Recent Supreme Court decisions such as American Express v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013), and AT&T Mobility v. Concepcion, 131 S. Ct. 1740 (2011), represent dramatic developments with implications that extend far beyond the arbitration context. These decisions are a product of what the author refers to as the “contract model” of the Federal Arbitration Act (FAA). Heretofore largely unquestioned, the contract model posits the FAA’s original and dominant purpose as the promotion of private ordering in dispute resolution, as free as possible from state regulation. The model has, in turn, helped courts and commentators claim that the FAA requires arbitration agreements to be enforced strictly “according to their terms”—without regard to the way those agreements might compromise procedural values, such as when they preclude classwide relief.
This Article questions both the descriptive accuracy and normative persuasiveness of the contract model. It argues that when placed in their proper historical context, the FAA’s text and legislative history appear equally consistent (if not more so) with a purpose to improve upon the widely discussed procedural failings of the courts circa 1925. From this standpoint, the FAA can be understood as an offshoot of ongoing efforts at the time to reform procedure in the federal courts—efforts spearheaded by figures such as Roscoe Pound and Charles E. Clark, and that eventually culminated in the Federal Rules of Civil Procedure in 1938. The FAA, in short, was arguably a type of procedural reform.
These insights lead the author to propose a “procedural reform” model of the FAA, one that he contends is both more faithful to the statute’s history (legislative and otherwise) and more adept at answering the difficult questions that confront arbitration law in the age of “contract procedure.” The author considers two recent examples to illustrate.
Standard-form contracting is the engine of the mass-market economy, yet we know little about what drives it and what factors are associated with its evolution. Understanding change and innovation of the substance, length, and complexity of fine print in the consumer context can help regulators identify sources of potential intervention as well as help them evaluate the effectiveness of mandatory disclosure regimes, which are commonly used as consumer protection tools. This Article studies the rate, direction, and determinants of change in consumer standard-form contracting. We examine what changed between 2003 and 2010 in the terms of 264 mass-market consumer software license agreements. Thirty-nine percent of contracts materially changed at least one term, and some changed as many as fourteen terms. The average contract became more pro-seller as well as several hundred words longer. The increase in length is not due to the use of simpler language. Contract readability has been constant: The average contract is as readable as an article in a scientific journal. The variance of contract length has grown, as has the variance in overall pro-seller bias, resulting in reduced contract standardization over time. Firms that were younger, larger, or growing, as well as firms with inhouse counsel, were more likely to change existing terms and to introduce new terms to take advantage of technological and market developments. Contracts appear to respond to litigation outcomes: Terms that were increasingly enforced by courts were more frequently used in contracts, and vice-versa. The results indicate that software license agreements are relatively dynamic and shaped by multiple factors over time. We discuss potential consumer protection implications as a result of the increased length and complexity of contracts over time.
This Article investigates why North American businesses typically do not adopt the trust form, other than as a financing vehicle. It examines an episode in Canada in which the trust form became very popular amongst publicly traded businesses. Until 2006, there were significant tax advantages associated with adopting an “income trust” structure. Regardless of the tax motivations for the form, the income trust offered businesses greater flexibility in choosing their governance rules than that offered by the corporate form. Income trusts often took advantage of this flexibility, deviating from mandatory corporate law rules on a number of dimensions. This Article finds that there were positive market reactions to innovations in governance by income trusts. However, once the law changed to remove the tax advantages of income trusts, the form all but ceased to be adopted—despite relatively low costs of adoption. On balance, this Article suggests that innovative trust structures are not especially valuable from a pure governance perspective, though governance innovations may be valuable if combined with tax advantages.
In developing a contractual response to changes in the economic environment, parties choose the method by which their innovation will be adapted to the particulars of their context. These choices are driven centrally by the thickness of the relevant market—the number of actors who see themselves as facing similar circumstances— and the uncertainty related to that market. In turn, the parties’ choice of method will shape how generalist courts can best support the parties’ innovation and the novel regimes they envision. In this Article, we argue that contractual innovation does not come to courts incrementally, but instead reaches courts later in the innovation’s evolution and more fully developed than the standard picture contemplates. Highly stylized, the trajectory of innovation in contract we find is this: Private actors respond to exogenous shocks in their economic environments by changing existing structures or procedures to make them efficient under the new circumstances. The innovating parties stabilize their newly emergent practices through a variety of regimes—both bilateral and multilateral—with the goal of establishing the context through which the innovation is implemented. It is only at this point, and when a dispute is presented to them, that courts step in. If contract innovation does indeed reach generalist courts through the mediating institution of these contextualizing regimes, then our argument follows directly: Because a central goal of contract adjudication is to enforce the agreement in the context the parties intended, the courts’ willingness to defer to the context provided by the parties will put the law more directly in the service of innovation.
