Faux Contracts

Cathy Hwang (University of Utah, S.J. Quinney College of Law)

Abstract: In deals of many varieties, parties enter into “faux contracts”—documents that look like contracts, but that lack the legal bite of formal legal contracts. Parties use faux contracts to pair formal contracting with informal (or non-existent) enforcement, thereby adding value in contexts as wide-ranging as sexual abstinence pledges and mergers and acquisitions. Parties use faux contracts in a variety of contexts. Examples include surrogacy contracts in states where they are outlawed, employment non-competition provisions where they are unenforceable, and non-binding term sheets in mergers and acquisitions deals. Use of faux contracts is most puzzling when parties are sophisticated—that is, when parties have the financial means and technical sophistication to enter into binding legal contracts, but choose to use faux contracts instead. This Article makes two contributions to the literature. First, it provides an account of when and why faux contracts flourish. Parties use faux contracts to decouple ex ante contracting from ex post enforcement, and to create a bespoke blend of formal contracting and informal or non-existent sanctions to meet their needs. Parties thereby harness the benefits of formal contracting without subjecting themselves to formal enforcement for breach. Second, this Article contributes to robust literatures in formal and relational contracting. It illuminates a new type of contract that occupies a space between formal and relational contracts. Formal contracts attach formal legal consequences for breach, while relational (or informal) contracts rely on informal sanctions—such as damage to reputation—to deter breach. Faux contracts break apart well-understood conventional pairings of contracting and enforcement, and reconstitute them to form innovative and fascinating contractual tools. Understanding faux contracting has significant implications for contract theory and practice, and has wide-ranging effects on parties, the economy, and society.