Source: https://www.lawnet.gov.lk/1959/12/31/the-case-for-formalism-in-relational-contract/
Timestamp: 2019-04-19 07:29:29+00:00

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The distinguished scholars who gathered last year to honor Ian Macneil and to reflect on his contributions to the understanding of contract and contract law represent diverse methodologies and approach the vexing problems raised by relational contracts from different normative perspectives. But on one point, I daresay, we all agree: The central task in developing a plausible normative theory of contract law is to specify the appropriate role of the state in regulating incomplete or relational contracts. Complete contracts (to the extent that they exist in the real world) are rarely, if ever, breached since by definition the pay-offs for every relevant action and the corresponding sanctions for non performance are prescribed in the contract. In the case of incomplete (or relational) contracts, however, parties have incentives to breach by exploiting gaps in the contract. Making the verifiable terms of the contract legally enforceable and regulating incompleteness in a consistent manner reduces, but does not eliminate, these incentives to breach. There still remains the fundamental question: Should the law seek to complete the contract for the parties? And, if so, from what vantage point should the contractual gaps be filled? Determining the answers to these questions has preoccupied contract law scholars for the past fifteen years.
In the essay that follows, I review the academic debate and outline the core arguments for (and difficulties with) three alternative strategies for interpreting relational contracts. Thereafter, I evaluate each strategy in terms of the lessons that are available to us from theory and experience. In particular, I examine the insights from the recent theoretical literature on the economics of incomplete contracting and test those insights against the results of an analysis of the cases interpreting disputed contracts under the significantly different regimes of the Uniform Commercial Code and the common law over the past thirty years.
law formalism has an heretofore unrecognized role in expanding the menu of legally blessed standard form terms and clauses that further reduce contracting costs for most parties.
The academic debate begins with a factual claim about which all contract law theorists would agree. If the state chooses to legally enforce disputed contracts, courts and other decision makers will be asked to interpret the signals that the contracting parties have used, however imperfectly, as their instruments for allocating contractual risk. These signals include what the parties wrote (and did not write) and said (and did not say), as well as the context in which these signals were exchanged.2 But this interpretive task is not self-executing. It requires a court (or other decision maker) to select among (at least) three discrete interpretive strategies. The choice among these strategies will determine the mode of interpretation that is chosen and, consequently, the shape and content of contract law. Given the stakes, it is not surprising that the academic debate over which strategy is best has been fierce and contentious.
P1	2	The state’s general rules of contract provide a set of standard gap-filling assumptions or default terms. But every contract requires the parties to provide some additional individualized content. These combinations of express terms and default terms operate on two distinct levels. On one level, they serve as an attempted interparty communication of the risks and entitlements being exchanged. On another level, express terms and default terms communicate evidence of the contractual understanding to the state. Thus, they also signal the legal relationship between the parties. Unfortunately, these signals are inherently error prone. Much of the risk of error derives from the inherent tensions between the verifiable express terms that the parties supply and the state supplied default terms. See generally, Charles J. Goetz & Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Interactions Between Express and Implied Contract Terms, 73 Cal. L. Rev. 261 (1985).
P1	6	Robert Hillman, Court Adjustment of Long-Term Contracts: An Analysis Under Modern Contract Law, 1987 Duke L. J. 1.
the available contractual remedies-whether specific performance or damages– implies that the disadvantaged party did not fully consent to the losses that enforcement would cause. In this situation, Richard Speidel has argued that a court-imposed solution would do “little damage to the requirement of consent in contract law.”7 There is simply a “gap in the agreement or risk allocation” that a court can fill based upon information available to it at the time of adjudication.8 In sum, courts should fill such gaps by creating contract terms that are fair ex post.
P1	7	Richard E. Speidel, Court Imposed Price Adjustments Under Long-Term Supply Contracts, 76 Nw. U. L. Rev. 369 (1981).
P1	8	Richard E. Speidel, The New Spirit of Contract, 2 J. Law & Commerce 193 (1983).
P1	9	Eric Posner, Relational Contracts and Incompetent Courts,– Nw. U. L. Rev.– (2000). Posner poses a mind experiment in which he assumes that courts are “radically incompetent” and asks what legal arrangements can be justified in those circumstances. The formalist strategy discussed in text does not assume radical incompetence, but only that courts are poorly equipped to pursue either of the two previous strategies.
