2006): “Should Courts Always Enforce What Contracting Parties Write

Abstract. We find an economic rationale for the common sense answer to the question in our title — courts (that maximize the parties ’ welfare under a veil of ignorance) should not always enforce what the contracting parties write. Courts can improve on the outcome that the parties would achieve without their intervention. We study a buyer-seller model with risk-neutral agents and asymmetric information. The court must decide when to uphold a contract and when to void it. The parties know their private information at the time of contracting, and this drives a wedge between ex-ante and interim-efficient contracts. In particular, if the court enforces all contracts, inefficient pooling obtains in equilibrium. By voiding some contracts the court is able to induce them to separate, and hence improve ex-ante welfare. Our results can also be interpreted as supporting the normative case for mandatory rules in contract law