Debremarkos University

School of Law
Postgraduate program
LLM students in Business and Investment Law
Theoretical foundations of Business Law
Course code Laws-

Set by:- Dejen Al. (LL.B, LL.M, Asst. professor)

 The Nature of Law
• No consensus in defining the term “law”;
• Deferent scholars define law differently;
• Defn.1, Aristotle defined “law” as “ a rule of Conduct”;
• Defn.2, Plato defined “law” as “a form of social control”;
• Defn.3, Cicero - “law is agreement of reason and nature and the distinction
between just and unjust”;
• Defn.4, Blackstone >> >> law as “ a rule of civil conduct prescribed by a
supreme power in a state, commanding what is right and prohibiting what is
wrong;
• Defn.5, Holmes - law as “a set of rule that allowed one to perdict how a court
would resolve a particular dispute”
Though business law is defined similar to the definitions given to the term
“law,” business law, in its special nature, regulates the relationship between
individuals with one another as they affect economic order;
Law may be permissive or prohibitive, and is true to business law
 What's law
Natural Law
s

Realism Positivism
Schools of
Jurisprudence

Sociological
Marxist

3
 What do you think is a Law?
There is no agreed, comprehensive and universally accepted definition of the law.
The definitions are as many as legal theories. Different schools of thought also explain the
concept of law from their own respective perspective.
Natural Law School – law is associated with justice. It emanates from the above,
supernatural power (God)
Universal applicability of law (applicable regardless of place and time) – (True law is the
same in all places)
Law is perpetual , unchanged, everlasting and inalienable.

Positivist school of law - Law is a Command of Sovereign backed by Sanction

Marxist school of Law – though social system structures it, Law an instrument in the
hands of the classes in power to use it to protect their own interests. Law is an instrument made
by the /in the hands of/ upper class to exploit the lower class
Legal Realism –

law as made by judge

law is dynamic which can be varied in accordance with the existing time and prevailing

situations/conditions

Sociological school of thought

law as a means to shape the society i.e. has an instrumental role in bringing the

desired change within the society.

Law is distinguished from other normative orders such as custom and convention -

externally guaranteed by the coercion (physical or psychological) to bring about

conformity.
 Business law is a body of law which governs business
(in particular, it regulates: law of person, contracts,
agency, business organizations/partnerships);
A branch of civil law;
Hence, every business oriented person should be
aware of the legal environment that regulates the
business activities he/she is operating.
 COURSE CONTENT
 Them one: Overview of some cross cutting issues
Theoretical foundations of political economy
• some philosophical concepts
• Law in the Risk Society
 Theme two: Concepts and theories of property rights
• Why did property rights emerge?
• How did property rights emerge?
• The Theoretical Foundations of Different Modes of Ownership
• The Theoretical and Conceptual Foundations of Ethiopian Property Laws
 Theme three: Theoretical foundations of contract law
• Subjective and objective theories of contract law
• Economic analysis of contract law
• Theoretical foundations of Ethiopian contract law
Theme four: Nature and theories of the firm
• Neoclassical, Transaction Cost and Agency Theories of the Firm
• Nexus-of-Contracts’ and ‘Property Right’ Theories of the Firm
 Theme one
Overview of some cross- cutting
issues
(An Overview of Economic Theories that influence
laws of property, contracts and business firms )
 Political Economic Thoughts
• What is political economy?
the distribution of power and wealth between different groups and
individuals, and the processes that create, sustain and transform these
relationships over time.
production and trade and their relations with law, custom and government;
and with the distribution of national income and wealth .
It is concerned with how political forces influence the
economy and economic outcomes and the reverse.
 What are the issues?

–A. Actor behavior

– State (government, public sector) vs. society (markets, private sector)
– Levels of analysis: international (structural, systemic) vs. domestic

–B. System governance

Formulation, implementation, and enforcement of rules; promotion of cooperation; management of conflict

–C. Globalization
Inter-national vs. globalized model of world economy
 Categories?
• Countries and non-state actors have historically
pursued several different approaches to the
international political economy:
• Mercantilism (Imperialism/Realism)
• Capitalism (Liberalism)
• Marxism
 Mercantilism (Imperialism/Realism)

Analytical Perspectives
A. Focus: states
B. Nature of economic relations:
conflictual (zero-sum game)
C. Relationship between economics and politics:
politics drives economics
Way to organize a nation’s economy
• Goal: make Mother Country wealthy
 Basic Ideas of Mercantilism
 What Were the Main Beliefs of Mercantilism?

 Mercantilism was the dominant economic system from the 16th century to the
18th century.
 Mercantilism's original foundation was the beliefs that the world
had limited wealth in the form of gold and silver;
 that nations had to build their stores of gold at the expense of
others;
 that colonies were important for supplying labour and trading
partners;
 that armies and navies were crucial to protecting trade practices;
and
 that protectionism was required to guarantee trade surpluses.
 Basic Ideas of Mercantilism
• Establish colonies
• Control/regulate trade
• Export raw materials & resources from
colony to Mother Country
• Export finished products from MC to colony
• Favorable Trade Balance for MC
 Cont,

• Wealth cannot be created, only acquired

• Through conquest and theft (imperialism)
• Through exporting more than you import and protecting
domestic industries
• Economics is a zero-sum game
• One country’s gain is another’s loss
• Emphasis on relative gains
 Mercantilism: Positive Effects
• Guaranteed markets
• Protection from competition
• Especially helpful when colonies young to
limit risk
 Colonists wealthier
 Colonial economies more diverse
• Raised prices for smugglers 
Mercantilism: Negative Effects
• Limited opportunities to trade
• Industrial development restricted
• A bigger problem toward end of colonial
period
 con
• Mercantilist governments manipulate a nation's economy to
create favorable trade balances.
• Imperialism uses a combination of military force and mass
immigration to foist mercantilism on less-developed regions.
• Military campaigns forced inhabitants to follow the dominant
countries' laws.
• One of the most powerful examples of the relationship
between mercantilism and imperialism is Britain's
establishment of the American colonies.
 Mercantilism Today
• Today, mercantilism is deemed out-dated. The disaster of World War II
underscored the potential danger of nationalistic policies. It also prodded
the world toward global trading and relationships as a way to combat
them.
• However, it is hard to escape mercantilism.
• For example,
• barriers to trade were still used to protect locally entrenched industries.
• Due to the effects of globalization, many nations and their people suffer from feeling
that they've lost wealth, control, and prestige. This has made the nationalism (part of
mercantilism) more appealing. It helped bring to power the likes of Donald Trump in
the U.S. and Narendra Modi in India.
• In 2018, President Trump imposed tariffs on Chinese imports, launching a trade
war that exists to this day.
 o l i tical
a lism p
/ C a p it
be ra lism
o mic L i n o m y
Econ eco
 Analytical
Analytical Perspectives
Perspectives on
on Liberalism
Liberalism

• A. Focus: individuals, households, enterprises

• B. Nature of economic relations: harmonious; interests
reconcilable
• C. Relationship between economics and politics: economics
drives politics
 Economic Liberalism (Capitalism)

• Became popular in 1800s

• Economics is a positive-sum game
• It is possible to expand the pie, not just fight over how it will be divided
• Emphasis on absolute gains through competition
 classical political economy

