Three recent Nobel prizes, to George Akerloff, Michael Spence and Joseph Stiglitz, were awarded largely for work in contract theory, but the field itself is less than thirty years old.9 Moreover, much of the work in the field takes a mathematical form, and thus has not been easily accessible to nonspecialists. The effective domain of state supplied contract law thus is necessarily smaller than is widely believed. In both models, parties negotiate a contract whose object is to maximize the surplus the deal could create, and they divide that surplus through the price term. (B) Parties sometimes use contract terms, such as merger clauses or no oral modification clauses, that restrict the ability of courts to find the parties intentions. As applied to our illustration, admitting the memorandum, perhaps together with an industry custom as to a sellers preparation obligations, would leave little doubt regarding what the seller was supposed to do. This Article challenges this prevailing view and argues that a formalist theory of adjudication is the best approach to resolve contractual disputes. Enforcement of written agreements presupposes a theory of interpretation. If demand turns out to be high, the buyer would be willing to pay more or to take more product, Incomplete contracts sometimes produce law suits because parties will not always agree ex post regarding the treatment of omitted contingencies.97 Courts in such cases no longer can do interpretation because, by definition, the contracts they see contain gaps. According to this theory, once lawmakers produce rules, judges apply them to the facts of a case without regard to social interests and public policy. Paternalism with respect to the interpretation rules thus is misplaced because it frustrates rather than advances the parties welfare: parties choosing under ideal conditions would want what the state prohibits. 53The distinction between party and majority talk can blur at the edges but there are core cases. This will require the agent to bear risk, B. See, e.g., Omri Ben-Shahar, The Tentative Case Against Flexibility in Commercial Law, 66 U. Chi. 335 (2002). This article addresses that need by developing a general theory of the rules of contract interpretation and construction contract "exposition." The theory distinguishes inter . Bargaining power is a function of two factors. The alternative judicial assumption would hold that the parties, 68See Peter Linzer, The Comfort of Certainty: Plain Meaning and the Parol Evidence Rule, 71 Fordham L. Rev. Taking freedom of contract seriously, however, would radically truncate current contract law. Moreover, formalism is an adequate means to deal with value pluralism and is consistent with the main values served by the law of contracts, such as autonomy and efficiency. In this example, if the inability to contribute to fixed costs would impose only a $30 disruption cost on the buyer, it would write a contract for future delivery ($2 < $30/3). Contract theory has become one of the most significant fields in modern micro and industrial organization economics. See Yongmin Chen, Promises, Trust and Contracts, 16 J. Against the common assumption, the answer is that a formalist approachthe specific contours of which are set out belowwould be instrumentally best. and uncoerced parties have good reasons to use the intention blocking contract terms that the Code disfavors and that many courts do not enforce. In this illustration, there was consensus regarding the language in which the contract was written but that language was arguably unclear. The justification for these rules apparently is a form of paternalism. Many observers would agree that contract law should attempt to facilitate efficient trade and investment. This article takes up Trebilcocks invitation and proposes a normative theory that fits business contracts, the subsidiary category of contractual relationships that the law most affects. For the reasons given, our default would do better at this than current law. Law, Econ. The question we take up here, therefore, is whether firms would prefer the state to complete these contracts with default legal terms. About | The commitment to party sovereignty that we defend in this Article requires courts to delegate to parties both the choice of a contracts substantive terms and the choice of the interpretive theory that will be used to enforce those terms. Put more vididly, if a party may introduce extrinsic evidence to show that the parties meant green when they wrote red, extrinsic evidence could explain but never contradict their contract. Here, an unfavorable interpretation that is close to the correct answer will have negative consequences for a firm that are as severe as interpretations that are far from the correct answer. Expressed more fully, parties would not change their minds regarding the deals substance without good reasons, so parties can have had no good reason to prevent themselves from changing their minds regarding the deals substance. 