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

tracts. On the other hand, vertical contracts are now an essential and regular part of the business of life for virtually everyone.

No one has a fixed place in this hierarchy. All of us occupy different levels depending on whether we are the producer or the consumer of the product concerned. The university that employs me is a producer in its capacity of contracting with its students, who are consumers of its services. However, the university is a consumer in virtually every other contract it makes, for example, when it purchases computers, office supplies, books and periodicals, and so on. This is the case no matter how wealthy or powerful a person is. It is true for IBM as well as for people who make their living mowing lawns. Vertical contracts inherently give the party on the higher level the superior bargaining power that derives from the level’s technology. If the party uses standard forms to contract, he also gains the bargaining advantages they offer. Unequal bargaining power is now characteristic of contracting generally. The long-held assumption that “sophisticated businesspeople” do not need the law’s protection when they contract with each other10 is no longer correct. We all need the law’s protection except when we contract about what we produce.

Consequences

As one would expect, the chief and most evident consequence of these systematic inequalities of bargaining power was to make contracts very unfavorable to consumers. Producers everywhere took advantage of the opportunities their superior bargaining powers opened to them. Thanks to the developments treated in the coming chapters, however, the worst is past. Although many one-sided consumer contracts are still in use, and virtually all consumer contracts are still one-sided in certain respects, the truly egregious cases are by now over two decades old. I will describe a few of the egregious cases, however, in order to give the reader an idea of how much advantage some producers took of their superior bargaining power before the law began to change.

The standard contract that American automobile manufacturers used until the courts began invalidating it in 1960 disclaimed the manufacturer’s liability for any personal injuries, property damage, or other loss a purchaser might incur as a result of a defect. It limited the manufacturer’s liability on the car itself to defects that surfaced within thirty days or 3,000 miles, whichever came first. Even then, the manufacturer’s only liability was to repair or replace the part. The purchaser had to ship the part to the manufacturer’s place of business (normally Detroit) at the purchaser’s expense, and the manufacturer had to agree after its own inspection that the

part was defective. A purchaser had no right to return the car to the dealer from whom he bought it for repairs even within the thirty days or 3,000 miles. The only promise to which this contract effectively bound the manufacturer was to deliver something that looked like an automobile.

Manufacturers did not always hide behind their contractual defenses; they usually made minor repairs voluntarily. However, they were ruthless in avoiding large liabilities. The facts of the first judicial decision to overturn the standard American automobile industry contract provide an example. A defect in the steering mechanism swerved the car into a brick wall near the highway and destroyed the car only ten days after the owner had purchased it. The owner’s wife, who was driving the car, was seriously injured. The Chrysler Motor Company denied liability for all the losses and injuries on the basis of the contract provisions I described in the preceding paragraph, although in this case, the Supreme Court of New Jersey overrode them. The case was Henningsen v. Bloomfield Motors, Inc.11

Individual consumers were not the only victims. Businesses were also denied significant contractual rights when they were consumers. Typical of the remedies limitations on business consumers were those invalidated in

Wilson Trading Corp. v. David Ferguson, Ltd.12 in 1968. The contract was for the sale of yarn. The producer was the manufacturer of the yarn; the consumer, a manufacturer of sweaters. The consumer cut and knitted the yarn into sweaters, and then washed the sweaters. The color “shaded” during the washing, making the sweaters unmarketable. The producer defended on the basis of the following language in the contract:

2. No claims relating to excessive moisture content, short weight, . . . or shade shall be allowed if made after weaving, knitting or processing, or more than 10 days after receipt of the shipment. . . .

The consumer had not made the claim until after the knitting and also more than ten days after receipt of the shipment. The trial court gave summary judgment for the producer, and the first two levels of appellate courts affirmed. However, the New York Court of Appeals reversed and remanded for trial on the factual issues of whether the shading defects were discoverable before the knitting and, if not, whether the consumer had reported them to the seller within a reasonable time after he should have discovered them. The fact that the consumer had not reported the damage until more than ten days after receipt of shipment was not conclusive against him.

