Theresa Arnold, Amanda Gray Dixon, Hadar Tanne, Madison Sherrill and G. Mitu Gulati, 'Lipstick on a Pig': Specific Performance Clauses in Action
, __ Wisconsin L.R. __ (forthcoming, 2020), available at SSRN.
“Lipstick on a Pig”: Specific Performance Clauses in Action, forthcoming in the Wisconsin Law Review, is a good example of how to pack a deep insight into a short essay. The authors—Theresa Arnold, Amanda Dixon, Hadar Tanne, Madison Sherrill and Mitu Gulati—have made a real contribution. That they were able to do so about an old topic—damages or injunctions in contract law—illustrates the continuing value of the Wisconsin-school tradition of looking at real contracts to teach us something about the state of doctrine.
As readers will be well-aware, we teach specific performance as a disfavored remedy, available rarely outside of the unique goods and real estate contexts. But, as the authors cogently show, this is a puzzle: the damages preference is both comparatively exceptional and theoretically hard to defend. It’s also hard to know if it’s a majoritarian default. The existing literature on the prevalence of specific performance opt-in clauses in contracts is sparse, being limited to Eisenberg and Miller’s (2015) finding that lawyers drafted specific performance clauses in around 50% of a small sample of M&A clauses from 2002.
The author extend the Eisenberg and Miller analysis significantly. They hand-collect and code 1000 contracts from 2010-2019, randomly selected from the universe contained in the What’s Market database on Westlaw set of deals from that time period, while balancing public deals and deals where at least one party was privately held.
Their empirical finding is striking: 85% of all deals contracted into specific performance. That number has increased slightly over the time period (particularly for private deals, where only 3 in 4 in in 2010 had such a clause but now greater than 9 in 10 do). The authors slice at this data in various ways (including the sort of deal, and rationale) without finding a particularly striking difference. Overall, sophisticated lawyers overwhelmingly prefer to contract into specific performance for breach of M&A deals.
The question is why? To begin to find out, the authors asked practitioners. As in previous work, these seasoned lawyers told stories. As one pointed out, when asked if what we’re teaching in the 1L classroom is “wrong”:
I would not say that it is wrong. The law does prefer money damages. [But one learns how to get around that. To be granted the remedy] [o]ne has to pay homage to history, perform the right rituals. It is like saying at the front of contract that the parties acknowledge that there has been “full and adequate consideration.” You are in the south, so you know the expression “putting lipstick on a pig.”
The lawyers discussed the need for specific performance in light of the deal synergies. But, when pressed, their real concern was that that judges would not be comfortable with the kind of damage numbers that a broken M&A transaction would entail—simply put, damages would never make them whole. Finally, many asserted that “Delaware was different,” i.e., both thinking that the state’s Chancery Court was open to enforcing specific performance, and the deals were likely to be litigated there.
Interestingly, Delaware’s distinct approach is new: it appears to date from a 2001 opinion from then Vice Chancellor Leo Strine in the IBP/Tyson Merger. Both in the case, and in a series of talks given to M&A audiences afterwards, Strine welcomed the sellers and buyers alike to draft specific performance opt-ins, promising their swift enforcement in the Chancery Court. The authors posit that this welcome spurred adoption of clauses, which were thus revealed to be what practitioners wanted all along.
As the authors point out, the movement in Delaware (and, more slowly, New York) toward permitting specific performance in this important class of “service contracts” has implications for how we teach and think about remedies in contract law.
First, if it’s true that specific performance isn’t limited in practice to “unique goods” and “real estate” but rather is the preferred—and awarded—remedy in other classes of contract, we should ask some hard questions of what we teach in the 1L classroom. Rather than thinking of specific performance as a rare doctrine, we might want to consider if it is not, in fact, the rule in a large swath of litigated cases. And why not? Psychological research strongly suggests this is what even naïve parties prefer. The result would be that contract casebook authors should take more affirmative steps to find examples of the award of specific performance outside of the highly sentimental good cases one often sees.
We might also want to work on buttressing practice with a theory. One thing to note about the M&A context is that the request for specific performance is made against a firm. As VC Strine pointed out in IBP, though it’s true that normally injunctions create monitoring concerns, firms can simply fire workers who don’t like the order. In future work the authors might consider exploring the implications of this concept more generally. Might we consider limiting the preference against specific performance for services contracts to those with natural parties? Or is there something distinctive about the M&A context?
The authors only gesture at these ideas, but what they’ve given us, in a short and highly readable piece, is enough.
Cite as: David Hoffman, Folk Wisdom about Remedies
(April 21, 2021) (reviewing Theresa Arnold, Amanda Gray Dixon, Hadar Tanne, Madison Sherrill and G. Mitu Gulati, 'Lipstick on a Pig': Specific Performance Clauses in Action
, __ Wisconsin L.R. __ (forthcoming, 2020), available at SSRN), https://contracts.jotwell.com/folk-wisdom-about-remedies/
John Linarelli, Advanced Artificial Intelligence and Contract
, 24 UNIF. L. REV.
330 (2019), available at SSRN
Contracts and contracting have changed dramatically in the past fifty years. We have moved from negotiated paper contracts to standard form contracts to digital contracts presented in various ways. The next fifty years promises even more dramatic changes, and not just to the form of contracts. Technological innovation and marketplace needs will undoubtedly disrupt contracting in ways that don’t exist today. John Linarelli’s article Advanced Artificial Intelligence and Contract addresses one of the biggest anticipated disruptions – a not-quite human contracting party. In this article, Linarelli asks the provocative question, “How might contract law adapt to a situation in which at least one of the contract parties could, from the standpoint of a capacity to engage in promising and exchange, be an AGI?”
Linarelli states that artificial intelligence will bring about transformational changes in the law. He uses the term “artificial general intelligence” or “AGI” to refer to an advanced form of artificial intelligence which has a cognitive architecture of its own, unlike the artificial intelligence that currently exists. He invites us to consider the “feasibility of investing an AGI, from a legal point of view, with the power to enter into contracts, either with humans or other AGIs.”