1995, Ewan McKendrick, Editor). The over-investment problem therefore exists because information is asymmetric. That in turn means a substantial increase in transaction costs. This goal, however, cannot support many of the mandatory rules that today govern much contracting behavior between firms. doi: 10.26054/0D1ZXD4E33. The parties course of performance under a contract differs from evidence in the other evidential categories because it can be offered not only to show what the parties originally meant, but also to prove that the parties meaning had changed. On the other hand, a contract likely is written in party talk if one party gave to the other a written unconditional option to buy all of the stock in the grantors company at a stated price by a stated date, but the parties meant unconditional to mean conditional. However, nonlegal incentives can be ineffective in larger markets and in countries where social trust is low. Home | By way of contrast, socio-legal scholars have sought to put law firmly in its social, political and economic contexts. It is a firms systematic decisions that may affect third parties in material ways. The $60 price therefore gives the buyer a gain of $80 $60 = $20, and it gives the seller a gain of $60 $50 = $10. 1261 (1981), 2 The problems that pluralist theories without meta norms pose are nicely illustrated in Melvin Eisenbergs effort, that purports to solve the broad scope of contract problem by proposing overlapping sets of norms. The minor premises are the facts of the case. xWnF}W# $_ -mHm(&WT(*/KBJ9gVLaTWU7|: #zH[=Vi !f^27`S}.hYx7K)"m$@-c` H%"gQ*G>/I< The state, that is, should let the preferences of firms control because firms can better pursue the objective that both the state and firms share. In some states of the world, the sellers cost to produce the specialized product will be lower than the buyers valuation, as in the original example, well known overinvestment problem.122 The buyers damages if the seller breaches will be the difference between its realized valuation and the price. 209 (2000). Rather, the Restatement of Contracts and Article 2 of the UCC primarily contain standards. If the parties agree to produce the specialized version, they will bargain over how to divide the expected surplus. 847, 853-56 (2000), A typical statement of the parol evidence rule provides that when terms are set forth in a writing intended by the parties as a final expression of their agreement, the terms may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented by course of performance, course of dealing, or usage of trade.86 This rule comes in a hard and a soft version. 32The buyer earns its valuation less the price, which must equal its payoff from bargaining. The oldest theory by far is generally known in the literature as "formalism.". 29 0 obj at 60-61. is. The law of duress applies in two contexts. For discussion, see Seana V. Shiffrin, Paternalism, Unconscionability Doctrine and Accomodation, 29 Philosophy & Public Affairs 205 (2000). This criterion is difficult to meet even for ancient standards, such as those governing excuse, that have generated extensive, and largely inconclusive, litigation. 1998). Parties Must Accept Substantial Performance, Courts will generally require parties to accept substantial rather than full performance unless, in the courts view, the deviation is material.137 Parties sometimes try to opt out of this substantial performance default by making full performance an express condition of the promisees duty to pay. legal formalism A theory that legal rules stand separate from other social and political institutions. An erroneous decision could expose one or the other party to a damage judgment. The accuracy of this assumption recently has been challenged. > These objections should trouble a unitary efficiency approach to the regulation of all contract types, but we will argue that the objections have little force when Category 1 contracts alone are considered. The law will excuse only when the sellers inability to perform resulted from causes that were difficult to anticipate and prevent. The buyer cannot later claim that it was coerced to accept a price increase because, ex ante, this buyer would have wanted the court to enforce a modification that would leave it better off than performance under the original contract would have done. Formalism has been called an "autonomous discipline," in reference to the formalist belief that judges require only the facts and the law, all normative issues such as morality or politics being irrelevant. Because standards permit parties much latitude (the seller must deliver in a reasonable time), a good standard will confer discretion only when a partys likely actions under it will maximize joint rather than individual gains. A buyers ability itself to take precautions or to insure efficiently also may differ across buyers. Thus, it likely would not be cost justified to create a publically supplied