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The Accuracy of Economic Analysis of Contract Interpretation

Omer Pelled & Ohad Somech, The Value of Accuracy in Contract Interpretation (Aug. 5, 2021), available at SSRN.

In the past twenty years or so, the new formalism, led mostly by legal economists, has been quite influential in contract theory. Focusing on commercial transactions between sophisticated firms, leading scholars have questioned the courts’ competence to accurately determine the parties’ intentions and called for a textualist approach to contract interpretation (see, e.g., Schwartz & Scott 2000; 2003).

Two common responses to the new formalism are to deny that economic efficiency is the only value underlying contract interpretation, even in commercial contracts, and to shift attention from negotiated, commercial transactions to standard-form and consumer contracts. In The Value of Accuracy in Contract Interpretation, Omer Pelled and Ohad Somech take a different route. They convincingly criticize one of Schwartz & Scott’s key arguments on the latters’ own terms, thereby casting doubt on the accuracy of mainstream economic analysis of contract interpretation even in bespoke commercial transactions between sophisticated parties.

A key insight of Schwartz & Scott’s theory is that contract interpretation need not strive to effectuate the parties’ true intentions. Rather, courts should apply interpretation rules that most contracting parties would have preferred (while allowing those who prefer other rules of interpretation to opt out of the majoritarian default rules). Furthermore, it is assumed that large commercial firms are risk-neutral. Assuming that there is a range of possible interpretations, and that the payoffs for each party are continuous along this range, a “risk-neutral party cares about the mean of the interpretation distribution, but not the variance. This is because the variance term measures risk while risk-neutral parties are indifferent to risk.” (Schwartz & Scott 2003, at 576). It follows that it suffices for a risk-neutral firm that the mean interpretation equals the correct interpretation. This argument, in turn, lends support for textual, rather than contextual interpretation of contracts: even if taking into account extrinsic evidence can enhance the accuracy of interpretation, as long as a literal interpretation is accurate on average, sophisticated, risk-neutral parties would prefer to save on the extra litigation costs involved in the production of such evidence.

Using a series of simple examples, Pelled and Somech demonstrate that this analysis is flawed. In the first part of the article, they show that even if the distribution of a court’s possible textual interpretations is symmetrically distributed around the mean, risk-neutral parties do care about the variance, because typically a more accurate interpretation increases the joint surplus of the contract. Consider the following example: in a contractual dispute, there are three possible interpretations of a given clause, A, B, and C. Under interpretation A, the seller’s cost of performance is 100, the buyer’s benefit from the seller’s performance is 150, and the joint surplus is therefore 50 (150 minus 100). Under interpretation B, the seller’s cost of performance is 150, the benefit from this performance to the buyer is 250, and the joint surplus is therefore 100 (250 minus 150). Under interpretation C, the seller’s cost is 250, the buyer’s benefit is 300, and so the contract surplus is 50 (300 minus 250). Clearly, rational parties must have meant the contract to mean B, as under this interpretation the transaction yields a joint profit of 100, rather than only 50 under each of the other interpretations.

Now, suppose that a textual interpretation of the contract can lead the court to adopt interpretation B with a probability of 0.5, and interpretations A or C with a probability of 0.25 each. In that case, the expected joint surplus of the contract would be 0.5×100 + 0.25×50 + 0.25×50 = 75. In contrast, a contextual interpretation that would accurately adopt interpretation B with certainty would yield a joint profit of 100. It follows that, as long as the added litigation costs of providing external evidence that would enable the court to reach the accurate interpretation is smaller than 25, rational parties would prefer a contextual, rather than textual, interpretation.

Pelled and Somech go on to show that under plausible circumstances, the textualist approach, which is likely to reduce the accuracy of interpretation, may lead rational parties to adopt inefficient clauses in order to reduce the expected costs of inaccurate interpretation, and may even affect the agreed price. The second part of the article then analyzes how accuracy determines the parties’ preferred interpretative approach, taking into account transaction costs, the possibilities of settlement and renegotiation, the contractual environment, and the type of disputed term. Finally, in the third part of the article, Pelled and Somech argue that their modified analysis is actually reflected in legal practice, focusing on the interpretation of force majeure clauses, alternative dispute resolution clauses, and loan agreements. In doing so, they considerably enrich the economic analysis of contract interpretation and bring its conclusions closer to conventional legal thinking.

Both Schwartz & Scott and Pelled & Somech restrict their analysis to negotiated contracts between not-too-small firms, thus excluding most commercial contracts (which are executed through standard forms), private contracts, employment and consumer contracts, and more. They further limit the scope of the analysis by assuming that firms are perfectly rational, do not care about anything but their profits, and are risk-neutral – assumptions that are all contestable. Finally, they posit that the rules of interpretation should reflect a single normative criterion: welfare maximization, thus excluding other values that should arguably inform contract interpretation, such as fairness (see, e.g., Zamir 1997). Adding the fact that sophisticated firms mostly resolve their disagreements outside of the court system, and not necessarily according to the prevailing legal norms, one may wonder how relevant the discussion is for the great majority of contractual disputes.

I believe that, as long as one keeps in mind its premises and limits, the analysis is important and intriguing. Eric Posner (2003) has argued that economic models generate predictions and normative recommendations that are either wrong (because they rest on too many simplifying assumptions) or indeterminate (because the more complex a model is, the more difficult it is to ascertain all the information necessary for its implementation). According to Pelled and Somech, one of the economic rationales for textualism is problematic even under its simplifying assumptions. Nonetheless, like much of economic analysis in general, the present discussion should be praised for challenging accepted truths and provoking new thinking, even if it does not provide simple answers to complex questions.

Pelled and Somech show that economic analysis does not necessarily lend support for formalism and textualism. Indeed, there is no logical connection between individualism, economic efficiency, and formalism. Yet, as Duncan Kennedy (1976) has argued theoretically, individualism and formalism share similar “visions of humanity and society.” And as Ori Katz (2021) has recently demonstrated empirically, individualists actually tend to be more formalists, and vice versa. Possibly, then, the support of many legal economists for formalism is not a product of the normative or methodological commitments of economic analysis, but rather of ideological inclinations.

Cite as: Eyal Zamir, The Accuracy of Economic Analysis of Contract Interpretation, JOTWELL (November 30, 2021) (reviewing Omer Pelled & Ohad Somech, The Value of Accuracy in Contract Interpretation (Aug. 5, 2021), available at SSRN), https://contracts.jotwell.com/the-accuracy-of-economic-analysis-of-contract-interpretation/.

