Monday, May 25, 2009

The Constitution has gone to the dogs

Actually, it should have gone to the dogs, but didn't. I'm talking about Leona Helmsley's estate, of course.

The contract clause of the Constitution says,

"No State shall ... pass any ... Law impairing the Obligation of Contracts..."

This means that private contracts cannot be changed by legislative edict. This clause is incredibly important because the willingness of private individuals to engage in profitable enterprise - which is the foundation of social welfare - crucially depends on their belief that they can realize a profit. In turn, their belief that they can realize a profit depends on their belief that they can hold parties to a contract liable to the terms in the contract. For example, lenders must have confidence that they can repossess the collateral for a loan if the loan is defaulted on. Otherwise, they will not take the risk of giving the loan in the first place. When lenders are too scared to lend, everyone is worse off.

In the case of Leona Helmsley's estate, the contract is a trusteeship and it is being blatantly violated by the judiciary. From the article,

Only $1 million of the estate, valued at about $5 billion, was donated to the care of dogs, which Mrs. Helmsley had designated as her primary beneficiary.

So, "the care of dogs" should have been the largest single item, since the definition of "primary" in this context is "greatest". Going on,

[A] judge reduced Trouble’s trust fund [from $12 million] to $2 million; the dog’s security costs the estate $100,000 a year.

This is a blatant violation of private contract. $12 million dollars was specifically stated by Mrs. Helmsley to go to the dog's care.

(The judge also negotiated a $6 million settlement with two of Mrs. Helmsley’s grandchildren who were explicitly left out of her will.)

This is the most egregious violation. Disinheritance - along with inheritance - is a basic human behavior and the meddling of the courts to violate it in this case has the effect of sending the signal to all holders of wealth (large or small) that their wishes regarding who will or will not receive money from their estate, after death, may not be respected. As with any violation of private contract, this reduces the incentive for individuals to build wealth (by contributing to the social welfare), making us all poorer.

It might seem inane to get all hung up about $10 million not going to the care of a single dog, or that only $1m is going to the care of dogs from a $5bn estate against the desires of the deceased owner of the estate. But it's exactly these kinds of cases where our commitment to the integrity of private contract and the rule of law are tested most. If we follow the "common sense" urge to override the obviously wacky decisions of Leona Helmsley, the consequences are much greater than whether a single dog has $2m or $12m from an estate put towards its care. The signal that is sent is, "if the court system thinks your contract is unusual, it reserves the right to rewrite it ex post facto." The effect is that a lot of contracts that could be written aren't. A lot of experimental business ideas or contractual arrangements that could be tried aren't. And we're left the poorer for this lack of imaginative and creative exploration of contractual arrangements.

Monopoly privilege always degrades quality. The quality of our court system is abysmal. The laziness of judges who don't want to study contracts on a case-by-case basis, and the artificial scarcity of producers of arbitration services guarantees that the types of contracts which can be written and enforced is very narrow. The business models which can be constructed on this contractual foundation is likewise constricted. We need to abolish the state's monopoly on the production of law.


cheesecake said...

The law with regards to deceased estates in countries that adhere to the English adverarial system favours the lawyers. See I bet you the legal fees where far greater than what the dog got

Clayton said...

I bet you're right