It is not relevant to our purposes to go into the grounds of reversal in detail, except to say that the Uniform Commercial Code makes remedies limitations like this unenforceable. The yarn producer had evidently artfully designed the remedies to give only the appearance of protection. Be-

cause the consumer could not discover the yarn’s tendency to “shade” during washing until he had washed it, he would never discover the defect until after the warranty had expired. The producer apparently designed the ten-day limitation to have the same effect. Any defects that might appear in its yarns would likely not appear until after ten days.

Wilson illustrates how deeply entrenched freedom of contract was before the new developments began to challenge it. The New York Court of Appeals’s application of the Code to the facts of the case was simple and straightforward. The same facts today would present too easy a case even for a good law school examination. New York enacted the Code in 1962. The New York State bar and legislature held hearings and deliberated on it for three years before the legislature enacted it. Members of the bench and bar could hardly have failed to notice. Yet it was not until three courts had heard the case and it had reached the highest court in the state that the lawyers for the garment manufacturer could persuade a majority of the court that the Code set limits on a seller’s ability to limit a buyer’s remedies for breach.

Egregious examples of unfair insurance contracts are still legion, despite the efforts of courts to combat them. For example, disability insurance policies promise monthly payments for life only if the insured is “permanently disabled from engaging in gainful employment” and “subject to continuous house confinement.”13 Think for a moment about the chances that all the conditions thus expressed will simultaneously exist. Disabled from engaging in any gainful employment? If one can still talk, presumably one can still solicit orders for magazine subscriptions over the telephone. If one still has the use of one hand, presumably one can still write with a pen and so still hold a desk job. Permanently disabled? Almost any condition other than the loss of a limb or organ could get better.

Even if an insured could meet both conditions, the chances that he could continue to meet both of them for more than a few months are practically nil. An individual who was truly unable to engage in any gainful employment and continuously confined to the house would not long remain confined there. His family or doctors would soon remove him to a hospital or nursing home, and the insurer presumably could stop paying the benefit when they did, because the claimant would no longer be in “continuous house confinement.” It seems doubtful that the insurers who sell these policies would ever pay a dollar in claims if the courts did not order them to.

Even producers who might want to treat consumers fairly have difficulty doing so in a competitive economy when the law sets no limits on the elimination of a party’s contractual rights. The money a producer can save by eliminating consumers’ rights is pure profit. It costs no more to make an

unfair contract than a fair one, and an unfair one will not noticeably reduce sales because so few consumers will read it. Competitive pressure therefore works to compel every producer to make its contracts at least as unfair as the contracts of the other members of its industry. It will make fewer profits than its competitors if it does not. The logical end result is for all the contracts in the industry to be the same and all to be as unfavorable to the consumer as a lawyer’s skills can make them. There have been no studies to test the extent to which our economy actually reached this state before contract law began to change, but the pre-1960 standard contract for the American automobile industry shows that at least the American automobile industry had reached this state by 1960. I know from my experience as a practicing lawyer that the finance industry had also reached it by the 1960s.

A law of contract that fails to prevent producers from exploiting their superior bargaining powers also ultimately reduces the value of the products themselves. Producers have less to fear from making or performing them inadequately. The general quality of American products had in fact fallen to a low level by the 1960s, which was one reason foreign manufacturers began entering American markets so successfully. That American products (as well as foreign products sold in the United States) are now generally much safer than they were in the 1960s is due in no small part to the new tort and contract laws that were made then and thereafter, especially the laws that overrode contractual disclaimers of liability for personal injuries. However, the law still has a way to go before consumer’s will be adequately protected against the purely economic losses they can suffer from defective or poor-quality products.

The Effects of Classical Contract on the Law’s Ability to Serve Public Purposes or to Prevent Abuses of Bargaining Power

Although the U.S. Supreme Court implicitly overruled the constitutional decisions of the Lochner era in the 1930s, the common law characteristics of classical contract continued to aggravate the harmful effects of inequalities of bargaining power until the advent of the reforms that are the subject of this book. The principle of freedom of contract prohibited a court from either invalidating provisions in a contract that it concluded were unfair or from overriding unfair contract terms with laws it created itself. The first option would violate the parties’ “freedom to” include anything in their contracts they chose. The second would violate their “freedom from” laws that would limit this freedom. The clear distinction between contract and

tort reinforced the “freedom from” prohibition by clearly separating contract laws from laws limiting contractual freedom.

