THE PROBLEM

Legal rules facilitate as well as constrain human freedom. H.L.A. Hart captures the difference between these two functions of law by distinguishing between primary and secondary rules. Primary rules impose obligations and thereby constrain behavior. Secondary rules empower individuals to create relations that confer rights and impose duties. Thus, the criminal law constrains individual liberty; the law of contracts enhances it.

Within this framework, the foundation of contracting is mutual agreement. Contractual duties are self-imposed. They are consequences of individuals authoritatively exercising their autonomy under private enabling rules. Coercive civil authority is justifiably employed to enforce contractual obligations because the parties have agreed so to constrain themselves. Of course, even if the parties to a contract agree to bind themselves to one another, it does not follow that they have agreed thereby to have their obligations to one another enforced by the state (or by any other third party).

The default rule

On the assumption that contracting parties are narrowly rational and fully informed, a contract between them that foresees and responds to all possible contingencies would be efficient, or Pareto optimal. That is the definition of a fully specified contract. Because a fully specified contract is efficient, it puts the parties to it in a position where neither can improve his or her lot except at the other's expense.