Tailored Standard Form Contracts and Inequality

Manisha Padi, Contractual Inequality,120 Mich. L. Rev. ___ (forthcoming, 2022), available at SSRN.

Standard form contracts have long been thought to be, well, standard. One size for all. A long and distinguished line of commentary has convincingly explained why mass contracts, like mass products, are standardized, what benefits uniformity brings to business and even to consumers, and why a take-it-or-leave method of negotiating them is inevitable.

But a recent empirical line of scholarship has begun to cast doubt on that idée fixe. Standard form contracts, the new perspective suggests, are uniform in paper but personalized in practice. They are handed equally to all customers, but they merely serve as baseline for what some scholars previously called “tailored forgiveness.” In the shadow of boilerplate contracts, businesses exercise discretion and negotiate with individual parties specific accommodations and other variations from the text.

This conjecture—that standard form contracts are in fact adjusted individually—has now received powerful empirical support from Manisha Padi, but with a twist. Against the earlier theoretical accounts, which viewed discretionary variations from one-sided “adhesion” contracts as good news, Padi’s account is more troubling. She finds that the negotiated variations from the standard terms indeed offer some relief from harsh consequences, but are not distributed evenly or fairly across consumers. Businesses reserve these accommodations to select groups among their clientele. To whom are these discretionary benefits directed? Not surprising, to those who need them least. To the more affluent consumers.

Padi’s forthcoming law review article is based on her earlier empirical work, which looked at mortgage loan modifications during the financial meltdown of the early 2000’s. Borrowers who fell behind on their debt payments—who breached their promise to repay—faced the risk of foreclosure. Lenders had the unambiguous contractual rights to foreclose and liquidate the homes, but they exercised these rights selectively and with personalized discretion. After all, lenders, too, stood to lose from foreclosure, recouping only a fraction of each loan in the ensuing fire sales. They therefore often agreed to modify the loans, avert liquidation, and afford the borrowers more manageable payment plans. Padi’s data shows that foreclosure avoidance occurred more often in the more affluent neighborhoods. She estimates the magnitude of the dollar loss poorer borrowers suffered by not being granted the same reprieve.

Padi recognizes (albeit in a footnote) that we don’t know the reasons for these disparities. Maybe more affluent borrowers are also more capable of demonstrating a realistic path for repayment. Or maybe they are more likely to fight foreclosure tooth and nail with every legal means and inflict higher enforcement costs on the banks. But, in truth, it doesn’t matter. What we see is a form of regressive distribution of a specific benefit—the benefit of tailored contractual modification. Those least likely to recover from personal financial ruin are also least likely to be offered a rescue plan.

This pattern, Padi thinks, must be occurring in other consumer contract sectors. Businesses are negotiating with their customers discretionary treatments beyond the contractual rights, but are (probably) distributing them unequally. Indeed, Meirav Furth-Matzkin found in a (yet unpublished) field study that retail stores accept returned merchandize even when shoppers do not abide by the uniform return policy, but that such extra-contractual privileges are distributed unequally across shoppers, favoring whiter and more affluent consumers.

Padi’s insight of post-contractual inequality illustrates a far broader distribution paradox in society. The pattern is familiar. It starts with the enactment of a protective program, to address the hardships people encounter. It offers some benefits or grants access to open resources. But access is not exercised equally. The benefits of the program are enjoyed disproportionately by those who need them less—those more sophisticated who better identify and know how to deploy the programs. Elsewhere, I labeled this phenomenon “the paradox of access justice” and showed that it occurs more often than we realize, with harsh regressive consequences. Governments, for example, provide subsidized insurance that benefits wealthier people; Disclosure schemes which aim to make people more informed and thus more protected are used more effectively by the educated, younger, healthier, and wealthier recipients of the information. In short, many pro-consumer programs have unintended regressive effect.

What, then, can be done about post-contractual inequality? Padi proposes an information-based reform. Governments should require lenders to report patterns of loan modifications, so as to identify the inequality. And do what? Well, unfortunately not much. They might be able to pressure banks to institute more progressive loan programs, or, in extreme cases, sue for violations of civil rights. Or maybe (this is a bit quixotic) trigger reputational sanctions. In the end, it is hard to find a solution because the inequality of tailored standard contracts is yet another artifact of the injustice of poverty. The poor buy worse products at higher prices with more risks and less insurance. And they also—it is important to realize—are disfavored in their post-contractual treatment.

Cite as: Omri Ben-Shahar, Tailored Standard Form Contracts and Inequality, JOTWELL (November 2, 2021) (reviewing Manisha Padi, Contractual Inequality,120 Mich. L. Rev. ___ (forthcoming, 2022), available at SSRN), https://contracts.jotwell.com/tailored-standard-form-contracts-and-inequality/.

The Exaggerated Rumors of the Death of Unconscionability

Babette Boliek, Upgrading Unconscionability: A Common Law Ally for a Digital World, __ Md. L. Rev. __ (forthcoming, 2021), available at SSRN.

Professor Babette Boliek makes two important contributions in Upgrading Unconscionability: A Common Law Ally for a Digital World before even reaching the article’s normative argument.

First, the article challenges what has become a surprisingly prevalent bit of supposed wisdom among commentators on contract law: that the doctrine of unconscionability barely exists and that nobody should take it seriously—or, as Professor Boliek puts it, that “the application of unconscionability is so rare that it is the last refuge of fools.” The pessimistic view of unconscionability’s role may confuse a paucity of rules about unconscionability with a paucity of cases (or more generally with a lack of importance of the doctrine). It is true that unconscionability is a vague doctrine. Even its statutory formulations in US law tend not to supply clear definitions; for example, the Uniform Commercial Code provides general rules that let courts respond to “unconscionable” contracts (see U.C.C. § 2-302), but never defines the term. But while that may make it hard to apply unconscionability on a Contracts exam, it doesn’t mean the doctrine of unconscionability isn’t important. Indeed, if the purpose of the rule is simply to give courts flexibility to prevent the worst abuses of contract-related processes or the most oppressive contracting outcomes, the doctrine needn’t be specific, and pinning it down too tightly may limit the doctrine’s ability to respond flexibly to abuses.