Classical contract’s failure to limit contracting power was the most harmful of all. The objective theory of contract interpretation seemingly compelled the conclusion that people could bind themselves to contracts without giving consent in any meaningful sense. Something purely formal, such as a signature or a handshake, was enough, even if the person had only the vaguest notion of what he was accepting. Thus, classical contract gave producers the power to make contracts without the consumers’ meaningful consent. This aspect of classical contract gave producers considerable advantages even under the relatively primitive economic conditions of the nineteenth century. The advances in technology and increases in the use of standard contracts in the present century made the producer’s advantages overwhelming.

Classical contract also increased the producer’s superiority of bargaining power in certain other respects. The only real discussion of rights and duties that occurs in most standard contract situations occurs after the parties have made the contract, and then only if something goes wrong. They will then generally have to settle at least two questions: who, if anyone, breached the contract, and what the contract obligates the breacher to do. It is reasonable to characterize the settlement of these questions as bargaining for our purposes, because the same bargaining strengths and weaknesses that affected the parties’ making of the contract are likely to affect their settlement of these questions, too. A producer can ensure that he will also have the superior bargaining power in such settlements if something goes wrong by using the standard contract to eliminate as many of the rights the consumer will have as the law will allow. Then, even if the producer breaches the contract, there will still be little or nothing the law will require him to do about it.

Freedom of contract ensured that a court would enforce whatever the producer’s contract provided in this respect. The standard contract that was universal in the American automobile industry until 1960 was typical. It gave the manufacturer the exclusive right to decide whether he was at fault if the automobile failed to function as it should, and it left the purchaser with virtually no rights against the manufacturer even if the manufacturer admitted he was at fault. On the other hand, in situations in which the consumer rather than the producer was the more likely to breach the contract, the producer could include provisions in the contract to increase his remedies. The law still generally permits these kinds of contractual remedies provisions. For example, a credit institution can require large amounts of security, provide for quick methods of foreclosure, and require the borrower to pay all expenses of collection, including attorneys’ fees. Freedom

of contract allows producers to increase their own remedies for breach for the same reason it allows them to reduce the consumer’s remedies.

A producer can also use the American Rule to enhance his “secondround” bargaining power. If he structures the transaction to require the consumer to sue him for any redress if anything goes wrong, the consumer’s inability to recover his litigation costs will usually be sufficient to prevent him from suing the producer, even if the contract provides for remedies otherwise sufficient to make suing worthwhile. The American Rule has such a powerfully discouraging effect on contract litigation because the amounts involved are characteristically too small to cover the litigation costs. For this reason, it is currently rarely worth suing for less than about $25,000 in a large metropolitan area even in a simple case, or for less than about $100,000 if the case is complicated.

The simplest way a producer can require the consumer to sue him for redress is to make the consumer pay for the product up front. This prevents the consumer from subtracting what he thinks the producer owes him from the purchase price. The producer can achieve the same result even in a credit transaction by keeping the credit period shorter than the period of time after which any defects in the product are likely to appear. There are also more complicated ways of achieving the same result in a credit transaction. The producer can require the consumer to borrow the purchase money from someone else (typically a bank) or to sign a negotiable note, which the producer assigns to someone else (again, typically a bank). Defects in the product will not entitle the consumer to cease making payments in either case. If the consumer ceases paying nevertheless, the only result will be to get him in trouble with the person to whom he owes the money, because the producer will already have been paid.

The effects of the American Rule go beyond merely discouraging suits. The rule also leaves a plaintiff undercompensated if he sues and wins. Moreover, because both producers and consumers understand this fact, the rule reduces the amount a consumer is likely to get in settlement. The consumer will accept less in order to avoid incurring unrecoverable litigation costs, and the producer will offer less because he knows the consumer will accept it.