By referring to AGI as a contracting party, Linarelli is not talking about as an agent for a human, nor is he talking about “smart contracts” which he states is “not a legal concept” and which is simply a substitution of “algorithms for human contract performance and enforcement.” In his words, “(t)he difference between contracting with or by an AGI and smart (or algorithmic) contracts is that human or legal persons in the form of entities such as corporations are the actual parties to smart contracts, whereas contracts with AGIs involve at least one contract party that is neither a human nor a currently recognized legal person such as a corporation, limited liability company, or partnership.” (P. 333-34.)
So should the law grant AGIs legal status with all the rights and obligations that such a designation confers? And how should contract law respond to AGIs as potential contracting parties?
The issues pertaining to the first question have been discussed before in the context of limited liability firms, such as corporations. As Linarelli notes, “(a)n artificial person with limited liability, however, still must operate through human agents” unlike the AGIs that he is anticipating which would operate independently of humans. Linarelli argues that AGIs should be granted legal status as contracting parties only when AGIs develop the cognitive architecture that humans possess. His rationale is simply that “(c)ontract law exists to meet human needs in human societies for voluntary exchange.” (P. 343.) Accordingly, AGIs should exhibit a “sufficient level of mutuality in terms of autonomy, interaction, and adaptability” before granting them contract rights and liabilities otherwise “cooperation with humans will fail.” (P. 343.) Thus, he makes a simple yet profound observation — that one of the primary societal benefits of contract law is to encourage cooperative activity — and cautions that to recognize a contracting party without the relevant human qualities poses serious risks to society: “Worse, an alien system of AGI values and cognitive abilities, based on norms humans do not understand and cannot reasonably accept, may be considered by humans to be harmful or pernicious or may cause harm to humans.” (P. 343.) (Of course, one could argue that by recognizing limited liability entities as contracting parties, we have done just that….) Linarelli notes, “It will be difficult for AGI to engage in contracting or to be subject to contract law if it cannot interact with humans since humans have evolved to interact and to be regulated by institutions that humans have constructed to reflect the intentions they hold in common.” (P. 342.) Thus, before we recognize AGIs as contracting agents, they should exhibit cognitive capabilities that are human-like as it will be “far more practical to align their cognition to contract law and values it represents than to change contract law and the humans who invented it.”
But are those values reflected in modern contract doctrine? While the “smarter-than-us” AI scenario is what tends to capture the public imagination and terrify entrepreneurs like Elon Musk, it is the second question – how should contract law respond to AGIs as a contracting party? — that is perhaps more intriguing to contracts scholars. Linarelli notes that the objective theory of contracts “coincides closely to the Turing test for assessing whether AI exists” and therefore, may “at least partly, and with some adaptation…answer the question of how to treat an AGI as a contract party.” (P. 334.) The objective of the Turing test is to determine whether a human interrogator can distinguish the answers given by a machine from those given by a human. The Turing test may be useful for “weak AI” but in order to qualify as “strong AI,” the machine must also “simulate thinking and intentions.” (P. 335.) Linarelli observes that contract law, however, would be satisfied with weak AI: “Weak AI is sufficient for the purposes of determining whether an AGI could be a party to a contract in terms of understanding the question as one that is internal to contract law…The Turing test has been effectively embedded into Anglo-American contract law in the objective theory of contract.” (P. 336.) In other words, contracts and contract law — capitalism’s vaunted tools of autonomy — require very little of contracting parties; they require only outward appearances regardless of mental states: “The objective theory of contract tells us that the intention to be bound to, or form, a contract is determined by evidence external to the actual intentions of the parties.” (P. 336.)
Linarelli isn’t the only scholar to point out the ways that contract law seems to permit – even encourage – automated, mechanical behavior from contracting parties. Notably, Brett Frischmann and Evan Selinger questioned the way that wrap contracts and in particular, clickwraps, have conditioned humans to act like machines. But Linarelli’s questions are directed more pointedly to contracts scholars who may not have considered the way technology changes contract law – and the way that contract law alters our expectations and standards for human and human-like behavior.
First year teachers of common law subjects describe the common law system with a little bit of romanticism. Through the aggregation of many court opinions, and through learning from variant approaches in different states’ jurisdictions, a process of reflective equilibrium finds legal rules that make sense as applied to diverse fact patterns and that reflect ongoing changes in technology and social mores. The status of each state’s supreme court as the final arbiter of questions of common law features keenly in Louis Brandeis’s oft-quoted characterization of the states as “laboratories of democracy.” Writing with Samuel Warren, Louis Brandeis famously declared that “the common law, in its eternal youth, grows to meet the new demands of society.”
As Samuel Issacharoff and Florencia Marotta-Wurgler’s important new paper The Hollowed Out Common Law shows, changes in procedure and surrounding law have caused the common law of contracts not to function as it has in the past. Specifically, they argue that there has been a dearth of doctrinal elaboration and robustness in the burgeoning domain of online contracting over the past three decades. They document several shifts in law and legal practice that has led to the decline in number and refinement of analysis in these consumer contracting cases. As Brandeis’s comments show, the pressure on common law judges to develop doctrine comes from contrasting apex state supreme court opinions, and the consideration of a variety of novel fact patterns by all courts. Yet Issacharoff and Marotta-Wurgler’s study shows two shifts against the creation of a robust common law of contracts (1) state supreme courts are no longer the dominant voice in consumer contract law and (2) a depressed number of consumer contract cases are decided on their merits before any court. I will address their contributions on each of these points in turn.
Through an empirical study of cases from 1954 to 2016, the authors show that most consumer contract cases are being heard in federal courts and that federal circuit court opinions have stronger influence than other courts. They show that the dominance of federal courts as forums for state law claims has steadily increased over time. A concomitant trend they document is the rise of class action in consumer contract cases, and the role of the Class Action Fairness Act of 2005 in pushing most class actions into federal court. The statistics here show a striking shift. Before 2000, class actions composed less than 20 percent of the consumer contract cases adjudicated in federal court. Yet the post-2000 data shows that class actions make up 60 percent of consumer contract cases in federal court. The result has been that the leaders in contract law innovation in the information era—such that they are—are courts that do not even have the power to create new state common law. Despite their persuasive influence, such cases are as a technical matter one-off developments, with no binding effect on other courts. Yet the common law lacks robustness for another, more meaningful reason besides the lack of definitive doctrinal statements from state supreme courts: an insufficient amount of cases that reach the merits.