• Adam Smith
• He and his contemporary began their analysis opposing the then
mercantilism.
• He maintains that capitalist economic development as a self-sustaining,
largely self-regulating virtuous circle of capital accumulation.
• The growth of wealth through private initiative creates a wider and deeper
market that allows for
• a more detailed division of labor, which in turn raises labor productivity and creates
more wealth.
• When this virtuous circle functions well it is the source of many
social and political advantages; when it becomes dysfunctional, it can
be the source of intractable conflicts and social harm.
• (According to Adam government shall have no role in the market)
 Cont’d…
• Thomas Malthus
• He puts forward a rhetorically powerful argument that the tendency toward explosive
population growth dooms any schemes for ameliorating the average state of human
society.
• a scientific model of demography.
• a rise in the standard of living resulting from an increase in real wages
• lower mortality rates, especially infant mortality,
• an increase in population and labor supply,
• pushing the real wage back down.
• (A fall in the real wage would be reversed by symmetrical mechanisms, in his view.)
• Since Malthus thought that food production was relatively inflexible, he predicted a
situation in which human population is maintained in equilibrium at a low standard of
living with high mortality and chronic food shortages.
• Question humanitarian intervention for hunger, war etc
• Technology made his theory inapplicable
 Cont’d…
• David Ricardo
• Ricardo is one of the most penetrating thinkers ever to write on economic
topics.
• In Ricardo’s vision, workers and landlords consume their incomes, while
capitalists largely accumulate surplus.
• The expansion of capital through accumulation allows for population growth
• but this increase in population presses against limited land resources and raises
rents at the expense of profits.
• Eventually profits and the profit rate fall to zero, and the economy stagnates in a
stationary state.
• Ricardo’s analysis of diminishing returns to capital and labor inputs to
production
• technological change and international trade could at least postpone the
stationary state
 Cont’d…
• Ricardo, for example, argues that supply, the owner of a productive
resource like labor, land, or capital to offer the resource for productive
employment, creates demand sufficient to take the aggregate product
off the market.
• People have to spend their money one way or another, according to
Ricardo’s reasoning. If they sell their labor- power or capital services,
they will turn around to buy consumption goods.
• If they choose to save rather than to consume, then they will have to
buy capital goods through investment with their incomes. One way or
another, the demand will be there to buy back what has been
produced.
 Say’s Law
• The classical political economists (though not Marx)
share with the neoclassical tradition the assumption of
Say’s Law, which holds that the willingness to sell
commodities, including labor-power, on the market is
simultaneously an expression of the willingness to buy
other commodities,
• so that in the aggregate there can never be an excess
supply of commodities.
• Say’s Law has the important implication that aggregate
demand has no long run influence on economic
outcomes.
 What Is Say's Law of Markets?
• In His Book, Treatise on Political Economy,
Say's Law of Markets is theory from classical economics arguing that the
ability to purchase something depends on the ability to produce and
thereby generate income.
Say reasoned that to have the means to buy, a buyer must first have
produced something to sell. Thus, the source of demand is production, not
money itself.
Say's Law implies that production is the key to economic growth and
prosperity and the government policy should encourage (but not control)
production rather than promoting consumption.
pointed out that the scarcity of some goods and glut of others can persist when the
breakdown in production is perpetuated by on-going government interference.
governments should not interfere with the free market and should adopt
laissez-faire economics.
Marxist Critique of Political Economy (Marx, Engels)
Karl Marx
• Historical materialism is a philosophical explanation of history and
society. It argues that the course of history is most fundamentally
determined not by conscious deliberations and decisions--either
individual or collective--but by material and economic conditions.
• The development of human societies is seen as closely linked with the
social relations governing the appropriation and allocation of the
surplus product.
• He argued that history is a series of conflicts between economic classes.
• While Smith, Malthus and Ricardo assumed that there were universal
laws governing political economy, Marx argued that each stage of
human development produced its own particular laws of motion, and
that the contradictions of each mode of production such as slavery,
feudalism and capitalism, paved the way for the emergence of its
successor.
 Cont.
• Marx saw capitalism as an efficient way of producing wealth,
but also saw
A fatal flaw in how this wealth was distributed:
those who owned the means of production retained most of
the wealth.
Marx argued that this inequality would eventually lead the
working class to revolt.
• Marx directs his critical analysis to a study of the ways in which
human economic and political institutions reproduce
themselves and, when they fail to reproduce, lead to
revolutionary changes in society.
 Cont’d…
• Marx presents most human societies as class societies,
in which a particular class (slave-owners, feudal lords,
capitalists) appropriates the surplus product of the direct
producers (slaves, serfs, workers).
• The exact mode of appropriation of surplus is a key factor
in Marx’s analysis, and leads to very di fferent laws of
motion of society.
• Marx argued that capitalism would not subside into a
stationary state, but would transform itself into another
mode of production, socialism in which control of the social
surplus was democratized.
 Keynesianism
• John Maynard Keynes: the middle approach
• Keynes was a strong critic of central-planning socialism, and aimed rather at
reforming capitalism through a great expansion of the economic role of national
governments and central banks.
• Keynes begins The General Theory with a critique of Say’s Law.
• Based on his theory, Keynes advocated for increased government expenditures and
lower taxes to stimulate demand and pull the global economy out of the depression.
• Keynes challenges the laissez-faire consensus of previous political economy on the
ground that the state has to:
• engineer the appropriate boundary conditions of money supply and deficit policy to
allow for demand levels that approximate the full employment assumed.
• he believes that government’s increased expenditure could help in coming out from
economic depression
• For Keynes the state plays a vital and positive role in securing the conditions for
capital accumulation.
 Con’d…
• The classical economists saw money as a veil.
• They argue that a well-functioning monetary system acted
exactly as if commodities could be exchanged directly for
each other without the intervention of money.
• However, for Keynes money is the link between the present
and unknowable future.
• Because the existence of money separates the decision to
sell in the present from the commitment to buy in the
future, Say’s Law does not hold in Keynes’ view.
 o nce pt s
o phi ca l c
phi l o s
Free will vs. Determinism
(Am I really Free?)
 True or False?
All events are caused.
We are responsible for all our actions.
In some situations people perform actions, but they are not
responsible for what they do.
In each and every situation in my life, I could have acted otherwise
than I in fact acted.
God knows what will happen in the future. He knows especially
what will happen in my life later on; that is, he knows when I will
die and what I will have for dinner tomorrow night, etc.
Nobody (not even God) can know what will happen in the future
because the future has not yet happened.
 What is free will?
 The ability to act freely
 Our actions are free if they are under our control.
 David Hume defines freedom as “a power of acting or of not
acting, according to the determination of the will.”
• the power or capacity to choose among alternatives or to act in certain
situations independently of natural, social, or divine restraints
• The power of directing our own actions without constraint by necessity
or fate/Control over once action.
• Do we have the freedom to do otherwise?
– The argument is that if a person has free will, then they are the ultimate cause of their
actions.
People often say things such as:
– ‘I have free will so I can choose what I do’
– ‘I did it of my own free will’
• Are either of these statements really true? Are we completely free to choose what we do?
 The prominence of free will
o Human autonomy and dignity

o Value of deliberation

o Deserving praise and condemnation

o Moral responsibility
 Determinism
Our future is determined.
There is only one possible future.
• The universe has exactly one physically possible future.
• Something is deterministic if it has only one physically possible outcome.
• Not only for the physical world, but also for the moral world too.
Determinism vs. fate
Fate: certain actions or futures are fated to us, in spite of our own desires or
our efforts to change things
Determinism: every thought and every action has been determined in
advance by something outside of ourselves (e.g. God or the state of the
universe before we were born)
If determinism is true, then all of a person's choices are caused by events and
facts outside their control.
 Kinds of Determinism
Determinism by God
God made us in full knowledge of everything we would be and do.

 Determinism by physical laws

Every thought or decision we make is determined by physical processes in
the brain
The laws of nature work the same way within the brain as out in the world
All of our thoughts and actions are ultimately determined by the laws of the universe.
Every physical event is determined by prior events and physical states. There are no
random or miraculous causes.
If you knew all the physical states of all the matter in the universe at time t (e.g. the big
bang), you could theoretically predict all subsequent events, including every thought and
every action of every person who ever lives.
 Determinism and Free Will
3 common intuitions:

i) Our brains are deterministic systems

ii) Determinism is incompatible with free will
iii) We have free will

One of these must be wrong!

 Are free will and determinism compatible?
 Libertarianism: We do have free will. Therefore, the universe is not deterministic.
(Reject intuition 1: Our brains are deterministic systems.) = incompatibilism

 Hard determinism: The universe is deterministic and there is no free will.