Professor Boliek challenges the supposed withering of unconscionability doctrine by investigating real cases; as she points out, whether the doctrine of unconscionability is really “the last refuge of fools” is, “of course, an empirical question.” Professor Boliek’s investigation (which I reviewed only in draft form, so I do not comment here on the particulars of the empirics) finds that litigants do often raise arguments about unconscionability—and they succeed in roughly a fifth or a quarter of cases, depending on the type of argument. The precise numbers are not as important as the general observation that lawyers do routinely raise arguments about unconscionability and that those arguments are not destined to fail.

Second, Professor Boliek’s investigation and analysis divide cases based on whether the unconscionability argument is directed at an arbitration clause or not. Most or all analysis of form contracts should draw the same division. In discussions of form contracts generally, it’s become too easy to mistake a pattern of decisions that apply the Federal Arbitration Act as if it suggests that form terms generally are enforceable. Arbitration clauses are distinct both because they’re protected by federal statute and also, more generally, because they’re a known type of clause—standard and often predictable in their own way, aided by at least the formal concept that they vary only procedure rather than substantive rights, and plausibly an appropriate part of what Karl Llewellyn called “essentially private self-government in the lesser transactions of life…— if only [businesses] and all their lawyers would be reasonable.” Enforcing an arbitration clause is very different from enforcing, say, a clause that charges consumers money when they post negative online reviews of products or services. It’s not clear that idiosyncratic clauses in forms should even get off the ground as “contractual” in the first place and thus even require an analysis of unconscionability before striking them down: they’re not agreed to or constrained by any normal process of bargaining, they’re certainly not commonly read, and many probably wouldn’t be accepted if consumers were aware of them (see Restatement (Second) of Contracts § 211). But in that analysis, and in applying the doctrine of unconscionability as a final guardrail to prevent their enforcement, distinguishing clauses based on their content—and starting with the distinction between purely procedural clauses (involving arbitration and forum selection) and others—is a wise step.

Professor Boliek’s normative discussion favors statutory responses to particular types of concerns about form contracts—that is, outright prohibition of certain problematic types of terms—as is commonplace in other jurisdictions. That approach seems to have worked well in the jurisdictions that have used it. Online commerce hasn’t ground to a halt in Europe, for example; familiar commercial flexibility isn’t destroyed because sellers can’t unilaterally impose terms on consumers under the banner of private ordering. In an ideal world we probably wouldn’t need a statutory response, but identifying particular abuses and trying to prevent them with legislative or administrative processes is probably, in the real world, a step in the right direction.

Cite as: Shawn Bayern, The Exaggerated Rumors of the Death of Unconscionability, JOTWELL (October 4, 2021) (reviewing Babette Boliek, Upgrading Unconscionability: A Common Law Ally for a Digital World, __ Md. L. Rev. __ (forthcoming, 2021), available at SSRN), https://contracts.jotwell.com/the-exaggerated-rumors-of-the-death-of-unconscionability/.

Acknowledging Contract Law’s Contributions to Racial Inequities

Danielle Kie Hart, Contract Law & Racial Inequality: A Primer, 21-05 Sw. L. Sch. Res. Paper 1 (2021), available at SSRN.

For nearly a year and a half, our country has been in the grips of a global pandemic. Covid-19 has exposed and exacerbated racial and economic inequities that have plagued our society for centuries. As we have grappled with the dual pandemics of Covid-19 and systemic racism, there has been a renewed focus on interrogating historical and current practices that have contributed to the inequalities that many communities of color experience.  In her recent thought-provoking essay Contract Law & Racial Inequality: A Primer, Professor Danielle Kie Hart examines the role that contract law has played in creating, maintaining, and perpetuating such inequities. She argues that acknowledgement of this role is critical if America is to become a more equitable society.

Professor Hart begins her essay by detailing the medical and economic harms that members of Latinx, Black, indigenous and immigrant communities have disproportionately experienced during the pandemic. Death rates, job and wage loss, and housing and food insecurity were proportionately higher for communities of color, and, generally speaking, such communities did not share in the increases in wealth that occurred during the pandemic. According to Professor Hart, this disparate reality can be explained, in part, by the historical and present operation of contracts and contract law in our society.

In her discussion of the use of contracts to transfer property, Professor Hart explains the importance of bargaining power and asserts that “in the context of contract law, property also means bargaining power, because property is the original basis of bargaining power.” (Pp. 6-7.) She argues that a property owner’s right to withhold or exclude property from others gives the owner power to compel the non-owner to accept the owner’s terms. “Consequently, the more one person owns, the more potent the owner’s threat to withhold and, therefore, his ability to get his preferred terms becomes.” (P. 7.) Those with more property and, thus, more bargaining power “will be able to reap more gains from each contract that it enters into than it otherwise would with less bargaining power at its disposal.” (Pp. 11-12.) She contends that “[o]ver time, the party with more bargaining power will end up owning more—more land, money, labor, and other resources both tangible and intangible” (P. 12), which contributes to “pre-existing and intersecting hierarchies of race and class.” (P. 12.)

Given that unequal bargaining power is rarely a successful claim to justify the unenforceability of contracts, Professor Hart asserts that contract law’s lack of acknowledgment of the detrimental role such power can play in contract formation contributes to contract law’s “own structural inequality.” (P. 8.) She argues that ignoring this issue is particularly problematic considering the relative ease in which a party can be deemed to have consented to entering into a contract and the considerable difficulty a party will have in seeking to invalidate one. Although contractual defenses including duress and unconscionability remain available to parties challenging the enforceability of contracts, Professor Hart cites to empirical research evidencing that such defenses are rarely successful. Therefore, in order to minimize the reinforcement of structural inequities to which contract law contributes, she advocates for greater recognition and consideration of the societal consequences that can result from the operation of contractual bargaining power (or the lack thereof) in practice.

In examining bargaining power and its role in creating and fostering inequality, Professor Hart situates her discussion in the context of slavery, Emancipation, and Reconstruction, which I found to be quite illustrative. As she acknowledges, prior to obtaining their freedom, enslaved persons were considered to be property with no property rights of their own. Their owners, who had the contractual right to buy and sell them, possessed the power to bargain and negotiate. After Emancipation, freedmen’s newfound “freedom” to sell their labor was significantly hampered by their lack of bargaining power resulting in unfair arrangements that continued the exploitation experienced by Black people during slavery.

