Yearly Archives: 2018

On Contract Law’s Increasing Distortionary Effect on Substantive Trade Secret Law and How to Stop It

Dec 17, 2018 Lauren ScholzAdd a Comment

Trade secret law and contract law have a complicated relationship. Every subject of commerce is extensively privately regulated by contracts. Intellectual property is distinct from other things of value, because it provides exclusive rights to its owners, and burdens others with corresponding responsibilities to others. Yet unlike trade secret’s intellectual property cousins copyright and trademark, there is no state or federal public register of trade secret interests to give potential infringers notice of a trade secret. What’s more, trade secret rights are relational, that is, liability for disclosure of a trade secret based on the context and expectations of the owner and the discloser. Therefore in trade secret law, unlike other intellectual property, contracts frequently are key evidence of the substance of the trade secret and the standard of behavior required for former employees to avoid infringing trade secrets.

In The Trade Secret-Contract Interface Professor Deepa Varadarajan argues contract law should not be used to undermine the policy reason the law grants companies intellectual property in trade secrets—to promote the progress of science and the useful arts. And yet, as she chronicles in the article, contract law has increasingly been used to do just that in an economy where some of the most valuable assets are trade secrets, including algorithms and databases. She writes: “Contracts’ centrality to trade secret law provides putative owners ample opportunity to define—and overstate—the boundaries of their trade secret rights, particularly to employees. Trade secret’s intersection with contract law poses particular threats to employee mobility—as employee non-competes and non-disclosure provisions can deter employees from starting new jobs and competition enterprises.” (P. 1547.)

Varadarajan identifies two distinct functions that contracts play within trade secret law. First, she describes the “evidentiary function of contracts.” This is the use of contracts as evidence to support the content of the trade secret and the context of a particular employee’s relationship to it. Second, she describes the “evasive function of contracts.” This is the use of contracts, typically by employers in the context of non-compete agreements, to create rights that exceed or conflict with trade secret protections without disclaiming trade secret protection. Some specific examples she discusses are: enlarging trade secret subject matter, avoiding ongoing reasonable secrecy protections, and eliminating the reverse engineering defense.

Concerns about the moment of contract between employer and employee are paramount in Varadarajan’s analysis. She points out: “[f]irms’ trade secret-evasive uses of contract often occur in employee agreements and mass-market consumer licenses—contexts where the restricted party often lacks the capacity to understand, negotiate, and alter terms.” (P. 1573.) What’s more, most trade secret controversies arise out of contracts that were formed in the context she described, rather than out of espionage or some other form of disclosure.

As a result of these formational concerns, Varadarajan calls for what she calls a “reinvigoration” of contract law’s non-enforcement doctrines. Relying on a series of court opinions, she argues that courts can and should limit enforcement of non-disclosure, non-compete, and other trade secret-related contract provisions in light of “public policies that operate to restrict the scope of trade secret protection.” (P. 1589.) She argues that in some circumstances, the “evasive” uses of contract conflict with underlying trade secret policies, such as promoting innovation. She also cites unconscionability as a possible avenue for non-enforcement of some contracts regarding trade secrets.

Both the problem Varadarajan describes and the solution she sketches ultimately sound in contract law. In effect, contract law has allowed individual actors to distort substantive trade secret for their unilateral benefit. So, correspondingly, contract law must correct itself to prevent such an effect in the context of trade secret.

The Trade Secret-Contract Interface is a significant contribution to the contracts literature. It shows how the thin veneer of formal contractual consent is being used to upend not just the expectations of the less powerful contracting party, which is a longstanding and worsening problem in contract law generally, but also settled, established intellectual policy principles. A future agenda for other scholars inspired by Varadarajan’s work may be to examine how contract law consent’s increasing thinness without a corresponding decrease in formal power may be leading to distortionary effects in other sectors of law, society, and the economy.

