Terms such as “unfair” are foreign to the economic model of voluntary exchange which implies anticipated gains to all transactors. However, much recent statutory, regulatory and antitrust activity has run counter to this economic paradigm of the efficiency properties of “freedom of contract.” The growth of “dealer day in court” legislation, FTC franchise regulations, favorable judicial consideration of “unequal bargaining power,” and unconscionability arguments, are some examples of the recent legal propensity to “protect” transactors. This is done by declaring unenforceable or illegal particular contractual provisions that, although voluntarily agreed upon in the face of significant competition, appear to be one-sided or unfair. Presentation of the standard abstract economic analysis of the mutual gains from voluntary exchange is unlikely to be an effective counterweight to this recent legal movement without an explicit attempt to provide a positive rationale for the presence of the particular unfair contractual term. This paper considers some transaction costs that might explain the voluntary adoption of contractual provisions such as termination at will and long-term exclusive dealing clauses that have been under legal attack.

The “holdup” problem

Given the presence of incomplete contractual arrangements, wealth maximizing transactors have the ability and often the incentive to renege on the transaction by holding up the other party, in the sense of taking advantage of unspecified or unenforceable elements of the contractual relationship. Such behavior is, by definition, unanticipated and not a long-run equilibrium phenomenon. Oliver Williamson [1975] has identified and discussed this phenomenon of “opportunistic behavior,” and my recent paper with Robert Crawford and Armen Alchian [1978] attempted to make operational some of the conditions under which this holdup potential is likely to be large.