Professor Hart provides an informative historical account of the adoption of a “formal equality” (P. 21) approach during Reconstruction whereby newly freed persons were expected to “take care of themselves” (P. 20) rather than a reparative regime in which the government would take a more active role in mitigating the devastating harms of slavery. She makes a compelling argument that this misguided approach, which was based on an inherently false assumption that a “free” post-Emancipation market would produce just and equitable outcomes between private contracting parties, significantly impeded racial and economic progress then and continues to do so today. Professor Hart urges us to confront and interrogate this reality and to no longer overlook or accept contract law’s role “in facilitating and perpetuating” (P. 25) similar assumptions and inequities.

Using the housing market crisis as her example, she recounts the harms that disproportionately fell upon Black and other borrowers of color who were targeted by subprime lenders.  Unlike many banks and lenders who were bailed out by the government during the ensuing Great Rescission, the vast majority of borrowers, who were deemed to be private actors who willingly entered into mortgage contracts, found themselves with little or no recourse. This and other examples in Professor Hart’s essay highlight how contract law policies and assumptions can impede racial and economic equality rather than advance it.

With a renewed focus on examining issues of racial and social justice, particularly in the legal academy and profession, Professor Hart’s essay is a timely and helpful contribution. She provides a valuable perspective through which professors, scholars, jurists, and policymakers can reexamine and afford serious consideration to the role contracts and contract law play in contributing to inequities that continue to plague our society. As Professor Hart correctly notes, “there is a particular urgency to any discussions about inequality right now.” (P. 36.) We must all engage in such discussions and take concrete action if we are to achieve real and sustainable progress.

Cite as: Eboni Nelson, Acknowledging Contract Law’s Contributions to Racial Inequities, JOTWELL (September 15, 2021) (reviewing Danielle Kie Hart, Contract Law & Racial Inequality: A Primer, 21-05 Sw. L. Sch. Res. Paper 1 (2021), available at SSRN), https://contracts.jotwell.com/acknowledging-contract-laws-contributions-to-racial-inequities/.

Remedying Offensive Internet Conduct

Eric Goldman, Content Moderation Remedies, __ Mich. Telecomm. & Tech. L. Rev. __ (forthcoming, 2021), available at SSRN.

What are the appropriate remedies when Internet services, such as Twitter, Facebook, and YouTube, publish anti-social user content? Although regulators and analysts have pondered issues such as what constitutes offending content and who should decide the question, the issue of appropriate remedies needs development. This important question is the subject of an excellent article, Content Moderation Remedies, by Eric Goldman. Notwithstanding that the dominant strategy has been removal of the offending content, Goldman urges a more nuanced approach. He compiles useful and comprehensive examples of alternative remedies short of removal that Internet services already have employed and develops a helpful framework for determining when such remedies may be superior.

Content Moderation Remedies focuses on Internet services’ decisions on remedies, not on legal regulation. The article points out that although content may be illegal, Internet services most often are free from liability under Federal law.1 Services therefore enjoy some discretion in formulating appropriate remedies for offending content. Even if content is legal, services have discretion under their own house rules on how to deal with offensive material.

With this background, Goldman sees a clash of remedial policies, namely restricting anti-social online content, on the one hand, and avoiding the specter of censorship on the other. He argues that to date, the predominant remedy has been removal of offending content, leaving little room to explore the range of remedies that might better harmonize the clashing policies. The article then develops a framework for determining what alternative remedies might be more appropriate under particular circumstances. The goal is to employ nuanced solutions that are better than a one-size- fits-all remedy of removal of the content.

Notwithstanding the predominance of removal, the article offers many examples (36 to be exact) of remedies short of removal that Internet services have employed. Goldman helpfully sorts these promising remedies into five categories:

  1. actions directed at the content, such as editing or setting forth warnings about the content;
  2. actions directed at the online account, such as suspending the account or calling attention to the poster’s poor behavior;
  3. actions to reduce the visibility of the content, such as by reducing internal promotions or external search indexes;
  4. actions directed at financial consequences, such as terminating or suspending future earnings; and
  5. a catch-all category of assorted remedies that do not fit into the previous categories, such as educating users about the illicit content or reporting the issue to law enforcement.

Goldman argues that in many circumstances these remedies are superior to removal in no small part because removal may cause a litany of problems. For example, removal extinguishes evidence of the problem (such as Twitter’s removal of Trump’s tweets). Removal also orphans any comments on the offending content if the comments are not removed and breaks links to other content. Most harmful, removal impinges on free expression and contributes to a negative view of Internet services. Goldman urges flexibility so that the punishment fits the “crime” and offenders can be “rehabilitated rather than “banished.”

If a smorgasbord of potential remedies is to be successful, the challenge, of course, is to set forth a set of principles to guide the choice of remedies in various contexts. Goldman develops several sensible criteria, among others, whether the content in fact violates legal regulation or internal services’ rules, the severity of the violation, how a remedy will impact third parties, and the possibility of rehabilitation of the content provider.

Notwithstanding the article’s impressive effort to establish guidance for remedy selection, Content Moderation Remedies readers who favor certainty in the law may be concerned that the costs of remedial diversity outweigh its benefits. For example, Goldman proposes a scale from 1 to 100 to determine the severity of the violation that in turn impacts selection of the appropriate remedy. Situating particular content on such a scale and matching it to a remedy will be no small task in cases that do not demand removal.

The article’s opening example of problematic content, some might argue, is unfortunate if Goldman’s goal is to persuade readers of the need for remedial diversity:

In May 2019, a President Trump supporter published a video of House Speaker Nancy Pelosi, which slowed down authentic footage without lowering the voice pitch, conveying the inauthentic impression that Speaker Pelosi had delivered her remarks while intoxicated. The video quickly became a viral sensation and spread rapidly across the Internet… The video probably didn’t violate the law, and even if it did, the social media services likely were not legally liable for it. As a result, the social media services had the legal freedom to moderate the video as they saw fit.

Although Facebook, Twitter, and YouTube selected different remedies for this content, Goldman may face an uphill battle persuading many readers that anything other than removal is appropriate for fraudulent content such as this, which content could have major political implications. On the other hand, Goldman has a good argument that his many examples of responses short of removal in other contexts are the best evidence that Internet services should not automatically default to an all-or-nothing approach.

Goldman does not ignore the possibility that the best approach to the problem of offending content may be website design that would deter such content in the first place. In fact, Content Moderation Remedies treats all aspects of this important problem in a thoughtful and impressive way and is must reading for anyone interested in governance of the Internet.

