Meirav Furth-Matzkin & Roseanna Sommers, Consumer Psychology and the Problem of Fine Print Fraud
, 72 Stan. L. Rev.
__ (forthcoming 2020), available at SSRN
Sellers entice consumers to make purchases by advertising many lovely benefits of their products. It is quite common, however, to then qualify and narrow these marketing promises in the fine print terms attached to the transactions. What if sellers outright deceive consumers—by making loud promises that they surreptitiously negate or contradict in the fine print? What if, say, a phone carrier runs an ad for an “unlimited” data plan which, under the terms of service, is actually strictly limited?
In a surprising article, Meirav Furth-Matzkin and Roseanna Sommers (academic fellows at the University of Chicago Law School) expose the cognitive impact of this tension between explicit promises and fine print. Consumers, their experiments show, may feel committed to the fine print, even when it strips away explicit promises made to them. Laypeople are “intuitive formalists”: not only do they (incorrectly) believe that such conflicting fine print is binding, they also think this is how things should be! They blame themselves for not reading and knowing what’s in the boilerplate, and they are unlikely to complain or to hold the deceiving business accountable.
Lawyers know that consumer protection law does not permit deception. Material promises and representations made before the contract become part of it, and efforts to negate them in the fine print are ineffective, and rightly so. Luring consumers with phantom perks that the business has no intent to confer is fraud. But consumers don’t know what lawyers know. How do they react in the face of fine print terms that conflict with their expectations—those formed by the business’s explicit promises?
In prior work, Tess Wilkinson-Ryan showed that obligations appearing in the fine print are viewed by people as morally and legally legitimate even when they are not. But what if they directly conflict with an explicit assurance? In a set of experiments, a disturbing effect is drawn out: people feel subservient to the fine print. In one scenario, subjects were asked about a car loan guaranteed to be “without any fees” but which in fact came with Terms and Conditions requiring a $3 fee with each payment (totaling, overall, hundreds of dollars). The scenario was presented to lay people (M-Turk) as well as to Harvard/Yale legally trained folks. The two populations agreed that in light of the advertised promise it would be unfair to hold to a consumer bound to pay the fees. But they differed in two important ways. The legal elite correctly doubted whether the consumer “consented” to the fees, and tended to think courts are unlikely enforce them. The larger population reported a glummer attitude, saying that the consumer consented and that courts would enforce the boilerplate.
People do recognize fraud when they see it; and yet, the presence of fine print alters their judgment. In a separate experiment, respondents were given the same “no fees” express promise and were subsequently (and fraudulently) charged the fees. But one group did not receive any fine print disclosure of the fees (“fraud only” treatment), whereas the other group did receive an unread disclosure (“fraud and fine print” treatment). In the “fraud only” condition, the vast majority of respondents (85%) condemned the business for its fraudulent practice and wanted to take some kind of action. In the “fraud and fine print” condition, by contrast, most people (73%) surrendered and yielded to the fee. Given a disclosure—albeit a useless one—they no longer thought that they were wronged, and did not even intend to post a negative review of the business’s deceitful tactics.
The enormous power that fine print exerts on people’s perceptions of their obligation was further demonstrated when comparing “fraud and fine print” to a different treatment in which there is no fraud, only fine print. For one group of respondents, the disclosed fees conflicted with the advertised terms. For another group, there was no advertisement and thus no conflict—they were simply charged fees that were stipulated in the fine print. One would expect consumers to be more upset when the fine print terms conflict with an explicit promise. But no! misrepresentation or not, in both cases the existence of fine print leads people to feel equally beholden to the obligations buried in it.
These results reinforce the sobering insight of prior work: consumer protection doctrines are weakened by people’s cognitive response to fine print. Forget lawsuits, even the modest hope that consumers would denounce fraud by posting negative reviews may be over-estimated. The psychology of fine print seems to join the economics of litigation as barriers to private actions by consumers.
The article correctly recognizes that an entirely different regulatory action—relying on public rather than private enforcement—may be needed to address deception. But, like many other studies of consumer trouble, this article too does not resist the allure of the disclosure panacea. Could the easiest of all regulations—the one-size-fits-all mandated disclosure—solve the problem of consumers’ intuitive formalism? Could consumers be taught that fine print does not absolve fraud? The authors want to test this possibility, and indeed find that telling their participants about the law—about the rule that small terms cannot contradict the explicit statements made before the contract—has a modest effect in counteracting the psychological effect of fine print. They conclude that “education” about the law could be effective. They acknowledge that the effect they measure in the lab may not apply in the real-world, where consumers are overwhelmed by disclosures. Still, I am left wondering: why design a disclosure treatment known (and candidly admitted in the ensuing discussion) to be externally ineffective? Why dilute the agonizing lesson of the study with a gesture towards useless disclosure solutions?
Puzzled as I may be about ending such an excellent article with the superfluous notion of consumers’ “education,” my appreciation for the authors’ primary insight remain unshaken. I now realize the deeper futility of the pervasive hopes that consumers could read the fine print and rebel against its deceptive portions.
Cite as: Omri Ben-Shahar, Fine Print Subservience
(July 30, 2019) (reviewing Meirav Furth-Matzkin & Roseanna Sommers, Consumer Psychology and the Problem of Fine Print Fraud
, 72 Stan. L. Rev.
__ (forthcoming 2020), available at SSRN), https://contracts.jotwell.com/fine-print-subservience/
Both of the first two chapters of this new edited volume–The Contractualisation of Labour Law by John Gardner and Is the Contract of Employment Illiberal? by Hugh Collins—grapple with the structure of employment relationships and how they relate to their legal form. (We are lucky to have had another important recent treatment of this question by Elizabeth Anderson in Private Government (2017).)
John Gardner does not ask precisely the question of my title, but he does offer an answer to it. Gardner is primarily critical of a trend toward what he sees as the contractualization of labour, which he regards of a more general trend toward the contractualization of relationships generally. Tracing our obligations back to contract, he argues, tends to lead us to think that our contracts are the reason we owe other people what we owe them. We also tend to look at our contracts as the fountains of obligation, rather than the nature of our relationships with other people.
Gardner does not resist—or advocate for—any particular legal change. His is mostly a cultural lament. His target is the contractual model of employment, which is taken to justify authoritarianism at work and the idea that “work is there to pay for the life of the worker without being part of that life.” We tend now, he argues, to lose sight of how one’s role as a worker and her employment relationship can play a meaningful part in an employee’s life.