The Role of Contracts in ART

Nov 20, 2018 Eboni NelsonAdd a Comment

Every fall, the second day of my Contracts course is spent discussing the Baby M case concerning the enforceability of a surrogacy contract. The students engage in a moot court exercise for which they assume the roles of legal counsel for the Sterns, the biological father and adoptive mother, and Mrs. Whitehead, the surrogate. Students also serve as state supreme court justices with yours truly presiding as Chief Justice. Over the years, I have found this exercise to be a fun, interactive, and collaborative way to ease nervous angst-filled law students into the study and practice of law. It also affords the class the opportunity to consider and discuss important fundamental principles of contract law including freedom of contract and public policy concerns. During the three decades that have passed since the Baby M case, there has been enormous growth in the number of individuals using contractual agreements to help them meet their reproductive goals. This growth has necessitated a closer examination of the enforceability of such agreements, which Professor Deborah Zalesne undertakes in her thought-provoking article, The Intersection of Contract Law, Reproductive Technology, and the Market: Families in the Age of ART.

Professor Zalesne’s article begins with a very thorough discussion of the controversial ethical issues surrounding alternative reproductive technologies (ART). Although she acknowledges critics’ concerns about commodification, exploitation, consent, and access as they relate to reproductive practices such as surrogacy and gamete donation, Professor Zalesne argues that “these concerns are overstated, often rooted in traditional and untested beliefs about the sacredness of motherhood and family, and should give way to the paramount concern of reproductive autonomy.” (P. 427.)

Throughout her discussion of the tension between individual choice and moral values, Professor Zalesne explains the role of contracts in the reproductive arena and argues for their enforceability when freely entered into by the parties. For instance, in the context of surrogacy, she argues that courts’ unwillingness to enforce such agreements incentivizes exploitation not only by surrogate mothers who may “threaten to renege in order to get more money,” but also by intended parents who may “refuse to pay medical costs unless the surrogate acquiesces to unreasonable demands,” thereby “result[ing] in greater cost to both parties.” When discussing critics’ concerns regarding exploitation of surrogates and their perceived lack of voluntary consent, Professor Zalesne cautions against imposing impermissible limitations on women’s autonomy to freely contract. She also reminds us that contract law defenses such as unconscionability, undue influence, and economic duress protect against unfair and exploitative contract terms by helping to determine whether surrogates knowingly and voluntarily entered into their agreements. Professor Zalesne thoughtfully suggests that “[c]onsent must include extensive counseling about the inherent medical and emotional benefits and risks associated with most forms of ART, and participants must participate voluntarily and without coercion or undue influence.” (P. 442.)

When Professor Zalesne turns her attention to the reproductive technology of pre-implantation genetic testing, she confronts the many ethical issues that accompany such technology, particularly as it relates to trait selection. Whether contracting parties select for gender, race, height, complexion, or hair and eye color, Professor Zalesne generally advocates for protecting individual reproductive choices provided that they are “private choices for private purposes” rather than “centralized choices for the state’s purposes.”

Respecting private choices, as long as they are not against public policy, is a core tenet of contract law and one that is central to Professor Zalesne’s discussion regarding the importance of judicially enforced reproductive agreements. According to Professor Zalesne, such enforceability protects parties’ intentions and ensures that their wishes at the time of contracting are honored, particularly in cases concerning embryo disposal when one party’s desires may change some time after executing the agreement. Enforceability of reproductive contracts also avoids “unintended, and sometimes absurd, consequences” that can be life altering for parties involved and their families.

Because legislation can be slow to keep pace with evolving social values and technology in the context of ART, Professor Zalesne makes a compelling case that “[p]eople should be their own lawmakers when it comes to reproduction and their personal relationships,” (P. 486) and that contract law serves as an efficient and effective mechanism through which to govern these arrangements. Although we’ve “come a long way” since the Baby M case (to quote the decades old Virginia Slims ad), there continues to be much disagreement surrounding alternative reproduction. As the debate continues, as it undoubtedly will, I am confident that Professor Zalesne’s well-written article will inform it, particularly as it relates to the enforceability of ART agreements, for years to come.

Who Should Decide Whether the Parties Formed a Valid Agreement to Arbitrate?

