The Ethics Of Liberty - The Theory Of Contracts

 

The Ethics Of Liberty by Murray Rothbard

The fundamental principle for this subject is that only theft or inherent theft should be punished by contract law.  If no one violates the property rights of another, i.e. no theft, then no court should prosecute a dispute between individuals.  For there to be theft there must be a prior transfer of a title to property.  That property can be money, capital goods, consumer goods, or even labor.  A promise to transfer title or property in the future does not constitute a title transfer.  The distinction sounds small but it makes a huge difference in how we should think about the situation.  Rothbard calls his approach the title-transfer model.  

The example of a simple loan illustrates the basics of the title-transfer model.  In such a case, Party A lends $100 to Party B with an agreement that Party B will pay Party A $105 in a month.  Both Parties sign a contract committing to these actions.  Or they could simply "shake on it".  After agreeing, Party A hands over the $100. Notice two things.  First, the $100 has been transferred.  Second, the transfer was not "absolute" or one-sided.  It was "conditional" or two-sided.  Party B has a responsibility to fulfill the condition.  If he doesn't give Party A $105 the next month, then he has committed a form of theft.  Party A will have the right to use the law to force Party B to fulfill his obligations.

You could also sign an unconditional or absolute contract, where Party A states he will give Party B $100 on a certain date.  But this is where the subject could get confusing.  Rothbard argues that promises shouldn't be logically enforced, only agreements within a transfer-title model should.  The problem is how to tell the difference between the two.  The distinction isn't that one is spoken and one is written.  A simple promise written out would be unenforceable whereas a verbal contract would be enforceable.  Rothbard claims that using specific language determines the nature of the situation.

                "If A says to B, "I hereby give you $10,000," then title to the money has been

                transferred, and the gift is enforceable... On the other hand, if A says, "I promise

                to give you $10,000 in one year," then this is a mere promise...and therefore is 

                not properly enforceable."

                "if, on the contrary, A tells B: "I hereby agree to transfer $10,000 to you in one

                year's time," then this is a declared transfer of title at the future date, and should

                be enforceable."

Two factors determine if a title transfer has occurred.  The first is the verb tense.  A statement regarding the present or past indicates that the title to the property has already been transferred.  However, a future tense verb indicates the intention of the person, but it does not accomplish a transfer of title.  Agreements are only legally binding after the transfer has indeed occurred.

The second factor is the distinction between a promise and a contract.  A promise is inherently about the future and by definition is not enforceable.  Breaking a promise is a moral issue but not a legal one.  On the other hand, a contract is enforceable, because they are governed by law and there is specific language and formality required to create one.  On a side note, a promise can exist within a contract and thus be enforced, but a promise can not contain a contract.

In the examples above one of the keys to know you are dealing with a contract and not a promise is including the word "hereby", which means the actions described are executed at the moment of the statement.  It strengthens the statement past a mere whim and declares an action in the present.  Taking that into account another example of an enforceable contract would be "I hereby promise to give, transfer, or gift..." even though the word promised is used, which can be confusing.

To reduce the chance for confusion, the best case would be to develop very specific wording to determine what is enforceable versus unenforceable.  Maybe it is as simple as adding "hereby" as a magic word.  Or maybe a specific formula must be used.  It would be even better if the parties had to carry out some sort of ritual, anything to make it clear that a contract, not a promise, had been made.  In the ancient world covenants were "cut" by going through a ritual.  Covenants are described as cut because the ritual involved sacrificing an animal.  The idea the sacrifice communicated was, "may it be done to me as it was to this animal if I don't fulfill my obligations to you."

Let's also consider examples of promises which obviously do not involve title transfer and therefore are not theft.  The clearest example is marriage betrothal.  A man and a woman solemnly and excitedly promise to get married and set a date.  The man gives his fiancé an engagement ring.  The bride-to-be and her family pay for invitations, floral arrangements, and other preparations.  They rent space and hire a preacher to do the ceremony.  Then the man breaks off the wedding.

According to Rothbard, the bride's family should have no legal right to sue her ex-fiancé to recoup the money they spent preparing for the wedding.  Following the same logic the man should not be able to ask for the engagement ring back.  It is morally upstanding to work out an agreement about who should shoulder what cost, but neither party should be forced by a court of law to make amends.  This is the common risk of interacting with other people.