With the blessing of federal legislation and courts, over the past three decades there has been a rise of contract terms that take the adjudication of individual disputes out of the sight of courts altogether. Arbitration and anti-aggregation clauses have been enforced by courts, leading to the resolution of many cases outside of public observation and precedent. While the parties involved may save money in resolving disputes through such terms, decades of removing most consumer disputes to the private sphere retards the law’s understanding of contemporary issues in consumer contracting. This results in a collective loss to every actor, even though the costs of litigating an uncertain legal matter are expensive and undesired by parties. Issacharoff and Marotta-Wurgler explain “decisional law generates a public good, even though private parties have no reason to want to invest in its creation. …[P]arties are likely to be unable to settle and find themselves in litigation when legal claims are uncertain. The testing of boundaries of legal norms under conditions of uncertainty prompts the creation of additional positive law that, in turn, helps avoid costly litigation by future disputants. .” At a certain point, some actor needs to spend the money to figure out how law should apply to innovative forms of social organizing. Arbitration and aggregation clauses have allowed private actors to avoid footing the bill, but legislatures have not stepped up to provide guidance, either.
With no disputes between state courts to provoke conflicting approaches within jurisdictions, and an overall lack of cases to introduce new fact patterns to the case law, there has been dominance in consumer contracts of a handful of cases based largely on the prestige of the court or individual author with little serious contestation, analysis or willingness to adapt to new fact patterns by courts using the cases as persuasive authority. Issacharoff and Marotta-Wurgler seek not to contest the quality of these influential opinions but to observe that as a matter of procedure these leading cases were not subject to the same ongoing process of vetting and contestation as leading cases of yore.
Issacharoff and Marotta-Wurgler show that there is arrested development in the doctrine of consumer contracts due to legal developments outside the law of contracts. There is a natural corollary to this analysis in the specific context of the information age. The absence of court opinions on consumer contract law has lent an artificial youthful ambiguity to governing the information age. The common law is not just about determining rules of law, it is about the fact pattern and analysis that leads to the rule, and that it is a public, ongoing conversation that others in society can listen to.
The notion of the internet as an ungovernable frontier full of infant industries that need protection from lawsuits may have made sense in the mid-1990s, but the landscape has shifted considerably since then. The common law’s loss of elasticity and ability to develop due to the shifts Issacharoff and Marotta-Wurgler describe has led to a characterization of information age technology and business practices as permanently brand new and uncharted.
One does not have to be a common law lawyer to be concerned about the hollowing out of the common law. Common law and statutory law have a mutually reinforcing relationship to one another. When disputes are resolved at common law, it brings the attention of legislatures to new types of conflicts and gives them material to use to determine whether statutory law should reinforce the common law rule, alter the common law rule, or even take the matter out of the common law to be codified statutorily. The common law translates disputes in society into legal language that can then be applied by legislatures and stakeholders to predict how the law can and should apply to new forms of socio-economic ordering.
The information age has reached childhood’s end, yet due to the procedural hurdles to bringing disputes in consumer contract law, courts and legislators still discuss the field as if it is in its infancy. The common law process has traditionally helped society to understand the law’s effect on new phenomena, yet it has been hollowed out at a key inflection point in American history.
In this article, Jeffrey Harrison addresses the very real problem of contract law’s capacity to control wrongful conduct that deprives individuals of a meaningful ability to withhold consent. Specifically, for certain types of duress and undue influence, the remedies available under contract incentivize wrongful conduct against an apparently weaker party. Professor Harrison provides an insightful analysis of the situations in which contract promotes such absurd results and makes a convincing argument in favor of treating certain types of duress and undue influence as an independent tort in order to access the deterrence value of punitive damages.
Duress and undue influence are problematic for contract law in the sense that both defenses attempt to address the fundamental basis of contract in voluntary consent of both parties to the proposed bargain. Where there is no consent, there can be no contract.
Both duress and undue influence involve exploitation of another’s ability to withhold consent. In some situations, the apparently stronger party merely takes advantage of a difficult situation in which a weaker party finds itself. These situations–described as “pure advantage taking”–are not caused by the stronger party, but rather are the result of extrinsic factors that place the apparently weaker party in a position subject to advantage-taking by others. Although Harrison considers pure advantage-taking problematic, particularly where the advantage-taker knows or has reason to know of and deliberately exploits the vulnerability, the Article focuses on the more important issue of “active advantage-taking.” In the context of duress and undue influence, the active advantage-taking scenario involves the apparently stronger party creates the vulnerability in the apparently weaker party. Harrison argues that with respect to active advantage-taking, “illegitimate pressure alone is a harm that should be addressed regardless of” whether the apparently weaker party successfully resists the pressure. (P. 971.)
This approach would essentially create an independent tort out of duress and undue influence. In some ways, an independent tort is intuitive. In cases of duress, for example, Restatement (2d) of Contracts § 176(1) lists four situations in which a threat leading to duress is improper regardless of whether the resulting agreement is on fair terms: (1) threats to commit a crime or a tort, (2) threats of criminal prosecution, (3) threats of bad faith use of civil process, and (4) threats that breach the duty of good faith and fair dealing. The first three categories are clearly wrongful acts independent of contract law and, to the extent they harm the threatened party, may be actionable in tort or prosecuted as crimes in themselves. For these types of threats, the jump to an independent cause of action in tort seems odd only in that it has not been accepted by courts.
On the other hand, other improper threats, such as a threat that breaches the duty of good faith and fair dealing or the improper threats listed under § 176(2) such as those that would harm the recipient but would not significantly benefit the maker, do not in themselves constitute wrongful actions that would traditionally be recognized in tort. Likewise, the defense of undue influence may involve independent torts such as a breach of fiduciary duty by a fiduciary that unfairly persuades a beneficiary. But most undue influence situations do not involve fiduciary breaches. Rather, undue influence covers all a wide range of situations involving unfair persuasion by a dominant party over another in a relationship where the weaker party is justified in assuming that the dominant party will not act in a manner inconsistent with the weaker party’s welfare. (Restatement (2d) Contracts § 177(1).)
