Учебный год 22-23 / Binding Promises - The Late 20th-Century Reformation of Contract Law

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Product Dependence and Unequal

Bargaining Power

PRODUCT DEPENDENCE and unequal bargaining power are the two conditions that chiefly motivated courts to make the reforms that are the subject of this book.

Product Dependence

There is little to be said about the greater dependence upon products that exists in a modern society, because it is so obvious. The chief source is greater specialization. Each member of society produces only a narrow range of things but consumes or otherwise uses an enormous variety of them. The result is that all are dependent on others for almost everything they need or desire. Lawyers, for example, produce only legal services and in most cases only those that fall within a particular specialty, so they are dependent upon others for everything they eat, wear, or use or consume in any other manner. Of course specialization has long existed, but it did not exist to anything like its current extent when technology was less advanced.

Another source of greater dependence on products is the greater potential harmfulness of modern products if they are not designed, made, or used properly. For example, whereas about the only harm a badly made plow could do in the nineteenth century was to increase farmers’ labor unnecessarily, a badly made grain combine today can maim or kill people, and whereas farmers in the nineteenth century used only natural fertilizers and had no insecticides at all, the chemical fertilizers and insecticides farmers use today can pollute the environment for decades and poison millions of people.

Economic markets manage and control much of this dependence more or less automatically, and to the extent they do, the problem of dependence merges into the problem of unequal bargaining power. If people are dependent on producers only in the capacity of consumers, they will generally have all the protection they need if they and the producers have equal bargaining power. However, people are also dependent on producers in other capacities. We are all at risk if the brakes on someone else’s auto-

mobile are defective, for example, or if his financial assets or liability insurance would not be enough to compensate us if he injured us.

Dependence that is divorced from bargaining power creates a need for laws that serve public purposes: for example, laws that encourage or require automobile manufacturers to make reliable brakes or encourage or require drivers to carry adequate liability insurance. Although the courts that invalidated the liability limitations in the standard contract in use in the American automobile industry until 1960 (see the introduction) were motivated in part by a desire to protect consumers from the manufacturers’ superior bargaining power, they also hoped to protect everyone from the risks of defective automobiles. The hope was that if the manufacturers were unable to use their contractual defenses to shield themselves from consumers’ claims, the safer automobiles they would be encouraged to produce would protect everyone.

Unequal Bargaining Power

Bargaining power is the power to set the terms of a contract. Bargaining power is a social power, and like other social powers, it implies more than just an ability to cause consequences. It also implies an ability to choose the consequences intelligently. Power without this ability is blind, and blind power is not power in the social sense because it confers no advantages. “Bargaining power,” therefore, as I use the term, includes the ability to choose intelligently the results one seeks to achieve by making a contract.

Contracts are bargains. People make bargains in order to further their interests as they perceive them. I will therefore take the results people seek to achieve by contracting to be the furthering of their interests as they perceive them. This is neither a very precise definition nor a completely accurate one. It fails to include the use of contracts for the purpose of making gifts, for example, or situations in which the law will create a contract even against a person’s expressed wishes.1 However, it is precise enough for our purposes and sufficiently accurate to include the vast majority of contracts in our society.

Contract law should take bargaining power into account for the simple reason that if people lack it there is no assurance their contracts will take their interests intelligently into account. A lack of bargaining power in one or both parties is a reason for limiting their freedom of contract, their contracting power, or both. It is not a conclusive reason, because other considerations may point the other way; however, it always at least poses the question of whether the law should limit the freedom or the power. Twenti- eth-century lawmakers have been mostly concerned with inequalities of

bargaining power, but bargaining power is also necessary in an absolute sense. Two people making a contract with each other can injure their own interests even if they have equal bargaining power, if neither has a reasonable understanding of the probable results.

Before proceeding any further, I will define a few terms. Although of only instrumental importance, they will help to clarify the matters to come.

“Product” shall mean anything manmade in whole or in part, whether it is tangible or intangible. Foods and services as well as manufactured things are products under this definition. Insurance, professional sports, and telephone service are products, for example.

