Contract Law Should Return to Its Classical Form, Scott Urges

October 15, 2003

Professor ScottSocial science research indicates that contract law should become minimalist in its scope and outlook, said Robert E. Scott in a Chair Lecture Oct. 10 marking his inauguration as a David and Mary Harrison Distinguished Professor of Law. Experiments show that the human response to reciprocity gestures — acts predicated on trust and cooperation — results in better outcomes than those that rely on threats and punishment. Thus laws that presume humans to be strictly self-interested, and therefore needing to be closely regulated, may instead be unnecessarily complicating and weakening bargains, Scott said.

One of the nation's leading authorities and theorists on contract law, Scott spoke to a jammed Caplin Pavilion on "The Death of Contract Law," offering in fact a provocative new vision of its future.

Chair lectures are traditional at the School of Law when professors are elevated to prestigious chairs, and the five Harrison chairs, established last year with a $30 million gift from the estate of David and Mary Harrison of Hopewell, Virginia, are among the handful of most handsomely endowed professorships in the American legal academy. "We intend to make the name Harrison Professor the brand name for the foremost appointment in law," said Dean John C. Jeffries Jr. in his introduction of Scott. Professors Glen O. Robinson and G. Edward White have also been appointed to Harrison chairs and two chairs remain vacant. Jeffries credited Harrison, who also supported the extensive revocation of the Law Grounds in 1997, with imagining Caplin Pavilion, urging its architects to "aim high" and create for the Law School a space with the dignity of the Rotunda's Dome Room. Jeffries also noted that Harrison insisted that teaching ability be a prominent factor in the selection of scholars for the chairs.

Two of David and Mary Harrison's children, Mary Harrison Keevil and David A. Harrison IV, a 1971 law school graduate, were on hand for the occasion.

Thirty years ago prominent contract scholars were announcing the demise of the bargain theory of contract law, Scott said, predicting that it would be superceded by the Uniform Commercial Code or subsumed by tort law. That hasn't happened, he said-in fact theorists have since proven the coherence and vitality of the bargain paradigm-but the field is shifting nonetheless. "It's contract law rather than contract itself that is in severe peril," he explained.

"My claim, in brief, is that contract law is dying from hubris, from the belief that more contract law is always better than less. A significant effect of this expansion of liability has been a measurable increase in the costs of enforcing contracts. Ignored in this development is the fact that contract law regulates a consensual activity. This means that the parties to contractual agreements have a choice between legally enforceable contracts regulated by the state and other alternatives. The peril that public contract law faces is that many contracting parties have chosen to exit the public system of legal enforcement in favor of less costly alternatives over which they have more control."

Contract law is at risk of becoming "irrelevant," Scott said, unless "courts and legislators come to see that, in fact, less contract law is better than more." He proposed that the field move toward "self-enforcement as the preferable alternative to legal enforcement for many promises that fall outside the boundaries of the classical model."

From normative roots in common law, the bargain theory evolved through the 19th century alongside the corporate form, he said. Classically, contract law was "grounded in formalism. It emphasized the centrality of written agreements and the limited role of the law in enforcing and interpreting these agreements."

That formalism increasingly gave contract law problems in fitting the wide variety of promises it was meant to cover.

"The advantages of the classical approach are relatively low enforcement costs and relatively high transparency of the law to prospective contractors," he said. "The disadvantage is that the underlying justification of a particular rule may argue against allowing some cases that the rule permits, and in favor of allowing some cases the rule prohibits… A simple rule may not apply equally well in all contexts."

The response to this problem has been to expand contract law, but away from bright-line rules and toward vaguer standards. Formal rules may be helpful to the courts, Scott said, but "they are rarely a good fit for the contracting parties" because they are not sufficiently clear about each party's obligations. This tends to make standards ambiguous, creating incentives for inefficiency, opening the way for costly litigation over interpretation, and inviting inconsistency in court rulings.

Since the cure is hardly better than the disease, there has been a "mass exodus from the public enforcement regime by important classes of contracting parties," Scott said. Private-dispute resolutions have preferred to use binding arbitration and interpret terms according to their plain meaning.

"Replacing common law rules with vague standards imposes uncertainty costs without providing corresponding benefits," he said. "And, in response, contracting parties have voted with their feet."