P1	10	Formalism in contract interpretation is not new, of course. But the “new formalism” rejects the categorical imperative to deduce rules from first principles that characterized classical formalism as practiced by the late 19th century Langdellians. See Thomas Grey, Langdell ‘s Orthodoxy (199-). The new formalism is pragmatic at its core, emphasizing the instrumental value of formalist modes of analysis. Thomas Grey identifies three elements that offer a useful taxonomy of the new formalist approach to interpretation: objectivism (a general preference for rules over standards), common law conceptualism (a preference for treating common law categories like contract as coherent structures of concepts and principles), and statutory textualism (a preference for text-based over purposive interpretation. See Thomas Grey, The New Formalism 27-30 (unpublished paper on file). This pragmatic, formalist approach to interpretation in contract law was first suggested in the legal literature by Alan Schwartz. See Alan Schwartz, Incomplete Contracts, The New Palgrave Dictionary of Economics and Law (1997).
P1	11	Since formalist interpretation asks that the court respect the literal and explicit terms of the contract, it logically follows that individual parties can (and should be permitted to) opt out by agreeing ex ante to an express term in the contract that instructs courts to look to the contractual context in specific circumstances. Common examples of such terms are the “gross inequities” or “good faith adjustment” provisions commonly observed in long-term supply contracts. See generally, Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 Calif. L. Rev. 2005, 2051-53 (1987). Along the same general lines, the formalist approach would embrace the right of parties to expressly choose to have any subsequent contractual dispute adjudicated by courts using more functional or contextual modes of interpretation generally. Treating the interpretive methodology as a default rule rather than a mandatory or immutable rule is a logical corollary to one of the instrumental justifications for adopting a formalist methodology for interpretation: that most parties prefer inflexible legal rules deployed in concert with flexible social norms, but that reasons may exist for atypical parties to opt for a more aggressive approach to interpretation. See TAN infra. In sum, literalist modes of interpretation are preferable strategies for the state because (and only because) they better reflect majoritarian preferences than the alternative, functional approaches. To be sure, part of the argument for formalist interpretation is the claim that it is a superior mechanism for generating useful standardized terms over time. On this basis, making formalist interpretation a mandatory rule would be one way to produce a greater supply of standardized terms and clauses that might not otherwise emerge if modes of interpretation are regarded as a matter of party choice. I analyze these questions more completely in Part III infra.
P1	12	Macauley, supra note —-at-.
P1	13	Robert E. Scott, A Relational Theory of Default Rules, supra note— at 615 . Lisa Bernstein has subsequently developed this argument in much greater detail. See Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code ‘s Search for Immanent Business Norms, 144 U.Pa.L.Rev. 1765 (1996).
These, then, are the principal strategic choices the state faces when called upon to adjudicate disputed contracts. The particular strategy that is selected will necessarily affect the method of contractual interpretation that courts employ (and vice versa). If the state selects the “wrong” interpretive strategy or performs its regulatory function in an inconsistent manner, the costs of contracting will rise. Thus, the central question for contract law scholars remains: which strategic objective is best?
In evaluating this question, it is critically important to emphasize what the debate is and is not about. The debate that divides the academics who think about these questions is not over the nature of contract as an institution. We are all relationalists now. In that sense Macneil and Macauley have swept the field. Contract, we now know, is complex and subjective and synthetic in every sense of those terms. The debate, rather, is over the proper nature of contract law. All contracts are relational, complex and subjective. But contract law, whether we like it or not, is none of those things. Contract law is formal, simple and (returning to Macneil’s terminology) classical.
P1	14	Scott, A Relational Theory of Default Rules, supra note — at 615.
limitations on consequential damages. These rules assign risks on an all-or-nothing, binary basis. Given the outpouring of academic argument that establishes beyond question the complex, multifaceted dimensions of relational contract, the great question of the day is what to make of the equally well-established reluctance of courts to engage in creative adjustment or more tailored gap-filling to better regulate relational contracts. Thus, the core normative question is whether the failure of contract law to mirror the more complex institution of contract is a good thing or a bad thing. Should we enlarge contract law, as Mel Eisenberg would have us do, so as to better accommodate the complexities of contract?15 Or should we actually seek to narrow the scope of contract law to give it a smaller domain than it occupies under more aggressive strategies of interpretation?