Gardner comes at the problem of authoritarianism at work indirectly. He suggests that the emphasis on contract and its content-independent reasons for employer authority tend to distract from the matter of whether authority is well-used, which turn on the content-dependent reasons for an employee’s substantive obligations. Neither the reasons relating to the employee’s own life plan, such as a desire to put her talents to good use, nor the reasons relating to the employer’s purposes, such as the need to get some task done, are relevant to the employee’s obligations under contract. Those derive just from the fact that she is being paid; so as long as she is paid, anything can be asked of her. The employer has no duty to use his authority reasonably, at least in a popular imagination that has fully contractualized employment (Gardner, Pp. 43-44.) The problem with the resulting private tyranny in Gardner’s picture is that it leaves employees lives empty. Most of their day is spent earning compensation; work just makes it possible to live and at best to pursue life projects in the few remaining hours outside work. The charge is subtle, but yes–contract is to blame.
Hugh Collins comes at the question of private tyranny more directly. He begins with the observation that “[t]he contract of employment embraces an authoritarian structure that appears to be at odds with the commitment in liberal societies to values such as liberty, equal respect, and respect for privacy.” (Collins, P. 48.) Collins concludes by the end that there is indeed “an inherent tension between some liberal values and the institution of the contract of employment that can only be resolved by labour law adopting a particular, worker-protective, legal framework for employment relations.” (Collins, P. 51.)
Collins is not concerned that workers submit to their employers on the latter’s terms. He finds more problematic the subordination of employees to employers on a daily basis as an instrument for the latter’s ends. It is not just that the employer has coercive power by way of threatening termination; by virtue of their contract, the employer exercises practical authority over the employee. Finally, the open-ended nature of the employee’s obligations gives the employer a kind of lesser “prerogative power,” or wide managerial discretion.
Collins suggests that one problem for liberalism arises from the fact that civil liberties, like the right to speech, become subject to employer permission. There is also a contingent but serious risk that managerial discretion will be dominating. Finally, the different levels of esteem associated with the status of employer and employee, respectively, conflict with a principle of equal respect. Collins concludes that we need restrictions on the content of employees’ obligations, restrictions on employers’ restrictions of civil liberties, and restrictions on discipline and dismissal. Collins’ account of the conflict between liberalism and modern employment is more direct than Gardner’s but he similarly concludes that the employment contract as we know it is illiberal. However, he is more sanguine about the power of legal reform to redeem it. While Gardner sees the problem as an ideological one that doctrinal changes cannot undo, Collins suggest that concrete limits on employers can make the employment contract just.
First and foremost, these essays are an essential read because they grapple deeply with a pervasive moral challenge to modern society. If we cannot justify the private tyranny that is modern employment for most Americans (and most people generally—note both Gardner and Collins are British), one of the basic structures that most concretely shapes our everyday lives is unjust. It is hard to know where to start with such a problem. Gardner’s analysis takes as its object the individual relationship of employment and what it means for individual employees. It is a depressing analysis. Collins studies features of employment from a more social or systemic perspective. His analysis is not quite as depressing but it is not happy either. Between the two of them, they capture a lot about what is wrong with private tyranny. This reader is sympathetic to some of Collin’s prescriptions but is persuaded by Gardner that they would not sufficiently temper private tyranny at work, or ensure that work is more than just a means to live. We might hope, though, that even if most employees cannot find meaning in their relationships with their employers, they might still find satisfaction in other dimensions of employment, including relationships with co-workers, customers and the actual work, whether manual or intellectual. We might need to hear next from psychologists, or just more people, about whether we are capable of separating out the contractual and noncontractual dimensions of work life in this way.
Additi Bagchi, What is the Moral Problem with Private Tyranny? Is Contract to Blame?,
(October 1st, 2019)(reviewing John Gardner, The Contractualisation of Labour Law, in Philosophical Foundations of Labour Law
(Collins et al. eds., Oxford U. Press, 2019); Hugh Collins, Is the Contract of Employment Illiberal?, in Philosophical Foundations of Labour Law
(Collins et al. eds., Oxford U. Press, 2019)), https://contracts.jotwell.com/?p=789&preview=true.
David A. Hoffman & Erik Lampmann, Hushing Contracts
, __ Wash. U. Law Rev.
__ (forthcoming), available at SSRN
Contracts should not be confused with contract law: contracts are private tools, but contract law is public. This distinction is particularly evident when the legal system provides enforcement services to parties who cannot work out their relationship without seeking state help. What, then, is this legal system supposed to do when asked to enforce a private contract that threatens to harm the public? While this question is centuries old, it has re-surfaced in recent years with unusual urgency. The contemporary rise of the issue may be linked to peak levels of inequality: in their carefully drafted contracts, stronger parties use their power not only at the expense of their counter-parties, but many times also in ways that negatively impact the wellbeing of third parties and the fundamental values that support our social existence.
In Hushing Contracts, David Hoffman and Eric Lampmann provide an important case study of this problem by closely examining the practice of using non-disclosure agreements in the context of sexual misconduct in a deliberate effort to conceal sexual misbehaviors. To elicit our most intuitive ability to recognize the predicament, the authors powerfully open with a reminder of the USA Gymnastics sexual abuse scandal. They invite us to recall the “national furor” that followed the revelation that USA Gymnastics used a contract to buy the silence of McKayla Maroney, a gold-medal winning American gymnast, in an effort to hide the sexual scandal from the public eye. Such national furor in and of itself evidences a core idea of the article: that private contracts have the potential to infringe upon matters the public strongly and justifiably cares about.
Moreover, Hoffman and Lampmann highlight the point that, when exposed, hushing contracts that were drafted to hide sexual misconduct generate an emotional public response of disgust. The reported appearance of disgust, which is a moral emotion, is meaningful. It signals that at least in our #MeToo times the act of burying wrongdoing by contract is widely perceived as morally wrong, as adding an insult to an injury. As the article updates, such view of hushing contracts as wrongful has already induced legislative responses in a variety of jurisdictions. However, the article also makes clear that hushing contracts are “hard to kill” via legislation (read the article to see why). That leaves us with the authors’ main proposal: to revive the doctrine of public policy and use it to invalidate those hushing contracts that create the externality of harming the public. Fears of the unruly horse of public policy aside, the challenge is, of course, defining with enough carefulness and respect for contracts (as private tools) the reasons that may justify a refusal of contract law (as a public institution) to enforce hushing contracts. It is concerning this challenge that the article offers a particularly inspiring analysis.
