Coase-Sandor Working Paper Series in Law and Economics

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"No Contract" is on the rise in many consumer markets. Sellers are luring customers with the assurance that no commitment is required—that the consumer can terminate the service freely at any time, without paying a termination penalty. What explains the increasing prevalence of No Contract? Is it welfare enhancing? We examine the costs and benefits of No Contract, as compared to the lock-in alternative, and conclude that the rise of No Contract is generally desirable, a market response to consumers' growing awareness and understanding of the costs of lock-in. We argue, however, that lock-ins continue to prevail less conspicuously, through loyalty programs that, like termination penalties, punish consumers for switching. Doctrinally, courts scrutinize lock-in contracts as penalty liquidated damages, and reduce these fees when excessive. We show that while courts' skepticism of lock-in is generally justified, the doctrinal method is fundamentally misguided, resulting in inconsistent and welfare-reducing outcomes. In fact, with informed consumer choice disciplining sellers' actions, as evidenced by the rise of No Contract, the need to regulated this type of lock-in contracts is diminishing. Consumers, however, are not as alert when joining loyalty programs, and the distortions arising form such lock-ins are heightened, rather than resolved, by competition. Courts and regulators should be focusing their attention on loyalty programs, not early termination fees.



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