“Producer” shall mean a person who produces products for sale. “Consumer” shall mean a person who buys a product in order to consume

it. This is not the sense in which the term is commonly used, which includes just individuals who consume for personal purposes. In the sense in which I will use the term, even large business organizations can be consumers. For example, a manufacturer typically purchases hundreds of different kinds of products that it uses in its manufacturing processes, as office equipment, as office supplies, or for the comfort and convenience of its employees. To take a specific example, an automobile-manufacturing company would normally purchase steel for use in manufacturing processes. It might buy automobile tires from a tire manufacturer for installation on its vehicles. It would buy electricity, telephone service, and water for a variety of uses. It would buy word processors and paper for office use and coffeemaking equipment, paper cups, and napkins for the comfort and convenience of its employees. Thus, it would be a “consumer” of all these products.

“Person” shall mean either a natural person (a man or a woman) or an artificial person (a corporation, for example). I will ordinarily say “persons” if I mean to include both natural and artificial persons, but “people” if I mean to include only natural persons.

I will also state here my practice on gender-neutral terminology. I will use it unless it would be inaccurate, ungrammatical, unclear, awkward, or excessively lengthy. That I have defined “person” the way I have means I would have to say “he, she, or it” in order to be both gender neutral and accurate when referring to a person. The usually sufficient gender-neutral phrase “he or she” would inaccurately imply that I meant only a natural person, whereas “it” alone would inaccurately imply that I meant only an artificial person. Therefore I will often use a masculine singular pronoun to refer to a person.

The relevance of the distinction between producer and consumer for my purposes is threefold. First, in a modern society with a market economy, a very large proportion of all contracts made are between producers and consumers. Contracts between consumers of the product concerned are rare. (A person selling his used car to someone other than a used-car dealer

would be an example.) Contracts between producers of the product concerned are even rarer. (One car manufacturer selling cars to another would be an example.) Second, this distinction indicates the balance of bargaining power better than anything else. The party possessing the greater bargaining power is almost invariably the producer. Third, a producer almost invariably possesses substantial bargaining power over its own products in an absolute sense. It would not stay in business long if it did not.

Although I believe I am the first to attach such importance to this distinction, others have drawn similar distinctions for similar purposes. Section 2-104 of the Uniform Commercial Code defines “merchant” as a person who deals in goods of the kind involved in the contract at hand or who otherwise holds himself out as having knowledge or skill relative to such goods. Businesses as well as individual consumers may not be merchants under this definition. Article 2 of the Code holds “merchants” to higher standards of behavior and affords them less protection than it does persons who are not “merchants.” The “merchant/nonmerchant” distinction is similar to the producer/consumer distinction I draw, and Article 2 employs the distinction for purposes similar to mine.

When the Code introduced the doctrine of unconscionability, legal scholars generally thought that courts would limit its application to protecting individual consumers (i.e., not businesses). There was even speculation that courts might deny its protections to businesses as a matter of law.2 In fact, however, the protected parties in at least 40 percent of the reported cases involving unconscionability have been businesses in recent years.3 The courts have effectively adopted the same distinction I have. By using unconscionability when they see its protections are needed, they have used it even when the consumers are businesses.

It is not literally the case that nearly all contracts in a modern society are between a consumer and a producer. The consumer sometimes only contracts with a retailer or some other intermediary in the distribution train. We are interested in bargaining power, however, and it is the producer that almost invariably determines what the contract with the consumer will be, whether the producer “makes” it in the legal sense or not. If there is an intermediary, the producer still generally provides the standard contract that sets the terms of the transaction for all concerned. The intermediary merely delivers the contract to the consumer on the producer’s behalf. For example, the insurer almost invariably provides the insurance contract even if an independent agent sells the insurance. Retailers of tangible products typically pass along the producer’s warranty or other standard contract together with the product when it is sold; contract and product are often in the same box. In many instances, the consumer’s contractual expectations about a product are at least partly formed from advertising or from the producer’s reputation. The producer almost always controls

this kind of advertising, and of course the producer is responsible for its own reputation.