Harrison deals with this issue by creatively changing the focus of the inquiry to address the problem from two different angles. First, Harrison makes an important argument from consequence–under the current approach to duress and undue influence in the active advantage-taking scenario, the expected value of engaging in duress and undue influence to attempt to force weaker parties into disadvantageous contracts is positive. Contract law recognizes duress and undue influence only as defenses that render the contract void or voidable at the election of the party asserting the defense. The remedy for the weaker party is the power to avoid the unfair contract (if the weaker party elects to do so) and obtain restitution. This means that contract law actually incentivizes stronger parties to engage in duress and undue influence because not all disadvantaged parties will sue, legal expenses and other transaction costs will reduce the value of any recovery to restitution, and even if the stronger party must pay restitution there is no cost beyond giving back what it received from the deal. Because the expected value of duress and undue influence is net positive, stronger parties–particularly repeat players–will have strong incentives to engage in active advantage-taking.
Second, Harrison argues that duress and undue influence in active advantage-taking situations should be independent torts because victims of such actions do suffer real stress and real physical impacts as a result of “cognitive trespass” by the stronger party. As Harrison notes, “[t]his evidence leads us to question why contract law permits, and arguably encourages, the imposition of stress by those who make threats or unduly influence contracting partners.” (P. 988.)
The Article recognizes that many questions remain. The most significant is the difficulty of measuring damages in tort, although Harrison argues the value of the independent torts may lie in the availability of punitive damages against repeat bad actors. Similarly, Harrison observes that allowing victims who choose to keep their contracts to nonetheless sue for tort damages may raise moral hazard issues. While many such questions exist, the Article nonetheless takes a creative look at the very real harms caused to victims as a result of others’ legally or morally wrongful acts that attempt to induce duress and undue influence and is an important starting point for further investigation.
Jonathan F. Harris, Unconscionability in Contracting for Worker Training
, 72 Ala. L. Rev.
__ (forthcoming, 2021), available at SSRN
During the 2020 coronavirus pandemic, many firms turned to remote and computer assisted arrangements to get work done remotely and safely. During the summer, however, jobless claims rose as the economy took a downturn. These economic pressures have driven many workers to seek job training or even re-training to protect themselves from the worst of the recession. Out of desperation, some workers are turning to code academies or bootcamps to learn new skills, while existing employers have in some instances started charging workers for the cost of new training.
In his forthcoming article, Unconscionability in Contracting for Worker Training, Jonathan Harris explores the contractual issues that arise when workers or job applicants are asked to pay for their training outside of traditional educational structures. This could arise through a training repayment agreement (TRA), which requires an existing employee to repay the employer a fixed sum expended on training if the worker quits or is fired during a set period of time. This Jot, however, will focus on the other setting in which these non-traditional training arrangements are arising, and which Harris discusses at some length in the second part of his article. These are the so-called Income Sharing Agreements (ISAs), which for-profit code academies use. ISAs are contracts that require the trainee to repay a set percentage of future income in exchange for the tuition that enables them to attend a computer coding academy or bootcamp.
While at first glance this may seem like an positive career opportunity to many blue collar or displaced service industry workers, these arrangements have the potential to become exploitative. Harris’s article provides insights into these novel arrangements and he suggests using the lens of unconscionability to analyze both TRAs and ISAs.
Delving deeper into the issue, Harris notes that many coding programs last between three months and one year, but they do not offer a formal degree in computer science. Some target lower-income populations or youth from communities of color. These coding programs may bill themselves as “free upfront,” but as they take a percentage of future income, that may be misleading to jobseekers. Harris notes that the terms of the ISAs vary, but some require between six and seventeen percent of income for a period of three to ten years of employment.
Coding bootcamps largely aim their appeal to blue collar and service workers who look to them as a path toward a well-paying job, income stability, and upward mobility. What these trainees might find, however, is not always what is promised. Because these code academies are new, and they are for profit businesses, quality may also vary widely. The financing structure may be opaque and misleading. Harris provides one example of a bootcamp that takes future earnings of $30,600 that would typically cost a few thousand if paid upfront. While some trainees may receive excellent hands on training in coding, other students may find themselves watching publicly available videos on YouTube and be asked to cobble together their own learning. Still others may find that employers want degrees, not bootcamps, and that they are saddled with high debts. The concern is that these kinds of debts set up the modern equivalent of the debt-peonage system.
This is where Jonathan Harris’s unconscionability analysis comes into play. While ISAs are yet too new for analysis from courts, Harris describes some key factors to finding an ISA unconscionable, for example: How large is the repayment amount compared to the trainee’s future salary; whether the income threshold for repayment is relatively high; whether the debt can be discharged in bankruptcy; and whether provisions exist for disability or other situations the trainee may face. These are all elements that Harris correctly suggests should be part of any unconscionability analysis of ISAs.
But what of student loan debt, which bears a similar resemblance in that it puts the burden of training all on the student? Harris notes that while student loan debt may be an ongoing problem, at least it is quantifiable, whereas with ISAs, the amount owed is often opaque and it makes it very difficult for the trainee to understand how much their program is worth to them in future earnings and what they will eventually owe. Finally, the article ends with Harris discussing a tripartite solution (workers/unions, employers, and government) working together to put training programs in place that will assist not only the workers and employers who need skills, but also make sure that society benefits from that training and those skills.
Ultimately, in Contracting for Worker Training, Jonathan Harris shines a light on novel TRA and ISA contracts. ISA contracts could help some workers upgrade their skills. Unfortunately, as Harris notes, the ISAs could also take advantage of anxious jobseekers. Harris’s article is an illuminating and worthwhile read for those interested in the future of work and a novel application of the unconscionability doctrine.
David A. Hoffman and Cathy Hwang, The Social Cost of Contract
, __ Columbia L. Rev.