  1. 47 U.S.C. 230.
Cite as: Robert Hillman, Remedying Offensive Internet Conduct, JOTWELL (September 1, 2021) (reviewing Eric Goldman, Content Moderation Remedies, __ Mich. Telecomm. & Tech. L. Rev. __ (forthcoming, 2021), available at SSRN), https://contracts.jotwell.com/remedying-offensive-internet-conduct/.

Let’s Have a Legitimacy Crisis about Contract Law

The last couple decades in Europe have been an exciting time for private law. European integration created a dazzling opportunity to articulate a distinctly European private law, potentially even overcoming the classic line between common and civil law.

As it happens, even before the departure of the United Kingdom from the European Union, this project failed in its more ambitious forms. Although legal convergence would fit the mandate to harmonize the common market, it turned out that there was substantial disagreement even within continental Europe about what a European private law should look like.

The quiescence of the convergence project has actually opened space for a less politically fraught and doctrinally constrained discussion of contract law in Europe. Delinked from the political will to integrate or constitutional constraints on what the basis for a common framework could be, the conversation has broadened to ask first order questions about the basis for contract law in Europe. That conversation just got a big theoretical boost from Martijn Hesselink.

In Justifying Contract in Europe: Political Philosophies of European Contract Law, Hesselink explores how Europeans think about contract. By grounding divergent approaches to contract in divergent political theories, he is at once generous and rigorous in his characterization of diversity. That is, he starts with the premise that disagreement about fundamental policies does not reflect simple error but engages hard questions to which no democratic society has generated a univocal and consistent answer. Disagreement about contract doctrine reflects at some level potentially deep disagreement about the animating principles of contract, and the relative priority of distinct ends that contract serves. These disagreements themselves are rooted in divergent political philosophies. We cannot dismiss opposing views on contract without dismissing philosophical schools of thought that are rich and embedded in a variety of institutions. That is to say, we should take disagreement about contract seriously.

Hesselink takes disagreement seriously not only because it runs deep, but also because the primary parties to disagreement are neither bureaucrats nor political actors. They are the citizens of states that must make choices about the degree to which they should aim to harmonize their contract law with those of other states (whether in the context of the European Union or outside of that region); when contracts should be legally binding and with what consequence upon breach; to what extent weaker parties should be protected (and, of course, who is weak and from whom must they be protected); the boundaries of freedom of contract, and; the relative scope of default and mandatory rules in contract. One might object that citizens do not really make these choices, and indeed, many are not aware that these are choices they must collectively make. It is the job of lawyers–in a number of roles, including legal scholars–to construct a public discourse that underpins a society’s answers to these questions. That discourse helps to form collective answers, in part through exchange of ideas and arguments, but ultimately also by deciphering intellectual preferences as they stand among the people that will be governed by contract’s rules.

One of Hesselink’s insights is that we cannot take people to be silent about or indifferent to contract if they have not petitioned for a different rule on damages or organized a political action committee against the rule of consideration. Democracies sort through questions about contract by way of underlying political philosophies that direct political communities to distinct answers. Hesselink considers six leading theories: utilitarianism; liberal-egalitarianism; libertarianism; communitarianism; civic republicanism, and; discourse theory. We find robust debate among proponents of these philosophies even if we rarely find direct political engagement with contract. In fact, debate among these ideologies is effectively (albeit not limited to) a debate among approaches to contract.

American talk about contract law is almost entirely devoted to the question of what the best rules would be, without worrying too much about the process by which those rules are made or how our choices connect with other political questions. European integration put front and center in Europe meta-questions about the procedural legitimacy of contract law and the phenomenon of deep disagreement about what it should look like, even among liberal democratic states. In light of their heated debates, Hesselink has taken a much-needed step back to assess the democratic basis of contract law. American legal scholars should go there with him.

Cite as: Aditi Bagchi, Let’s Have a Legitimacy Crisis about Contract Law, JOTWELL (August 19, 2021) (reviewing Martijn Hesselink, Justifying Contract in Europe: Political Philosophies of European Contract Law (2021)), https://contracts.jotwell.com/lets-have-a-legitimacy-crisis-about-contract-law/.

Black Lines of Credit Matter

Mehrsa Baradaran, Jim Crow Credit, 9 UC Irvine L. Rev. 887 (2019).

Mehrsa Baradaran makes an outstanding contribution to the literature on de jure, systemic racial bias and lays a foundation for reparations in the context of consumer credit in Jim Crow Credit. Drawing from and building on her two Harvard U. Press books, How the Other Half Banks (2018) and The Color of Money (2017), Baradaran documents the systematic subsidization of white borrowers–and thus the creation of the white, suburban middle class–in the New Deal and subsequent 20th century government programs that brought us today’s home mortgages, credit cards, and predatory lending practices such as payday lending. Bottom line up front: in credit as elsewhere the haves come out ahead. The surprise is how the federal government subsidized this enormous giveaway to create a white, suburban middle class at the expense of urban and African-American communities.

In bumper sticker form, Baradaran’s message is that Black lines of credit matter. Just as driving or jogging while Black too often proves fatal, borrowing while Black harms Black lives by imposing financial and other injuries that white borrowers are much less likely to suffer. Perhaps most galling–and akin to criminal defendants funding mass incarceration through fees and fines–is that African Americans taxpayers helped fund the U.S subsidies to white borrowers via mortgages and later, credit cards. The compound interest resulting from those subsidies explains a good amount of today’s income inequality: whites enjoy 10 times the wealth of African-Americans, and measured in quasi-liquid assets like retirement accounts, that inequity jumps to a jaw-dropping 100 times more wealth.1

Baradaran flags the relevance of this breach of the social contract for concrete proposals to award damages for it via reparations, but the bulk of her article recites the history that justifies reparation proposals. We need this scholarly work, since at long last reparations are getting serious attention. For example, as much as $4 billion of the $1.9 trillion post-COVID stimulus package is slated to pay off the debt of Black farmers as reparations for the U.S. Dept. of Agriculture’s past credit discrimination against them.2 Baradaran tells the story of another credit market debacle involving New Deal and subsequent statutes, agencies, and lender practices.