Victims of sexual harassment may keep their injuries to themselves not only out of fear or shame but also because their lips “[are] sealed with a signature.” Such a mechanism of contractual silencing, the article argues, carries significant antisocial consequences. First and most directly, it allows the original wrongdoing to continue and expand because it operates “to leave in place abusers.” (P. 12.) Second, the investment in concealing the problem by definition impedes any hope for finding solutions such as organizational engagement in preventive interventions. Instead, “firms send a message to would-be harassers that they too will find protection––rather than accountability––in management.” (P. 17.) Ultimately, “a culture of complicity” develops, in which victims more generally feel themselves unwelcome. (P. 14.) In support of these alarming claims, the authors share data that have illuminated some of the possible costs of this contractual way of enabling, or even fostering, sexual harassment. For example, they describe a few studies that show that the problem amounts to “an organizational stressor that has significant negative outcomes,” and additionally cite an estimation that in just two years the damage caused by workplace sexual harassment reached a total of $327.1 million. (Pp. 16-17.) Finally, the authors emphasize the long-term emotional and political consequences of hushing contracts. Drawing a fascinating comparison between LGBTQ people and sexual harassment survivors, they explain how, in both contexts, silencing—as opposed to the freedom to speak by “coming out”—disempowers not only the suppressed individuals but also the social movements that fight for bringing about change on their behalf. For all these reasons combined, the article makes a very persuasive call for limiting the enforcement of hushing contracts.
The last part of the article broadens the discussion and importantly adds to the emerging literature regarding the expressive role of law in general and of contract law, and contract law’s defenses, in particular. The argument on this point beautifully adheres to the theme of favoring voice over silence. Shifting the focus from survivors’ voice to that of the judiciary, the authors posit that “when courts believe that there is significant third-party harm, they ought to loudly proclaim that public policy is violated.” (P. 47)(emphasis added). As powerful social institutions that are heavily involved in the shaping of social norms and deeply impact people’s behavior, courts should send a clear message that contract law is “infused with concerns for social welfare.” (P. 58.) Framed that way, judicial refusal to enforce contracts that threaten fundamental societal values does not stand in conflict with the central idea of freedom of contract but rather operates to enhance it—restoring the social value of the practice of contracting and with it the legitimacy of contract law. Such a re-legitimization project is, according to Hoffman and Lampmann, “an urgent social task” in an era that is flooded by “click-to-consent” agreements and other unauthentic acts of “consenting” that have even become the subject of widespread ridicule (on this point the authors dedicate a footnote to an episode from the satirical show of South Park). (P. 56, 58.) What’s necessary in this moment of increasing suspicion towards the contractual system, is what the authors call “a way to shock the audience”: a judicial creation of “a counter-story” to the myth of consent, one that underscores contract law’s “concern for social welfare.” (P. 58.)
Throughout the article, the authors do not shy away from discussing possible objections to their argument. Indeed, they originally raise one of the most severe problems: that hushing contracts may never get to courts to allow judges to scrutinize them for public policy concerns, as proposed by the authors. The risk stems from the rapidly growing use of arbitration clauses by stronger parties who utilize their dominance to mute their challengers and insulate themselves and their contracts from judicial review. I would therefore suggest that the next step should be to overcome the arbitration problem by applying the article’s proposal to arbitration clauses, especially those that also include one of the most aggressive hushing techniques—class action waivers. In other words, the authors’ compelling conclusion—“that courts should generally refuse to enforce contracts which create particularly egregious third-party harms”—is valuable beyond the scope of their case study. (P. 61.) Courts should be able to exercise similar refusal powers against other methods of using contracts to silence people. First and foremost, the judiciary should take a stand against attempts to contractually to prevent cases from even arriving in courts—attempts that are increasingly threatening to hush contract law itself.
The unique qualities of digital contracts—weightless, easily duplicable—have made them ubiquitous and much longer than their paper counterparts. Consequently, they are everywhere and accordingly, nobody reads them. Yet, courts have consistently argued that digital or “wrap” contracts (shrinkwrap, clickwrap, browsewrap, etc.) are just like paper contracts and that the same doctrinal rules should apply. Sure, tech giants like Facebook and Google use wrap contracts to vacuum our data under the guise of consent, and companies have used them to impose onerous one-sided clauses, but isn’t that just the same old “lack of consumer bargaining power in a capitalist society” problem that we’ve always had dressed up in digital form? It’s not like digital contracts will lead to the end of civilization as we know it—or will they? In Chapter 6 of their fascinating, original book, Re-Engineering Humanity, Brett Frischmannn and Evan Selinger argue that ubiquitous, digital contracts may have profound negative consequences for humanity.
It may seem an odd choice to select a non-contract specific book for a contracts section JOT, and even more so to focus specifically on a particular chapter in that book. Even though Re-Engineering Humanity is about more than contracts, it is also and importantly about contracts. Frischmann and Selinger argue that contracts are doing something much more sinister than implementing one-sided bargains and deleting our rights with a click. They argue that contracts are actually erasing our humanity and turning us into simple machines.
Their focus is on electronic contracting and how the “design of this environment might incline people to behave like simple stimulus-response machines” that become “increasingly predictable and programmable.” (P. 60.) They note that contracting practices have changed to “accommodate changes in economic, social, and technological systems” so that instead of enhancing individual and group autonomy, contracts “implemented in electronic architecture” may actually be “oppressive.” (P. 60.)
Frischmann and Selinger characterize the “contracting problem” in two ways: First, they argue that the “electronic contracting environment should be understood as a techno-social tool for engineering human beings to behave automatically, like simple machines.” Their second characterization is a bit abstruse and requires a foray into Frederick Taylor’s theory of scientific management (which they discuss in the preceding chapter). Basically, Taylor turned the late 19th century workplace into the more efficient and productive 20th century workplace. He did so by focusing on how workers could be better managed to be made more efficient, essentially viewing them as tools whose efficiency could and should be maximized. Often, this required workers to perform repetitive, discrete tasks without considering the dehumanizing effect that this might have on the worker, or how it might degrade the worker’s skills, essentially treating the worker as a machine. (Pp. 53-59.) Frischmann and Selinger describe the problem of electronic contracting as “a system of scientific management that’s directed toward consumers” in much the same way that laborers in Taylorist workplaces were conditioned to behave like efficiency machines. (P. 61.)