Different Conceptions of Bargaining Power

Duncan Kennedy has argued against using superior bargaining power as a justification for laws that protect or otherwise benefit the weaker parties. However, he conceives of bargaining power differently than I do. He offers three conceptions of superior bargaining power: one party is wealthier

or in some other sense financially stronger than the other; one party possesses more market power (in the economic sense) than the other; or one party (in this case, the weaker party) needs to make the contract more than the other does. He concludes that none of these conceptions provides a satisfactory justification for a law or judicial decision intended to protect or otherwise benefit the weaker party. He suggests instead that we frankly accept the paternalistic justification, which he defines as a belief that we know what is better for others, whether or not they realize it.14

I think I agree with the first part of Kennedy’s argument, although whether I do or not does not matter for present purposes, because none of the conceptions of superior bargaining power he offers is the one I am using. Bargaining power, to me, is simply the power to set the terms of a contract. Its principal sources, in my view, are the producer’s superior understanding of his products and his ability to make the contract more efficiently by standardizing it. Neither my conception of the power nor the sources I think it derives from bear any necessary connection to financial strength, market power, or relative need.

However, the second part of Kennedy’s argument does matter for present purposes, and I do not agree with it. There is indeed a large area of lawmaking for which the paternalistic justification is sufficient. Certain laws can serve their purposes only if everyone is subject to them. The Social Security system is an example. It could not provide the nearly universal protection it does if we did not require nearly everyone to contribute to it. Because a majority of the American electorate decided it wanted a Social Security system, it had the right to impose it on the minority that did not want it, in the belief that the minority would benefit even if it did not realize it would.

But the whole area of lawmaking is not like this. In particular, there is generally no need to impose something on people who do not want it if economic markets can provide it to the people who want it. Properly operating economic markets allow people to choose whether they want something and generally also offer them varieties to choose from. Therefore, the courts have been right sometimes to condition their reforms of contract law on a perception of inequalities of bargaining power and to justify the new laws on this basis. People generally express their choices in economic markets through contracts, and inequalities of bargaining power can prevent them from effectively expressing their choices or from enforcing them after they make them. Of course, the courts would have been wrong never to override a contract unless they perceived inequalities of bargaining power, but they have not done this. The second principal motivation for the reforms was to place public responsibilities on producers, and this motivation was enough in many cases.

Arguments in Opposition to the Reforms

Not everyone welcomed the reforms when they came, but the only arguments I will treat here are those that opposed any changes at all in classical contract. I will treat the arguments that opposed only certain reforms in connection with the reforms they opposed.

One could call the principal argument in opposition to any change at all the basic economic argument, because it rests on some of the most basic suppositions of economic theory. Any elementary economics text will explain why consumers in a competitive economy get what they want at the lowest prices consistent with the costs of producing it, if the “market” in which they are buying is working properly. One can even expand this basic theory to include the information consumers need in order to decide what they want, by characterizing information itself as a commodity. Then, if consumers are not getting what they would want if they knew enough to ask for it, the reason must be that they prefer choosing in ignorance to paying the costs of obtaining the information they would need to choose intelligently—so even when they seem not to be getting what they want, deeper analysis will disclose that they really are. What they really want is whatever mixture of ignorance and intelligent choice the market is providing them. Thus, it seems to follow that if the law intervenes to require producers to give consumers anything other than what they are already getting, the law will only harm consumers, at least in terms of their own preferences, because they are always already getting what they want the most, consistent with the costs of producing it. The law should leave freedom of contract and contracting power unconstrained. People should be free to make whatever contracts they like, and there should be no limits on what or how much they can include in them.

For example, if consumers really wanted stronger remedies for breach of contract, they would demand them, and some producers, at least, would include them in their contracts. These producers would increase their prices, but if the consumers really wanted the stronger remedies badly enough, they would be willing to pay the higher prices for them. The absence of contracts with strong consumer remedies in them in actual markets thus demonstrates that consumers do not want such contracts badly enough to pay what it would cost producers to provide them. If the law were to require producers to provide stronger consumer remedies, consumers would be less happy with the result than they are currently. One study showed that consumers rarely sued producers for breaches of contract before courts and legislatures changed the law to strengthen consumers’ remedies.15 This fact might seem to support the argument that consumers really preferred things as they were, at least for remedies. If consumers had

wanted stronger remedies, would they not have made more use of the remedies they already had?