Free will is not compatible with determinism. If the universe is deterministic, free will
is impossible(Reject intuition 3: We have free will.) = incompatibilism
? How can we be morally responsible if we have no free will? Can we be blamed
for an act we do ?
 Soft determinism/Compatibilism: Free will is compatible with determinism.
Free will can exist even if all our actions are ultimately determined by the laws of
physics.
A person is free if they are able to make choices rationally on the basis of their goals,
desires and values
(Reject intuition 2: Determinism is incompatible with free will.)
 Individualism and government intervention

• With regard to role of government:

• those who believe that all ills can be solved by government and
• those who believe market can solve all problems.
• Individualism is a commitment to
• personal initiative,
• self-reliance and
• material accumulation
• superiority of free-market economic system
• It claims that individuals are the core of society rather than any institution or group.
• Consequently, the government is traditionally expected to intervene in social life as little
as possible.
• However, the government's involvement keeps expanding ever since the Great
Depression, and the tendency seems strong. At present, there is hardly any aspect of
social life left without government regulation.
• The expansion of government intervention is an inevitable result of social development
and the inherent weakness of individualism.
 Cont’d…
 Reasons that call for government intervention:
• To avoid monopoly
• To maintain price mechanism
• Gvt should protect prices fixed by the market
• To meet externalities
• Externalities exist when private costs or benefits do not equal social
costs or benefits
• Increase social welfare or benefits
• Education, hospitals, parks, old age benefits
• To meet modern macro economic issues
• Control inflation, greater employment, economic growth, adequate
capital formation
  Deontological and teleological approaches
• Deontological (categorical) and teleological (consequential) approaches are
common in policy makings.
• Deontological( categorical) approach: Certain actions are inherently right. Moral
duty- something we believe that it is right thing to do regardless of its
consequences.
• The name comes from the Greek word deon, meaning duty or obligation.
• Eg. helping some one at risk regardless of the consequences
• Stealing is bad regardless of the consequences while the contrary is good
• Kantian view
• Means should be good
• Focus on protection of individuals and universal rights
• Teleological( consequential) approach: Certain actions are right due to their
consequences.
• The end matters rather than the means
 The ‘tragedy of the commons’ –versus- the ‘conscience dilemma’

• Tragedy of the commons: by Garrett Hardin, ecologist

• The idea behind the “tragedy of the commons” was first advanced in 1833 by
mathematician William Forster Lloyd. His thesis begins with a pasture, held in
common by a band of herdsmen.
• Therefore each herdsman, acting out of self-interest, will be tempted to exploit the
commons by grazing more livestock on the land. But the commons can only support so
many animals. This limit is called the carrying capacity.
• Exceeding the pasture’s carrying capacity leads to
• depleted grass stocks,
• soil erosion,
• malnourished animals — and, quite possibly,
• conflict among herdsmen.
• Unchecked, this process will lead to exhaustion of the commons.
• When this happens, everyone suffers, even those who — out of a sense of responsibility or
conscience — refrain from overusing the commons.
 Cont’d…
• Populations that are not constrained, serving their own
self-interest, inevitably exceed the carrying capacity of
their ecosystem.
• Exceeding this limit may produce severe and possibly
permanent damage to ecosystems and the populations that
depend on them.
• This is the essence of the “tragedy of the commons.”
• If the pasture has an owner, he has a vested interest in
preserving it for the future.
• The tragedy of the commons is a persuasive argument for
private property ownership. In a crowded world, privatisim
may help provide a stable social and economic life
 The Conscience Dilemma

• While private property ownership may mitigate the tragedy of the commons,
conscience will not mitigate problems in laissez faire market.
• However, Professor Hardin summons forth the rather startling conclusion
that under certain circumstances, conscience may eliminate itself from a
population.
• society demands an individual exploiting a commons to restrain himself for
the general good — by means of his conscience. To make such an appeal is
to set up a selective system that works toward the elimination of conscience
from the race…
• A laissez faire market system ruled by conscience alone rewards for a lack
of conscience…
• dissolution of a conscience-ruled system takes place because of envy.
• As the ‘good guys’ see the ‘bad guys’ prosper, their envy is energized and one after
another good guys become bad guys.
 
Law in the Risk Society

• Ulrich Beck- German sociologist

• Risk society is the manner in which modern society organizes in response to risks.
• Risk society is a society which is increasingly preoccupied with the future
• Risk society is a systematic way of dealing with hazards and insecurities induced and
introduced by modernization itself
• Beck defines modernization as change in technological rationalization, working
organization, societal characteristics, lifestyle, structures of power and influence
1. traditional society
• Traditional institutions and structures shaped people’s lives and gave them the symbols
that provided meaning, place and purpose in society.
• People knew themselves as primarily part of a we rather than as individual I’s who
contract with others.
• Some of these primary institutions and structures were:
• Church as shaping center of meaning and purpose in life.
• Extended family in which the I was formed and embedded in an extended network of
relationships.
• Village community in which I had a place in terms of role and identity.
 Cont’d…
• 2. Early modernity
• Beginning in the early 17th century the institutions and structures of these traditional societies
were challenged in the name of individual freedom and autonomy.
• The individual began to emerge as the center of life; the common, traditional comprehension
of life as lived within a we within traditional institutions was replaced by a new locus, the I.
• Early modernity championed the rights and freedoms of the individual; as this new
understanding entered the imagination of modern societies it began to effect and then replace
these traditional structures and institutions with new ones that shaped people in very different
ways.
• Some of these new institutions and structures were:
• Churches became less critical as they shaped the inner, private personal life of individuals
but had less and less to do with the ways individuals formed their meaning systems in the
public world.
• Nuclear family than extended family.
• The we was displaced by the social contracting I who now gave loyalty to professional
organizations, church groups, work places and other social institutions.
• Nation state: in the place of the village came the corporate, bureaucratic state, which,
impersonally, took responsibility for the ordering of people’s lives in a larger industrial
society.
 3. Late or Reflexive modernity: from structure to
agency
• Individualism deepened its hold in western societies
• The emergence of a highly educated information society which
displaced the older manual worker society
• No more long term loyalty to the corporate institutions and
structures of the 20th century
• A radical shift in the locus of meaning in western societies from a
culture where meaning and identity were grounded to the self
• Self as primary agent of meaning of life
• Legitimacy of institutions and structures of the 20th century was
questioned and most loyalty to them removed
• Reflexive modernization is a process of modernization that is characteristic
of risk society whereby progress is achieved through reorganization and
reform.
• The idea that society should examine itself
• As per Beck, In a world risk society, we are suffering the latent side effects
of the victories of modernity.
• The imperative to produce wealth more and more would lead to more and more risk.
• We move from the first modernity in which taking risks advances humanity to second
modernity/reflexive modernity in which humanity becomes more cautions or
reflexive about new projects.
• New concepts like sustainable development and precautionary principle emerge:
• implicating lose of trust on modernization.
• Managing risks such as Nuclear radiation, pesticide residues, Ozone depletion,
carbon emissions, biological pathogens, microchips etc.
• Distribution of risk: poverty is hierarchic while smoke is democratic
• What roles can law play in such risk society? how?
 Theme Two
s o f P ro p er t y R i g ht s
ept an d Th eo ri e
Co n c
proper t y r ight s)
c e and coales c enc e of
ure, scope , em ergen
(The nat
 THE CONCEPT OF PATRIMONY

Rights of a person:-
patrimonial rights, i.e.,
have a pecuniary value such as property rights over things and rights arising out of
contractual relations or those arising out of extra-contractual relations.
extra patrimonial rights;
cannot be assessed in terms of money such as family, political and civil rights.
 THE CONCEPT OF PATRIMONY
patrimonial rights are also referred to as
rights in-personem/personal rights/;
 kt and Tort rights
 against a specific person or persons.
rights in-rem/ real rights;
rights over things/ property rights/
governed by the law of property
against any person
 THE CONCEPT OF PATRIMONY
Similarly, the obligations or liabilities may be patrimonial or extra-patrimonial depending
up on whether they can be valued in terms of money or not.
The totality or unity of patrimonial rights and obligations of a person constitutes his
patrimony.
However, the modern conception of patrimony restricts the definition of
patrimony to the totality of a person’s patrimonial rights only.
According to this conception, a person’s patrimonial obligations are the
charges/burdens over a person’s patrimony rather than constituting its
elements.
 THE CONCEPT OF PATRIMONY
Yet another view expressed by Paul Esmein considers patrimony as the
totality of property rights,
i.e., rights related to objects of a person and its elements are such
objects w/c have the quality of property.
It is the totality/ universality/ of rights because the various property
interests are unified through the person of the owner.
 THE CONCEPT OF PATRIMONY
classical theory,
 patrimony is distinct from the actual elements of which it is composed.
 Hence, the loss or extinction of one or more of its elements does not
affect its existence,
and also its contents may vary from time to time to the extent where it may
be negative.
the unity of patrimony is derived from the person in whom the rights and obligations
are centered;
hence, patrimony should be regarded as the emanation of the personality of its holder
and the expression of the legal power with which a person is invested.
 THE CONCEPT OF PATRIMONY
Accordingly, the characteristics of patrimony are to be sought in the nature
of personality. Hence, it follows that:
1. Every patrimony presupposes a person who is its holder
2. Every person has a patrimony
3. A person can have only one patrimony
4. Patrimony is inseparable from the person of its holder.
.
 THE CONCEPT OF PROPERTY
The term property has a variety of uses
Ordinary, refers to ownership or title
it also refers to the res or the thing over which ownership right is exercised
 in its broad sense, - everything that has material or moral value for human
beings beginning with their own body, reputation, and freedom to think and
act,
 Property law
However, in its narrower and proper legal sense,
o exclusive right to control, use, transfer… an object or a thing of economic
importance and its fruits,
oexclude all other persons from its use and enjoyment and the follow of the
thing and its fruits in the hands of any person who might have unlawfully
taken it.
oHence, accurate legal terminology ought to reserve the use of the word
property for designation of rights of persons with respect to things.
 Property law
The things in relation to which such property rights are exercised are
objects of property rather than property itself.
. Hence, the house, or the car, or the table in relation to which an
ownership right is exercised is properly called an object of the right of
ownership.
Art 40/1/ of the FDRE Constitution which guarantees the right to property
provides that

Property right includes, unless restricted by law for public purposes, the
rights to acquire, use, and transfer things/ tangible or intangible/ of
financial value.
 Property
property:-
Appropriable – to be owned
Useful- economic or moral use to the owner
 DEFINITION AND SCOPE OF PROPERTY LAW

What is the law of property?