P1	15	Melvin A. Eisenberg, , –Nw.L.Rev.–(2000).
of whether the parties failed to complete the contract deliberately or inadvertently and whether the incompleteness is a product of high transaction costs or asymmetric information or other endogenous factors.
Standardization is the second function that enhances the ex ante efficiency of relational contracts. The state facilitates the contracting process to the extent that courts, in the process of interpretation, create standardized terms that parties can use thereafter in signaling their intentions thereby removing the uncertainties attendant on interpretation.17 Standardized signals can be developed in two ways. The first is through a process of “gap filling,” where courts interpreting relational contracts elect to condition or qualify the express terms of the contract by specifying default rules that complete the contract. Standardization also occurs when courts interpret authoritatively the meaning of widely used express terms or combinations of express terms. In either case, the key to this process is the standardization of the tools parties use to customize their contracts.
Hotchkiss v. National City Bank, 200 F. 287, 293 (S.D.N.Y. 1911), aff’d 201 F.2d 664 (2d Cir. 1912), aff ‘d 231U.S. 50 (1913).
Chernohorsky v. Northern Liquid Gas Co., 268 Wis. 586, 68 N.W. 2d 429 (1955).
P1	18	Courts typically interpret the meaning of express terms in an agreement by looking to precisely the same commercial and legal context they use to identify and incorporate default terms. Unfortunately, by giving custom and usages of trade interpretive priority over the express terms in the contract, courts may unwittingly misinterpret the meaning of the express terms the parties have used. Thus, if the law treats the words used to opt out of an otherwise applicable custom or usage as themselves highly elastic and context-relative, attempts to escape those default understandings become problematic. See Robert E. Scott & Douglas L. Leslie, Contract Law and Theory (2ed. 1993) at 534-35. See also, Goetz & Scott, The Limits of Expanded Choice, supra note-at 283-286.
These and other related problems expose a central question that challenges the simple form of the default rule paradigm: To what extent do express terms and default rules, and standardized and individualized forms of agreement function in antagonistic rather than complementary ways? To better understand these tensions, we must focus for a moment on the benefits (and the costs) of the incorporation process.
The Benefits of Incorporation. The state’s incorporation of standardized contract terms as either “majoritarian” or “tailored” defaults reduces many errors that inhere in incomplete contracting.21 The benefits of incorporation go far beyond a mere savings of additional resource costs. Standardized terms and understandings that are recognized and publicized by the state bring a collective wisdom and experience that parties are unable to generate individually.
P1	20	Jody S. Kraus & Steven D. Walt, In Defense of The Incorporation Strategy in The Jurisprudential Foundations of Corporate and Commercial Law, Cambridge University Press (forthcoming 2000).
P1	2 1	Majoritarian default rules are those that apply to the largest set of heterogeneous contractors. Tailored defaults, by contrast, apply to smaller subsets of homogeneous parties (such as merchants in a particular trade or business). See Robert E. Scott, The Uniformity Norm in Commercial Law: A Comparative Analysis of Common Law and Code Methodologies, in The Jurisprudential Foundations of Corporate and Commercial Law, Cambridge University Press, Jody S.. Kraus and Steven D. Walt eds. (forthcoming 2000).
Individual contracting parties are unlikely to carefully test the meaning of the customary understandings that “go without saying” in the particular trade or industry. Testing various combinations of terms for errors of inconsistency or omission by, for example, specifying all usages and course of dealings as well as dickered express terms explicitly in the contract involves both substantial risks and uncompensated resource costs. First, innovators face the risk that novel statements of common understandings will not express their agreement as they intended. Moreover, contracting parties face an additional, irreducible risk that a court subsequently called upon to interpret the contract will not interpret the novel terms in the manner understood by the parties at the time of contract. Finally, the costs of specification are borne disproportionately by the innovating contractors. Private parties who develop successful packages of standard form contractual terms cannot capture much of the benefit that will accrue to subsequent users.