__ (forthcoming), available at SSRN
Almost ninety years ago, Morris Cohen taught us that the primary role of contract law is to place the enforcement mechanism of the state at the service of one party against the other (Cohen 1933, Pp. 585–86; see also Zamir 1997, Pp. 1777–78). Since enforcement of contracts entails the exercise of governmental powers and the use of public resources, contract law (like the rest of private law) is part of public law. This means that whatever the role played by freedom of contract, it cannot be the only principle that motivates the law. Contract law inevitably reflects public concerns, as well. Most obviously, it follows that whenever a contract creates substantial negative externalities—that is, whenever it adversely affects the well-being of other people—there are prima-facie grounds for curtailing freedom of contract (Zamir & Ayres 2020, Sec. 1.A). Examples of doctrines that serve this goal include the rules concerning illegal contracts, contracts against public policy, and various other mandatory rules.
As in past epidemics, COVID-19 creates situations in which the performance of contracts might adversely affect the public at large. These include contracts pertaining to events with many participants—such as weddings, funerals, and conferences—which may turn into super-spreading events. It also includes more mundane contracts, such as between universities and students, since attending ordinary classes may also result in spreading the disease. Performing such contracts may or may not be forbidden by law. Either way, one of the parties (typically, but not invariably, the customer) may wish to back out of it—in which case a legal dispute may arise. How should such disputes be resolved? What should we advise the parties to do in such circumstances? These questions lie at the heart of David Hoffman’s and Cathy Hwang’s highly recommended article, The Social Cost of Contract.
The article consists of three parts. Part I is more theoretical. It argues that since contracts often entail social costs, the public is involved in contracts, and bargaining is carried out in the shadow of the law. Specifically, the authors highlight three mechanisms by which the law intervenes in contractual relationships. First, there are transactions (such as the sale of illegal substances) that simply cannot be performed through legally enforceable contracts. Second, some transactions require the approval of regulators (such as mergers that require the approval of antitrust authorities)—which often results in actual negotiations between the parties and the regulator. Third, when contractual disputes reach the courts, they may also take into account the negative externalities of contracts as they interpret or reform them, decide about contractual defenses, or design remedies for breach. Even when courts do not make explicit reference to the doctrine of public policy, public concerns inform the courts’ decisions in such cases. As the authors conclude, the public always has the last word—through interpretation and enforcement of contracts in court.
I would extend this insightful analysis even further. According to Morris Cohen’s argument, any enforcement of a contract, whether it entails externalities or not, is a public matter. If so, the state must ask itself whether to use its coercive powers and spend its limited resources to enforce contracts, even when no externalities are involved. In fact, some of the examples discussed in the article—such as the unenforceability of liquidated damages in tenancies (P. 14) and the rules about mutual mistake (P. 17)—are not primarily about externalities. Moreover, the public is involved in any contractual issue not only through mandatory rules that render contractual obligations unenforceable, or through judicial reformation of contracts, but also in establishing default rules, imposing pre-contractual disclosure duties, and so forth.
It should also be emphasized, as the authors do, that the three mechanisms they describe are only examples. There are additional mechanisms that curtail freedom of contract ex ante (including judicial precedents and regulatory guidelines); regulatory agencies are involved not only in the design of specific contracts, but also in ex ante lawmaking and ex post enforcement; all institutions use a mixture of standards and rules, and employ civil, administrative and even criminal sanctions to handle contractual externalities; and so forth.
Part II of the article contains a nuanced analysis of various doctrines and precedents by which courts reform contracts that give rise to significant negative externalities. These include excuses for non-performance, creative interpretation, reformation, and more. Collectively, they are described as “an anti-canon: a set of disfavored and odd cases that result from extraordinary facts” (P. 20). An interesting aspect of the case law (which lies beyond the scope of the present article, but is worth exploring), is that courts often prefer to use circumventive means (such as interpretation) to reach a sensible outcome, rather than explicitly rely on doctrines such as impossibility or public policy. Such rhetoric enables courts to play down their active role in contractual matters. This inclination is closely related to broader issues of the tension between what Robert Hillman has called “contract lore,” and the realities of contracts and contract law (Hillman 2002; 2020).
The practical importance of the doctrinal analysis of Part II is highlighted in Part III. Here, the authors persuasively argue that, rather than follow simplistic advice based on the binding force of contracts, contracting parties should realize that the outcomes of litigation in disputes arising from the COVID-19 pandemic—especially when contracts involve considerable externalities—are far from certain. Courts can use a multiplicity of doctrines to arrive at different results, depending on variables such as “the parties’ relative fault, the actions and signaling by public health authorities, and the specificity of contract terms about risks” (P. 27). It follows, that parties “should be more willing to split the difference in COVID-19 contract cases than they would ordinarily be” (P. 34). Interestingly, similar advice—namely, to negotiate in good faith with a view to adapting contracts to the changed circumstances of the pandemic—has recently been given to contracting parties by the Israeli Inter-Ministerial Team for the Examination of the Effect of the Coronavirus on Contracts (July 7, 2020, in Hebrew).
Hopefully, the challenges to contract law posed by COVID-19 will soon be a thing of the past. But Hoffman’s and Hwang’s analysis will remain relevant and important in many other contexts.
Inherent in contractual defenses such as infancy and mental incapacity is the goal of protection. In the case of infancy, contract law seeks to protect underage minors from themselves and from opportunistic adults who may attempt to take advantage of their lack of experience and judgment when entering into contracts. Similar protection goals underlie the contractual defense of mental incapacity whereby individuals with a mental disability or illness may avoid a contract due to their inability to understand the transaction or act reasonably with regards to it. The defense is intended to benefit those with mental disabilities. However, as currently conceived, it may actually do more harm than good. Utilizing the Americans with Disabilities Act (“ADA”) and the Disability Rights Movement (“DRM”) as her guides, Dean Sean Scott explores this important issue in her recent thought-provoking article, Contractual Incapacity and the Americans with Disabilities Act.
