NewYorkUniversity
LawReview

Symposium Articles

2013

Contract and Innovation: The Limited Role of Generalist Courts in the Evolution of Novel Contractual Forms

Ronald J. Gilson, Charles F. Sabel, Robert E. Scott

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.

Tacit Agreement and Relationship-Specific Investment

Clayton P. Gillette

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.

Contracts as Technology

Kevin E. Davis

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.

Market Conditions and Contract Design: Variations in Debt Contracting

Albert Choi, George Triantis

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.

The Dynamics of Contract Evolution

Stephen J. Choi, Mitu Gulati, Eric A. Posner

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.

2008

Fifty Years Later

N.Y.U. Law Review Editorial Board

In April 1957, the English legal philosopher H.L.A. Hart, Professor of Jurisprudence at Oxford, delivered the annual Oliver Wendell Holmes Lecture at Harvard Law School. Hart’s topic was “Positivism and the Separation of Law and Morals,” and he intended his lecture, offered at a “law school deeply influenced by the [legal] realism of Holmes and the sociological jurisprudence of Roscoe Pound,” to be provocative as well as informative. The focus of Hart’s lecture was a core tenet of traditional legal positivism—that there is no necessary connection between law and morality. This was a proposition that would later be defended in detail in Hart’s masterwork, The Concept of Law, published in 1961. Hart’s lecture sought to explain, clarify, and elaborate the positivist account of the relation between law and morality, while at the same time defending legal positivism against the accusation that it was complicitly silent on the evil of oppressive legal regimes.

The Grudge Informer Case Revisited

David Dyzenhaus

This Article explores a decision by a German postwar court—the Case of the Grudge Informer—which was central to the 1958 debate between H.L.A. Hart and Lon L. Fuller. The author argues that Fuller’s presentation of the problem in the case is better than Hart’s both as a descriptive matter and as a matter of promoting a morally responsible resolution—not least because Hart’s method of candor falls short of illuminating the complexities inherent in such cases. In particular, Hart’s positivist conception of law does not appreciate how judges in such cases have to contend with a connection between the doctrinal level and the fundamental level. At the former, judges have to resolve issues of substantive law such as the issues of criminal law in the Grudge Informer Case. At the latter, judges confront the question of what Fuller called their “ideal of fidelity to law,” since they are faced with questions about what legality—the principles of the rule of law—requires. The confrontation between such ideals is not, as Hart suggested, one that takes place in an extralegal political space. Rather, it is firmly within the scope of both law and the philosophy of law.

Positivism and the Inseparability of Law and Morals

Leslie Green

H.L.A Hart made a famous claim that legal positivism somehow involves a “separation of law and morals.” This Article seeks to clarify and assess this claim, contending that Hart’s separability thesis should not be confused with the social thesis, the sources thesis, or a methodological thesis about jurisprudence. In contrast, Hart’s separability thesis denies the existence of any necessary conceptual connections between law and morality. That thesis, however, is false: There are many necessary connections between law and morality, some of them conceptually significant. Among them is an important negative connection: Law is, of its nature, morally fallible and morally risky. Lon Fuller emphasized what he called the “internal morality of law,” the “morality that makes law possible.” This Article argues that Hart’s most important message is that there is also an immorality that law makes possible. Law’s nature is seen not only in its internal virtues, in legality, but also in its internal vices, in legalism.

Philsophy, Political Morality, and History: Explaining the Enduring Resonance of the Hart-Fuller Debate

Nicola Lacey

This Article argues that the historical, moral, and political dimensions of the Hart-Fuller debate deserve much credit for its continuing appeal and should prompt a reconsideration of Hart’s own claims about the universality of analytical jurisprudence. The debate illuminates the sense in which conceptual analysis needs to be contextualized and, in so doing, demonstrates the importance of clarity and rigor in legal theorizing. Moreover, the debate’s power to speak to us today is a product of its connection with pressing political issues. In analyzing the postwar development of international criminal law, this Article argues that Hart’s modest realism, pitched against Fuller’s more ambitious optimism, speaks to us in compelling ways.

Better to See Law This Way

Liam Murphy

With a clear and compelling ethical vision, H.L.A. Hart attempts to persuade us that it would be better to see law the positivist way. Much of Lon Fuller’s reply can be read as an equally compelling case for seeing law another way. Both articles are rewarding precisely because they bring to the fore the ethical and political stakes of the debate over the concept of law. The problem is that while these instrumental arguments do a lot to explain why philosophers have tended to be so invested in either positivism or nonpositivism, they have no chance of changing our social world such that either view can be said to be true.