Contract Modification: An Economic Analysis of the Hold-up Game

The very foundation of our contract law is based upon the premise of the bilateral voluntary exchange. In a market economy, such exchanges involve a process in which the parties bargain voluntarily, each striving to maximize his own economic advantage on terms that are acceptable to the other party.' The presumption is that this process yields a "Pareto improvement" in which at least one party is better off and neither party is worse off than would have been the case without the exchange.2 The same logic suggests that if the parties to a contract should subsequently wish to modify it due to some change in economic circumstances, unforeseen circumstances, or simply a change of mind,3 then modifications freely entered into by both parties should yield further Pareto improvement and should be enforceable.4 However, a problem arises when one party to a contract agrees to a proposed modification either because of expected dire consequences should that party not agree to the modification or because the available remedies for breach by the other party are inadequate to deter breach by the other party.5 This point is emphasized by White and Summers, who note that not all