In sum, incorporation carries costs as well as benefits. The process of incorporating standardized default terms, which aims to reduce the costs of contracting, indirectly produces negative effects in a related dimension of the interpretation process. This fact does not, of course, imply that the state’s role in facilitating standardized terms is on balance undesirable. It does suggest, however, that the normative claim that courts should strive for ex ante efficiency through incorporation has ignored significant trade offs in the process by which the state regulates relational contracting. Understanding how best to optimize these trade offs requires a better understanding of contacting behavior. What are the causes of incompleteness in contracts and how best can the state assist parties to such relational contracts? But before we can seek fresh answers to these questions, we first need to consider the alternative interpretive strategies.
Long-Term Supply Contracts, 76 Nw.U. L. Rev. 369 (1981).
The summary in the text does not, of course, do justice to the differences in approach of the various ex post analysts. Thus, for example, the claim by Robert Hillman that courts should enforce the long term “relational duties” that are created by relational contracts could also be understood as directing courts to find and enforce the ex ante “reasonable expectations” of the parties rather than seek to adjust the contract equitably in order to reach a “fair” result ex post. But this interpretation of Hillman’s argument seems inconsistent with the notion that enforcement of the contract should not be ordered where it would impose unforeseeable harms on the promisor. If the parties were aware of these relational duties when they signed the contract, then the duties would be part of the contract and the contract would allocate the risk optimally (or else the parties would not have agreed to it). Thus, this version of the argument collapses to the directive that courts should seek to achieve ex ante efficiency. The other way to understand Hillman’s relational argument is that these relational duties direct courts simply to implement “fair” outcomes. This collapses Hillman’s relational view into the argument for ex post adjustment advanced by Speidel and others.
Enforcing the terms of the contract as written apparently stems from the belief that unforeseeable events caused the promisor to incur large losses. Thus, the ex post strategy requires courts to answer the vexing questions of foreseeability and causation in order to decide how much of the loss the disadvantaged party should bear. There is significant evidence that courts have so much difficulty with these questions that they opt for full enforcement in the great majority of cases involving frustration and excuse.25 The ex post strategy may thus be assuming a level of competency that courts cannot reasonably achieve. In short, reaching “fair” results may simply be too difficult to implement in specific cases. Second, there is the distributional justice problem of deciding what is a “fair’ adjustment. Moral philosophy does not appear to provide criteria with which to answer such micro-distributional questions.
P1	25	See Alan Schwartz & Robert E. Scott, Sales Law and the Contracting Process at 436-486 (2ed. 1991) (citing cases and secondary sources).
P1	26	Schwartz & Scott, supra note – at 482-483. For a view that implicit contractual agreements exist and should be encouraged, see Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 Calif. L. Rev. 2005 (1987).
P1	27	This is the same argument that textualists in other areas of law, such as statutory interpretation, have used to reject the use of context evidence such as legislative history to illuminate the text. Under this formalist approach to contract interpretation, a court would enforce a contract–say one in which the seller expressly undertakes to deliver x quantity of goods at y price over z months– even though changed circumstances, in fact, caused one of the parties to face considerable losses. The argument is that the parties are as familiar as anyone with the risk of changed circumstances and this literal method of interpretation avoids the error that results when courts fill gaps incorrectly. To be sure, this method of interpretation will also generate error, in that courts will not complete contracts in ways that maximize the joint value of the contract to the parties. But this error is predictable and thus the parties can anticipate it and use the predicted and predictable legal outcome as the basis for renegotiating the contract once conditions change. This is a benefit to the parties, one that may outweigh the costs of not trying to fill contractual gaps, especially if the courts lack the competence to engage in socially beneficial gap filling. See Eric Posner, Relational Contracts and Incompetent Courts at 3 (manuscript on file).
Given these trade-offs, the formalist strategy is more or less attractive depending on the competency of courts to perform both core functions– correct interpretation of contractual text and incorporation of the customs and understandings that are immanent in the contractual context– at the same time. If these are functions that courts can (and do) perform with relative competence, then the one or the other of the activist interpretive strategies is preferable to formalism. If these are functions that courts do not perform well together, then leaving contextual and other relational norms to be enforced by extra-legal sanctions might actually improve the efficiency of the legal regulation of relational contracts.
uncopyrightable. The rationale for this limitation is to prevent the underlying idea from being monopolized. See Morrissey v. Proctor & Gamble Co., 379 F.2d 675 (1967). Moreover, even if copyright protection is available for a particular innovative contractual clause, the substantive ideas that it expresses remain public goods. Thus, other parties are free to embody similar contractual provisions in their agreements and may use suitable words to express such provisions. See e.g., Dorsey v. Old Surety Life Ins. Co., 98 F.2d 872 (10th Cir. 1938). Trade secret rules offer no alternative protection for innovative contract terms since it is the breach of confidence by unauthorized disclosure, rather than infringement of a property right that is the gravamen of trade secret liability. See, e.g., Wilkes v. Pioneer Am. Ins. Co.., 383 F. Supp. 1135 (D.S.C. 1974).