Dean Scott begins her article with a discussion of Renchard v. Prince William Marine Sales, Inc. wherein a buyer of a yacht sought to avoid the purchase agreement and other contracts with the seller due to his alleged physical and mental disabilities. Although the buyer unsuccessfully attempted to amend his compliant to allege discrimination under the ADA, Dean Scott hypothesizes that sellers may impose heightened scrutiny and screening and avoid making contracts with certain individuals based on their fear of contract rescission or avoidance due to courts’ current application of the mental incapacity doctrine. In light of this possibility and the conflicting language and principles associated with contractual incapacity as compared to the ADA and the DRM, she argues “that the mental incapacity doctrine should yield to the DRM and the ADA” (P. 257) and that the doctrine “should be limited to people with mental disabilities who were subject to a plenary guardianship when they entered into the contract at issue.” (P. 255.)
In developing her thesis, Dean Scott engages in a thorough and interesting discussion of the historical evolution of the mental incapacity doctrine as well as the various standards for measuring incapacity. She explains how the doctrine has been influenced by the competing interests of protecting freedom of contract, certainty, and expectancy on one hand and the interests of individuals with a mental disability on the other. After a discussion of discrimination claims under Title III of the ADA, Dean Scott skillfully and convincingly makes the case that current conceptions of mental incapacity as a contractual defense fail to adequately protect either interest and, thus, should be amended to afford greater protection for both.
Central to Dean Scott’s argument is her contention that “[t]he mental incapacity doctrine supports the misperception that simply having a mental disability justifies restrictions on one’s rights and liberties, including the ability to enter into a binding contract.” (P. 269.) She argues that such misperceptions are rooted in, and reinforce, stereotypes and gender norms that are harmful to the Disability Rights Movement and invite “the very kind of judgment the ADA and disability rights advocates are trying to eliminate.” (P. 279.) She is also concerned that incapacity claims can lead to “disability drift” (P. 274) whereby a physical disability such as deafness is used to evidence a mental disability. According to Dean Scott, parties’ and courts’ reliance on such evidence to establish incapacity is predicated on demeaning myths and stereotypes that impede the DRM’s efforts to eliminate the stigma, discrimination, and other negative consequences that individuals with disabilities often experience.
According to the article, the mental incapacity doctrine runs counter to the values of the ADA and DRM because it calls for lay people rather than medical experts to make judgements and determinations about whether someone has a mental disability, which they are not qualified to do. Without a previous adjudication of incompetence in some other proceeding, Dean Scott fears that jurists and jurors will base such determinations on inaccurate assumptions, incorrect information, and misconceptions about mental illness and disability. This current contractual defense landscape harms the DRM and hinders its progress, which is why Dean Scott proposes restricting the availability of the mental incapacity defense only to “those who have been adjudicated incompetent and were subject to a plenary guardianship at the time they entered into the contract.” (P. 268.)
At first glance, Dean Scott’s proposal may seem to thwart rather than advance the goal of protecting individuals with mental disabilities. People with mental illnesses or disabilities at the time of contracting who do not meet her restrictive criteria would be unable to rely on the incapacity defense to avoid harmful or unfair contracts. Dean Scott acknowledges this and other potential consequences that could result from imposing a bright line rule such as limiting judicial discretion and pricing individuals out of protection due to the costs associated with establishing and managing a guardianship. However, she thoughtfully addresses these concerns and includes discussion of other contract defenses such as undue influence and unconscionability that may offer protections for individuals with mental disabilities who enter into unjust or abusive contracts. In so doing, she strengthens her argument for reforming the mental incapacity doctrine, particularly as it relates to the goal of encouraging contract formation by promoting certainty in contract enforcement.
Dean Scott suggests that current conceptions of the incapacity defense serve as a disincentive for parties to contract with persons with mental disabilities. She argues that “[a]ctual knowledge that the potential customer was not subject to a guardianship would remove incapacity as a disincentive to engage in the transaction, which would be a desirable result.” (P. 306.) Increasing parties’ certainty in enforcement would encourage them to enter into more contracts with individuals with disabilities, which would advance the ADA’s and the DRM’s important goal of more fully integrating people with mental illnesses and disabilities into society.
As Dean Scott recognizes, the ability and freedom to contract is vital for such societal integration. Entering into contracts allows individuals to obtain the goods and services they need to survive and thrive in society. It also instills in them and demonstrates to others their dignity, independence, respect, and recognition. Now, more than ever, it is imperative that our laws and practices reflect and encourage such values for everyone, especially for those who are members of marginalized communities. If they fail to do so and, thus, perpetuate harms, such laws and practices should be amended to help mitigate those harms. I greatly appreciate Dean Scott’s recognition of the need for such reforms in the context of contractual incapacity, and I applaud her for penning this excellent article advocating on behalf of individuals with mental disabilities and urging the law to “hear their demands, consider their perspectives, honor their values, and construct a rule accordingly.” (P. 318.) Hopefully, we all will heed their call.
Shmuel I. Becher & Sarah Dadush, Relationship as Product: Transacting in the Age of Loneliness
, __ U. Ill. L. Rev
. __ (forthcoming, 2021), available at SSRN
Articles on contract law contribute to our understanding of the subject in many different ways. Professors Becher and Dadush’s article, Relationship as Product: Transacting in the Age of Loneliness is a must read, not because it resolves a legal issue or presents a novel way of looking at a problem, but because it raises a red flag about business practices with consumers that requires attention. Becher and Dadush argue that businesses have new methods of taking advantage of consumers in contracts brought about in part by technological advances and the concomitant social isolation and loneliness of people in our 21st century society. The authors write that “[B]usinesses increasingly utilize big data, sophisticated technology, and psychological vulnerabilities to design and tailor highly personalized and emotionally charged messages. Such messages are meant to signal, and instill in consumers, a sense of mutuality, care, compassion, intimacy, love, and affection.” (P. 4.) And more: “The loneliness epidemic makes it easy for firms to succeed in offering deep relationships to consumers—and to profit from doing so.” (P. 25-26.)
