In the diamond industry, even if fully specified legally enforceable contracts were widely used and could be inexpensively drafted, dealers would still incur many of the precontract transaction costs of entering into extralegal agreements. In general, as the cost of enforcing a contract in court increases relative to the expected benefit, even fully specified legally enforceable contracts contain an implicit and increasingly large extralegal component. This is also true when the expected value of the court-awarded remedy is insufficient to fully compensate the promisee. In the typical diamond transaction, litigation costs would be high relative to the amount that could be recovered, and the promisee would almost always be undercompensated under standard damage remedies. Therefore, even if legally enforceable contracts were used, diamond dealers would still need the benefit of the reputation bond posted in the formation of an extralegal agreement. And, consequently, dealers would still have to incur the transaction costs of inquiring into their trading partner's reputation and conforming to industry custom.

DEFINE: Introduces the 'extralegal component' concept — the implicit reliance on reputation and custom that persists even in formal contracts when court enforcement is disproportionately costly.

Lisa Bernestein, Opting out of the Legal Sys…, loc. 140