But before jumping to the fascinating – and appalling – history, a note on law. Entirely different statutory frameworks govern loans involving real property and credit relationships to purchase things and services. They are so different that many of us who teach and research debtor-creditor relations specialize in either “dirt law” regarding real estate finance or “thing law” that involves personal property as collateral or unsecured loans such as credit card debt. Baradaran’s article impressively bridges this divide to show readers the system-wide, outrageous patterns of favoritism to white borrowers.

A. Federally-Funded Great White Giveaway & Steal from African Americans

We start with dirt law because subsidized mortgages to help white borrowers purchase homes provided a template for parallel developments in credit card debt in subsequent decades.

1. Dirt Law

Baradaran traces the historic New Deal corrections to market failures in credit markets, providing specific evidence of how they built white supremacy into their very foundations. For example, everyone knows about red-lining, but who knew that the Federal Housing Administration explicitly used dark skin – and foreign birth – as proxies for credit risk. Their maps, Baradaran explains, assigned colors to neighborhoods: green for the lowest credit risk, red for the highest, and blue and yellow in between. But too few realize that the FHA’s underwriting manual warned against lending to “inharmonious racial or nationality groups,” meaning Blacks and immigrants. Or that years after Shelley v. Kraemer3 struck down restrictive racial covenants the FHA continued to promote the use of restrictive covenants to benefit white borrowers at Black borrowers’ expense.

Mortgages from private lenders operated in the shadow of the government give-away. To get the security of federal guaranteed mortgages, lenders tended to avoid redlined neighborhoods. Thus even purportedly private transactions reflected the federal subsidies directed to white borrowers.

Immense consequences flow from these bureaucratic maneuvers, Baradaran explains. Monthly mortgage payments that were cheaper than rent enabled working-class whites to become middle-class. Lily-white suburbs graced with parks, schools, and other amenities followed, as did retail districts that likewise extended low-cost credit to customers. Jim Crow Credit painstakingly catalogs this process of how New Deal credit policies socialized loss for white borrowers and privatized their gain, which then enabled them to accumulate wealth to pass along to their boomer children. Also that it happened at the expense of African American families.

The glaring “red” label slapped on to property in wealthy neighborhoods peopled by African-American professionals such as those surrounding Morehouse and Spelman College campuses prevented those professionals from accumulating wealth at the rate of their white counterparts. The only sources of credit were those left over from the bad old days before the Great Depression. Without federal-guaranteed mortgages, African-Americans too often could only purchase shoddier homes through installment contracts with high interest rates. In contrast to protections enjoyed by white borrowers, many or most African-American borrowers merely owned an option to purchase the home, which they could forfeit for missing a single payment. The devaluation of those properties, in turn prevented the accumulation of equity that could fund other life projects, such as a child’s education or a business.

2. Thing Law

Jim Crow also traces how this pattern played out in other credit markets. New Deal federal subsidies for loans to improve real estate–and thus stimulate the building industry–morphed into the infrastructure of today’s credit cards. Before the Depression, installment purchases with high interest rates were the norm until new banking regulations and policies lowered the cost of credit, at least for white borrowers. As with real estate loans, credit-card and finance companies avoided customers in redlined neighborhoods, due to both racism and the greater risks of issuing credit in communities with fragile economic bases due to the devaluation of that real estate due to federal red-lining and other forms of racism.

While white borrowers got used to doing laundry at home with the washing machines purchased with the low-interest loans from retailers and finance companies, Black borrowers were left behind in the much more expensive rent-to-own market. The unconscionable terms of those installment contracts are familiar to anyone who has taught or taken a 1L Contracts class thanks to the canonical case Williams v. Walker-Thomas,4 an injustice that state and federal law has since remedied.5 But other predations in the form of payday loans and check cashing centers replaced them, as Baradaran’s book How the Other Half Banks explores in great detail.

Today poor African-American communities, Baradaran explains, are banking deserts. Consequently, African Americans are more likely to obtain payday loans at interest rates of 300%–or even up to 2000%–in staggering comparison to the 10% interest rate on home equity loans.

B. Movements to Reveal, Challenge, and Remedy Racial Disparities in Credit

Jim Crow Credit also reveals that resistance to these unjust credit rules played a crucial role of credit in the 20th century civil rights movement. The Civil Rights Act of 1964 and the Voting Rights Act of 1965 banned discrimination, but as Baradaran says, “[e]nding credit discrimination was not the same as providing credit.” (P. 904.) They did nothing to provide restitution to African Americans for the unjust gains that systemic subsidies lavished on white borrowers.

She reports that urban riots in the 1960s–such as Watts–were fueled by rage about being “stuck in an ancient debt market while the rest of the country had taken off into the modern world of risk sharing, secondary markets, and large finance companies that all worked to lower the risks and the costs of debt.” (P. 911.) No wonder that media at the time reported rioting crowds shouting “burn the damn records,” and a mother telling grocery store looters, “Don’t grab the groceries, grab the book.” (P. 907.)

The article then explains that in the wake of those riots even politicians who understood the systemic bias failed to rectify that injustice. Instead they again forbade discrimination–this time via the Equal Credit Opportunity Act–and provided mechanisms for giving financial advice to Black borrowers and Black-owned banks. What those communities needed instead was restitution.

Jim Crow Credit concludes with a brief discussion of ways that law and policy could do better. First, of course, we must recognize the lopsided subsidies that undergird racial wealth disparities. Then remedy them. The article discusses a handful of possibilities:

  • “Follow the red lines” where poor African American communities were denied the stability and wealth accumulation enjoyed by their white suburban counterparts, and implement reforms to facilitate home ownership;
  • “Greenline” to lower interest rates by, for example, guarantying mortgages;
  • “Shared equity mortgages” or “SEMs” allow private investors such as a non-profit or bank to jointly make mortgage payments and accrue a proportion of home equity alongside the homeowner;
  • Vouchers for home purchases, akin to § 8 vouchers in which governments subsidize payments for rental housing; and
  • Direct loans from government entities such as the FHA could, as Baradaran says, “fix the problem the FHA itself created.”(Pp. 946-48, quoted language on 948.)

Scholars, litigators, and policy makers all will doubtless rely on Jim Crow Credit as they consider reforms like those listed, and also when they litigate inevitable challenges to those reparative efforts. We all owe Baradaran a debt for compiling the detailed history of government subsidies to white property accumulation, and thus providing key tools to right this wrong.