P1 32 See generally, Elizabeth S. Scott & Robert E. Scott, Marriage as Relational Contract, 84 Va. L. Rev. 1225, 1288-1300 (1998) (discussing the benefits of not judicializing social and relational norms in the marital context).
Recent theoretical literature on the economics of incomplete contracting offers some valuable insights into the reasons for incompleteness and, in turn, suggests the wisdom of a modest and circumscribed role for courts in filling gaps in relational contracts.33 The analysis starts with a simple question. If incomplete contracts carry such heightened risks of misinterpretation, why don’t contracting parties write complete contracts that specify the contract-based conditions that will apply for every possible state of the world?
If transactions costs are preventing the parties from completing contracts with efficient terms, then the state properly should fill the gaps with default terms that solve those problems whenever the state’s contracting costs are lower than the contracting costs to the parties. Much of the recent contract theory literature argues, however, that these conditions are hard to satisfy in a large economy with heterogenous parties.36 Under these conditions, many factors suggest a more modest state role–the more heterogenous are contracting parties the less the scale economies for any default and the greater the likelihood that the state is less capable than the parties themselves in solving their contracting problems. Unless the contracting solution is immanent in the commercial practice and relationship of the parties (as Llewellyn, for example, believed it was), and a court can identify and standardize the practice or experience as a default, a court is likely to create ill-fitting defaults in complex commercial environments.
Asymmetric information is the second reason why parties may choose to write incomplete contracts. Assume, for example, that the parties cannot observe a key economic variable either at the time of contracting or upon renegotiation. Or, in the alternative, even though important conditions can be observed, the parties cannot verify those conditions to courts (the variables are unprovable). Or, finally, the parties may choose for strategic reasons not to disclose private information about themselves.37 When these conditions of private or hidden information exist, parties would choose to write incomplete contracts even if transactions costs were zero. To do otherwise would require parties to either disclose information that they wish to keep private or to have enforcement turn on facts that one or both could not observe or establish in court. Writing an incomplete contract is preferable to these unpalatable alternatives.
The possibility that contracts are incomplete because of private information or other related factors urges even greater modesty about the state’s role in creating useful default rules for relational contracts. The state is incapable of completing contracts with useful default terms whenever contracts are incomplete because of the problems of coping with hidden information. Under these circumstances any contract term selected by a court to fill the gap would have to be based upon information that is either unobservable to the parties or unverifiable to the courts.
This analysis suggests that the traditional law and economics strategy of filling gaps so as to promote ex ante efficiency is likely to be of little utility for parties to relational contracts in a large and complex economy. If the gaps are a product of asymmetric information, then the courts will be incapable of doing what the parties themselves would not do. If the gaps are a product of high transactions costs, then ex ante gap filling will be efficient only where the courts have the capacity and the expertise to incorporate into the contract relevant commercial practice and experience for discrete commercial subgroups. While in theory this second function can and should be a valuable justification for pursuing a gap-filling strategy, as the discussion below will suggest, there are many reasons to believe that successful incorporation does not ( and perhaps cannot) occur.
But what about the second approach, the one suggested by the law and society relational scholars: direct courts to seek the ex post efficient result. Once again, modesty in legal intervention is what this literature seems to suggest. If the parties anticipate that the uncertainties they face at the time of contracting will subsequently be resolved, they would logically prefer (and naturally reach) a renegotiation as the optimal mechanism for ex post adjustment. From this perspective, an incomplete contract can be seen as a means by which the parties have chosen to achieve an efficient outcome ultimately. If the parties are symmetrically informed ex post, bargaining theory teaches us that they will renegotiate to the efficient result and the dispute will be settled. (In such a world, neither party can exploit the sunk cost investment of the other strategically).