Could it be said that it is the law relating to physical objects such as a

house, land a car … etc?

Or is it a branch of law dealing with or governing relations between a

person and things or objects?
.
 Property law
Not every transaction, right, or liability relating to physical objects/
material things/ is regarded as relevant to the law of property; ( contract
vs. tort matters)

It is a branch of law which deals with and regulates the property rights i.e.
the real rights /rights in-rem/ a person exercises over a certain object ;
rights to use, to collect and enjoy the fruits of, to transfer and even
abandon the object and exclude others.
 From the perspective of the right holder, key attributes of
property rights are
I) Transferability:
No transfer allowed • iii) Bundles of rights
 sharecropping allowed
 rental allowed • Use and management rights:
 inheritance allowed
• No right -- privilege
• non-destructive collection
 sale allowed, with restrictions
• seasonal cultivation & grazing
 unlimited sale allowed.
• right to determine withdrawal
II) Exclusion: levels
• No exclusion – open access / no right • right to transform/enhance (eg
• Access restricted to members of a planting trees)
defined group or certain conditions • right to destroy.
• Full exclusion -- right / privilege
 Property Rights Regimes

• Private property:
 Individual or “legal individual” holds rights.
• Common Property:
• Group (e.g. community) holds rights
• Can manage, exclude others
• Importance of rules to manage, distribute.
• Public Property
• State holds rights
• Is it effective in managing, excluding?
• Open Access(res nullius): no effective management
 Perspectives on the why and how of private property
A. Why did property rights emerge?
• Demsetz states
• The absence of private ownership in land in various communities which
hunted for food.
• The same act of hunting by others (i.e. externalities) did not affect the
needs of every member of a community to hunt for subsistence.
• In the course of hunting for fur production, however, the externalities of
hunting for exchange led to an increase in the value of furs and there was a
sharp increase in the scale of hunting, which led to the quest for private
hunting territory.
• Allotted territories thus emerged and
• The fur trade encouraged “the husbanding of fur-bearing animals” and
• this requires the ability to prevent poaching
• This suggests that socioeconomic changes in property in hunting land
 Cont’d…
• Demsetz argues that
• “property rights arise when it becomes economic for those affected
by externalities to internalize benefits and costs.”
• Property rights develop to internalize externalities when the gains of
internalization become larger than the costs of internalization. These
are the conclusion of demsetz why property rights emerged
• He identifies
• communal property,
• private property and
• state property
• Importance of the community’s recognition of “the right of the
owner to exclude others.
 Cont’d…
• Demsetz further shows
• The merits of [share companies] in contrast to
communal ownership.
• Reason for success:-
• Management by small group- recognition of high
negotiating costs.
• Economy of scale- benefit of mobilizing huge resource
• This would have been the case in communal ownership
 B. How Did Property Rights Emerge?
• He indicated Demsetz’s focuse on WHY aspect of the emergence and he on the HOW
aspect.
• Krier appreciates Demsetz’s contribution in demonstrating “how individual holdings reduce
the transaction costs of the negotiation process’’
• by reducing the number of people who have to negotiate.
• According to Jeremy Bentham, the concept of property “consists in an established
expectation” to draw “an advantage from the thing possessed” and
• He consider property as positive right.
• this expectation, this persuasion, can only be the work of law.
• Krier does not agree with Bentham’s idea of property is work of law due to de facto property.
• With regard to evolution of the concept of property: two approaches as to its
emeregence(krier)
• intended design or
• spontaneous unfolding of unintended consequences.
• He illustrates changes without design by using Adam Smith’s notion of the ‘invisible hand.
• An attempt to promote private ends---promote public ends
 Cont’d…
• He briefly highlights the views of Hobbes and
Locke(naturalist) on the emergence of private property.
• He further contrasts Hume’s view that private property is
unnatural to human beings with the view of many biologists
who argue that “deference to possession is the result of
biological evolution.”
• Krier states that possession “provides a clear indication of
the status of any claimant.”
• There is human tendency to respect the earlier expenditure of
effort, some labor, by the possessor;
• Humans, like other animals, have some ‘innate sense of
possession and territory.’
• Krier indicates the disadvantages of the intentional-
design approach
• origins and actions of the designer:
• a degree of human rationality that probably had not yet
developed by the time the first primitive property rights
emerged.
• He also states two limitations involved in the unintended
consequences approach.
• The assumption of respect by members of the community
owing to abundance of resources, and
• It cannot account for anything beyond very simple property
rules.
 Cont’d…
• He suggests that the two approaches be combined based on
which he constructs a sketch of the development of property.
• He forwards the sketch in the development of property rights
• With a long evolutionary development mainly as unintended and
ultimately evolving towards legally enforceable rights which
emerged along with the advent of the state, nation states and legal
systems.
• He underlines that and centuries rolled on, more and more
population was competing for resources which could have hardly
been facilitated by informal deference to possessions.
• repeated experience of the inconveniences of transgressing it led
to gradual emergence of property right- Hume
 C. Theories of private property
• We examine justificatory theories with the following main
objectives in mind.
• To see their applicability in modern property regimes
• To answer the following basic questions:
• What principles decide which individuals have ownership
rights over what things?
• what are the social or public functions of private
ownership?
• What individual interests are served by the existence of
private property as opposed to some other property
regime (such as communism?)
 Cont’d…
• The justificatory theories of private property in the western
philosophical tradition can roughly be divided into two. This is
well summarized by Getzler:
1. [t]here is a notion of property as pre-social, a natural right
expressing the rights of persons which are prior to the state and law,
• this being the view of Hugo Grotius, Samuel von Pufendorf, John Locke,
Immanuel Kant, and George W.F. Hegel; and
• 2. there is a notion of property as social, a positive right created
instrumentally by community, state, or law to secure other goals-
• the theory of Thomas Hobbes, David Hume, Adam Smith, Jeremy Bentham,
Emile Durkenheim, and Max Weber.
 Cont’d…
• We take it for granted that things are ours because we
have acquired them from another person who has
ownership to pass on to us. Such acquisitions can occur
through a voluntary transfer such as a gift or a bequest in
a will or; simply by a purchase for value.
• Thus, the law prescribes methods by which ownership can be
acquired from another, for example, a transfer by deed or mere
delivery of the thing in question.
• The law does not, however, tell us how that chain of
ownership began, in other words, why was ownership of
the thing recognized in the first place?
 Cont’d…
• In social contract theory, there is a conception of
human interaction before society. It is usually called the
state of nature.
• Contract theorists use the state of nature to
• - Explain the nature of society and its origin
• - Explain the need for government
• - Legitimize the authority of rulers
• - Explain the origin of social justice.
 Cont’d…
• Locke’s view of the state of Nature
• Perfect freedom, absolute liberty (but within the bounds of the laws
of nature)
• Equality: in power and jurisdiction (i.e., extent of application of
power)
• People have property (It is just not protected very well.)
• There can be industry and culture
• There is right and wrong (people just don’t follow it very well)
• There is civil justice, but people do not apply it very well. They have
to take justice into their own hands.
• For a long time, there was a state of plenty, so there weren’t many
quarrels.
 Cont’d…
• Hobbes’s State of Nature
• - A war of all against all
• - No developed culture, industry, arts, etc.
• - Constant danger of death and continual fear
• - No law, no right or wrong, nothing is just or unjust
• - Force and fraud are the cardinal values
• - No property (there is no “mine or thine”)
• - Everyone has a right to all things needed to preserve one’s
life
• - Life is “solitary, poor, nasty, brutish, and short.”
 THEORIES OF PROPERTY
the origin and foundation of private property;-
There are two main groups of theories of property
 1st group attempts to explain how private property came to existence,
i.e. it describes the facts, which purports to show the origin of private
property.
 It attempts to explain how things came to be owned privately.
 Theories Property

2nd group of theories

is concerned with passing a judgment on the institution of private

property and attempts to justify or condemn the institution.

it tries to explain the economic and social reasons behind the
recognition and protection or condemnation of private property.