According to Becher and Dadush, businesses seek to create caring social relationships with consumers, at least superficially, to benefit their bottom line. The authors call this strategy “relationship as product.” The authors worry that this businesses strategy exploits consumers, among other things, by lulling them into making emotional instead of rational decisions about their contracts. This culminates in consumers making unwanted purchases of goods and services that “undermine social trust and decrease overall well-being.” (P. 7.) Moreover, consumers resistant to “relationship as product” do not go unaffected: “Relationship as product may thus result in higher prices for goods and services for all consumers, not just those who fall for love promises.” (P. 44.)
The authors set forth numerous examples of “relationship as product.” For example,
A company sends an e-mail titled “A Love Note from Everyday Oil,” greeting its customers with “Hello to this beautiful community of people we love!” A telecom company greets a customer returning from a trip overseas with an unsolicited text message that simply says “Welcome home! We hope you had a safe trip.” An oil and gas company e-mails a customer, congratulating him on being “a great customer” and informing him that “we thought we’d return the favor” by offering a few cents discount on fuel. (P. 5.)
Relationship as Product: Transacting in the Age of Loneliness is well-documented and contains numerous insights, including a helpful discussion of the reasons for 21st Century isolation (which includes the amount of time we spend on our devices) and the manner in which businesses may exploit consumer cognitive biases. The article also usefully sets forth and develops the various stages of the business and consumer relationship that helps establish “relationship as product.”
Simply put, Stage 1 includes B2C communications and interactions up to the point at which a consumer decides to transact. Stage 2 encompasses the communications and interactions during the transaction itself. Stages 3 and 4 relate to interactions and communications between the parties once the transaction is completed . . . . (P. 16.)
Becher and Dadush recognize the need for more work that documents the effect on consumers of the business strategies they identify. In fact, the authors acknowledge that some of these business practices actually may benefit consumers. Consider another example reported by the authors:
In case you missed tomorrow’s local weather memo for the NY/Philadelphia area, it’s going to rain . . . and quite a lot we hear. This could easily put a damper on your travel plans. Wear your galoshes, remember your umbrella, and be sure to give yourself extra time getting to and from the airport tomorrow, August 7. If your travel plans are flexible, you may want to consider flying on a different day or connecting in a different city. The good news is that we’ll waive all the change fees. So, visit the United app or united.com to check out your options instead of holding for one of our busy call centers. Thank you for flying with us! (P. 21.)
Although Becher and Dadush seem troubled by this communication, it does not strike me as the kind of opportunism that cries out for regulation.
Another topical example of “relationship as product” identified by the authors is firms’ response to the Covid 19 epidemic.
Consider, for instance, the many firms that cancelled contracts with their consumers in the wake of Covid-19. Often, these firms asked consumers to accept a credit or a voucher rather than a refund, or to wait patiently for months to be refunded. Consumers who believe they share an emotional connection with these firms may be more tolerant of such requests and may not protest them. (P. 37.)
A good argument can be made, however, that these firms are suggesting a valid compromise of a problem currently vexing contract law, namely how to allocate the risk of the pandemic that has disrupted countless contracts across the globe.
Even assuming such communications are problematic, as Becher and Dadush suggest, lawmakers would face lots of additional challenges acknowledged by the authors. Isolating the potential problem does not mean there is a ready solution. The authors suggest reviewing whether contract law should relax the age-old distinction between “puffing” and promise or warranty. In addition, they worry about whether the “reasonable consumer” standard should be applied to this problem. The authors do not hide their sympathy for change here. But line drawing will be difficult. Should the already shifty car sales person be sanctioned for trying to establish a friendly rapport with the potential buyer? For that matter, what about the university president or dean meeting with potential donors?
Becher and Dadush sum up their concerns thusly: “By their nature, firms’ promises of love, intimacy and friendship are impossible to keep. As such, they are false.” (P. 46.) And further: “The law neglects to police this reality properly. It adopts a narrow and outdated view of B2C relationships and consumer behavior . . . . the law tends to assume that consumers can maximize their welfare and their well-being.” (P. 56.) Whether or not the reader agrees with their concerns and suggestions for reform, Relationship as Product: Transacting in the Age of Loneliness is food for thought that should not be ignored.
Theresa Arnold, Amanda Dixon, Madison Whalen, & Mitu Gulati, The Myth of Optimal Expectation Damages
, __ Marquette L. Rev. __ (forthcoming), available at SSRN
Everyone knows that the expectation measure is the standard, default measure of damages for a bargain contract, and for the last few decades most scholars have regarded the expectation measure as backed by weighty, straightforward justifications grounded on economic efficiency. But there are several reasons to doubt both of these general propositions, as the authors of The Myth of Optimal Expectation Damages nicely suggest and begin to demonstrate using empirical data from bond markets.
As doctrinal background, the expectation measure is not in fact as widely established as the default damages measure in contract law as many teachers of Contracts suppose. It’s true that it’s one standard measure, but the law uses other defaults in several important and often neglected contexts. For example, in many states, buyers of real estate don’t get expectation damages for breach by the seller unless the breach is in bad faith; instead, the buyer is often limited to reliance damages (and often quite a limited subset of reliance damages). Similarly, doctrines that are commonly regarded as non-remedial, like doctrines of mistake, increasingly lead to remedies other than expectation damages.
As economic background, the standard instrumental justification for expectation damages is, on reflection, surprisingly circular. Expectation damages are treated as necessary to require the promisor to take appropriate precautions against breach, but at bottom “appropriate” ordinarily ends up resolving to some definition that assumes the efficiency of the expectation measure. And as a purportedly comprehensive refutation of remedial measures greater than expectation damages—such as disgorgement or specific performance—the simple version of the “theory of efficient breach” still often taught uncritically by Contracts professors has proven to be an analytical disaster.
The Myth of Optimal Expectation Damages makes a specific, important empirical contribution to this debate. As the authors note, empirical contributions here are difficult for several reasons. For example, some remedial rules are mandatory rules, like those that prevent stipulated “penalties” in excess of expectation damages, so the absence of such provisions from contracts isn’t evidence that parties prefer expectation damages. To get around this and other problems, the article focuses on terms that are not formally remedial but that serve an economically identical role: alternative performance terms in bond contracts that specify costs for an issuer who prepays debt in advance of the schedule otherwise contemplated in the bond. Of course, this is just one domain—though, as the authors point out, “a multi-trillion dollar one”—but the authors’ data is important and is consistent with skepticism of a single, efficient measure of contract damages.