So, here is the empirical condition that must be satisfied in order to pursue successfully an activist strategy of ex post adjustment: informed and capable courts and uninformed parties.
P1	39	Schwartz, Incomplete Contracts, supra note —at –.
P1	4 1	The risk that judicial incorporation of context may inadvertently undermine the parties ex ante risk allocation may explain the well documented anomaly of well-developed legal doctrines of mistake, commercial impracticability, and frustration of purpose and the courts’ simultaneous reluctance to excuse nonperformance in particular cases. See Scott, Conflict and Cooperation, supra note — at 2050.
P1	42	Scott, The Limits of Expanded Choice, supra note–at–.
The case for formalist interpretation ultimately turns, of course, on the underlying empirical realities. And, so long as those realities remain unknown, any intelligent speculation is just that–speculation. There are some ways, however, to test these theoretical speculations. Perhaps the best natural experiment is to compare the results of courts using a liberal parol evidence and plain meaning interpretive framework to resolve disputed sales contracts under the Uniform Commercial Code with the results of courts interpreting disputed commercial services contracts under the traditional approach of the common law.
P1	43	The following discussion draws upon the analysis in Scott, The Uniformity Norm in Commercial Law, supra note -. That paper focuses on an analysis of litigated cases under Article 2 and the common law over the thirty year period from 1969 to 1999 and compares the relative success of both regimes in achieving the substantive values that inhere in uniformity in commercial law.
P1	47	U.C.C. section 1-205(4).
P1	48	Goetz & Scott, The Limits of Expanded Choice, supra note – at 285-286. Professors White and Summers assert that usage and course of dealings ” may not only supplement or qualify express terms, but in appropriate circumstances, may even override express terms.” They go on to say that “the provision that express terms control inconsistent course of dealing and usages cannot really be taken at face value.” James J. White & Robert Summers, Handbook of the Law Under the Uniform Commercial Code section 3-3 at 98, 101 (2d ed. 1980).
relational contract are frequently construed as conditioned on the broader contractual context.50 Whatever benefits this practice may provide in incorporating commercial context as tailored default terms, it clearly results in less predictable interpretation of express contractual language.
See cases cited in note –infra.
Scott, The Uniformity Norm in Commercial Law, supra note — at -.
See cases cited in note–infra. Scott, The Uniformity Norm in Commercial Law, supra note– at–.
P1	54	Alan Schwartz & Robert E. Scott, Commercial Transactions: Principles and Policies (2ed. 1991). Many of the specific provisions of Article 2 require the parties to obey directives or perform obligations “in good faith” or in a “commercially reasonable” manner. The vague form in which these admonitions are cast works to delegate to the courts the function of announcing the relevant commercial rule. Commercial reasonableness is perhaps the most significant and innovative of these admonitory concepts. Commercial reasonableness is not defined in the Code, but appears prominently in numerous contexts. For example, the Code requires that all “contracts made by a merchant have incorporated in them the explicit standard not only of honesty in fact (1-201), but also of observance by the merchant of reasonable commercial standards of fair dealing in the trade” (sec. 1-203 comment). The notion of commercial reasonableness, inspired by Karl Llewellyn, reflects the legal realists’ belief that the law can be (and is) revealed by the behavior and practices of commercial parties. Thus, the admonition to act in a commercially reasonable manner functions for courts as an empirical directive: to decide if the parties have acted in a commercially reasonable manner, the decision maker is asked to look to the marketplace and observe relevant commercial behavior to determine the legal norm. Thus, for example, section 2-609 directs that “commercial rather than legal standards ” govern whether grounds for insecurity are “reasonable” or assurances of due performance are “adequate” within the meaning of that section. Id. at 5.
P1	55	See cases and search strategies discussed in Scott, The Uniformity Norm in Commercial Law, supra note – -at 26 and n.44.
charged with the responsibility of implementing the Code’s activist policy towards incorporation have declined to do so. In sum, the costs of a strategy of incorporation– a highly contextualized interpretive methodology that seeks to embed the explicit terms of a contract within a larger commercial context– seem not to be justified by corresponding enhancements in the supply of useful defaults for appropriate subsets of commercial contractors.