Sometimes those two aims are combined

.
 THEORIES REGARDING ORIGIN OF PROPERTY

A. THE POSITIVIST THEORY

 law is nothing but the command of the sovereign
 the rules promulgated for reasons of public policy, protection of individual
rights, promote the general welfare, increase social wealth or maximize
social utility
 Ppty is all about expectation and persuasion of deriving advantage from the
thing owned
 Now this expectation, this persuasion, can only be the work of law- law
makes to forget weakness- via protection
 Property and law are born together and die together
 v+st

 Property rights exist only if and to the extent they are recognized by the legal

system.

 Before laws were made there was no property; take away laws, and property

ceases.

 rights, including property rights, arise only through government is known as

legal positivism.
 Critics
Critics; John Locke
the state and private property are the results of the same social and
economic forces and we can hardly say one is the creation of the other.

the state is the result of a social contract in which the society transferred
some of their rights to the state for the purpose of protection their rights
including the right to property.
 B. THE HEGELIAN THEORY
(Locke, Hegel, Margaret Jane Radin )
According to George Wilhelm Friedrich Hegel,
a human person is merely an abstract unit of free will or autonomy that does
not have a concrete existence until that will acts on the external world.
From the need to embody the person's free will from the abstract realm to the
actual, extends his will to external things
the person becomes a real self only by engaging in a property relationship
with something external.
 THE HEGELIAN THEORY
Hence, private property originated in the person’s attempt to actualize his/her free will,
i.e., when someone extends his wills to external things he makes that thing a part of
himself.

to be a person, an individual needs some control over resources in the external world.

Locke says that “every man has a property in his own person,” from which it
immediately follows that “the labor of his body, and the work of his hands… are properly
his.”

.
 D. The Natural Law Theory

In contrast to legal positivism;

natural law theory posits that rights arise in nature as a matter of fundamental justice,
independent of government.
As John Locke observed, “[t]he Law of Nature stands as an Eternal Rule to all Men,

Legislators as well as others.”

The role of government, Locke argued, was to enforce natural law, not to invent new law

the “unalienable Rights” of “Life, Liberty, and the Pursuit of Happiness” were endowed upon

humans “by their Creator”; governments exist merely “to secure these rights.”
 n d g ro u p o f t h e o r i e s
2 rg e s
p r o p e rt y E m e
How Priva t e
? ??
a n y p ro p e rty
t h e re e v e r b e
why shoul d ’ )
right s a t a l l ?
 A. Occupation Theory
• It is all about question of how things become the subject
matter of private ownership.
• The basic principle emerging here is the first occupation gives
rise to private property.
• Private property was born out of individual taking
• possession is the root of title.
• the consent of or agreement with the rest of mankind.
• Such agreements can be
• Express---a clear acceptance by a group of individuals ---on a mutual
understanding.
• implied agreement ---simply on the basis of first occupation.
 Cont’d…
• when does first occupation take place?
• The problem is particularly acute when there are overlapping efforts to take
first possession.
• Pierson v. Post, a classic wild animal case from the early 19th century.
• The case involved an action of trespass by Post against Pierson on the grounds
that Pierson had interfered with Post's property in a wild fox.
• The facts of the case
• Post in possession of certain dogs was hunting on an abandoned beach, having caught
sight of a wild fox, he led pursuit for it and had the fox in his gunsight.
• Before Post had any chance of killing the fox, Pierson intercepted his pursuit and killed
the fox and took away the carcass.
• Pierson's interception took place with the full knowledge that Post was in hot pursuit of
the animal.
• The basis of Post's action was that his pursuit had given him property in the fox that had
now been interfered with by Pierson.
 Cont’d…
• Justice Tompkins delivered the decision of the majority,
who held in favor of Pierson.
• The majority held that actual capture and control of the
thing in question could give rise to first possession.
• The hot pursuit of Post was insufficient to give him any
property in the fox.
• For the majority, possession meant a clear act whereby the
entire world understands that the pursuer has an unequivocal
intention of appropriating the animal to his individual use.
• killing and complete control of the animal
 Labor Theory: Property a Natural Right
• John Locke (1632-1704)
• John Locke lived through a period of European history which witnessed
post-Westphalian decades of nation-state building
• The emergence of constitutional monarchy
• His theory of the state was liberal and anti-authoritarian
• Locke rejects the idea that persons are subjects of a sovereign, and argues
against the view that only one universal monarch should have property.
• a person has the right to everything that is necessary for self-preservation
which is private property
• The right was natural, not in the sense that every individual was born with the
right to property, rather, the right was acquired through conduct which is
natural to man
• Private property rights existed before the state and independently of laws
prescribed by the state.
 Cont’d…
• The basis of his thesis thereafter can be summarized in
three main points.
• In the first place, every man has a right to his own person,
we may describe this as self-ownership.
• Secondly, every man has a right to own his own labour.
• Finally, every man has a right to own that which he has
mixed the labour of his own person with.
• Mixing one's labor with the common resources converts
that resource into private ownership.
• the same premise as the occupation theory
 Cont’d…
• Locke does impose restrictions on the amount of such
property.
• The first limitation requires that “enough and as good”
ought to be left in common to others.
• And Secondly, one cannot take what will not be used
or things that will not be wasted (spoiled).
• In the French and American Revolutions such natural
rights to property were clearly embedded in the
resulting declarations.
 ……Nutshell………

 the first occupier should be rewarded and

 property acquired in such a manner is ethically justifiable

o He who first reduces in to possession of a piece of property

has the best of justifications for remaining in control, and
hence the institution.

.
B. Utilitarian Theory of Private Property: Property as
positive Right
• The utilitarian theory of property regards property as a positive
right created instrumentally by law to achieve
• social and economic objectives.
• the right is both given and protected by state.

• The principal thrust of Bentham's argument is that

• the total or average happiness of society cannot be maximized unless
there exists rights to appropriate, use and transfer objects of value or
 Utilitarian theory
the function of the legislator/ state is to maximize the sum of human felicity (Utility)
or happiness
private property, which is the expectation of protection provided by the state, is
justifiable

because it increases human felicity/ happiness..

 C. Economic Justifications For Private Property(Posner & demsetz)

• Posner argues that the legal protection of property rights performs a

very important economic function
• To create incentives to use resources much more efficiently.
• Economic justification for private property argues that there are costs or
disutility when there is no ownership of resources.
• Posner identifies three criteria for an efficient system of property
rights.
• Universality -- all resources should be owned by someone
• Exclusivity --to give owners the incentive to incur the cost required to make
efficient use of resources which they own.
• Transferability-- as it is the way to reallocate resources from a less productive
use to a more productive one.
 Cont’d…

• The essence of the economic justification for

private property is the minimizing of cost and the
resulting efficiency in distribution of resources.

• Like Posner, Demsetz argues that the general

welfare will be better served if material resources
are owned and controlled by private individuals.
 In sum…….
private property is the result of individual labor
industry should be encouraged by granting to a worker the ownership of the res,
greater productivity is achieved
it encourages independent and specialized risk taking
The whole effect of these ensures economic growth.
 D. Marx and Engels about private property
• Marx and Engels argue that
• Capitalism has brought about the polarization of classes into the
bourgeoisie and the proletariat (as opposed to the aspirations of
1789 French Revolution towards liberty, equality and fraternity).

