Freedom of contract is the process in which individuals and groups form contracts without government restrictions. This is opposed to government regulations such as minimum-wage laws, competition laws,

economic sanctions Economic sanctions are commercial and financial penalties applied by one or more countries against a targeted self-governing state, group, or individual. Economic sanctions are not necessarily imposed because of economic circumstances—they ma ...

, restrictions on

price fixing Price fixing is an anticompetitive agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given ...

, or restrictions on contracting with

undocumented workers Illegal immigration is the migration of people into a country in violation of the immigration laws of that country or the continued residence without the legal right to live in that country. Illegal immigration tends to be financially upwar ...

. The freedom to contract is the underpinning of ''

laissez-faire ''Laissez-faire'' ( ; from french: laissez faire , ) is an economic system in which transactions between private groups of people are free from any form of economic interventionism (such as subsidies) deriving from special interest groups. ...

'' economics and is a cornerstone of

free-market In economics, a free market is an economic system in which the prices of goods and services are determined by supply and demand expressed by sellers and buyers. Such markets, as modeled, operate without the intervention of government or any ot ...

libertarianism Libertarianism (from french: libertaire, "libertarian"; from la, libertas, "freedom") is a political philosophy that upholds liberty as a core value. Libertarians seek to maximize autonomy and political freedom, and minimize the state's en ...

. The proponents of the concept believe that through "freedom of contract", individuals possess a general freedom to choose with whom to contract, whether to contract or not, and on which terms to contract.

History

Henry James Sumner Maine Sir Henry James Sumner Maine, (15 August 1822 – 3 February 1888), was a British Whig comparative jurist and historian. He is famous for the thesis outlined in his book ''Ancient Law'' that law and society developed "from status to contract." ...

proposed that social structures evolve from roles derived from

social status Social status is the level of social value a person is considered to possess. More specifically, it refers to the relative level of respect, honour, assumed competence, and deference accorded to people, groups, and organizations in a society. Stat ...

to those based on contractual freedom. A status system establishes obligations and relationships by birth, but a contract presumes that the individuals are free and equal. Modern libertarianism, such as that advanced by

Robert Nozick Robert Nozick (; November 16, 1938 – January 23, 2002) was an American philosopher. He held the Joseph Pellegrino University Professorship at Harvard University,

, sees freedom of contract as the expression of the independent decisions of separate individuals pursuing their own interests under a "

minimal state A night-watchman state, or minarchy, whose proponents are known as minarchists, is a model of a state that is limited and minimal, whose functions depend on libertarian theory. Right-libertarians support it only as an enforcer of the non-aggr ...

United States

''Lochner v. New York''

In 1902, a New York baker named Joseph Lochner was fined for violating a state law limiting the number of hours his employees could work. He sued the state on the grounds that he was denied his right to "due process." Lochner claimed that he had the right to freely contract with his employees and that the state had unfairly interfered with this. In 1905, the

Supreme Court A supreme court is the highest court within the hierarchy of courts in most legal jurisdictions. Other descriptions for such courts include court of last resort, apex court, and high (or final) court of appeal. Broadly speaking, the decisions of ...

used the

due process clause In United States constitutional law, a Due Process Clause is found in both the Fifth and Fourteenth Amendments to the United States Constitution, which prohibits arbitrary deprivation of "life, liberty, or property" by the government except as ...

to declare unconstitutional the New York state statute imposing a limit on hours of work. Rufus Wheeler Peckham wrote for the majority: "Under that provision no state shall deprive any person of life, liberty, or property without due process of law. The right to purchase or to sell labor is part of the liberty protected by this amendment." Writing in dissent,

Oliver Wendell Holmes Jr. Oliver Wendell Holmes Jr. (March 8, 1841 – March 6, 1935) was an American jurist and legal scholar who served as an associate justice of the Supreme Court of the United States from 1902 to 1932.Holmes was Acting Chief Justice of the Un ...

accused the majority of basing its decision on

ideology. He believed that it was making law based on economics rather than interpreting the constitution. He believed that "Liberty of Contract" did not exist and that it was not intended in the Constitution.