Contracts were intended to be tools to implement autonomy but in the electronic environment they have the opposite effect, “they condition us to devalue our own autonomy,” (P. 61.) by making us act like automatons, clicking and swiping as obediently as well-programmed robots. Their argument “is not about the goodness or badness of contract terms per se. Nor is it about the outcomes in specific contracts, transactions, or cases. Rather, our concern is with the social costs associated with rampant techno-social engineering that devalues and diminishes human autonomy and sociality.” (P. 62.) In Appendix E, they engage with contract theory more directly, finding that “even if electronic contracting perfected markets by lowering transaction costs and improving efficiency, society might nonetheless be much worse off.” (P. 316.) In their view, the real threat to society is not from the substantive terms in a given transaction, but from the design of digital contracts which is intended to make us humans act like “simple stimulus-response machines.” (P. 78.)
Frischmann and Selinger present a compelling argument that digital contracts are actually erasing our humanity and turning us into simple machines. The ubiquity of contracts and their design mean that we are constantly clicking and swiping without thinking. Frischmann and Selinger offer a unique and very big picture perspective which should disabuse those who might think of contracts solely as tools of efficiency. They urge that the law of electronic contracting should be reformed because more is at stake than the (unread) terms and conditions—it is the concept of human autonomy itself. Chapter 6 and Appendix E alone are worth the price of the book, but the other chapters of Re-Engineering Humanity are equally compelling. I urge you to put down your phone and give it a careful, non-tech distracted read.
Uri Benoliel, The Impossibility Doctrine in Commercial Contracts: An Empirical Analysis
, __ Brooklyn L. Rev.
__ (forthcoming), available at SSRN
The use of theoretical economics to analyze legal rules faces a special challenge in contract law, particularly when applied to default rules rather than mandatory ones: it has to match up with what contracting parties are actually doing. One of the foundations of the economic analysis of contract law is that business parties ordinarily know what’s in their own best interests, so economic prescriptions about default, gap-filling rules are also ordinarily predictions: they are statements of what parties actually wanted but didn’t express or what they would have wanted if they had thought about a particular problem in advance.
Economic pronouncements about rules of contract law, therefore, are subject to a particular type of empirical verification unavailable in at least many other areas of law: we can simply look at what sophisticated business parties are doing and see if it matches up with what economists predict they will do. This is precisely what Uri Benoliel has been doing. And the result of his recent empirical study on the impossibility doctrine in contract law, The Impossibility Doctrine in Commercial Contracts: An Empirical Analysis, bears out Grant Gilmore’s famous observation in The Ages of American Law that “no historian, social scientist, or legal theorist has ever succeeded in predicting anything.”
The specific prediction that Professor Benoliel analyzes and helps disprove comes from Richard Posner and Andrew Rosenfield’s foundational legal-economic analysis of the doctrine of unexpected circumstances (mainly impossibility and impracticability) in contract law. Posner and Rosenfield’s analysis is subtle, but its core is that the law should assign the risk of unexpected events to the party best able to avoid or bear them. As an example of avoiding a risk, the seller of goods may more easily be able to take precautions to reduce the risk of fire while the goods are still in its possession; as an example of bearing a risk, the government, or a party able to purchase insurance, may be able to absorb it at lower cost than its counterparty. Posner and Rosenfield argue that the party best able to avoid or bear a risk should be made to bear it because that is what rational contracting parties do, or would do. As Posner and Rosenfield explain, if a draft of a contract assigns the risk differently, the parties can produce a new contract that is better in the aggregate, for both of them, and they can simply adjust the price accordingly so that each party is better off than under the original draft agreement.
Though this argument remains immensely influential, there are many theoretical objections to it. As Mel Eisenberg has pointed out, the rule that Posner and Rosenfield propose would probably be impossible to administer in practice. As I have argued, there is no reason to assume rational parties are focused on particular cost-reductions associated with impossibility or impracticability, and once we recognize that parties may have other considerations, the cleanliness of Posner and Rosenfield’s argument falls apart and it becomes extremely difficult to make predictions about their views on impossibility or impracticability.
Either way, however, Posner and Rosenfield’s argument comes down to a relatively simple prediction: rational parties will assign risks to those best able to bear them. This is what Professor Benoliel’s study tests. And he finds, after reviewing a database of almost 2000 commercial contracts disclosed to the SEC, that parties do not behave in the way that Posner and Rosenfield have predicted. Commercially sophisticated parties are free to choose, explicitly, the rule that Posner and Rosenfield have identified—or to adopt a clause that roughly mirrors it. But they do not. They seem, in other words, to be happy with the traditional legal rule, with all its potential ex post fuzziness and admission of noneconomic criteria, than with the structured variant that Posner and Rosenfield have proposed. That is, the contracts in Professor Benoliel’s study came from sophisticated firms that easily could have allocated the risks of impossibility as Posner and Rosenfield suggest, but in fact a majority chose not to contract around the traditional default at all—and of the minority that did, none explicitly used the superior-risk-bearer formulation, and few seemed consistent with it. The findings, as Professor Benoliel succinctly puts it, “cast significant doubt on the validity of the existing economic analysis of the impossibility doctrine.”
In May 2019 the ALI is scheduled to vote on the 5th Draft Restatement of the Law of Consumer Contracts (“5th Draft Restatement”), a project that seeks to help courts balance the integrity of contract doctrine and commercial reality. Two recent empirical studies in the Yale Journal on Regulation have convinced me that the ALI Council should click “pause” on its adoption because the 5th Draft seems more like a normative statement of what the law should be than a restatement of the common law of contracts in this area.
The truly committed would benefit from reading letters submitted to the ALI that express concern about the Draft Restatement from Consumers Union, state Attorneys General, Sen. Elizabeth Warren, and a variety of other organizations.
The Reporters say in the Introduction to the September, 2018 Draft “[i]t is both irrational and infeasible for most consumers to keep up with the increasingly complex terms provided by businesses in the multitude of transactions, large and small, entered into daily.” To resolve this tension between contract doctrine and commercial realities, the Restatement proposes what the Reporters have called a “Llewellynian Grand Bargain” that would jettison the common law requirement of mutual assent in consumer contracts in return for beefing up defenses to enforcement.