P1	56	See cases cited in Goetz & Scott, The Limits of Expanded Choice, 73 Calif. L. Rev. at n. 124.
P1	59	The fast-track method of phased construction has emerged in recent years in response to the combination of high interest rates and rapid cost inflation. Under this method, many construction tasks are initiated before overall design is complete. The economic motive for this accelerated procedure is to minimize both financing costs and inflation of labor and material costs during the construction period. The consolidation of the design and building process is typically combined with the use of a construction manager (or “CM”). The CM combines functions traditionally performed separately by the design architect and the contractor. Thus, the CM participates in the design process by reviewing designs during development, recommending cost efficiencies and design alternatives and proposing construction schedules. Thereafter, the CM serves as a “super general contractor” who coordinates the other contractors work, reviews change orders, super vises contract bids and prepares and revises project budgets.
P1	6 1	For an example of this testing process in litigation, see e.g., Bolton Corp. v. T.A. Loving Co., 94 N.C. App. 392, 380 S.E. 2d 796 (N.C. Court of Appeals 1989). For a review of the testing of contract terms through arbitration, see Thomas J. Stipanowich, Beyond Arbitration: Innovation and Evolution in the United States Construction Industry, 31 Wake Forest L. Rev. 65 (1996). Out of this testing process a set of standardized “official” terms emerges that collectively reduce the risks of writing construction contracts. See Trepasso, The Lawyer ‘s Use of AIA Construction Contracts, 19 Prac. Law. 37 (1973) to the industry. Thereafter, those forms are incorporated into the legal vocabulary, not as default rules, but as additions to the menu of contractual prototypes among which parties within that industry are then free to choose. These model or standard forms thus provide an effective mechanism for internalizing at least some of the benefits from contractual innovation and standardization that private parties may otherwise be unable to capture. By contrast, these standardized options have been far slower to develop under Article 2 of the Code. The National Grain and Feed Association, for example, has elected to opt out of the Code altogether and, through the mechanism of mandatory arbitration, have their standard contract terms subject to a plain meaning interpretation62.
in outcomes between Code and common law regimes. The common law regulation of contracts for services seems to have created an hospitable legal environment, one that, at the least, seems to support the evolutionary production of standardized and appropriately tailored contract terms.
corresponding gains in the efficient incorporation of industry-specific default terms.
P1	62	See Bernstein, Merchant Law in a Merchant Court, supra note – at -.
The lesson from theory and experience points toward legal modesty as the superior strategy for courts seeking to regulate relational contracts. Successful incorporation of context, whether to specify efficient default rules ex ante or achieve efficient adjustment ex post, requires that a key empirical condition–competent courts and incompetent parties– be satisfied. Comparing the efforts of courts instructed to engage in activist incorporation with courts instructed to follow constrained modes of interpretation suggests some skepticism about the plausibility of this condition.
P1	64	Id. at -.
P1	6 5	A central difference between the uniform commercial statues that preceded the UCC and the new Code lay in the uniquely different interpretive methodologies dictated by a code. A code is a preemptive, systematic and comprehensive enactment of a whole field of law. It presumes to carry within it the answers to all possible questions. Thus, when a court confronts a gap in an incomplete contract, its duty in interpreting a code is to find by extrapolation and analogy a solution consistent with the purposes and policy of the codifying law. The net effect of this institutional design is a highly contextualized interpretive methodology, one that seeks to embed the explicit terms of a contract within the larger jurisprudential context of the Code as well as within the specific commercial context being regulated. Thus, one reason for the unwillingness of the courts to embrace incorporation may be the peculiar distortions created by code methodology: courts are required to interpret the Code’s default rules with reference to the hermetic regulatory framework of the Code itself. Code methodology thus stimulates a static equilibrium that impedes the dynamic process by with novel default rules and contract terms evolve. See Scott, The Uniformity Norm in Commercial Law, supra note -at-.
Bernstein, Merchant Law in a Merchant Court, supra note -at-.
Scott, The Uniformity Norm in Commercial Law, supra note-at-.
P1	70	David Charny, The New Formalism in Contract, 66 U. Chi. L. Rev. 842, 845 (1999) (declaring that “Llewellyn’s antiformalism is a flop”).