  1. Dorothy Brown, The Whiteness of Wealth (2021); Carole Pateman & Charles Mills, Contract & Domination (2007).
  2. Alan Rappeport, Banks Fight Biden’s $4 Billion Plan to Ease Black Farmers’ Debt, N.Y. Times, May 20, 2021, Pp. A1 & A 17.
  3. 334 U.S. 1 (1948).
  4. 350 F.2d 445 (D.C. App. 1965).
  5. See, e.g., U.C.C. 9-204; FTC Credit Practice Rules 16 C.F.R. §444,1-2 (2012).
Cite as: Martha Ertman, Black Lines of Credit Matter, JOTWELL (July 21, 2021) (reviewing Mehrsa Baradaran, Jim Crow Credit, 9 UC Irvine L. Rev. 887 (2019)), https://contracts.jotwell.com/black-lines-of-credit-matter/.

Update of Jotwell Mailing Lists

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Many Jotwell readers choose to subscribe to Jotwell either by RSS or by email.

For a long time Jotwell has run two parallel sets of email mailing lists, one of which serves only long-time subscribers. The provider of that legacy service is closing its email portal next week, so we are going to merge the lists. We hope and intend that this will be a seamless process, but if you find you are not receiving the Jotwell email updates you expect from the Contracts section, then you may need to resubscribe via the subscribe to Jotwell portal. This change to email delivery should not affect subscribers to the RSS feed.

The links at the subscription portal already point to the new email delivery system. It is open to all readers whether or not they previously subscribed for email delivery. From there you can choose to subscribe to all Jotwell content, or only the sections that most interest you.

Gendered Culture and Pricing Bias

Renée B. Adams, Roman Kräussl, Marco A. Navone, and Patrick Verwijmeren, Gendered Prices (Dec. 10, 2020), available at SSRN.

We know prices are neither gender neutral nor race neutral. Prices reflect not only factors such as quality but also bias. Thirty years ago, Ian Ayers demonstrated, in a pioneering study, that Chicago retail car dealerships systematically offered substantially better prices on identical cars to white men than they did to both Black men and women and to white women.

In a more recent study, Tamar Kricheli-Katz and Tali Regev showed that women sellers on eBay obtained a smaller number of bids and lower final prices in auctions for both used and new products. While the former study addressed the prices women buyers paid, the latter study addressed the prices women sellers were paid. These studies were conducted nearly 25 years apart from one another, and examined different merchandise. However, in both cases (and in many other similar studies) gender had an impact on the prices, and men got better deals than women as both buyers and sellers.

Gendered Prices, a new study by Adams, Kräussl, Navone and Verwijmeren explores gender bias in the pricing of artwork. The authors examined a sample of 1.9 million transactions conducted at more than 68,000 auctions for 69,189 individual artists in 49 countries from 1970 to 2016. This sample was taken from Blouin Art Sales Index, the largest database of artwork, and was limited to paintings only. This sample showed that auction prices for paintings by female artists were significantly lower than prices for paintings by male artists. The mean transaction price for male artists was around US $50,480, while the mean price for female artists was only US $29,235, meaning that the discount for paintings by women was 42.1%. When excluding mega-transactions (above one million dollars), the discount dropped from 33.1% in the 1970s to below 22% after 2000 (and to 8.4% after 2010).

In addition, the study showed that the gender discount in auction prices is generally higher in countries with greater gender inequality. The authors concluded that culture was a source of pricing bias. The authors ruled out the explanation that “female” art was less appealing to investors since they showed that it was no different from “male” art in style and themes. The authors concluded that art by women artists sold for a lower price simply because it is made by women. To affirm their conclusion, the authors conducted two experiments using surveys. In the first experiment using a sample of ten paintings they asked 1,000 participants how much they liked the painting on a scale of 0-10 after guessing the gender of the artist. They found that participants who were male, affluent and who visit art galleries (the prototype of a typical bidder in art auctions) had a lower appreciation of works they associated with female artists than other participants. In the second experiment they “created” ten paintings using a neural network algorithm. Then they randomly associated fake male and female names with these paintings and again asked 2,000 participants how much they liked the paintings (again in a 0-10 scale). They found that affluent participants who visit art galleries had a lower appreciation of works which were associated with a female artist name. These experiments again supported the conclusion that women’s art was sold for less simply because it was women’s art. Therefore, price indicated not only quality but other factors like culture. Since culture is not immutable and social inequality can decrease over time, the paper is ultimately an optimistic one.

What are the legal implications of these studies? It is challenging to formulate a legal response to this systematic price discrimination. With that, here are three preliminary thoughts:

First, all of the above sales (of used cars, products on eBay or paintings) are contracts. Can contract law address gendered pricing? A known contract law principle is that the court will not look at the adequacy of consideration. In other words, the parties decide the terms (such as price) of their exchange and the court will refrain from intervening. However, should contracts that perpetuate discrimination be allowed? Hila Keren, for example, has argued that contract law has an important role to play in addressing discrimination. Though Keren focused on precontractual negotiations and on the refusal to contract, she generally argued that contract law should not ignore discrimination. There are advocates for fair exchange or fair price rules under contract law. This could ultimately mean that contracts that discriminate on the basis of gender or race should not be enforced.

Second, consumer protection laws and regulations might also address gendered pricing. Given that the studies demonstrated systematic racial and gender discrimination, it is necessary for the government to intervene in the way the market sets the prices, rather than restricting its role to that of contract enforcement. It is especially important in markets for necessities or large transactions to mitigate the effect of factors such as race or gender on price. Laws and regulations, however, which are limited to consumer transactions would unfortunately not apply to other cases where women pay more/are paid less than men.

Third, the most promising legal avenue is anti-discrimination laws. Since discrimination is a social and cultural phenomenon, it is imperative to uproot stereotypes and notions of inferiority of marginalized groups and to protect underprivileged parties. As the study of Adams et al showed, gender discounts reduce over time as gender equality increases, thus one optimistically hopes that advancement of social equality in general would bear fruits also in terms of fair pricing. In other words, in a post-patriarchal world, women would get as good a deal as men whether they are artists, buyers, or sellers.

Cite as: Orit Gan, Gendered Culture and Pricing Bias, JOTWELL (June 15, 2021) (reviewing Renée B. Adams, Roman Kräussl, Marco A. Navone, and Patrick Verwijmeren, Gendered Prices (Dec. 10, 2020), available at SSRN), https://contracts.jotwell.com/gendered-culture-and-pricing-bias/.