• Every stage of social development has its own mode of

production which is characterized by two elements.
• the means of production which refers to “the material means
of production, the hardware, tools, machines, buildings,
workers, etc.”),
• the relations of production, i.e. the “property relations under
which a society produces, manufactures, and exchanges
products.”
 Marxist
the history of all societies in the world is the history of class
 struggles slaves vs. freemen, feudal lords vs. serfs or vassals, the
bourgeoisie and the proletariat.
These relations were not always based on equal or even fair exchange of
labor and wages
In effect private property served and is serving as a means of exploitation
of the ….by……..
Hence, private property is the evil that has to be abolished is the
Communist Manifesto.
 cont

• According to Marx’s Das Capital, capitalism

brings about social production which becomes
contradictory with private appropriation; and

• this contradiction can only be resolved through

social appropriation which necessitates the abolition
of private property of the means of production
 E. Hobbesian conception of the absolute sovereign
• Thomas Hobbes lived during the most turbulent years of
European history
• his views were influenced by the realities that prevailed during the
English civil wars in 1642-46 and 1648-49.
• According to Hobbes, human beings are naturally egoistic,
quarrelsome and distrustful. (1588-1679),
• human beings seek peace in the absence of which they resort to war
• the reduction of wills to a single will by giving part of the power of
human beings under a given state to one man, or one assembly of
men.
• In the realm of property rights, the sovereign determines the rules
that tell every man what goods he may enjoy and what actions he
may do.
 possession
THEORIES
o three theories regarding definition of possession
1/ SAVIGNY’S/CLASSICAL/ THEORY OF POSSESSION; (subjective theory )
possession consisted o f two ingredients,
 corpus possessions, i.e., effective control and
 animus domino, i.e., the intention to hold as an owner. (detention and
possession)
 i.e. Possession is made up of two elements
 The corpus or element of physical control and
 Animus or element of intent with which such control is exercised
limitation
• derivative possession -a non-owner possessory right
 Possession
2/ JEHRING’S THEORY OF POSSESSION /Objective theory/
 To be possessor
 physical control of the thing- direct physical control of such thing
No need of animus or intent to own and use- animus being merely an intelligent
consciousness of the fact
This theory explains those cases, which were difficult to Savigny such as the pledgee
and the usufructuary that were given possession right
Limitation
it fails to explain the cases where the law denies possessory right to those who are in
exclusive physical control of a thing such as a borrower, a tenant and a depositor.
 Possession
3/ SALMOND'S THEORY/realist theory
A Modified version of Savigny's theory
-shift in the meaning of possession has occurred and the term is not confined to
physical control.
He started by distinguishing b/n
 possession in truth------ ----in fact
 possession in law- ----------- a legal fiction
 possession -corporeal possession and possession of rights, which he called
incorporeal possession
•physical or corporeal things involves two ingredients
o corpus possessions and animus posidendi
Hence, corporeal possession is animus and corpus the animus possidendi is the
intent to exclude others, i.e., to hold for one’s own interest.
 Possession
He further classified the corpus possession is under two headings
a. The relation of the possessor to the thing,
which must allow him to put the thing to the use which accords with its nature
b. The relation of the possession to other persons- create a reasonable expectation of
non-interference in the use of it.
Critiques
1. Expectation of non-interference is not necessary for the continuation of possession.
Eg. pocket book vs pickpocket - interfere with his use in a few moments
2. the assumption that corpus and animus, which are only conditions for the
acquisition of possession, are possession themselves.
 Possession
To sum up
the following three situations became possible in relation to
possession of a thing.
 A man could have physical control with out possession and its
advantages.
 He could have possession and its advantages with out physical
control.
 He could have both, i.e., he may have physical control as well as the
advantages attached to possession.
 Theories/justification of Possession
1. Public order theory

2. Will theory

3. Ownership theory

4. Continuity theory

5. Entitlement theory

…………………///////……………….
 Theme Three

fo u n d ati o n o f co nt ract
Theoreti cal
Objective and Subjective Theories of Contract
• Free consent/mutual assent as basis for contract
• The steps for determining whether mutual assent has
occurred are the offer and acceptance.
• There are two planes on which mutual assent can be
analyzed through
• the objective theory and
• the subjective theory.
  The Objective Theory of Contracts
• In this approach contractual assent is determined by analyzing external evidence.
• formation is concerned with communication, not cognition.
• objective manifestations of intent
• pragmatism of the rule;
• This approach analyzes the external evidences of the parties’ intention as the
only relevant consideration
• The law has nothing to do with the actual state of the parties’ minds.
• In contract, as elsewhere, it must go by externals, and judge parties by their
conduct.
• It also serves many of the philosophical underpinnings of contract law, such as
• principles of fairness and protection of reliance,
• freedom of contract, and
• protects personal autonomy- does not require to guess what is in the mind of others
 Cont’d…
• The subjective approach, or “meeting of the minds.”
• This approach is concerned with the actual, literal
intentions of the parties.
• External manifestations of assent are taken merely as
evidence of the actual intent of the contracting party.
• Proponents of this subjective theory promote the freedom
of contract above all other principles --- they only wish to
bind those who clearly and subjectively intended
themselves to be so bound.
• attaches the binding force to the subjective will.
• concurrence of wills is important consideration
 The French Subjective Theory of Contract and
Comparison to Objectivist Rules
• The French Republic’s motto --- “Liberté, Egalité,
Fraternité” ---
• was the ideological framework
• spilled over into the law of contracts
• autonomy of the will was a natural companion to the idea
of laissez-faire and the idea that people are the best
judges of their own interests.
 Revocability of Offers
• The French subjective theory of contract manifests itself in the
accepted doctrine on revocation of offers.
• the concern is with the extent that the law requires communication
and receipt of an offer's revocation in order for it to be effective to
terminate the power of acceptance.
• In objective theory, of course, though an offer may generally be
freely revoked prior to acceptance
• any such revocation is not effective to terminate the offeree’s
power of acceptance until the revocation is received by the offeree
 Cont’d…
• However, with the French subjective theory and pure “autonomy of will”
philosophy, this is not the case.
• Rather, once the offeror changes his mind and revokes,
• the offeree’s power of acceptance ends at that moment regardless of whether the offeree
was instantaneously aware of the revocation (so long as there is some external evidence of
the offeror’s change of mind, for reasons of proof only).
• The fact that there could not have been a concurrence of the wills is conclusive.
• However, there is a mitigating principle in French law
• In this case, the principle is that offers are not nearly as freely revocable in
the first place, as they are in common law jurisdictions. Though in principle
an offer may be revoked prior to acceptance
• French doctrine provides that an offer usually must be held open – that is, it is
irrevocable – for any period of time stated, or if no period of time is stated,
then for a reasonable time.
 Cont’d…
• The reason typically given for the French rule of
temporarily-imposed irrevocability is that the offeree must
be afforded sufficient time “to learn about the offer and to
examine it.”
• in the Anglo American common law offer is freely
revocable, even if there is a period of time stated, unless
consideration is paid to hold the offer open.
 Need for Communication of Acceptance

• Modern law of French:

• Communication of acceptance is not necessary for the formation of contract.
• Objective view:
• it is not the acceptance that concludes the contract but the offerors knowledge of
intention to accept.
• But others have argued that what is needed is not merely the co-existence of two wills,
but mutual awareness of such co-existence, I e the communication of the acceptance
(theory of information).
• Subjective view:
• it does not recognize the need for the acceptance to be communicated and
received by the offeror.
• For at that moment the two wills are at one, and communication of the
acceptance can add nothing.
• And this is commonly called the theory of emission.
 Cont’d…

