ContractsProf Blog

Strategic Default: The Popularization of a Debate Among Contract Scholars

I apologize for my general absence from the blog.  I’ve posted my excuse to SSRN; it is titled Strategic Default: The Popularization of a Debate Among Contract Scholars.  Here’s the abstract:

A June 2010 report estimates that roughly 20% of mortgage defaults in the first half of 2009 were “strategic.” “Strategic default” describes the situation where a home borrower has the financial ability to continue to pay her mortgage but chooses not to pay and walks away. The ubiquity of strategic default has lead to innumerable newspaper articles, blog posts, website comments and editorial musings on the morality of homeowners who can afford to pay but choose, instead, to walk away. This Article centers on the current public discourse concerning strategic default, which mirrors a continuing debate among scholars regarding whether the willful breach of a contract has a moral element.

For those scholars that maintain that it is possible to describe and prescribe contract law with a general, unifying theory, the debate is primarily one between promise-based theories and economic theory. This debate between promissory and economic theory reflects a perpetual volley concerning whether contract law should reflect the primacy of morality or efficiency.

The argument of those that support strategic default reads like a case for efficient breach. Many of these commentators argue that the mortgage contract simply presents home borrowers with a choice: pay or surrender the property in foreclosure. If a homeowner is deep underwater, she is better off defaulting and the lender is no worse off relative to the bargain (after all, the lender agreed to foreclosure as a remedy). However, those who argue in favor of strategic default are counteracting a prevailing social norm that it is fundamentally immoral to willfully breach a contract. Many of the blog comments and even newspaper editorials have reflected a general sense that the homeowners who strategically default are acting shamefully.

The public discussion further mirrors the academic debate about whether encouraging efficient breach enables the greatest public good or, instead, undermines the very convention of contracting. On the one hand, strategic default serves as an example of how encouragement of breach of contract may lead to a breakdown of confidence in the marketplace and, in turn, could inhibit market activity. On the other, it is difficult to muster sympathy for lenders, whose imprudent loans are a large piece of the systemic problems that precipitated the housing crisis.

In the end, to the extent that questions of morality are nuanced and contextual, the example of strategic default elucidates the futility of either morality or efficiency as a unifying descriptive or normative theory of contract law. Indeed, it suggests that instead of focusing on individual contracts between borrowers and lenders, a more fruitful public discourse should be reframed to focus on appropriate systemic reforms to prevent the practices that played a part in devastating outcomes for the housing industry, families and communities. Because the concerns about strategic default – neighborhood depreciation and market collapse – are systemic, the solutions should be driven by those concerns, rather than shaming individual borrowers who decide to walk away.

The article is forthcoming in the Cornell Real Estate Journal.  There is still time for your feedback, which I welcome.

[Meredith R. Miller]

 

Lipshaw on Concept, Metaphor and the Synergy of Teaching and Scholarship

Jeffrey Lipshaw has a characteristically thoughtful post over at the Faculty Lounge about how his scholarship is informing his teaching of contracts and a "nascent article" on that topic.  He's even illustrated his thoughts in diagrams.

As always, interesting stuff - go check it out.

[Meredith R. Miller]

People's Court: Contract Dispute at the Flaming Hearth

One of my former contracts students brought this People's Court dispute to my attention because of its eerie (and coincidental) similarity to the fact pattern on my Spring 2010 exam.  Though, I had the added issue of a supervening referendum that (re)banned same-sex marriage.  

Short of it: Plaintiff put down a $1000 deposit on a wedding reception venue called the Flaming Hearth.  She was only required to put down a $500 deposit.  She decided the dance floor wasn't big enough ("cause it's all about dancing to me") and reneged on the contract, asking for the extra $500 back.  The owner of the Flaming Hearth refused to return any portion of the deposit, stating that the dance floor was big enough and the plaintiff was in breach of contract.

Here's the dispute:

Here's the "Judge's" "ruling":

Do you agree with the result?  

[Meredith R. Miller h/t Cynthia Motschmann]