It is rare to find this argument made as baldly and sweepingly as I have made it here, but it underlies practically innumerable more modestly expressed arguments and opinions. I will mention just one, Judge Richard A. Posner’s well-known opinion in Lake River Corp. v. Carborundum Co.16

Posner is an economist as well as a lawyer and was a law professor before becoming a judge on the U.S. Court of Appeals for the Seventh Circuit. At issue was the validity of a liquidated-damages provision that provided damages greatly in excess of those that the plaintiff actually suffered or could reasonably have expected to suffer from a breach of the kind the provision covered. Traditional contract law invalidates such a liquidateddamages provision on the ground, among others, that it coerces a party into performing the contract even if everyone concerned would be better off if the party breached and compensated the other party for the actual damages. Illinois followed the traditional law, and the court was obligated to follow Illinois law. Posner recognized all this and consequently joined the other members of the court in invalidating the provision, but he nevertheless took the occasion to lecture the courts of Illinois on how they ought to treat liquidated-damages provisions. He told them they should not interfere with what the parties had chosen to include in their contract, at least if, as here, the parties were “fully competent”:

[The traditional rule] . . . overlooks the . . . important point that the parties (always assuming they are fully competent) will, in deciding whether to include a penalty clause in their contract, weigh the gains against the costs—costs that include the possibility of discouraging an efficient breach somewhere down the road—and will include the clause only if the benefits exceed those costs as well as all other costs.17

The basic economic argument suffers from the characteristic weakness of any argument that reasons from fact to preference. That consumers must be content with the way things are because it is the way things are constitutes a valid argument only if consumers have the power to change things. However, the chief point of this chapter has been to explain why consumers lack this power. They lack it because they lack bargaining power, which is, by definition, the power to set the terms of a contract. Moreover, the principal source of the consumer’s lack of bargaining power is not lack of information; it is lack of understanding, which is not nearly so easily rectified. Even with all the information they wanted, people could not understand most products today sufficiently well to choose intelligently among them if the law did not require producers to conform their products to the relatively simple expectations that consumers have about them. Therefore, to take the example first mentioned, the more plausible explanation for the

rarity of consumer suits against producers before the law gave consumers stronger remedies is that consumers generally realized it was not worth suing with only the weak remedies they had.

I am aware of only one argument that goes deeper into the problem than does the basic economic argument. Alan Schwartz and Louis L. Wilde are the authors of one article that makes it,18 and Douglas G. Baird and Robert Weisberg, of another.19 The argument concerns contract formation, that is, offers and acceptances. Schwartz and Wilde treat contract formation under the common law, and Baird and Weisberg treat it under the Code. The differences between contract formation under the two laws are only technical, and the technicalities are irrelevant to the argument both articles make.

In this view, the economic market in which the parties make their contracts should be examined to determine whether it satisfies three conditions. It must be of substantial size, competitive, and such that the sellers cannot “price discriminate” between large-volume and small-volume buyers. “Price” is used as a term of art to mean anything about a product, including its quality and the contracts the sellers use to sell it. Therefore, “price discrimination” includes differences between the contracts of sale for some buyers and those for other buyers. Any market of substantial size, the argument goes, is likely to have a significant number of largevolume buyers, for whom it will be worthwhile to ascertain the sellers’ standard terms and understand their factual and legal implications. These large-volume buyers will bargain to get the best deals they can. Because the market is by hypothesis competitive, the terms that result will be economically “efficient,” which means that these buyers will get the terms they like the most at the price they are willing to pay. Finally, because the sellers must give everyone the same terms as they give these largevolume buyers (they cannot “price discriminate”), every buyer will obtain the same advantages as the large-volume buyers, no matter how weak the bargaining power of the particular buyer may be. Where the three stated conditions exist, therefore, every buyer gets the best deal possible regardless of any weakness in any buyer’s own bargaining position. Any attempt by a court or legislature to make the contracts more favorable to buyers would backfire. It would only make things worse for most buyers even if it made things better for a few of them. Therefore, freedom of contract ought to be maintained.20

The argument sounds too good to be true, and it is. It has at least two flaws. First, the assumed community of interest between largeand smallvolume buyers rarely exists. As a result, the advantages that large-volume buyers obtain for themselves with their superior bargaining power do not necessarily work to the benefit of small-volume buyers, or at least not as much. Second, and more important, sellers generally can and do discrimi-