• With in the subjective theory

• Emission theory:
• pure subjective theory---mere declaration of acceptance
suffices for the formation of the contract.
• Expedition theory:
• dispatch of the acceptance/dispossesion of acceptance
from the offeree is important to form the contract.
 Some Other Aspects of Formation and Interpretation
• 1. Death of offeror
• Another contract formation rule in France that illustrates the subjective theory
which pervades French contract law is that the intervening death of the offeror
---- subsequent to the offer being made and prior to an effective acceptance
being made by the offeree --- will terminate the offer, assuming the offer was
generally revocable in the first place.
• This is certainly applicable when the offered proposal is personal to one of the
parties,
• for example, a partnership contract, or one to render services, such as an architect.
• On the other hand, French law provides that the death does not terminate the
offer in the event it had become irrevocable before the offeror’s death occurred.
• The rule is of Civil law origin which is imported to the common law too. As a
result no point for comparison.
 cont’d…
• 2. Mistake and Misunderstanding
• Article 1109 of the Civil Code provides that “[t]here is no valid consent if consent was
only given because of error . . . .”
• And Article 1110 of the Code provides a further clarification of the mistake doctrine in
France: “Error is not a ground for nullity of a convention unless it goes to the very
substance of the thing forming the object of the contract.”
• French doctrine confirms that the presence of such a serious mistake or error, going to
the whole substance of the subject matter of the contract, completely “vitiate[s] the will,
and contaminate[s] the appearance of consent.”
• sell a house and lease of a house
• serious mistakes constitute defects in consent, and this precludes formation of a contract.
• This is fully consistent with the subjective theory in France, and the autonomy of the will.
• The mistake doctrine in contract law is imported to the common law.
• Slight rhetorical difference: in French serious mistake preclude formation, while in Anglo
America it makes the contract voidable.
 Cont’d…
• 3. Rules of Interpretation
• The subjectivist rule of construction is found in Article 1156, provides the following:
• “In interpreting agreements, one ought to seek the common intention of the
contracting parties instead of adhering to the literal meaning of the words.”
• The provision states that, in the end for matters of interpretation, what the parties
actually (i.e., subjectively/internally) intended is paramount, and the literal (i.e.,
objective/external) meaning of the contract language is lessened in importance
compared to subjective intent of the parties in entering into the contract.
• In objective theory, interpretation is based on objective meaning of contract
language.
• Of course “[w]ords and other conduct are interpreted in the light of all the
circumstances, and if the principal purpose of the parties is ascertainable it is
given great weight.”
• thus provides a commonality between the two approaches.
 Economic analysis of contract law
• The Jurisprudential Basis of ‘Law and Economics’
• Law and economics -- application of economic theory and methods
to law
• Analysis of the nature of economic society---
 e.g, men are rational economic decision makers-self interest maximizers-
respond to incentives/disincentives
• Analysis of economic framework laws like contract
• Application of economic theory to examine the making, enforcement and
impact of legal rules and institutions
• ∆ in law
• ∆ in incentive structure for economic behavior
• ∆ in economic performance
 Cont’d…
Exchange – at the heart of free market economy:
• Allocation & re-allocation of resources
• Contract – as means for mutually beneficial arrangement
• Contract – as commitment & incentive mechanism for economic
action:
• Production, distribution, consumption
• Contract – as means for:
• Economic coordination & cooperation
• Coordinating private choice
• Implementing exchange over time
• Managing present and future sell of goods
• Implementing production over time
• Managing sinking cost of production
 Cont’d…
• The study of economics is concerned about allocation of scarce
resource.
• Efficiency is a key theme dominating the distribution of these
recourses.
• Society is best of when these scarce resources are allotted to their
highest valued use and competitive free market(exchange institution)
achieve this result based on freely negotiated contracts.
• This theory holds that “[c]ontract law maximizes individual autonomy
by enabling individuals to undertake obligations to one another,
thereby expanding their life choices, without fear of detrimental
reliance” because the “legal enforcement of promises ensures that
promise-breakers compensate their victims for the harm they cause.
 Cont’d…
• People enter into a contract only when the contracting parties
are benefiting.
• Contract is not a zero sum game, in which gains of one party
are loss of the other party.
• In the absence of mechanism to enforce contract, society will
get worse of as contracts benefiting both parties never be
formed.
• This is the economic base for contract law
• Society gains by having enforceable contracts and legal
institutions and remedies promote these welfare enhancing
gains.
Freedom of contract Vs. paternalism/contract regulation
• Every body is best suited to decide over his own fairs. Every
body is rational decision maker. Self interest maximizer.
• The traditional anti-paternalist view of mainstream economics
based on ‘consumer sovereignty’ and efficiency considerations
supports contractual freedom at its edge.
• There are three conditions for an act to be paternalistic. The
paternalist
• (1) interferes with the subject’s liberty;
• (2) acts primarily out of benevolence toward the subject (i.e., his
goal is to protect or promote the interests, good or welfare of the
subject); and
• (3) acts without the consent of the subject.
 Cont’d…
• The economic reasons for intervention in contracts are
essentially twofold:
• contracting failures –bounded rationality, constrained choice
• market failures-monopoly, horizontal agreements, mergers
• There is scope for justified paternalistic intervention in cases
where there
• (1) are systematic cognitive failures or insufficient cognitive
capacities;
• (2) is insufficient information (asymmetric information); and,
• (3) to some extent where there are insufficient outside
opportunities (necessity, situational or structural monopoly)
 Theme 4. Nature and theories of the firm