The Klass and Levitin articles seek to replicate the Reporters’ interpretation of the caselaw by reviewing the same dataset of cases. But the exercise did not validate the Reporters’ findings. Instead both articles conclude that the data set is largely irrelevant to the rules proposed by the 5th Draft Restatement. While between a third and one-half of the cases do take the view of law propounded by the Reporters, the trend is not nearly as strong nor as uniform as the Reporters represent it to be.
Faulty Foundation is an offshoot of the drafting process for the Draft Restatement. Its authors are eight Advisors and members of its Consultative Group: Adam Levitin, Nancy Kim, Christina Kunz, Peter Linzer, Patricia McCoy, Juliet Moringiello, Elizabeth Renuart, and Lauren Willis. After becoming aware of Klass’s attempt to validate the Reporter’s interpretation of cases that address whether privacy policies are binding contracts, they sought to confirm the match between the Grand Bargain and case law in the two datasets regarding contract modification issues such as whether the right to unilateral change terms defeats contract formation and cases on clickwrap contract formation.
That review failed to replicate the Draft Restatement’s claims regarding these two datasets. First, the review showed that between half and two-thirds of the cases are not relevant (i.e., were business-to-business cases or vacated decisions) or based on statutory rather than common law principles (i.e., the Federal Arbitration Act or state statutes allowing credit card agreements to contain unilateral modification clauses). Second, the remaining cases revealed a lower rate of courts disregarding contract doctrine re: modification and enforcement in consumer contracting than the Draft Restatement claims. Levitin et al see these gaps between the Reporters’ claims and the cases holdings as “clear errors on a massive scale.” These errors “raise questions about the accuracy and soundness of the entire project and [have] the potential to undermine the legitimacy of the ALI Restatement drafting process.” (P. 451.)
Here’s the big take-away from the Klass & Levitin articles: the 5th Draft Restatement is grounded on a faulty empirical foundation. The ALI’s Annual Meeting in May 2019 should set aside time for thorough discussion of these two studies. ALI Members alarmed by the Levitin and Klass articles could move to change the Restatement to a Principles project that would better reflect its “Grand Bargain.” In the alternative, the ALI Council could direct the Reporters to revise the 5th Draft Restatement and update the data set to include cases since 2014. Third and finally, the ALI could put the project on hold until the law in the area is sufficiently clear to restate. An “as is” adoption of the 5th Draft Restatement would endanger the reputation of the ALI and the larger Restatement drafting process by publishing a “Restatement” that does not actually restate the law.
Faulty Foundations Tested Restatement Claims by Replicating Reporter Study
The Reporters justify their Grand Bargain of disregarding contract formation requirements in consumer contracting by asserting that the courts already take this position. They claim that a data set of 353 cases support that conclusion. Levitin and his co-authors conducted a blind review of the two largest datasets: 88 modification cases, and 98 clickwrap cases. (P. 455) Although the authors are skeptical that dicta “restate” the law, they, like the Reporters, treated dicta as well as holdings as relevant. They built in verification for their case interpretation by having between two and three of them code each modification case, and between one and three of the authors code the clickwrap cases. (P. 455.)
Because the Faulty Foundation article replicates the Reporters’ review, their data set excluded cases decided after 2015. More recent cases suggest a definite minority position in which courts follow conventional contract formation requirements to consumer contracting. (A list of some recent cases appears at the end of this Jotwell entry.)
Faulty Foundations separately reports on each data set. Here’s the breakdown of errors in the modification dataset:
Problems with the Modification Data Set
Levitin et al identify two main reasons that the modification dataset does not justify the 5th Draft’s approach to consumer contracting: (1) more than half of the cases are simply irrelevant to the common law doctrine re: modification; and (2) the remaining cases are either atypical or not precedential. Together these revelations greatly weaken the Reporters’ claim that their Grand Bargain restates the law of consumer contracting.
First, irrelevance. The authors of Faulty Foundations found that more than half—61%—of the 88 modification cases are “irrelevant” to the issue of when a consumer has adopted modified standard terms in a contract. The biggest set of inapplicable cases—26 cases—were decided on statutory rather than common law analysis, as when state statutes permit unilateral modification terms in a credit card agreement. The Faulty Foundations authors also identified other factors that made 28 other cases in the modification data set inappropriate for designating trends in common law doctrine re: modification of standard-form contracts between businesses and consumers. They found that the irrelevant cases:
- focus on the substance of the contract clause instead of modification;
- concern multiple contracts instead of modification;
- involve business-to-business disputes instead of consumer contracts;
- follow statutory cases on stare decisis grounds;
- address only retroactive modification;
- address illusory promise doctrine instead of modification;
- refuse to evaluate the contract as modified because it wasn’t entered into the record;
- involve a consumer’s effort to enforce a modified contract, instead of the business;
- appear twice in the data set (a case counted at the intermediate appellate and supreme court level);
- reserve the modification question for determination in arbitration; or
- are no longer good law (i.e., vacated).
In light of the U.S. Supreme Court’s recent cases that impose a heavy thumb on the scale in favor of enforcing arbitration clauses—see e.g., AT & T Mobility v. Concepcion, 563 U.S. 333 (2011)—the dataset’s reliance on cases regarding arbitration clauses is particularly likely to skew the data in favor of enforcing a variety of business-drafted terms. Another error in the modification dataset is that Levitin et al report finding cases that the Reporters should have included in the dataset, but did not.
If Levitin et al.’s case coding is correct, their analysis leaves a much smaller data set of 34 modification cases. According to Faulty Foundations, these remaining cases also make a much weaker case for the 5th Draft Restatement’s approach than the Reporters claim. The vast majority of these cases—82%—involve contracts with express clauses allowing unilateral modification by one party. The cases don’t tell us much about the enforceability of unilateral modification clause at common law because most of them are credit card or deposit account contracts decided under the state statutes that expressly allow courts to enforce unilateral modification clauses. In the many cases—88%—that involved attempts to compel arbitration, federal statutory law also constrains the ability of those cases to reflect the common law of consumer contracting. Finally, the Faulty Foundation authors found that many of the seemingly relevant cases were either unpublished, federal courts interpreting state law, or lower state courts. Startlingly, according to Levitin et al, “only ten of the relevant cases are state court decisions, with only a single decision from a state supreme court.” (P. 460.)