The authors’ central empirical findings are clear: virtually none of the contracts they studied call for prepayment penalties that would implement expectation damages; in fact, a range of measures is used; and parties often seek what would formally be labeled “supracompensatory” damages. This finding adds to other literature showing that sophisticated parties often choose measures of damages other than the expectation measure, which undercuts one type of efficiency-based analysis in contract law: that default rules should do what theoreticians predict rational parties would want them to do.
The authors also interviewed transactional lawyers who work with debt agreements and found that these lawyers don’t appear to think in terms that orthodox contract-law theory would suggest. Instead, they adopt other perspectives, including one that the authors interestingly characterize as associated more with joint ventures than with simple contracts: borrowers may ask for “supracompensatory” damages from issuers because they want to share in the issuer’s upside in the event an issuer finds itself with the ability to prepay debt. (After all, this is only fair: borrowers face significant downside in the event an issuer is unable to pay on the original schedule.)
A coda to the article (which, admittedly as a theoretician myself, I wish were longer!) raises the notion that simple analyses of allocative efficiency may not be an appropriate basis after all for a justification of expectation damages. The authors propose one alternative (that the default availability of expectation damages is an information-forcing rule—a penalty default that parties don’t want and ought to bargain around), but others are important to consider as well. The most obvious is perhaps the administrative simplicity of expectation damages: by focusing on the contract price or the cost of substitute performance, expectation damages give courts a readily workable measure.
Another possibility, of course, is that the justification for expectation damages as at least the dominant measure of contract damages does not lie in a simple conception of efficiency at all. For example, maybe the main purpose of expectation damages is to prevent unfair speculation by one party against another in rapidly changing marketplaces. The quicker and deeper a market, the more appealing expectation damages appear to become. Of course, this rationale can be framed in economic terms too —one party ought to pay the other to reserve an option to select a future market price rather than the present market price—but it suggests that the orthodox legal-economic view needs to be rethought.
Articles like The Myth of Optimal Expectation Damages highlight some of the dangers in trying to defend too broadly a single remedial measure of supposedly universal applicability by means only of simple theoretical explanations. Its attention to the details of real transactional practice is a useful reminder that the world of contracting is richer than commentators often pretend.
Cite as: Shawn Bayern, A Crisis of Faith in (the Efficiency of) Expectation Damages
(July 22, 2020) (reviewing Theresa Arnold, Amanda Dixon, Madison Whalen, & Mitu Gulati, The Myth of Optimal Expectation Damages
, __ Marquette L. Rev. __ (forthcoming), available at SSRN), https://contracts.jotwell.com/a-crisis-of-faith-in-the-efficiency-of-expectation-damages/
Is there a moral principle that animates contract law everywhere? In his thoughtful book that elegantly spans high theory and ground-level doctrine, Prince Saprai argues that there is not. While contract law in Great Britain might be designed to promote trust through cooperative relations, that is not its exclusive purpose. Moreover, even that purpose is contingent on the particular normative priorities of the British with respect to contract. Saprai says that contract theorists, especially those who promote the idea that contract law tracks promissory morality, are not just wrong about their primary claim but also about their underlying assumption that contract law has an essential governing moral principle that is independent of the commitments of those who use it in a given time and place.
Saprai suggests that contract theorists tend to overclaim in another respect as well. Whatever the constitutive purpose of contract law in a jurisdiction, that purpose is usually not determinative of doctrine in any complete way. There are many ways to interpret the purpose and how it is best served by rule choices. Even systems that espouse the same purpose for contract law are likely to diverge in their substantive doctrines.
The pluralism we should expect from divergent purposes and varied interpretations of even coincident purposes is not a cause for concern. While some dominant views of contract seem to proceed as if there is one optimal law of contract in relation to which each body of actual law is but a pale shadow, Saprai takes pluralism of purpose and doctrine as evidence of legitimacy. The most exciting chapter in Saprai’s book is Chapter 4, in which he elaborates the republican character of his theory and sources it to Dworkin’s view of law more broadly. Saprai reads Dworkin to recommend that scholars not impose a favored moral principle on a body of law but instead uncover it from the ground up in the particular laws of a jurisdiction. Local priority, or looking first to the rules of the immediate area of law that governs a legal question, helps jurisprudence to track how citizens understand questions in each domain. By so tethering doctrine to popular understanding of relevant moral principles, local priority renders legal doctrines accessible to citizens. It is essential to the legitimacy of law, on the republic view, that citizens be able to directly engage and take ownership of law, including contract law.
The picture that Saprai paints is an attractive one. One might reject the idea of a universal contract law, though, without fully embracing the republican alternative he offers. In particular, one might endorse pluralism on avowedly liberal grounds – liberal democratic grounds. The line between a republican and democratic account of contract is not bright but Saprai would seem to emphasize the significance of civic engagement with the law and with one another, and borrowing from Pettit, the commitment to non-domination in one’s social relations rather than rights against the state alone. But civic engagement, or the conditions of public discourse, are important to modern theories of liberal democracy too. Liberal theory might also offer a more compelling account of why private domination is an affront to the liberal subject than does republican theory, which tends to take the ideal of non-domination as more a starting point.
Of course, much of liberal theory fails to concern itself seriously with private domination. The trouble is, this is also true of common law contract. Although Saprai teases out contract doctrines that appear protective of weaker parties as evidence of its fidelity to the non-domination principle, these doctrines appear to operate on the margins. As Saprai himself acknowledges, it is not clear that contract on the whole promotes non-domination among participants in the institution. A republican theory of contract must contend with the facts of rampant domination no less than liberal theory. In light of their influence over mainstream discourse, liberal theorists of contract might need to grapple with a further worry that their historical lack of attention to the problem of domination has actually enabled institutional neglect of the problem – but this worry is justified only to the extent that liberal theories of contract really do track how people think about contract after all.