Application of Proactive Provisions to Ensure Incentive Alignment in the Context of a Commercial Real Estate Transaction

Abstract

This master thesis examines whether the application of hardship, gain and renegotiation provisions can contribute to ensure incentive alignment between the contracting parties, in the context of a commercial real estate transaction, to ensure optimal profit sharing and risk allocation, as well as prevent opportunistic behavior (including hold-up) and ultimately contract breach and termination. Inferred from this study, it is examined whether the application of proactive provisions contribute to the contractors’ possibilities of creating a relational rent. The methodological starting point for the study is given by the new-institutional, respectively, the legal dogmatic method, which forms the basis of an integrated law and economics study in which several existing theories are operationalized and applied alternatively throughout. Firstly, the thesis clarifies that, under the conventional contractual paradigm, there exists an incentive insufficiency between parties that is not adequately governed by the current litigation. Furthermore, it is concluded that the existing proactive hardship and gain provisions, with a few modifications, generally contributes to addressing a number of the economic issues and a possible solution. However, it is being examined in more detail whether a mutual commitment of an ongoing loyalty can be incorporated to a greater extent through a modification of the traditional renegotiation provision. In this context, it is concluded that, on the basis of the operationalized concept of renegotiation, a new proactive provision can be prepared, which commits loyalty to the parties through ongoing - so-called "ad hoc renegotiation" - in the strategic partnership. The provision is considered to eliminate the asymmetric information, including being considered Kaldor Hicks efficient. Finally, it is concluded that the complementary application of hardship, gain and renegotiation provisions (with the modifications stated in the thesis), contributes to the establishment of a remuneration structure which, in accordance with the traditional assumptions of PA theory, resolves the market failure of the issue of incentive incommunicability between principal and agent