This leads to a new problem. "The major social cost of a wholesale exit from the public contract law is the loss of the social benefits that derive from judicial resolution of disputed agreements," Scott explained. "The activity of contracting becomes less dangerous when courts, in the process of interpretation, create standardized terms that future parties can safely use in signaling their intentions. The primary public role for the state is this testing process-the standardization of the meaning and jurisdiction of state-supplied default rules and commonly used contract language from which individual parties can safely customize their contracts. Commercial arbitration decisions, on the other hand, remain unpublished for the most part. This means that the positive benefits that result from authoritative resolution of disputes are sacrificed. Substituting unpublished arbitration decisions for published judicial opinions thus represents a true social cost. It is the equivalent of approving new drug therapies without clinical trials."

Scott said he favors "a return to the classical common law of contract that … begins by borrowing from the physician's injunction, 'first, do no harm' and resolutely declines to enforce incomplete or indefinite promises."

Self-enforcement is "a minimalist approach" that relies on "powerful informal norms, rather than legal rules, to govern most contracting behavior," he said. He pointed to recent work in experimental economics that suggests that a significant fraction of individuals behave as if reciprocity were an important motivation, even in isolated interactions with strangers.

"This new experimental evidence provides the foundation for a theory of fairness grounded in the human motivation to reciprocate. This theory predicts that self-enforcement of many types of incomplete agreements, even those between perfect strangers, is more efficient than the alternative of legal enforcement," Scott explained. He elaborated on the three key findings:

"One: Many people deviate from purely self-interested behavior in a reciprocal manner. Reciprocity means that in response to friendly actions, many people are much more cooperative than predicted by the axioms of rational choice. Conversely, in response to hostile actions many people are much more nasty and vengeful." Scott cited the old Norse adage, "A man ought to repay gift with gift and lies with treachery.

"Two: People repay gifts and take revenge even in interactions with complete strangers and even if it is costly for them and yields neither present nor future material rewards.

"Three: Some people exhibit reciprocal fairness and others are selfish. Taking all the experiments together from countries as diverse as Austria, Indonesia, Russia, and the U.S., the fraction of fair subjects ranges from 40 to 60 percent as does the fraction of subjects who are selfish."

He described one experiment as an example. "Economists designed an experiment in which buyers were matched randomly and anonymously with different sellers. The buyers had to choose between an unenforceable bonus agreement and a (more costly) legally enforceable contract with sanctions for nonperformance. Ninety percent of the buyers in the experiments chose the bonus agreement. Some buyers then failed to pay any bonus, but a significant fraction did respond generously to higher levels of effort from their sellers by paying an appropriate bonus. Thus, the average bonus increased significantly and proportionately with the level of effort actually provided. This made it worthwhile for sellers (whether they were fair or selfish) to put forth much greater effort than one would otherwise predict. Indeed, the average amount of effort induced by the unenforceable bonus agreement was two times that which was induced by the legally enforceable contract. In short, the self-enforcing option produced a much higher payoff on average, for both parties."

"These experiments demonstrate that powerful incentives can be stimulated in a very incomplete agreement between total strangers who may never interact again," Scott said. "The experimental evidence strongly suggests that the effect of reciprocal fairness, an effect that thus far has been neglected in contract theory, is an important element in optimal contract design."

After describing other experiments that reinforced the point, Scott said he has concluded that the proper course is to "narrow the scope of contract law to give it a smaller domain than it occupies under more aggressive strategies of interpretation."

He acknowledged that self-enforcement will not work all the time. "Reciprocity functions best where the agreements are simple in form and the commitments made by each party are clear. Where transactions are complex and the respective promises interrelated, it is more difficult to characterize behavior as either generous or unfair. These complex interactions are the sort of agreements that commercial parties typically reduce to legally enforceable obligations… Contracting parties may simply prefer to behave under two sets of rules: an explicit (and rigid) set of rules for those parts of their relationship that require legal enforcement and a flexible (and implicit) set of rules for those aspects that respond best to self-enforcement. It may be that the great lesson for courts is that any effort to judicialize preferences for fairness will destroy the very informality that makes them so effective in the first instance."

Lawyers should be careful not to exaggerate the role of law, he said. "The costs of the imperialism of contract law will be felt in a reduction in the potency of social forces such as reciprocal fairness," he warned. "Precisely because fairness matters, the law should leave space for reciprocity to work. In short, the lesson may simply be that fairness imposed is fairness denied."

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