Threatening an Irrational Breach of Contract

Abstract

When circumstances surrounding the contract change, a party might consider breach a more attractive option than performance. Threatening breach, this party may induce the other party to modify the original agreement. The contract law doctrine of modification determines whether and when these modifications are enforceable. To promote social welfare as well as the interests of the threatened party, the law should enforce modifications if and only if the modification demand is backed by a credible threat to breach. This paper argues that credibility is not a function of pecuniary interests alone. A decision to breach can be motivated also by sentiments towards the fairness of the division of the surplus between the parties. A party whose share in the surplus is reduced in an unexpected fashion might have a credible threat to breach, even if his absolute payoff from performance is still positive and greater than his payoff from breach. The paper explores the patterns by which such fairness concerns arise. Recognizing the prevalence of these concerns suggests that modifications should be enforced in a larger set of circumstances than previously perceived. Lastly, the paper offers a fresh perspective on some of the landmark cases in the law of modification and duress.