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

classical contract, and the Code sections the court cited do not support the argument. The only intent those sections evidence is to reject the old “four corners rule,” under which a court would interpret a written contract without regard to the circumstances under which the parties made it. On the other hand, the court’s argument makes good sense if one accepts the principle of reasonable expectations, and a reading of the whole opinion suggests that this is the spirit in which the court made the argument. The evidence showed that neither party paid attention to the written provisions about price at the time of delivery, but that until a new man took charge of Shell operations on Oahu, both parties assumed Shell would give price protection to Nanakuli.

Acceptance

The principle of reasonable expectations has been a part of American contract law at least since the adoption of the objective theory of contract around the turn of the century. The principle has grown in importance since to become probably the most important principle in contract law. Section 1 of Arthur L. Corbin’s great treatise on contract, first published in 1950, is titled “The Main Purpose of Contract Law Is the Realization of Reasonable Expectations Induced by Promises.”75 Corbin’s assertion was allinclusive. He was not just saying that contracts should be interpreted to give effect to the parties’ reasonable expectations. He meant to include the whole law of contract: the grounds of enforceability, the excuses of performance, the damages measures, the allowances for assignment and delegation, the recognition of the rights of third parties—everything. The principle manifests itself in the damages measures by making the expectation measure the norm, for example.

Although Keeton and I did not discover or devise the principle of reasonable expectations in 1970, we did discover or devise some radically new applications of it. No one had thought before that the parties’ reasonable expectations should override the standard contract, as Keeton discovered the courts using them in some insurance cases, nor had anyone thought before that the parties’ reasonable expectations were the contract, as I concluded they should be. Although a few of the decisions Keeton discovered were as far back as the late 1950s, no court accepted my suggested application of the principle until the Iowa Supreme Court accepted it in

C & J Fertilizer, Inc. v. Allied Mutual Insurance Co.,76 a decision it handed down in 1975. In this instance, there was no gap between the court’s accepting the principle for insurance and its accepting it for general application. Although the Iowa Supreme Court had once used the weak version of the principle in an insurance case,77 C & J was the first time it used the

strong version, and the court accepted it in its general application. More precisely, although the court’s opinion accepted the general application, only three of the five justices who joined in the opinion agreed to go so far. The other two only accepted the principle for insurance. The three justices who agreed to the general application were W. W. Reynoldson, who wrote the opinion, David Harris, and Mark McCormick. A majority of the Iowa Supreme Court accepted the principle for general application in 1981.78

C & J involved burglary insurance. The plaintiff’s store was burglarized over the weekend when it was not open for business. The evidence of burglary included marks of forceful entry on some interior doors. No such marks appeared on the exterior doors despite unrefuted evidence that they had been locked before the weekend closing. However, there was also evidence that the burglars could have forced open the exterior doors without leaving marks. The insurance policy was entitled, “BROAD FORM STOREKEEPERS POLICY” and “MERCANTILE BURGLARY AND ROBBERY POLICY,” but it contained provisions defining burglary as only a felonious entry that left “visible marks” on the exterior of the premises. The agent who sold the insurance to the plaintiff had told him there would have to be some visible evidence to distinguish a true burglary from an “inside job,” but when the insurer denied coverage for this burglary, the agent expressed “complete

. . . surprise” and testified at trial for the plaintiff.

Justice Reynoldson’s opinion held for the plaintiff on three grounds: breach of warranty, reasonable expectations, and unconscionability. The policy definition contradicted the common meaning of “burglary,” and because the defendant had not informed the plaintiff beforehand of its intention of literally enforcing the definition, the plaintiff could reasonably have expected that the insurance he was buying would cover burglaries in the common meaning of the term. The insurer therefore implicitly warranted that the policy covered burglaries as they are commonly understood (the breach of warranty grounds). Likewise, the plaintiff could reasonably expect the policy to cover burglaries as they are commonly understood (the reasonable expectations grounds), and the policy definition of “burglary” was unconscionable.