I take the analysis a step further to properly apply property rights theory.  No money or other property was transferred between the man or the woman, except the engagement ring.  If the woman breaks off the engagement, the man should be able to receive back the ring since he did transfer title of the ring to the woman on the condition that they get married.  A court could force the return of the ring.  If the man breaks off the engagement, then it would be fair for the woman to keep the ring to cover any expenses she paid for the wedding.  She still fulfilled the conditions of the ring transfer.  The ring could be considered up front money or a kind of common-money bond covering for expenses in the chance he backs out.  There will be more to come about those two potential forms of contract protection.

Many such situations occur in real life where money is spent to prepare for an event or celebrity appearance, and then the celebrity or other important participant backs out ruining the event.  But if no money was transferred between the parties leading up to the breakup, or no agreement was signed with penalties involved, then there should be no basis for one party suing the other.  However, there are good ways to protect one party if the other doesn't fulfill their obligations.

The first protection is up-front money.  An example scenario is when a club owner pays a performer before a concert date.  That way if he no-shows, he can be forced to return the money.  That gives the performer incentive to follow through with the appearance.  If he has already spent it that gives even more incentive, because it will be more difficult to pay back.  The down side is that up-front money has limited application.

The second protection is similar.  It is broadly called a penal bond.  In specific situations the same concept is called a performance bond or common-money bond. They were the predominant protection against contract breeches during the Middle Ages, but their use faded out during the Enlightenment as courts sought to soften the blow to contract violators.

                "These performance bonds evolved on the market as voluntary penalty

                or penal bonds, in which the contractor obligated himself to pay what

                was usually twice the sum he owed in case of failure to pay his debt or

                fulfill his contract at the agreed-upon date."

The system was flexible as it applied to many kinds of agreements.  It also didn't give much work to courts since the penalties were spelled out before the agreement was formalized.  During the 17th century, courts became much more involved, ruling if the debtor owed the full penalty or not based on the level of hardship the debtor experienced.  By the end of that century contract violators usually paid back the amount lent plus "reasonable damages".  Courts were no longer concerned with protecting property rights but with deciding on proper compensation.

In cases where the penal bond was agreed to beforehand, court decisions like this interfered with the natural rights of those who entered into the agreement.  They violated the contracts that citizens voluntarily agreed upon.  Even if it helped poor debtors it was still a step in the wrong direction because it replaced the sovereignty of individuals with the sovereignty of the state.  However, even without penal-bonds, as long as both parties agreed up front to go to court for resolution and as long as those penalties replaced the money due to the creditor there was no violation of property rights.  The sovereignty of individuals was still reduced though.

Bankruptcy law is a great example of the problems caused by the move away from penal-bonds.  When a bankruptcy happens the debtor is allowed to payback an amount less than what he received.  That is implicit theft against the creditor.  Rothbard quotes historian F. Regis Noel to explain his point.

                "If the laws of bankruptcies were based on the legal rights of

                individuals, there would be no warrant for the discharge of debtors

                from the payment of their debts as long as they lived, or their

                estates would continue to exist... The creditor has right which must

                not be violated even if adversity be the cause of the bankrupt's

                condition.  His claims are part of his property."

I agree with this statement.  I will also add context to further explain why our bankruptcy system is wrong.  It is wrong because the law is forced upon property owners.  For any contract they sign, they are forced to go to a bankruptcy court and abide by its decision, even if it means receiving less money at the end than they loaned in the beginning.  Still, creditors always have the right to forgive debts, partially or completely.  That means there would be no rights violation if the contracting parties agreed up front to go to a bankruptcy court in the case of a dispute.  That also means there has to be different options the parties can choose between.  The state wouldn't force them by law to go to bankruptcy courts.  Individuals would choose what dispute resolution method they want to use: a penal bond, bankruptcy or another type of court, or they could participate in a contract insurance system.

Insurance is the third kind of agreement protection.  A contract insurance system would work much like car insurance.  You require anyone you do business with to have an insurance policy.  Both sides pay in.  Then when no-shows, mishaps, and other violations occur, the insurance company pays the victim on behalf of the guilty party.  For a just insurance system full restitution would have to be made unless a different amount was agreed upon.  The drawback is using insurance increases the cost of doing business.  In a way it penalizes both parties even when no violation occurs, but it removes the state and protects the sovereignty of the individuals, while the market constrains insurance companies to keep premiums as low as possible.  The system also gives incentive to individuals to fulfill their agreements so that the insurance companies don't raise their premiums.

No system is perfect.  The real world involves physical constraints and that includes the ability to put theory into practice.  Still, the only way to enforce contracts in a way that protects property rights is to use Rothbard's title-transfer model.