rule if the rule had to contain directions for parties in many possible future states. Further, firms are more able than courts or statutory drafters at choosing efficient terms and strategies. See Alan Schwartz, Karl Llewellyn and the Origins of Contract Theory in THE JURISPRUDENTIAL FOUNDATIONS OF CORPORATE AND COMMERCIAL LAW __ (J. S. Kraus and S. D. Walt, eds., 2000). The doctrine of mistake is a grounds for setting aside a contract, the term . test.117 As evidence for this view, the customary product warranty for machines contracts out of the quality standard (2-314), In sum, the project of creating default rules founders on the costs of rule creation for heterogenous parties that function in complex commercial environments. The set of possible causes of a sellers incapacity to perform can be large, ranging from fire or flood, to a temporary or permanent supply shortage, to a government regulation, and so on. But then the owner will know that the contracts penultimate performance will be the final one, and it will cheat then. When evidence is expected to be less productive, parties will be less inclined to have courts make interpretations on a broad evidentiary base. I have chosen his theory rather than the more recent and in some ways more refined writings of Raz, because Now assume that each partys share in the contracting surplus ($100 $80) is fixed in advance at one half each. > The more patient bargainer will reject offers it dislikes to wait for more favorable offers, while the less patient bargainer will accept relatively unfavorable offers just to get a deal.21 The second factor is each partys disagreement point. 349 (1981). There are other reasons for using courts, such as the ability to get discovery, to have appeals, to have the substantive law applied by experts in it, to create effective precedents and the like. Contract Law Minimalism advances the thesis that commercial parties prefer a minimalist law that sets out to enforce what they have. Oil, Inc. v. Consolidated Edison Co. of New York, 457 N.Y.S. This negative view of formalism is widespread in American legal culture, and has been particularly influential in contract law. The renegotiated contract, however, would be a product of ex post duress. In this literature, some individuals act in experiments as if they have a taste for fairness, while other individuals behave only out of self interest. Demand for the product turns out to be higher than the parties initially believed: it becomes efficient to trade 50 units. The rule also is simple in form: the seller is excused or not, depending on whether there was a fire or not. The linguistic default that supposes parties to be writing majority talk thus would reduce strategic behavior more effectively than the rules in the comments to todays Uniform Commercial Code. These gaps are unsurprising given the traditional definition of contract as embracing all promises that the law will enforce. Since the buyers gross valuation is $120, one third of the time a purchase of the goods would contribute nothing toward the buyers fixed obligations. 73Some scholars argue that if courts are Willistonian, and thus implicitly adopt majority talk as the linguistic default, parties will incur additional drafting costs translating their private language into the majority language in order to make their intentions clear to judicial interpreters. The unreliability of renegotiation promises coerced by duress reduces the incentive to extract them (that is, to behave as did the buyer in our example). Cookie Settings. 113An interesting summary of the effect in England of adopting an excuse standard is given by an English lawyer (Andrew Rogers, QC) in his introduction to a book on the excuse doctrine: It is only in relatively recent times that the English courts relented in their demand that the strict words of the contract be adhered to, notwithstanding changes in circumstances. 3In a thoughtful critique of autonomy and efficiency theories of contract, Michael Trebilcock concludes that both theory types are valid in their own right, but without a meta-theory that weights and ranks these various values, both values should be pursued in various social contexts according to the relative competency of different legal institutions to perform effectively. 47Most autonomy-based theories are premised either on a notion of consent or the exercise of will, such as the making of a promise. 