• Neoclassical, Transaction Cost and Agency Theories of the

Firm
• Nexus-of-Contracts’ and ‘Property Right’ Theories of the Firm
• Ownership and Control in Ethiopian Share Companies
 R.H. Coase- Nature of the firm
• R.H. Coase- short biography:
• Nobel prize award---1991. ‘Nature of the firm’, ‘the problem of social cost’
• One of founders of discipline called ‘law and economics’
• He was socialist in his early days
• He visited Ford and General Motors and came up with a puzzle: how could economists
say that Lenin was wrong in thinking that the Russian economy could be run like one
big factory, when some big firms in the United States seemed to be run very well?
• In answering his own question, Coase came up with a fundamental insight about why
firms exist.
• Theories of firm are all about:
• What is a firm?
• Why firms come into existence?
• Where is firms boundary/what is their optimum size?
• What is their significance to legal problems?
 Cont’d…
• Describing the economic system.
• Coase provides us description of the economic system by economists like Sir Arthur Salter
• Over the whole range of human activity and human need, supply is adjusted to demand and production is
adjusted to consumption by a process that is automatic, elastic and responsive.
• The normal economic system works itself-It needs no central control.
• An economist thinks of the economic system as being coordinated by the price mechanism and society
becomes not organization but organism-the economic system works itself.
• This does not mean that there is no planning by individuals.
• This theory assumes that the direction of resources is dependent directly on the price
mechanism.
• Coase argues that the above description gives incomplete picture about the economic
system.
• With in a firm the description does not fit at all.
• For instance of a work man ordered to move from department y to x with in a firm, he does not go due to
the change in relative price but because of the fact that he is ordered.(planning)
• Coase takes the firm as non market institution embedded in the market.( it does not use price
mechanism)
• Affairs in the firm are organized not by continual higgling and haggling of the market place but rather by
 Cont’d…
• Coase wonders that in view of the fact that it is usually argued that coordination
will be done by the price mechanism, why is such organization necessary?
• Outside the firm, production is directed and coordinated by price mechanism.
• With in the firm, production is directed and coordinated by the entrepreneur coordinator.
• Having regard to the fact that production is regulated by the price mechanism,
production could be carried on with out any organization at all.
• He declares in his seminal work that it is important to enquire why coordination is
the work of the price mechanism in one case and the work of the entrepreneur in
an other case.
• The main reason why it is profitable to establish a firm would seem to be there is a
cost of using the price mechanism.
• The most obvious cost of organizing production through the price mechanism is that of
discovering what the relevant prices are.
• This cost may be reduced but will not be eliminated by the emergence of specialists who will
sell this information.
• Contracts(market transactions) are not eliminated but greatly reduced when there is a firm.
 Cont’d…
• Two important implications of Coase’s view of the firm
• Firms come into existence to save the costs of bargaining
• Boundaries of the firm is indicated in his view than in the neoclassical theory
• If markets were costless to use, firms would not exist. Instead, people would
make arm's-length transactions.
• But because markets are costly to use, the most efficient
production process often takes place in a firm.
• Firms are in this sense by Coase essentially viewed as “islands of conscious
power in this ocean of unconscious co-operation [the market] like lumps of
butter coagulating in a pail of buttermilk” (Robertson 1923, p. 85, quoted in
Coase 1937, p. 388).
• The firm supersedes the price mechanism.
 Cont’d…
• The firm reproduces the market’s resource allocation, but relies on
direction and planning.
• Indeed, Coase’s firm is “the system of relationships which comes into
existence when the direction of resources is dependent on an entrepreneur”.
• There is planning in our economic system which is a kin to economic planning.
• In economic theory we find that the allocation of factors of production
between different uses is determined by the price mechanism.
• The price of factor A becomes lower in y than in x. As a result A moves
from Y to x until the difference between the prices in x and y
disappears.
• However in the real world there are many areas where this does not apply.
 Cont’d…
• A firm, therefore, consists of a system of relationships which comes into
existence when the direction of resources is dependent on an
entrepreneur.
• With regard to boundary of the firm and size:
• A firm becomes larger as additional transactions ( transactions which could be
co ordinated through the price mechanism) are organized by the entrepreneur
and becomes smaller as he abandons the organization of such transactions.
• Why is not all production carried out by one big firm?
• Possible explanations:
• First as the firm gets larger, there may be decreasing return to the
entrepreneur function, that is, a cost of organizing additional transactions
may appear.
• Second as the transactions which are organized increase, the entrepreneur
fails to put the factors of production in the place where their value is largest,
he fails to make the best use of factors of production.
 Cont’d…
• With regard to size:
• Diminishing return to management
• Rising costs of supply of factors of production
• Other things being equal, therefore, a firm will tend to be larger;
• 1. the lesser the costs of organizing and the slower these costs rise with an increase in
the transaction organized.
• As far as it is possible to organize with lesser cost
• 2. the less likely the entrepreneur is to make mistakes and the smaller the increase in
mistakes with an increase in the transactions organized.
• As far as it is possible to organize with less mistakes
• 3. the larger the lowering( or the less the rise) in the supply price of factors of production
to firms of larger size.
• As fare as there is lower supply price compared to other larger firms
• The central nobility of Coase’s Nature of the firm is that it recognizes cost of
voluntary exchange.
• As a result alternative form of resource allocation may be cheaper.
 Economists’ perspective of theory of the firm
Many of the economic theories of the firm are progeny/offspring of the Coasean
view of the firm.
1. The neoclassical theory of the firm:
 It is also known as conventional theory of the firm and has strong hold in
economics for long time.
 According to the neo-classical theory, the firm is “a set of feasible production
plans” in which its manager “presides over this production set, buying and selling
inputs and outputs in a spot market and choosing the plan that maximizes
owners' welfare.”
• Owners welfare is profit maximization
• The reasons for the firms existence were
• Economy of specialization
• Economy of scale– ability to pool large capital
 Cont’d…
 Hart notes that this theory failed to “explain how production is
organized within a firm, how conflicts of interest between the
firm's various constituencies - its owners, managers, workers,
and consumers-are resolved, or, more generally, how the goal
of profit- maximization is achieved.”
 According to Hart, the neoclassical theory of the firm does not
address issues of size, extent, the consequences of mergers or
split into smaller firms.
 It merely describes in rudimentary terms how firms function.
 2. Transaction cost theory of the firm
• Hart summarizes the theme of the transaction theory of the firm by
stating Coase’s idea that the existence of firms can be traced from
• “the thinking,
• planning and
• contracting costs that accompany any transaction”
• and that “in some situations these costs will be lower if a transaction is carried
out within a firm rather than in the market.”
• According to this theory, transaction costs are lower where one administrative
authority determines the terms of trade.
• The theory also states the boundary of the firm as “the point where the
marginal cost savings from transacting within the firm equal these additional
error and rigidity costs.”
• Firms arise to economize on transaction costs.
• Learning and haggling costs as major costs
 3. The principal agent theory
• The principal-agent theory “views the firm as a production set, but now a
professional manager makes production choices, such as investment or effort
allocations, that the firm's owners do not observe” thereby marking the
beginning of the managerial theory of the firm.
• The virtue of this theory lies in its role of significantly enriching neoclassical
theory.
• This theory recognizes conflict of interest between different corporate actors in
the firm.
• Agency cost arise
• Cost of monitoring
• Bonding costs(if the a manager performs best it is important to stay in the firm)
• Residual loss- welfare loss of the principal due to divergence of the decision by the agent
and decision that maximize welfare of the principal.
• Designed to limit abnormal activities
 Cont’d…
• This theory is of the view that misalignment of interest of the owners
and the managers can be mitigated by installing optimal incentive
schemes.
• For example profit sharing agreement
• Still conflict of interest could no be avoided totally.
• Manager may require to promote his own interests like building his own
empire, easy life, on job perk,
• This theory does not predict about the nature and the extent of the
firm.
• Hart states that this theory “fails to answer the vital questions of what
defines a firm and where the boundaries of its structure are located.”
• Hart observes the virtue of this theory in indicating optimal incentive
schemes and its failure to directly address the issue of organizational
 4. The nexus of contracts
• In 1976 Michale Jensen and William Mekling formulated the
conception that corporation is nexus of contracts in their famous
Article the theory of the firm: managerial behavior, agency cost and
ownership structure.
• They thus conclude that “most organizations are simply legal fictions’ which
serve as a nexus for a set of contracting relationships among individuals.”
• Contract- reciprocal expectation, arrangement in economics.
• Other Proponents define
• firm as a set of bilateral contracts between each stakeholders and the
manager or common agent.
• the firm as a common signatory of a group of contracts.
• This conception(contractarian view of the firm) dominated the law and
economics literature.
 Cont’d…
• This theory of the firm considers transactions within the firm and
between firms as “part of a continuum of types of contractual
relations.”
• It views modern corporations as agglomeration of contractual relations.
• Hart believes that this view “is helpful in drawing attention to the fact
that contractual relations with employees, suppliers, customers,
creditors and others are an essential aspect of the firm.”
• Critics on this conception of the firm like Eisenberg argues:
• It does not take dual nature of the firm into consideration
• Reciprocal relation ships with in the firm
• Bureaucratic nature of the firm—what about directions by the employer?
 Cont’d…
• This conception of the firm lacks intellectual coherence.
• What does a nexus mean? What creates this nexus?
• Many of the reciprocal arrangements that are relevant to the
corporation are not linked/or have no intersection/does not overlap.
• Eg. Contract of steel supplier is not linked to contract of advertisement.
• This theory does not also solve issues of boundary
• Moreover, he states that “the body of shareholders is not
conceived to own the corporation” and instead, “shareholders
are conceived to have only contractual claims against the
corporation.”
• Such “denial of shareholder ownership is critical to the nexus-of-
contracts conception”.
 5. Property rights theory of the firm
• According to Hart, the firm’s non human assets represent the glue that
holds the firm together.
• Without property the firm is just a phantom.
• Firms arise where contractual relationship fails and where allocation of
power and control is essential.
• Hart criticizes contractarian theories for failing to explain the source of an
employer’s authority, and he emphasizes that control over non human assets
leads to control over human assets.
• Ownership of capital assets puts a person in a position to organize
production through the purchase of economic factors including labor.
• The 'property rights’ theory of the firm emphasizes how entitlements to
control assets can be used as governance mechanisms that complement
incomplete contracts.
 Cont’d…
• This theory is an advance from contractarian theories.
• Property or capital explains the economic leverage required for the
creation of relationship of authority with in the firm, usually
through contracts.
• proprietary rights protect their holders' claims better than do
contractual ones, thereby enabling them more effective use as
governance mechanisms within the firm,
• The property rights theory of the firm argues that the
contingent allocation of control rights responds to agency
costs in the firm.
• for example, the shareholders' residual right to remove managers
assists in focusing managers' attention on the shareholders'
interests
 Legal theory of the firm
• This theory complements economic theory of the firm.
• It explains firms, not as nexus of contracts, but as nexus of agency
relationships.
• Nexus of contracts leads to a question; what creates the nexus?
• Only the legal theory of the firm can answer this question:
• Agency and legal recognition of specific forms of organization
• Three specialized roles with in the firm includes control, ownership and
employment
• legal agency establish relationship of authority and power.
• The boundaries of the firm are drawn along the lines of control, ownership
and employment.
 Cont’d…
• Except in the case of sole proprietorships, firms are created in two
directions
• Horizontally in the sense of sharing ownership and control
• Vertically by creating hierarchical relation ships of control through ownership
structures and employment, parent and subsidiaries or branches
• Both of these dimensions involve the creation of legal agency relationships.
Hence the nexus of agency relation ships which characterize most of the firms
• Partners become legal agent of each other in a partnership firm
horizontally.
• There is also vertical agency relationship between employers and
employees, between parents and subsidiaries/branches
• Vicariously liable for tortious harms
• Each owe one an other fiduciary duties under the law of agency.
 Cont’d…
• In addition to its economic importance, ownership structure is
essential for determining the legal control of firms.
• Capital structure:
• debt and
• Equity
• Though creditors seem outside the agency relationship, secured
creditors exercise power of control as they are empowered to seize
property of the firm
• In Adverse economic situations of the firm, creditors may exercise ownership
and control rights.
• Creditors could also influence the governance of the firm by requiring
detailed contractual provisions in the loan agreements.
 Cont’d…
• Boundaries of a firm:
• The boundaries of the firm fluctuate in the key areas of control, ownership,
and employment
• They include the vertical dimension of legal control and employment and the
horizontal dimension of equity and debt ownership and financing.
• Final remark
• Law should evolve with the ever changing form of business organization to
constrain the opportunism of both the agent and the principal with in the
firm.
• Controlling Sharking(opportunism by the principals) and shirking problems
(opportunism by the agents)
• The traditional fiduciary duties should be continually updated to constrain the
costs of shirking and sharking