Oct 22, 2018 Robert HillmanAdd a Comment

David Horton’s Arbitration About Arbitration is a thorough and insightful treatment, with both normative and descriptive elements, of the law’s approach to delegation clauses in contracts calling for arbitration. Delegation clauses assign to arbitrators the question of the validity of an agreement to arbitrate (including defenses such as unconscionability and the like) that would otherwise be decided by courts. A typical delegation clause would go something like this: “Enforceability of the arbitration clause shall be determined by the arbitrator and not by a court” or “[t]he arbitrator[s] shall determine all issues regarding the arbitrability of the dispute.” Horton focuses on delegation clauses in employment and consumer adhesion contracts, where delegation is most troubling.

The article first sets forth a very helpful history detailing the rise of delegation clauses against the backdrop of initial judicial hostility to arbitration, Congress’s enactment of the Federal Arbitration Act (FAA), and the Supreme Court’s recent championing of arbitration, including the enforcement of delegation clauses. As for the latter, in First Options of Chicago, Inc. v. Kaplan, the Supreme Court established that enforcement depends on the parties’ intentions, but the Court required “clea[r] and unmistakabl[e] evidence” of an agreement to delegate. Then in Rent-A-Center, West, Inc. v. Jackson, Justice Scalia diluted the “clear and unmistakable” rule, by observing that courts should enforce delegation clauses if a party merely manifested an intent to delegate. As a result, a court can justify enforcement of a delegation clause by finding that a consumer clicked on an “I agree” button or signed a form contract, even if the consumer never saw or understood the clause. Horton also observes that the treatment of delegation clauses also “rode the wake” of additional Supreme Court decisions, such as AT&T Mobility LLC v. Concepcion, that for practical and legal reasons all but excluded consumers from pursuing rights in court.

Horton is clearly right that the state of the law on delegation clauses in consumer and employee adhesion contracts is problematic. Perhaps most worrisome is the point that arbitrators face what amounts to a conflict of interest when deciding the validity of an agreement to arbitrate. Arbitrators are often paid handsomely for their efforts, so if they decide an agreement to arbitrate is unenforceable, they’ve short circuited their chance for considerable compensation. When this conflict is combined with the common hurdles for consumers and employees in arbitration, such as far-off venues, expenses, and biased arbitrators, a strong argument exists that the threshold issue—whether the case should be arbitrated at all—belongs in a court.

But what is to be done? Horton’s series of solutions is sensible and pragmatic, if somewhat cautious. Despite noting the strong argument that “adhesive delegation clauses never satisfy the ‘clear and unmistakable’ criterion,” (P. 404) he does not go that far. Rather, he calls for treating delegation clauses as “‘lite’ arbitration clauses” (P. 405) that should be “presumptively valid,” (P. 375) but should be subject to various exceptions, including defenses such as unconscionability and “wholly groundless.” Further, despite Section 4 of the FAA’s language that “[t]he court shall hear the parties . . . [i]f the making of arbitration agreement . . . [is] in issue,”¹ Horton finds that the FAA is not “ironclad and unyielding” (P. 403) in part because courts “have insisted for decades that parties can arbitrate arbitrability.” (P. 403.) Instead, the FAA should “exist halfway between inexorable commands and pure background principles,” and its rules should be “hard to draft around.” (P. 403.)

In addition, Horton urges that unconscionability defenses “should have a particularly sharp bite” (P. 406) when the issue is delegation, although Horton points out that a challenger faces a high hurdle to demonstrate unconscionability when the delegation clause alone is the subject of examination. (P. 396.) Finally, although quite critical of the decision, Horton does not argue that Rent-A-Center is simply wrongly decided. Instead, he proposes that courts should read Rent-A-Center narrowly, which would allow a “more nuanced account of delegation clauses.” (P. 399.) Specifically, Horton observes that the “clear and unmistakable” test survives the case, as evidenced by a Scalia footnote. (P. 406.) Further, Horton distinguishes the case on its facts, which he says are atypical and include an unusual delegation clause.