Bargaining power, as I have defined it, is not the same as what economists call market power and has little to do with economic power of any kind. There are two chief sources of the producer’s generally superior bargaining power in a modern economy. One is that he understands the products he produces better than the consumer does. The other is that he can make the contract more efficiently, by making a standard contract and using it for every sale. Neither source depends on the producer’s having market power.

The arguments and descriptions I provided in Chapter 1 were largely uncontroversial. This will no longer be the case. In order to make the presentations as understandable as possible, I will generally make my own arguments first and treat the arguments others have made in opposition toward the end. I hope the reader will keep this in mind if he or she thinks I have overlooked a counterargument or weak point in my own arguments.

Technology

Technology has increased the producer’s bargaining power through product proliferation. Products today exist in virtually infinite kinds and varieties, and consumers buy thousands of kinds and varieties over the course of their lives. Therefore, consumers cannot hope to have more than a minimal understanding of all the different kinds and varieties of products they will buy. On the other hand, a producer only needs to understand the products he produces. Product proliferation does not reduce his ability to do this at all.

The producer also possesses much greater resources for gaining an understanding and has a much more powerful motive for using them. He must understand his products very well if he is to be competitive. He can afford to gain a deep understanding of them, because relative to the resources required to produce a product, the additional resources required to understand it are typically small. On the other hand, the consumer lacks the resources the producer has for gaining a deep understanding, and he is not subject to competitive pressures to gain as much understanding as he can. The only pressure on the consumer is to gain a sufficient understanding to use the product for his own purposes.

Technology has also increased the producer’s bargaining power by making products more difficult to understand. For example, although the typical purchaser of an automobile can appreciate design, color, comfort, and how the car handles on the road, he has no understanding of the underlying mechanical, chemical, and electronic properties the car possesses. Most

consumers know next to nothing about a car’s safety and durability, because they cannot assess either of these qualities without understanding the engineering that went into the car’s manufacture and design. Of course consumers can learn about a producer’s reputation for product safety or durability, but this information still leaves them in a position much inferior to that of the producer in at least two respects. First, whatever the producer’s reputation, the particular product the consumer buys may fall short of it. In order adequately to protect themselves against this eventuality, consumers would have to understand the probabilities of each respect in which the product might fall short, how great a loss or injury such a defect probably would cause, and what rights, if any, the contract of sale provides for their protection if such a defect should occur. Second, consumers have no way of quantifying a producer’s reputation; that is, no effective way of estimating how much higher a price it is worth.

Technology also enables producers to engage in continual product testing. A typical automobile manufacturer, for example, tests its automobiles’ resistance to collision, their ability to hold the road under slippery conditions, their stability when turning at high speeds, how long their finishes can be expected to last in different climates and under different driving conditions, and so on, practically ad infinitum. A producer today also knows the effectiveness of its quality-control procedures. This knowledge enables it to predict the frequency with which defects will manifest themselves after the product has been sold.

Magazines such as Consumer Reports and those catering to special interests, in computers or sports cars, for example, reduce some of the producer’s advantages, but only to a small extent. The consumer’s ability to understand sharply limits the usefulness of the information these magazines can convey, and the consumer’s attention span limits it still further. Moreover, few consumers read the magazines for more than just the one or two kinds of products in which they have a special interest, and only a few could read those for all the different kinds of products sold. Finally, the understanding that such magazines can provide is subject to the same inherent deficiencies as is the understanding a consumer can gain from a producer’s reputation. It is impossible to quantify, and it does nothing to help the consumer deal with the possibility that the particular product he buys may not conform to what the magazines report.

We do not ordinarily think of laws as technology, but they can have the same effect on consumers’ ability to understand the consequences of what they are buying. The number of laws that affect products and the sales of products has multiplied many times over since the nineteenth century, and these laws have also become individually more important. Implied warranties now attach to many more kinds of things than they used to4 and cover many more kinds of losses.5 Product liability6 and expanded notions of

negligence7 have become a part of the law, although they did not exist fifty years ago. The legal implications arising from credit8 and insurance transactions9 alone have probably multiplied several times since the nineteenth century. A producer can efficiently inform itself of the laws that affect its products and their sale and change its practices accordingly, because it can spread the costs over all of its affected products. A consumer typically has no such cost-spreading opportunities.