Justice Reynoldson took the breach of warranty ground from my 1971 article. I did not limit it to insurance in the article, and he did not limit it to insurance in the opinion. The unconscionability grounds was also not limited to insurance, because the unconscionability doctrine applies to all contracts. Justice Reynoldson did not even limit the reasonable expectations ground to insurance, although he only cited insurance cases (from other states) as precedents for it. Rather, he rested this part of the decision primarily on Section 211 of the Restatement (Second), which applies to all standard contracts. Henderson’s 1990 article regards C & J as one of the most important decisions in the principle’s development in insurance up to

that time.79 I would say that it is the most important decision in the principle’s development for all contracts to date, because it so clearly explains and justifies the grounds on which it rests. Its only rivals on the present subject are two opinions by Justice Stanley G. Feldman of the Supreme Court of Arizona,80 which Henderson also admires.81

Eleven of the sixteen jurisdictions Henderson counted in 1990 as adopting what he called the strong version of reasonable expectations for insurance also recognized the principle’s general applicability. Iowa and Arizona have already been noted. The others were California, Colorado,82 Hawaii,83 Montana,84 New Jersey,85 Nevada, North Carolina,86 Pennsylvania,87 and Rhode Island.88 (The California and Nevada decisions demonstrating the recognition are those that use the reasonable expectations principle under the name of “contract of adhesion,” noted earlier.) In addition, two Missouri Court of Appeals decisions apply the principle to insurance contracts but cite my article and make arguments that recognize its general applicability.89 All the implicit recognitions of the principle, for example, in decisions concerning employment contracts and in Section 2- 207 of the Code, were outside insurance and thus also support the general application. Simple logic also favors it. The principle protects consumers from contracts the producers could not reasonably expect them to read or understand. There is no more reason to limit the principle to insurance contracts than there is to limit it to contracts made on a Tuesday. There can be little doubt that the courts of every jurisdiction will eventually accept the principle for all contracts.

Why did the courts create reasonable expectations for insurance contracts almost twenty years before they began accepting it for contracts generally? The typically greater bargaining power that insurers have relative to producers in other industries must be at least part of the answer. Many aspects of insurance are very difficult for consumers to understand, and insurance contracts are notoriously complicated. However, the greater importance of the insurance contract to the consumer relative to the importance of the contract to the consumer in other industries must also have contributed. The insurance contract is almost the whole product in itself, because the purchaser of insurance obtains almost nothing other than what the contract gives him. (One has to say “almost,” because the honesty, competency and financial soundness of the insurer are also important.) The product and the contract are separate and distinct in almost every other industry, and the consumer generally regards the product as much more important. For example, purchasers of automobiles get the automobile itself, which they presumably regard as much more important than the contract effecting the sale. The nature of insurance also makes the insurance contract of relatively greater importance. People generally buy insurance to protect themselves or others against what would other-

wise be very large financial losses. The insurance contract is likely to be the only thing that stands between the insured person and financial ruin if such a loss eventuates.

The relatively great importance of the insurance contract to the insured makes it more likely that the insured will litigate if he and the insurer cannot settle their differences, and it makes it more likely that the court will be alert to protect the insured if it suspects that the insurer may not have treated him fairly. Insurance litigation is also probably more likely to reach the appellate courts than other kinds of contract litigation, because the greater complexity of insurance contracts makes it more likely that the litigation will involve appealable issues. An informal computer sampling showed that about a fifth of the reported decisions on contracts are on insurance contracts.90

One can see that all these factors probably contributed to bringing reasonable expectations to insurance before it came to other industries by comparing insurance with industries in which some but not all of the same factors are present. For example, contracts for residential mortgages are typically much longer and more complicated than even insurance contracts, but residential mortgages are not difficult to understand (they are essentially just secured loans), and home buyers presumably regard the money the bank lent and the interest rate it charges as much more important than anything in the mortgage contract. Membership contracts of health maintenance organizations are another example. They, too, are generally longer and more complicated than insurance contracts, but HMO members presumably regard the quality and extent of the medical care they receive as more important than the written description of their rights to it in the membership contract.

Public Lawmaking and Contracting Power

Reasonable expectations does not limit freedom of contract, but it limits contracting power. People remain free to set whatever terms they like in offers to contract, but the terms will become a part of any contracts they make only to the extent they could reasonably expect the offeree to understand them. For obvious reasons, this limitation has its major impact on contracting by standard form.

Consumers will have accumulated a large pool of actual expectations about the products of any industry that has been in existence for more than a few years. A court can draw upon this pool of actual expectations to determine the reasonable expectations. Large areas of ignorance and only partial understanding are bound to exist, however, for the reasons stated in Chapter 2. Products in the modern world are technologically complex.

They come in too many varieties for anyone to have anything except a superficial understanding of more than a small fraction of them. The same limitations apply to the standard contracts themselves. They, too, are frequently complex, and they, too, come in too many varieties for anyone to have anything except a superficial understanding of more than a small fraction of them.