Afterward

In his "Liberty of Contract" (1909),

Roscoe Pound Nathan Roscoe Pound (October 27, 1870 – June 30, 1964) was an American legal scholar and educator. He served as Dean of the University of Nebraska College of Law from 1903 to 1911 and Dean of Harvard Law School from 1916 to 1936. He was a membe ...

critiqued freedom-of-contract laws by laying out case after case in which labor rights were struck down by state and federal Supreme Courts. Pound argued the courts' rulings were "simply wrong" from the standpoint of common law and "even from that of a sane individualism" (482). Pound further compared the situation of labor legislation in his time to common opinion of

usury Usury () is the practice of making unethical or immoral monetary loans that unfairly enrich the lender. The term may be used in a moral sense—condemning taking advantage of others' misfortunes—or in a legal sense, where an interest rate is ch ...

and that the two were "of the same type" (484). Pound lamented that the legacy of such "academic" and "artificial" judicial rulings for liberty of contract engendered a "lost respect for the courts" but predicted a "bright" future for labor legislation (486-487). The Supreme Court applied the liberty of contract doctrine sporadically over the next three decades but generally upheld reformist legislation as being within the states' police power. In 1937 the Court reversed its view in the case ''

West Coast Hotel Co. v. Parrish ''West Coast Hotel Co. v. Parrish'', 300 U.S. 379 (1937), was a decision by the United States Supreme Court upholding the constitutionality of state minimum wage legislation. The court's decision overturned an earlier holding in ''Adkins v. Child ...

''. In that case the court upheld a

Washington state Washington (), officially the State of Washington, is a state in the Pacific Northwest region of the Western United States. Named for George Washington—the first U.S. president—the state was formed from the western part of the Washington ...

law setting a

minimum wage A minimum wage is the lowest remuneration that employers can legally pay their employees—the price floor below which employees may not sell their labor. Most countries had introduced minimum wage legislation by the end of the 20th century. Bec ...

United Kingdom

In the late 19th century, the English judiciary espoused "freedom of contract" as a generally applicable feature of public policy, best expressed in ''

Printing and Numerical Registering Co v Sampson ''Printing and Numerical Registering Co v Sampson'' (1875) 19 Eq 462 is an English contract law and patent case. It is most notable for strong advocacy of the principle of freedom of contract put forward by Sir George Jessel MR. The strict princi ...

'' by Sir George Jessel MR. In the later 20th century, the view of the common law had changed completely. In ''

George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd ''George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd'' 982EWCA Civ 5and [19832 AC 803 is a case concerning the sale of goods and exclusion clauses. It was decided under the Unfair Contract Terms Act 1977 and the Sale of Goods Act 1979. ...

'', Lord Denning MR compared "freedom of contract" with oppression of the weak, as he outlined the development the law had undergone.

Law and economics

In economics, the freedom of contract has been studied in the field of

contract theory From a legal point of view, a contract is an institutional arrangement for the way in which resources flow, which defines the various relationships between the parties to a transaction or limits the rights and obligations of the parties. From an ...

. According to the

Coase Theorem In law and economics, the Coase theorem () describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are sufficiently low tra ...

, the freedom of contract is beneficial in the absence of transaction costs. When two rational parties voluntarily enter into a contract, they must be (at least weakly) better off than in the absence of the contract. The parties will agree on a contract that maximizes the total surplus that they can generate. Hence, restrictions on the class of enforceable contracts can only reduce the total surplus. Yet, prohibiting certain contracts can be beneficial when there are transaction costs. For example, Spier and Whinston (1995) have shown that not enforcing a contract between two parties can be desirable when the contract has negative external effects on a third party (which does not participate in the contract due to transaction costs). It has also been argued that the presence of asymmetric information can make restrictions on the freedom of contract desirable, since such restrictions can prevent inefficient distortions due to

signalling In signal processing, a signal is a function that conveys information about a phenomenon. Any quantity that can vary over space or time can be used as a signal to share messages between observers. The ''IEEE Transactions on Signal Processing'' ...

and

screening Screening may refer to: * Screening cultures, a type a medical test that is done to find an infection * Screening (economics), a strategy of combating adverse selection (includes sorting resumes to select employees) * Screening (environmental), a ...

.^, Similarly, when there are transaction costs due to

moral hazard In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk ...

problems, restrictions on the freedom of contract can be welfare-enhancing. Furthermore, it can be desirable not to enforce certain contracts when agents are susceptible to

cognitive bias A cognitive bias is a systematic pattern of deviation from norm or rationality in judgment. Individuals create their own "subjective reality" from their perception of the input. An individual's construction of reality, not the objective input, m ...

es. Finally, an important problem is whether contractual parties should have the freedom to restrict their own freedom to modify their contract in the future. Schmitz (2005) and Davis (2006) argue that it can be beneficial not to enforce non-renegotiation clauses in contracts.^,

References

* Atiyah, P.S: "The Rise and Fall of Freedom of Contract" (Oxford University Press, USA; New ed; Dec 12, 1985) * Bernstein, David E.
''Freedom of Contract, George Mason Law & Economics Research Paper No. 08-51 (2008)''
* Trebilcock, Michael J.: "The Limits of Freedom of Contract" (Harvard University Press)

Notes

External links

by Dr. Edward Younkins {{DEFAULTSORT:Freedom Of Contract Classical liberalism Contract law Libertarian theory Philosophy of law Social philosophy