Some states have enacted “plain-language laws” requiring certain kinds of contracts to be in easily understandable language. However, plain language in the contract does nothing to reduce the advantage the producer gains from its superior understanding of the product; understanding the contract is not the same as understanding the product. Any legal advice the consumer might obtain is generally unhelpful for the same reason. A lawyer may be able to explain the contract, but he will understand the product no better than the consumer does. For example, on a multimillion-dollar financing arrangement that was brought to my attention recently, the contract devoted slightly more than a thousand words merely to describe the formula the lender would use to set the interest rate. One small part of the formula read as follows:

the rate obtained by dividing the latest three-week moving average of secondary market morning offering rates in the United States for three-month certificates of deposit of major United States money market banks, such three-week moving average (adjusted to the basis of a year of 365 or 366 days, as the case may be) being determined weekly by . . . [the lender] on the basis of such rates reported by certificate of deposit dealers to, and published by, the Federal Reserve Bank of New York or, if such publication shall be suspended or terminated, on the basis of quotations for such rates received by . . . [the lender] from three New York certificate of deposit dealers of recognized standing selected by . . . [the lender], by a percentage equal to one hundred percent (100%) minus the “Reserve Percentage” (as defined below) for such three-week period, . . .

This is not simple prose, but a reasonably intelligent person can understand it. The difficulty is appreciating its significance. Why is the rate thus computed deemed to be appropriate for this transaction? What relationship is it likely to have with the rates borrowers similarly situated can obtain from other lenders? Why is the Federal Reserve Bank of New York being used rather than the Federal Reserve Bank of San Francisco, which would seem more appropriate for a financing in California? What is a “secondary market morning offering rate,” and how does it relevantly differ from other rates for three-month certificates of deposit? Why use three-month certificates of deposit rather than certificates of deposit for some other time period? Why use certificates of deposit instead of, say, residential mort-

gages? The only advice that would be truly helpful for the consumer in this kind of situation would be the advice of someone who knew the producer’s product as well as the producer did. The lawyer’s merely legal expertise means very little.

Examples closer to home are also common. Suppose a health insurance policy provides coverage of up to $250 a day for thirty days for a hospital room. That in itself would be perfectly understandable, but consumers could not gauge its significance unless they knew what the hospitals they were likely to stay in charged for the use of a room, and how long various illnesses or injuries would likely require them to stay in a hospital. If the hospitals were charging over $700 a day in large metropolitan areas, a daily rate limit of $250 would be grossly inadequate for a city dweller. On the other hand, it might still be sufficient in some rural areas. A consumer would encounter similar difficulties in gauging the adequacy of the thirtyday limit. The point is that understanding the language is only a small part of the problem. The much more difficult part is understanding the product.

The warranties on new automobiles provide an even more common example. Many now cover just the “power train” and are limited to 36,000 miles or three years, whichever comes sooner. What does the “power train” include, and what doesn’t it include? What are the likely consequences of a defect appearing in some part of the car not in the “power train”? Is 36,000 miles or three years long enough to cover most of the kinds of defects that might appear, or did the manufacturer choose these limits precisely because most defects would not appear until the warranties had expired? Again, the consumer cannot hope to answer such questions without expert knowledge of the product.

One might think that competition would make any differences in knowledge or understanding between producers and consumers unimportant. For example, a consumer might not need a detailed understanding of the significance or value of a new car warranty in order to compare warranties being offered by different manufacturers. The thought is incorrect, however. The warranties may be different in ways that make it impossible for the consumer to judge their relative worth without a deeper understanding of the warranties, the law, and the products involved. Even identical warranties will have markedly different worth if the products they cover have substantially different maintenance requirements or repair prospects. Competition works to eliminate the producer’s bargaining advantage only if the products in competition with one another are substantially identical. All consumers then need to know are the prices, because none of their other interests will be affected by their choices. Consumers today are rarely confronted with choices among substantially identical products, however.