Perhaps, in light of the Supreme Court’s strong sponsorship of arbitration, combined with general contract law’s rather permissive attitude towards assent issues in boilerplate adhesion contracts, Horton’s careful analysis is the best solution. Nevertheless, it is not crazy to argue that, in the context of consumer and employee adhesion contracts, businesses should not have the power to use contracts to avoid the rights of challengers to have courts determine the validity of agreements to arbitrate. Personally, I am most moved by the argument that arbitrators have a strong economic incentive to allow arbitration to proceed. Therefore, delegation clauses in this context should be presumptively unenforceable, not the other way around.

In sum, Arbitration About Arbitration is an excellent article that should be a “must read” for anyone interested in the current treatment of arbitration clauses in the context of adhesion contracts. Though no fault of Horton’s, however, consumers and employee advocates will come away with some trepidation about the state of the law in this area and its future.

Commitment in the Real World

Sep 24, 2018 David HoffmanAdd a Comment

What is the point of signing on the dotted line? In days of yore (i.e., before the E-Signature Act), signing your name with a pen was thought to caution, evidence, and channel promissory behavior. But of late, the dotted line has gotten a bad rap. In April 2018, one of the last domains of contractually-related autographs—credit cards—gave up the ghost. It seems likely that the next generation of contracting parties will never sign a physical contract. Sic transit gloria Montblanc.

Apart from pen manufacturers, should anyone care about the loss? As it turns out, there’s a body of scholarship that shows that being present at a contract’s inception—and personally marking your assent—makes later breach less likely. Several recent experimental studies have found that signing a contract has meaning—it induces caution and retards promise-breaking. Now, in an interesting draft paper, Joshua Mitts has shown that borrowers who do not personally attend their mortgage closing are much (40%!) more likely to default than buyers who are in the room where it happened. That’s true even though borrowers who skip the closing and use a power of attorney (POA) to close, are no more likely to initially show signs of financial distress.

Mitts’ first herculean task in the draft paper is to amass a dataset capable of making the claim and describe that process without benumbing the reader. He does so by combining multiple large, unwieldy databases from New York City and the Federal Government. Some of those databases must be linked through probabilistic matching (because they lacked personally identifiable information), some require OCR and pattern recognition to extract terms from mortgage contracts, while others must be hand-inspected. The result is an excess of a million mortgage/property/borrower records, mostly from the mid to late aughts. (I will admit to being slightly concerned by how easy Mitts makes it seem to match shrouded borrower data to properties.)

The paper’s central analytical challenge is to convince the reader that the sort of people who use a POA at their closings aren’t also those who breach their contracts for other reasons. Given that these are observational data, it’s not a problem that admits of an easy solution. His response is to triangulate from linear regression results: borrowers with POAs aren’t statistically more likely to be house-flippers, aren’t frequent-fliers, don’t have meaningfully different demographic characteristics, aren’t taking on different sorts of loans, aren’t more savvy, etc. (In a revision—which Mitts is working on—he’s trying to deal with the worry that POA borrowers might be more likely to be old/ill, which could be driving defaults and could be uncorrelated to other measures of wealth.)

Having chased down the selection story on borrower characteristics, Mitts interprets the results as being about selection on enhanced commitment to promise-keeping. He does so largely through an estimation showing that loans which remain with their originators are less likely to be breached—here, the POA effect “disappears entirely.” He concludes that “this evidence suggests that repeated contact between lender and borrower enhances promise-keeping, which is consistent with the hypothesis that personal promising leads to a greater sense of personal responsibility and a more salient commitment.” (P. 27.)

This is plausible, and it is consistent with experimental evidence from the contract literature (which Mitts could better use to motivate his story) that assigned contracts/mortgages are more likely to be breached. However, Mitts might have done more to try to tease out the ongoing reputational/relational story with one about commitment at the moment of the bargain. If it’s true that there is no POA effect when you control for the borrower’s ongoing relationship (if one exists), how should we think about the results?