Default rules of contract law permit recovery of consequential damages for breach when the breaching party had “reason to know” of those damages at the time of contracting. It is a common observation that sophisticated parties systematically bargain out of these default rules, since the scope of consequential damages is highly uncertain and largely within the control of the non-breaching party. Nevertheless, some parties retain the default rules, and some contracts involving sophisticated actors contain an explicit provision allowing consequential damages, including lost profits, for breach. In effect, these parties satisfy the test that awards consequential damages only when there has been “tacit agreement” to their recovery. That test, which has been repudiated by commentators and most case law outside of New York, limits recovery of consequential damages more severely than the standard “reason to know” test. In this Article, I examine contracts that include explicit “lost profits” clauses and cases in which courts have determined whether parties either tacitly agreed to or had reason to know of prospective lost profits. I claim that the relevant contracts and cases reveal that consequential damage clauses are used to solve a contracting problem that might otherwise frustrate mutually beneficial exchange. Parties and courts have perceived that a commitment to pay lost profits can diminish the threat of opportunistic behavior that is inherent where one party must make a relationship-specific investment prior to performance by the counterparty. In transactions with those characteristics, the investing party risk holdup by its counterparty between the period when the initial investment is made and when the second party must act. I suggest that a commitment to pay lost profits in the event of breach constrains the threat of holdup, and that in these circumstances the value of the promise compensates for the efficiency loss otherwise inherent in assigning consequential damages to the party least able to avoid them. While a pledge of lost profits in the event of breach is not the exclusive response to this holdup problem, it is a plausible and perhaps superior means of avoiding it. I conclude that the combination of near-universal opt-out of the default rule for consequential damages and the explicit adoption of a broad consequential damages clause in investment cases indicates that the “tacit agreement” test may be more consistent with the preferences of commercial parties for a contract default rule than the “reason to know” test.
If technology means “useful knowledge about how to produce things at low cost,” then contracts should qualify. Just as mechanical technologies are embodied in blueprints, technologies of contracting are embodied in contractual documents that serve as “blueprints for collaboration.” This Article analyzes innovations in contractual documents using the same kind of framework that is used to analyze other kinds of technological innovation. The analysis begins by laying out an informal model of the demand for and supply of innovative contractual documents. The discussion of demand emphasizes the impact of innovations upon not only each party’s incentives to collaborate efficiently, but also upon reading costs and litigation costs. The analysis of supply considers both the generation and dissemination of innovations and emphasizes the importance of cumulative innovation, learningby- doing, economies of scale and scope, and trustworthiness. Recent literature has raised concerns about the extent to which law firms produce contractual innovations. In fact, a wide range of actors other than law firms supply contractual documents, including end users of contracts, specialized providers of legal documents, legal database firms, trade associations, and academic institutions. This Article discusses the incentives and capabilites of each of these potential sources of innovation. It concludes by discussing potential interventions such as (1) enhancing intellectual property rights, (2) relaxing rules concerning the unauthorized practice of law, and (3) creating or expanding publicly sponsored clearinghouses for contracts.
Scholars have catalogued rigidities in contract design. Some have observed that boilerplate provisions are remarkably resistant to change, even in the face of shocks such as adverse judicial interpretations. Empirical studies of debt contracts and collateral, in contrast, suggest that covenant and collateral terms are customized to the characteristics of the borrower and evolve in response to changes in market conditions, such as expansion and contraction in credit supply. Building on the adverse selection and moral hazard theories of covenants and collateral, we demonstrate that an expansion (contraction) of credit will lead not only to a decrease (increase) in the interest rate but also a reduction (expansion) of covenants and collateral through lessening (worsening) adverse selection and moral hazard problems. We conclude with some empirical implications of this analysis.
Contract scholarship has given little attention to the production process for contracts. The usual assumption is that the parties will construct the contract ex nihilo, choosing all the terms so that they will maximize the surplus from the contract. In fact, parties draft most contracts by slightly modifying the terms of contracts that they have used in the past, or that other parties have used in related transactions. A small literature on boilerplate recognizes this phenomenon, but little empirical work examines the process. This Article provides an empirical analysis by drawing on a dataset of sovereign bonds. We show that exogenous factors are key determinants in the evolution of these contracts. We find an evolutionary pattern that roughly separates into three stages: stage one when a particular standard form dominates in the absence of external shocks; stage two when there are external shocks and marginal players experimenting with deviations from the standard form; and stage three when a new standard emerges. We find that more marginal law firms are likely to be leaders in innovation at early stages of the innovation cycle but that dominant law firms are leaders at later stages.
Opponents of the death penalty typically base their opposition on contingent features of its administration, arguing that the death penalty is applied discriminatorily, that the innocent are sometimes executed, or that there is insufficient evidence of the death penalty's deterrent efficacy. Implicit in these arguments is the suggestion that if these contingencies did not obtain, serious moral objections to the death penalty would be misplaced. In this Article, Professor Finkelsteindeterrence and retributivismis capable of justifying the death penalty. More generally, she suggests that while each theory captures an important part of the justification for punishment, each must appeal to some further limiting principle to accommodate common intuitions about appropriate punishments for crimes. Professor Finkelstein claims that contractarianism supplies this additional principle, by requiring that individuals consent to the system of punishment under whose threat they must live. Moreover, on the version of contractarianism for which she argues, they must do so based on a belief that they will benefit under the terms of that system as compared with how they would fare in its absence. While the notion of benefit is often best understood in terms of maximizing one's expected utility, Professor Finkelsteingambling" decision rule. She then argues that rational contractors applying this conception of benefit would reject any system of punishment that includes the death penalty. For while contractors would recognize the death penalty's deterrent value, they must also consider the high cost they would pay in the event they end up subject to such a penalty. This Article presents both a significant new approach to the death penalty and a general theory of punishment, one that incorporates the central intuitions about deterrence and desert that have made competing theories of punishment seem compelling.