.doi.org/10.2139/ssrn.983040

Bernhard Ganglmair (Contact Author)

ZEW – Leibniz Centre for European Economic Research - Junior Research Group Competition and Innovation ( email )

L7,1
Mannheim, 68161
Germany

University of Mannheim - Department of Economics ( email )

D-68131 Mannheim
Germany

Mannheim Centre for Competition and Innovation (MaCCI) ( email )

L 7, 1
Mannheim, 68131
Germany

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