One hypothesis (building on the signature work above) would be to try to disentangle signing a contract from the closing ceremony. The data Mitts has gathered contains some mortgages that were digitally signed and others than were signed with pens: could he test whether signing (versus clicking) has an effect? If so, then I think we could feel more comfortable with the interpretation he advanced.

In either event, Mitts is right to identify the important real-world consequences that flow from his results. This is the sort of paper that will daunt contract professors who thought that empirical work in our field required nothing more than looking at a few hundred EDGAR-coded contracts, or reading some number of appellate cases and discerning patterns. But it’s a major project that shows the continuing vitality of contractual ceremonies. I like it lots!

Is Contract Law Only for the Stubborn?

Aug 10, 2018 Shawn BayernAdd a Comment

Whether by design or by accident (or both), the world rewards people who are stable—who have reliable desires, low discount rates, and long-term plans. Young children who pass the marshmallow test appear to do well on achievement tests ten years later. “Commitment” and “follow-through” are often prized cultural values, and focus and single-mindedness often correlate with success. We link consistency with rationality; economists often don’t even know what to do with people who don’t have consistent preferences.

As Aditi Bagchi suggests in Contract and the Problem of Fickle People, maybe the law inappropriately helps to enshrine this state of affairs. Even if stability contributes to productivity—we can’t build skyscrapers or microprocessors if we’re changing our minds all the time—perhaps arguments routinely made about the private law artificially and accidentally overvalue stubbornness, rigidity, and resistance to change.

As Professor Bagchi observes, different people might assign different meanings to the ability to change beliefs and moral commitments over time. “Some people pride themselves on being constant and only reluctantly let go of beliefs and values as they prove untenable. They call it personal stability,” she writes. “Others pride themselves on self-reinvention, shedding identities often. They call it personal growth.” Apart from concerns about how one person’s fickleness may harm others—which the law should clearly consider—Professor Bagchi asks whether it is appropriate for contract law to favor one approach to personal development over the other.

Her argument is mainly a challenge to theories of contract law that rest on the morality of promises alone—and particularly on a view of that morality that rests, in turn, on a traditional understanding of personal autonomy. “Our moral interest in changing our minds does not generate a right to harm others,” she argues, “but it does generate a reason not to have courts hold us to our commitments for our own sake.” Promises may promote a particular type of personal autonomy, grounded in a view of humans as stable creatures. Many people may value this conception of human morality. But Professor Bagchi’s point is that it’s not obviously desirable in all circumstances, and it’s not necessarily valued by everyone. After all, while we prize stability, we also value open-mindedness; we admire moral conviction, but we also seek to change and to grow. Holding us to a past promise just because we once made it does give a new sort of capability to stable people, but maybe it also discourages us from reevaluating our priorities; after all, on its face, a set of moral rules that prioritize our past priorities over our current ones seems, at the very least, a bit stagnant.

Of course, none of this means that promises generally shouldn’t be enforced. After all, while personal growth might encourage us to try to get out of a past commitment, so might cynical self-interest. Professor Bagchi’s point is just that while the morality of promises alone may justify the legal enforcement of promises in some cases, for some types of people, its justification is not necessarily as universal or persuasive as philosophers often take it to be. “It is surprising,” she observes, “that the philosophical literature on promise has rallied so completely around the value to one’s autonomy of being bound.”

So, instead of grounding contract law exclusively on a traditional conception of promissory morality, contract law should rest on other bases as well. As Professor Bagchi reminds us, contract law has no single justification—or as Mel Eisenberg once put it, “law generally, and contract law specifically, have too many rooms to unlock with one key.”

That is, modern contract law isn’t a simple implementation of analytical moral philosophy, much less particular views of human autonomy. Simple donative promises are, of course, not enforceable merely for the reason that a promise has been made. Many contract rules—principles of mitigation, Hadley v. Baxendale, and so on—end up splitting losses among the parties in various ways, rather than letting damages serve exclusively as a way to right the moral wrong of breach. Some legal rules exist just because they make the law more administrable. Professor Bagchi’s nice questioning of the broad application of a single type of philosophical argument is a reminder that contract law is not—and should not be—easily reduced to one clean, theoretical framework.