Contract Law v. Tort Law

Zahra Takhshid, Assumption of Risk in Consumer Contracts and the Distraction of Unconscionability, 42 Cardozo L. Rev. __ (forthcoming, 2021), available at SSRN.

It has been a while since many of us have been able to attend the gym. Yet, before Covid-19, those committed to working out in this setting were kindly asked (read: required) to sign a contract that released the business operating the fitness facility from liability for any injury that might occur while using the premises. Accordingly, if an injury happened due to the business’ negligence, its defense against tort-based liability was contractual: it relied on the exculpatory clause that the user signed before the user was hurt. If the user took legal action, courts faced a Hamlet-style dilemma: to enforce or not to enforce the contract that was designed to prevent the operation of tort law. On the one hand, as we all know and as Danielle Hart has empirically shown, courts are heavily inclined to enforce contracts. On the other, at stake are bodily injuries that the business could have probably prevented if only it had exercised more caution.

In her forthcoming article, Assumption of Risk in Consumer Contracts and the Distraction of Unconscionability, Zahra Takhshid importantly focuses on this tension between contract law and tort law and pays particular attention to recreational activities in the commercial sphere that have resulted in bodily injuries. She opens with the unfortunate story of Gina Stelluti, a woman who suffered long-term injuries because an instructor of a spinning class she took for the first time neglected to secure her bicycle’s handlebars. The New Jersey Supreme Court upheld an exculpatory clause signed by Stelluti in which she released the gym from liability for negligence. This court clarified that only gross negligence—as opposed to the gym’s ordinary negligence—might have justified invalidating the exculpatory clause. For Stelluti, that meant no compensation.

Descriptively, Takhshid reports that “exculpatory clauses are now routinely enforced in a stunningly broad range of cases” in which “plaintiffs injured in recreational activities [sue] those who negligently provided such activities.” Her use of the word “now” is significant because Takhshid also argues that the result in cases like Stelluti v. Casapenn Enters., LLC would have probably been different in the past. She explains that for many years courts in a variety of jurisdictions had followed the 1963 Californian decision in Tunkl v. Regents of Univ. of Cal., holding negligent businesses responsible for physical injuries despite exculpation clauses. More recently, however, courts have demonstrated increasing reluctance to hold negligent businesses liable. Takhshid attributes the change to a shift in the way courts analyze the issue. Courts, she reports, have moved from scrutinizing exculpation clauses under the public policy doctrine to handling them via the unconscionability doctrine. Takhshid sees this doctrinal shift as detrimental to the state’s ability to protect injured consumers. While the older cases “were concerned with the public policy as part of the regulatory role of the state to protect consumers,” the newer cases narrowly focus on the relationship between the contractual parties. Accordingly, if no evidence of oppression is available, they enforce the parties’ contract.

The question raised by Takhshid’s article is normative: should we let standard contracts have this impact over tort law? Significantly, she emphasizes that when people decide to participate in certain activities, they assume the risks that come with them. For example, those who play soccer assume the risk of an injury that may come from physical contact with another player. Signing an exculpation contract with the business organizing the game would add an obligation not to sue this business when such injury occurs. But, Takhshid insists, we must distinguish between such assumed risks and other perils that originate in the organizer’s negligence. When an exculpation clause is raised as a defense against a business’ carelessness, the legal response must differ. Then, she argues, “courts should announce the clause void as against tort law’s public policy of protecting physical integrity.”

The article offers strong comparative support to its normative call. Delving into the parallel regulation of the issue in other countries across the pond, it shows that “many foreign jurisdictions–both common law and civil law–treat physical integrity as an inalienable right.” Similarly, Takhshid concludes, bodily injuries that arise from the negligence of service providers such as the gym in Stelluti should remain beyond the reach of private parties and contractual terms. Allowing contracts to undermine tort law’s duty of care would put at risk “one of the main ways societies and legal systems protect people against bodily injures and promote safety.”

Takhshid’s observations about the state of the law and her normative arguments are highly compelling. Her new article contributes to the growing literature that criticizes the unfair use of standard contracts in ways that generally exploit and enhance consumers’ powerlessness and particularly deprive them of the right to their day in court. Consumers’ re-empowerment, however, may demand more than a return to the public policy principles that guided decisions such as Tunkl. We may also need to re-embrace the ideology that inspired courts to refuse to enforce contracts in the decades between the end of the Lochner era and neoliberalism’s rise to dominance. This period of demonstrated willingness to refuse enforcement was explained in a recent Jot as follows: “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.”

Nonetheless, the newer cases described by Takhshid, which enforce exculpation clauses even when it means legitimizing negligence, turn back to unrestrained freedom of contract. They epitomize a neoliberal era in which corporations increasingly use contracts and contract law to manipulate and even take over the state’s regulatory role. In that sense, these cases can demonstrate the model presented in Katarina Pistor’s The Code of Capital. What Pistor calls “legal coding” is a capital-producing process that heavily depends on adding unique legal qualities to regular assets. The coding process starts privately. In the case of recreational injuries, it takes place by adding exculpation clauses to standard contracts. The next step, however, depends on the state. In the context of exculpation clauses, enforcement by courts is necessary to insulate businesses from the risk of having to pay for their negligence. And, as Pistor argues, the more the state is willing “to recognize and enforce privately coded capital,” the greater socioeconomic inequalities grow.

Takhshid’s article offers a chilling demonstration of Pistor’s theory. The more the state’s courts enforce privately drafted exculpation clauses, the less the state can secure health and safety via its tort law. The obvious beneficiaries are the businesses while consumers pay the price and inequality increases. Thus, the article belongs with the law and political economy project as it illuminates how contracts’ enforcement is far from being neutral and instead facilitates rising inequality. For that reason, courts must protect the state’s power to regulate what Takhshid calls “risk-creating enterprises” and incentivize them to take due care of their clients’ health and safety. As the article concludes: we should not “let contract erode tort for a domain where tort law’s regulatory bite is important.”

Cite as: Hila Keren, Contract Law v. Tort Law, JOTWELL (May 19, 2021) (reviewing Zahra Takhshid, Assumption of Risk in Consumer Contracts and the Distraction of Unconscionability, 42 Cardozo L. Rev. __ (forthcoming, 2021), available at SSRN), https://contracts.jotwell.com/contract-law-v-tort-law/.