Problems with the Clickwrap Data Set
The Faulty Foundation authors found similar defects in the 98-case clickwrap data set. Nearly half—46%—of the cases were irrelevant, the remaining cases did not strongly support the Reporter’s version of consumer contracting law, and nearly half lacked precedential value because they apply the law of other jurisdictions.
Because of overlap between the defects in the modification and clickwrap data set, I’ll focus on what, according to Levitin et al, make so much of the clickwrap data set irrelevant, and the most glaring defects with the remaining cases.
To my mind, three defects in this data set were most noteworthy:
- 16 of the cases were business to business cases, which may not reflect the law of consumer contracting;
- 11 cases did not address contract formation; and
- 2 did not involve a contract of any sort.
If Levitin et al are right to exclude those cases, the Restatement would rest on 53 remaining clickwrap cases. The authors’ review found a distinct minority position—11% of the cases—in which courts refused to enforce clickwrap terms. Yet the Draft Restatement Reporters found only a 2% rate of non-enforcement. Levitin et al contend that overlooking this minority but important position prevents the Draft Resatement from accurately restating the law.
The defects in the data sets overlap. For example, Levitin et al. criticize the clickwrap contract cases as not-precedential because they apply the law of other jurisdictions. Choice of law clauses that amplify the significance of state statutes enforcing unilateral modification clauses drown out common law patterns in other jurisdictions. Likewise, the fact that 40% of the remaining clickwrap cases involved efforts to compel arbitration shows the long shadow that the Federal Arbitration Act casts across both the modification and clickwrap data sets.
The painstaking replication project undertaken by the authors of Faulty Foundations is all the more credible because of the article’s restraint from any ad hominem attacks or speculation as to why the data set did not reflect the Draft Restatement’s conclusions. The article inspired me to do a quick and dirty investigation of what an updated and cleaned up data set might tell us about the state of consumer contracting.
As of spring 2019, a distinct minority of jurisdictions show a reluctance to enforce standard form contracts that do not meet contract formation requirements, even in cases involving arbitration clauses. Interested readers could check out the Massachusetts and First Circuit cases of Nat’l Federation of the Blind v. Container Store, 904 F.3d 70 (1st Cir. 2018); Cullinane v. Uber Tech., 893 F.3d 53 (1st Cir. 2018); and Kauders v. Uber Tech., 2019 WL 510568 (Mass. Super. Ct. 2019). The California cases include Norcia v. Samsung Telecom. Am., 845 F.3d 1279 (9th Cir. 2017); Metter v. Uber Tech., 2017 WL 1374579 (N.D. Cal. 2017); Velasquez-Reyes v. Samsung Elec. Am., 2017 WL 4082419 (C.D. Cal. 2017); and McKee v. Audible, 2018 WL 2422582 (C.D. Cal. 2018). These new developments should be reflected in any Restatement of the Law of Consumer Contracting.
The articles by Klass & Levitin et al provide readers with a few takeaways. First, the ALI membership should know about these attempts to replicate the case law interpretation underlying the 5th Draft of the Restatement of Consumer Contracts. ALI members who are troubled by the apparent mismatch between the law and the 5th Draft Restatement could speak up at the May 2019 Annual Meeting in a number of ways.
Motions that the ALI could and perhaps should debate and vote on include the following:
- A motion to change the Restatement to a Principles project;
- A motion to delay the Restatement project to reflect closer look at the existing data set and incorporate newly developing law; or
- A motion to put the Restatement of Consumer Contracts on hold and revisit it when trend of common law more clear.
If the ALI instead opts to adopt the Draft Restatement in its current form, contract law will suffer, as will the integrity of the Restatement drafting process as a whole.
The most pressing issue in contract doctrine today may well be what to do about the gap between the ideal of mutual assent required for contract formation and the reality that the vast majority of us click “yes” to agreements every day without reading a single clause. The long and tumultuous history of the ALI’s attempt to update UCC Article 2 to reflect on-line communications shows how difficult it is to do this type of updating. Both the Klauss article & Faulty Foundations should help place this project on accurate foundations.
Cite as: Martha Ertman, Properly Restating the Law of Consumer Contracting, JOTWELL (May 10, 2019) (reviewing Gregory Klass, Empiricism and Privacy Policies in the Restatement of Consumer Contract Law, 36 Yale J. on Reg. 45 (2019) and Adam Levitin et al., The Faulty Foundation of the Draft Restatement of Consumer Contracts, 36 Yale J. on Reg. 447 (2019)), https://contracts.jotwell.com/properly-restating-the-law-of-consumer-contracting.
Jacob Hale Russell, Unconscionability’s Greatly Exaggerated Death
, 53 U.C. Davis L. Rev.
__ (forthcoming), available on SSRN
Jacob Russell has a bone to pick with the contract professoriate, who have consigned unconscionability to a backwater in our courses, trotted out today only in 9th circuit cases that excoriate arbitration clauses before being consigned to an inevitable Supreme Court reversal. In his excellent new draft paper, Russell aims to show that true unconscionability—“rotten deal unconscionability”—didn’t die with the 1960s and 1970s but remains a vibrant part of today’s contracting landscape. The paper offers a compelling account of the functioning of an oft-derided doctrine, and even better, the grist for an enriched classroom exploration of the ways that courts deal with inequality in exchange. You should read it.
The heart of the paper is a caselaw survey, mostly of state court cases that follow the Great Recession. Hiding, as it were, in plain sight, Russell finds dozens of cases in which courts simply are rejecting deals because they were unequal: interests rates too high, foreclosures procured from vulnerable borrowers, routine overdraft fees on debit cards, and payday loans. Two common themes emerge, both remarkable given the doctrine’s repute: the cases involved “common products…sold by mainstream players in the credit industry,” and the courts themselves characterized the remedies as “routine.” Or to put it differently, unconscionability seemingly is routinely disrupting deals at the center of our credit markets. Why, then, are contract professors convinced that substantive unconscionability is a dead letter?
Russell argues that the conventional wisdom can be “slow to update,” especially when it is built on the backs of contracts casebooks. Second, and here Russell is “necessarily speculative,” perhaps there has been a post-crisis uptick in bad-deal unconscionability which changed how judges saw them. He argues that this change is reflected in the common treatment of unconscionability in consumer protection legislation, and in the American Law Institute’s (ALI) new proposed Restatement of Consumer Contracts, which would go beyond the caselaw in making the doctrine available when terms are not salient.