Whether the practice of homogeneous groups of commercial parties opting for formal methods of contractual interpretation reflects an underlying inefficiency in the law is, of course, a complex question. We would first have to know how widespread is the practice that I and Bernstein and others have observed. Thereafter, we must confront in more depth the difficult questions this essay seeks to raise. What are the efficiency values that inhere in contractual interpretation? Can courts do what the functionalist strategies ask of them in a complex environment of heterogeneous contractors? At this point answers to these questions suffer from the defects of a first cut at a difficult problem. Nevertheless, the evidence that incorporation does not work is sufficiently striking to undermine the uncritical assumption of the academic and professional proponents of the Code that an activist role in regulating relational contracts is a priori preferable to the more modest objectives for the state embodied in the common law.
To be sure, building the case against incorporation does not establish the case for formalism. Nevertheless, the objections that have been mounted to date against formalism have largely missed their mark. Formalist interpretation is not an inflexible and wooden application of arid first principles -the criticism launched so successfully at the early formalists. Formalism in relational contract is an interpretative strategy that deserves careful scrutiny to the extent that it is a superior method for reducing the costs of contracting for most parties to commercial contracts.
the law should copy those forms. The case for formalism must rest, at bottom, on the efficiencies that inhere in formalist contractual interpretation and on the relative inability of courts in complex environments to craft tailored default rules and/or resolve disputes ex post more efficiently than the parties themselves.
P1	72	For a detailed analysis of the historic willingness of contract law to embrace arguments for limiting itself, see Robert E. Scott & William J. Stuntz, Plea Bargaining as Contract, 101 Yale L. J. 1909, 1918-1935 (1992).
Charny, The New Formalism, supra note – at -.
See e.g., Macauley, Non-Contractual Relations in Business, supra note — at -.
P1	75	See, e.g., UCC 2-316(2) (“to exclude or modify the implied warranty of merchantability …the language must mention merchantability…”) (emphasis added).
Nor is it a fair objection to the case for formalism that the world of incomplete contracting is more complex than the arguments for formalist interpretation recognize. To be sure, an activist interpretive strategy is appropriate under certain empirical assumptions. Karen Eggleston, Eric Posner and Richard Zeckhauser argue, for example that ex ante gap filling is appropriate where the asymmetry of information and bounded rationality that hamper the contracting parties ex ante is more severe than the information and rationality problems that hamper courts ex post.76 As we have seen, these conditions are unlikely to be satisfied in contracts between sophisticated commercial parties and more likely to be found in contracts with consumers or other single-shot contractors. They propose a legal regime in which courts elect between literal and aggressive modes of interpretation depending on the underlying causes for the simplicity of the contract. But if courts are sufficiently competent to make those kinds of judgments, then they are clearly competent to adopt a single formalist mode of interpretation and deploy other contract doctrines-such as unconscionability- to guard against rent seeking or other exploitative behavior by firms with informational advantages. Moreover, particular contracting parties should always be free to opt out of formalism (by appropriately clear contractual language) and choose instead more contextualized forms of interpretation instead.
P1	76	Karen Eggleston, Eric A. Posner, and Richard Zeckhauser, Simplicity and Complexity in Contracts (unpublished paper on file) at 38.
The central claim of this essay can be stated quite clearly. Formalist modes of interpretation are justified because and only because they offer the best prospect for maximizing the value of contractual relationships, given the empirical conditions that seem to prevail. The apparent failure of the grand experiment in functional interpretation under the Code does not prove that the incorporation project was misguided in principle.77 It merely suggests that implementing such a project may require a more complex institutional design than courts are able to handle competently. Thus, at bottom the case for formalism in relational contract turns on the relative implausibility of the empirical conditions necessary for activist incorporation: competent courts and incompetent parties. The evidence from the cases adjudicating contract disputes under both the Code and the common law is that the more likely empirical condition is competent parties and incompetent courts. The common law interpretive methodology is grounded on the implicit assumption that courts function well when they operate within tightly constrained, formal modes of analysis. Courts will perform poorly, on the other hand, where they attempt the typically legislative tasks of harmonizing value conflicts and actively regulating complex economic activity. This essay offers some evidence of the wisdom of the common law.
P1	77	See Kraus & Walt, In Defense of Incorporation, supra note-at-.

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