101See Charles J. Goetz and Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Interactions Between Express and Implied Contract Terms, 73 Cal. The seller also can produce a specialized version of the product for buyers who are willing to pay the extra cost. endobj This is the theory we all learned in law school, according to which every decision turns on four factors, each completely extrinsic to the background and ideology of the individual judge: (1) the case record on appeal; (2) the applicable law; (3) controlling . To illustrate this claim, recall that todays interpretation rules are justifiable if the laws goal is to discern the parties intentions regarding the contracts terms, but the rules are not justifiable if the laws goal is to follow the parties preferences regarding judicial interpretive styles. Distributional effects are an appropriate state concern, but there are several reasons why commercial contract rules seldom could create systematic distributional benefits for particular classes of parties. The two linguistic defaults at issue now can be reconsidered in light of this analysis. The overall socially optimal outcome might, instead, be achieved through a decision procedure that directs judges to decide by applying pre-existing doctrine and expanding it incrementally. 29See Janet Landa, A Theory of the Ethnically Homogenous Middleman Group: An Institutional Alternative to Contract Law, 10 J. The structure of the payoff invariant case creates the possibility that a party will incur a large loss because of a small judicial error. 1975). The members of M read and write what we call majority talk because it is the language that people typically use when attempting to communicate with each other. Fine collection of clarets for sale. 13Consider the Restatements definition of consideration [in 75] taken in connection with its most celebrated section, 90 (promissory estoppel)One thing that is clear is that these two contradictory propositions cannot live comfortably together: in the end one must swallow the other up. Id. Hence, a disappointed party may plausibly claim that the parties course of dealing or their oral negotiations showed that, in the parties. Since perfection is difficult to achieve, the builder will expect not to receive the final payment. Reputations, therefore, are difficult to establish in large economies in which particular contracting parties often are anonymous to most market participants. L. Rev. There are two justifications for the goal of finding the correct answer. Then there would need to be as many legal rules as there are sets of contracting parties. The case in which the parties payoffs are invariant to the degree of judicial error probably is less common. Against the common assumption, the answer is that a formalist approach - the specific contours of which are set out below - would be instrumentally best. The satisfaction of this preference thus requires legal rules that maximize surplus across firms. Potential investors would not deal unless the host country or local firm could make credible promises to adhere to the terms originally agreed upon rather than renegotiate those terms after investments had been made. J. Thus, any contract would have to guarantee the buyer $10 and the seller at least zero. typescript cheat sheet github. <>1]/P 6 0 R/Pg 39 0 R/S/Link>> Broad evidentiary bases also increase the risk of judicial error and truncate the set of efficient contracts parties can write. 39Using our illustrative numbers, E(Gk) = a($120 $120) + a($120 $100) + a($120 $80) = $20. 57 (1999). 374, 650 P.2d 1080 (1982). Parties with high discount rates thus are impatient bargainers: they want their share of the surplus now. To a lesser extent, it also serves as a substitute for the notoriously ineffective Russian courts., Actual numbers might make this story a little more concrete. See Bernstein, supra note, The debate between textualists and contextualists is irrelevant to issues of interpretation for cases that resemble the performance preparation illustration. & Org. First, we let the sellers costs be stochastic. For our second example, return to the relation specific investment model set out above. To see why, assume that the contract was made as described. The moral hazard difficulty is exacerbated by the presence of asymmetric information. Courts cannot conduct investigations into the efficiency properties of possible rules and rule combinations. Managers, however, have no incentive to degrade the quality of the contracts that they do write, Firms that attempt to maximize expected profits commonly do as well as their circumstances permit. It is often seen as a naive and unsophisticated approach to the adjudication of legal disputes. 98Since these rules are facilitative, courts should permit future parties to vary them. The employer did not create the employees low wealth, nor did the seller lure the buyer to the solitary spot. Normative theories that are grounded in a single norm such as autonomy or efficiency also have foundered over the heterogeneity of contractual contexts to which the theory is to apply.1 Pluralist theories attempt to respond to the difficulty that unitary, 1 See Michael Trebilcock, THE LIMITS OF FREEDOM OF CONTRACT (1993). 57In a well known case, Justice Traynor thus stated: The fact that the terms of an instrument appear clear to a judge does not preclude the possibility that the parties chose the language of the instrument to express different terms.
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