After describing this stealthy source of unconscionability cases, Russell attempts to give the doctrine more content by discussing its tailoring. That is, which consumer should courts have in mind when applying the doctrine, the “subjective, specific individual sitting in front of the court,” “a typical consumer,” or “somewhere in between.” As Russell points out, the choice of tailoring can be outcome-determinative, but it is rarely discussed explicitly, either by courts or scholars.
Russell argues that particularly in a world of individualized digital contracting, judicial inquiry, too, ought to be targeted at the consumer in the room. That’s so because he believes that unconscionability’s true purpose is “policing merchant misbehavior, not preventing consumer harm.” Russell would cabin the doctrine to those merchants who “know, or should have known, that their contacts were unfair or extremely inappropriate for the consumer,” evaluated ex post. In this way, courts could act as flexible agents for market-wide consumer protection, and might be able to alleviate some of the problems that mass-digitization of contracting has created.
The article thus makes a big move, offering readers a new take on how to police individualized contracts. While I was not entirely convinced of the tailoring story, my priors about unconscionability’s incidence and nature were updated. I won’t be teaching the doctrine the same way again. I like it lots.
Ronen Avraham & Anthony Sebok, An Empirical Investigation of Third Party Consumer Litigant Funding
, 104 Cornell L. Rev.
__ (forthcoming), available at SSRN
Contracting parties often suffer from information problems, lack of expertise, and limited cognitive abilities. They sometimes make decisions under stressful conditions. There are always others happy to exploit these phenomena to make extra profits. One sphere in which such exploitation has attracted much attention since time immemorial is usurious interest rates. In their fascinating empirical study, Ronen Avraham and Anthony Sebok shed new light on this phenomenon in an expanding new market for credit—namely, Litigants Third-Party Funding (LTPF). These are nonrecourse loans, given by commercial firms to individual tort plaintiffs, which are then repaid from the proceeds of the lawsuit.
Avraham and Sebok obtained a unique dataset of about 200,000 plaintiffs’ applications for loans handled by one of the largest firms that engages in such funding. The dataset comprised both approved and refused applications. Among other things, it included the personal details of each applicant; the name of the attorney representing him or her; a description of the case; the amount sued for; medical and insurance reports on the accident; an independent legal assessment of the lawsuit’s likelihood of success and potential value; and information about existing liens on the award that the plaintiff might receive. With regard to approved applications, the dataset included also the amount funded; the monthly interest rate; the length of the legal proceedings; the amount owed when the case was resolved; and the amount actually repaid. (Pp. 6–7.)
The article offers rich and very lucid descriptive statistics of the data, and discusses the policy implications of the findings. Among other things, it was found that only about half of the applications were actually funded, and that the average loan was around 7% of the estimated case value. (P. 10.) The interest was calculated on a monthly basis, with a median interest of 3% per month. In the great majority of cases, the interest was compounded on a monthly basis. In most of the contracts, there was a minimal period for which interest was charged, regardless of the actual length of the funding—usually three months. Beyond this period, the compounded interest was commonly calculated using interest buckets—namely, minimal periods (usually of three months) for which interest was charged, even if the loan was paid back before the end of that period. (Pp. 15–16.) The average period of the loans was 14 months. Most borrowers took only one loan per case, but a considerable minority received two, three, or even more loans per case. (P. 9.) Only applicants whose requests had been approved were charged a processing fee, which was paid along with the principal and interest at the end of the loan period (subject to the same compound interest and buckets). The most frequent fee for the first funding request was $250, with an additional fee of $75 for each additional request in the same case. (Pp. 19–21.) The average total amount of the funding was around $7,000, and the median—around $2,250.
Given what we know about people’s limited literacy, innumeracy, and lack of legal and financial expertise, one could reasonably surmise that most borrowers believed that the effective annual percentage rate (APR) was somewhat higher than 36% (the stipulated monthly rate multiplied by 12). In fact, due to the complex calculation described above, the median APR was 101%! Twelve percent of the borrowers paid back only the principal, or even less than the principal, and many more paid only part of the sum due, as the lender had not insisted on repayment in full (so-called haircuts). Consequently, the median effective APR collected by the lender was approximately 44%. The article shows that the contractual terms offered to borrowers and the haircuts they got ex post depended on whether the borrower’s lawyer had an ongoing relationship with the lender. (Pp. 24–29.)
The article offers a unique, large-scale empirical analysis of the LTPF market, which is crucial for any regulation thereof. It elucidates the relationships between lenders, borrowers, and the borrowers’ lawyers at the formation and performance stages of the contract, and offers insightful policy recommendations.
The authors place much emphasis on the effective APR of 44%. They note that it is considerably lower than some previous estimates (Pp. 4–5), and close to the statutory cap proposed in negotiations between the LTPF industry and its critics (P. 8). However, one might question this framing of the data. First, caps on interest rates refer to the contractual terms, rather than their ex post enforcement by lenders. Gaps between contractual terms and suppliers’ reliance on them serve important functions, but they also have troubling, and potentially harmful implications. As the data shows, while most borrowers get considerable haircuts, 34% pay the full amount due, and 5% apparently pay more than the amount due. (Pp. 21–24.) Those who pay back the full amount will find little comfort in the fact that others do not repay the loans at all, or get considerable haircuts—and from a societal perspective, the redistributive effects of this practice (exacerbated by the existence or absence of an ongoing relationship between the lender and the client’s attorney) are troubling.
It should be noted that the high median APR of 44% cannot be explained or justified by the risks LTPF lenders take, because this figure already embodies loans that have not been repaid in full or at all. The authors argue persuasively that their findings call for regulation. Their key recommendation—which I find very compelling—is that regulation should neither be content with setting default rules or disclosure duties (both of which may well be futile), nor imposing caps on interest rates (which firms may creatively bypass). Rather, the law should prohibit any contract terms that impinge upon the APR more than a simple interest rate (that is, ban all compounding interest, minimal periods, buckets, and fees paid upon repayment of the loan). (Pp. 34–37.)