Standard Contracts

When businesses become large enough to engage in numerous transactions of a kind, they can reduce their transaction costs by making their contracts in standard form. Businesses incur the costs of drafting a standard contract only once and spread them over as many transactions as they use the contracts. Standard contracts also make a business’s legal risks more manageable by making them more uniform, also effecting a cost saving. These savings ultimately benefit consumers, because producers’ cost savings are largely passed on in the form of lower prices in a competitive economy.

In fact, the savings effected by standardizing contracts are so great that when for some reason a business cannot realize them, the business is likely not to use contracts at all. The costs of composing a contract tailored to the particular aspects of each sale are usually prohibitive. Before contracts became standard, goods were generally sold without contracts, and sales of services were generally accompanied with just brief notations of the most basic elements of what the parties had agreed. For example, a contract to install a new roof might state just the price, the kind of shingles, the building to be roofed, and the expected completion date. Retailers still generally sell inexpensive goods without contracts. Food and clothing are examples.

An overwhelming proportion of all contracts made today are standard whether or not they appear to be. The “secretly” standard are those that appear to be individually crafted to the transaction at hand, but which the producers composed from standard parts taken from a form book (the old way) or from the memory bank of a word processor (the new way). For example, the lender had apparently composed the contract used in the financing transaction I mentioned earlier entirely from parts stored in the memory of a word processor—a standard contract for a financing of $20 million.

Although everyone ultimately benefits from the producer’s ability to reduce its costs by standardization, the consumer does not benefit from the producer’s enhanced bargaining power. The standard contract enables the producer to take maximum advantage of his superior understanding of the product and the law. Neither length, lack of understandability, nor onesidedness reduces sales, because consumers rarely read the contracts. They know there is no reason to do so. There is no reason to read them if they cannot change them, if they probably would not understand them, or if they are unlikely to discover anything in them that would persuade them to buy the product from another producer. If there were anything in a standard contract to the consumer’s benefit that other producers were not also

offering, the producer concerned would surely have drawn the consumer’s attention to the benefit as an inducement to making the sale. If there were anything in a standard contract to the consumer’s detriment that other producers did not also require, the other producers would have drawn it to consumers’ attention as an inducement to making their sales. Salespeople also rarely read the standard contracts for the products they sell. For example, I have never met an insurance or mortgage salesperson who read the insurance policies or the mortgages. Both learn what they need to know about the contracts they sell from instruction booklets their employers give them.

Consumers so regularly fail to read standard contracts that in industries with especially long and complicated contracts, producers often dispense even with the formality of showing the contract to the consumer and having him or her sign it. They ask the consumer instead to sign a short and simple “order” or “agreement” that incorporates the contract by reference. The practice in the insurance industry for years has been to send a person the insurance policy some weeks after he has purchased the insurance. Before purchasing their insurance, buyers typically see only a one-page form on which they check the blanks to indicate the coverage amounts, exemptions, and additional coverages they want. Prepaid health plans, such as Blue Cross and Kaiser-Permanente, generally do not show subscribers their contracts at all. Those who inquire are told they can come down to a certain office, where the health plan keeps a copy. Mortgage and real estate companies typically do the same.

The Disappearance of the “Level Playing Field”

One can describe the condition of equal bargaining power presupposed by freedom of contract as a level playing field. Most contracting did not really occur on a level playing field even in the nineteenth century, but at least the description then would have been approximately accurate. It no longer is, however. We now contract on a field of hills, so to speak.

The producer-consumer relationship is vertical. The producer of a product is always higher than the consumer of the product in the production and distribution chain. Almost all contracts now made are between persons related in this way. Horizontally related persons rarely contract. Two corporations in the same industry will contract if one acquires the other’s assets. Two lawyers will contract to settle a dispute. Two individuals or two couples will contract if one is buying the other’s house. As these examples illustrate, however, these occasions are exceptional. None is a routine occurrence for the persons concerned. Not even lawyers who specialize in litigation devote a large portion of their time to making settlement con-