One question that must be answered when considering regulation of the LTPF industry is to what extent it enhances access to justice for poor people—a potential major justification for its existence. My own impression is that LTPF has little to do with litigation funding. Since the great majority of tort plaintiffs hire their attorneys on a contingent fee basis (P. 32), they do not need additional funding for the litigation. Presumably, then, they are taking out the loans to finance daily needs that may have risen due to the accident and its possible adverse effect on their earnings. Thus, the expected recovery from the lawsuit serves primarily as collateral. Indeed, the fact that these are nonrecourse loans provides an important advantage to borrowers whose net recovery is smaller than the amount due. However, the contingent nature of repayment (including the payment of the processing fees) may actually allow LTPF lenders to charge much higher APR than otherwise possible. Since repayment is contingent upon the success of the claim, borrowers may view it as protecting them from a possible loss—and loss-averse people are willing to pay much for such protection (just as they are in the context of attorneys’ contingent fees).
Avraham and Sebok’s beautifully executed study lays the groundwork for further empirical work, theoretical analysis, and legal policymaking (further empirical research would be useful because the LTPF market is fraught with traditional and behavioral market failures—hence there may be considerable variance among firms). However, none of my quibbles detract from the important empirical research and thought-provoking analysis that it already offers. More generally, the reality of the LTPF market—apparently a distinctively American phenomenon—should give one pause about the current U.S. economy and its legal system.
Antonia Eliason, Lillian McMurry and the Blues Contracts of Trumpet Records
, 87 Miss. L.J.
279 (2018), available at SSRN
Professor Eliason’s Lillian McMurry and the Blues Contracts of Trumpet Records combines some of my favorite things—contract law, legal history, and Mississippi blues. Through the article, Eliason weaves a narrative of a compelling female protagonist, Lillian McMurry, who founded, operated, and finally closed the Trumpet Records (“Trumpet”) label in 1950s Jackson, Mississippi. This article provides a fantastic historical snapshot of the music industry at the time of itinerant blues artists who created the musical backbone of rock ‘n roll.
My interest in music industry contracting was sparked by Judge Jerome Frank’s dissent in M. Whitmark & Sons v. Fred Fisher Music Co. The majority opinion is relatively straightforward in upholding an artist’s assignment of contingent copyright renewal rights that would mature twenty-two years in the future. In contrast, Judge Frank in dissent exhibited remarkable judicial hubris (as well as, perhaps, the dark side of Legal Realist judging) in attempting to refuse specific enforcement of the original contract on fairness grounds. Specifically, Judge Frank would have substituted his own biased view of the relationship between artists and publishers:
We need only take judicial notice of that which every schoolboy knows—that, usually, with a few notable exceptions (such as W. Shakespeare and G. B. Shaw), authors are hopelessly inept in business transactions and that lyricists, like the defendant Graff, often sell their songs “for a song.”
Frank’s generalization of the ineptitude of artists also has a corollary implication that publishers who exploit this perceived weakness should lose the ability to enforce their contracts in equity. In so doing, Frank illustrates Arthur Allen Leff’s observation that “[T]he benevolent have a tendency to colonize, whether geographically or legally.”
Eliason’s article is useful as a subtle rebuke of Frank’s sweeping schoolboy generalization. Instead of one-sided exploitation, Eliason presents a nuanced picture of Trumpet Records as its contracts developed and its owner built relationships with artists.
McMurry founded Trumpet in 1950, having no experience in the industry. A 28-year-old white woman, McMurry worked with white and black artists across a range of musical styles. As Eliason relates, “At both a contractual and a personal level, McMurry did not distinguish between her white and black artists, and her correspondences demonstrate that she operated without concern for segregationist attitudes in Mississippi at the time.” (P. 282.) Moreover, Eliason’s analysis of the terms of the Trumpet contracts opens a window on the challenges and frustrations experienced by a new business owner trying to create a successful business on principled terms in a highly competitive field.
Eliason’s original historical research delved into the Blues Archives at the University of Mississippi, as well as documents preserved in the Mississippi Supreme Court relating to Trumpet’s contract dispute over copyright with one artist, Sherman “Blues” Johnson. The historical contracts demonstrate that McMurry and Trumpet became increasingly sophisticated in their contracts over the life of the label. Eliason helpfully includes examples of these contracts in appendices to the article.
The Trumpet contracts showed McMurry’s development as she gained experience. For example, early contracts required artists to secure their own copyright permissions to use others’ work, but McMurry later made Trumpet responsible given the lack of sophistication among the Trumpet artists and the general borrowing culture among blues musicians. Similarly, early Trumpet contracts required artists to provide a fixed number of “test records” or auditions every month. Over time however, McMurry reduced the fixed recording requirements, eventually merely requiring such material only “from time to time,” apparently recognizing that artistic works were not well-suited to a fixed production schedule.
Eliason addresses many challenges that McMurry encountered while running Trumpet records. Most notably, Eliason analyzes a 1954 dispute with artist Sherman “Blues” Johnson over whether the Trumpet contract assigned Trumpet copyright to materials created before the contract term. Johnson recorded Pretty Baby Blues for Trumpet. But Saving My Love For You, the song at issue in Trumpet’s dispute with Johnson, was sung by artist Johnny Ace. Ultimately, the Mississippi Supreme Court held the Trumpet contract ambiguous and interpreted the term to apply only to materials created during the term of the contract, an outcome that left McMurry feeling distressed and betrayed. Likewise, Eliason analyzes McMurry’s work to protect the Trumpet artists against piracy even decades after Trumpet closed its doors.
The most intriguing section of the article presents McMurry’s personal interactions with the Trumpet artists. Analyzing McMurry’s correspondence with the artists, Eliason paints a picture of a business owner who truly cared about the artists who worked for her, but at the same time attempted to operate the business professionally. The correspondence shows McMurry insisting on performance of the Trumpet contract terms but also being willing to work with the artists as they encountered difficulties. In one instance, for example, McMurry advanced an artist money to travel home to Mississippi while at the same time noting that the artist was in violation of the contract. In another letter, McMurry attempted to locate the widow of an artist (for whom Trumpet had paid medical and funeral expenses) to ensure the widow received royalty payments. And other correspondence indicates a close personal relationship with artist Sonny Boy Williamson and his wife Mattie during the breakup of their apparently troubled marriage. These letters reveal McMurry as both a hard-nosed businessperson and someone who cared about those who worked with her.
As Eliason concludes, in the context of the highly-competitive and often exploitative music industry, “Lillian McMurry was an exceptional individual whose adherence to the letter of her contracts and treatment of her artists was unusual.” (P. 310.) This article is a great piece of legal history that provides valuable real-life information about a fascinating time in music history.
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.