The question arises, therefore, of how to treat aspects of a contract that we cannot reasonably expect the consumer to understand. I suggested one answer in my 1971 article: we should regard the reasonable expectations as pertaining to ends rather than means.91 This is the way we regard warranties for tangible products. If a new automobile fails to start when you turn the ignition key, this is generally all you need to know to conclude that the manufacturer breached the warranty of merchantability. The end is that the car should start when you turn the key. There is no need to know the technological means by which the automobile manufacturer sought to achieve this end. Similarly, the contractual formula for varying the interest rate quoted in Chapter 2 is a good illustration of how one could take the same approach for services. Presumably, the purpose of the formula was to protect the lender against losses from rising market interest rates and to provide the borrower with the gains from falling market interest rates, but not to provide either a windfall at the other’s expense. The reasonable expectations were therefore that the formula would in fact achieve these results. If the particular interest rate measures the formula used failed to do this, to the borrower’s disadvantage, one should regard the failure as a breach of the borrower’s reasonable expectations. One can logically reach this result without supposing that the consumer (i.e., the borrower) knows anything about how the formula works. It is enough that he would reasonably expect it to achieve the results described.

Viewing reasonable expectations as relating to ends rather than means greatly increases contracting power, but contracting power is still not unlimited. Questions will still arise that one cannot answer even by regarding reasonable expectations as ends rather than means. At this point, contract law should cease. A court can no longer rest its decision on the parties’ manifested consents. Some public lawmaking institution will have to make the law for governing transactions beyond this point. We should frankly acknowledge this fact, not hide it under a cloak of contrived “reasonable expectations.”

In fact, public institutions have been making much of the law that is ostensibly contract on certain subjects for over a century. For example, public law governs many aspects of the relationships of debtor and creditor92 and of insurer and insured.93 The standard insurance policy in current use for business liability shows why this supplementation by public law is necessary.94 The Insurance Services Office drafted the policy to com-

ply with the plain language laws many states have enacted. We can therefore fairly attribute any difficulties of understanding that remain to the inherent difficulties of the subject, which clear language alone cannot overcome. The policy is divided into five sections, titled “Coverages,” “Who is an Insured,” “Limits of Insurance,” “Commercial General Liability Conditions,” and “Definitions.” Each section is written in outline form, and there are forty-three paragraphs, subparagraphs or sub-subpara- graphs in all. Courts have interpreted many of the phrases the policy uses, in some instances hundreds of times. An insurer could not possibly convey all this information to a purchaser of insurance in an understandable form. No single individual fully understands it. It is a body of knowledge available only in parts, after research and study, like the knowledge in an encyclopedia.

Although legislatures and administrative agencies can make some of this law, courts will have to make most of it. Most of it lies beneath the notice of a legislature, and there are too many industries for there to be a regulatory agency for each of them. One can get an idea of how courts could make this law for other industries by observing how they have made it for insurance. The insurance policy (i.e., the standard form) is the usual starting point. It presumably states the law as the insurer would like it. The lawyers for the insurer and the insured make arguments about the insured’s reasonable expectations, the parties’ and the industry’s needs, and public policies of a more general nature. The court makes the law, taking all of this into account. Precedents accumulate, treatises and reporting services extract rules and principles from the precedents, and the result is what we call “insurance law.”

Weber v. IMT Insurance Co.,95 which the Iowa Supreme Court decided some years after C & J, illustrates the process. The Weber brothers raised crops and hogs. They used the hog manure to fertilize the crops and used the same machines both to transport the manure from the hog pens and to spread it on the crops. One route from the hog pens to the crops went past a farm owned by Newman. Manure dropped from the machines onto the road by Newman’s farm, and the tires also tracked the manure. The odor eventually contaminated Newman’s sweet corn, making it unmarketable. The Webers kept doing this for several years despite Newman’s protests. Newman sued them and won a judgment, and the Webers subsequently sued their insurer under their Farmer’s Comprehensive Personal Liability Policy, which covered liability resulting from “accidents.” The trial court held for the insurer, and the Iowa Supreme Court affirmed on several grounds. It was not reasonable for the Webers to expect such repeated conduct to be classified as an accident. Requiring liability insurers to pay for people’s intentionally harmful conduct would be contrary to public policy.

The courts’ authority for making this kind of law is their constitutional authority to make common law. It does not really matter what particular category of common law (property, tort, etc.) we regard this law as falling into, except that we cannot reasonably call it contract law because courts do not derive it from the parties’ manifested consents. Most courts making or applying this kind of law in insurance cases do not bother to categorize it, except occasionally as the law of insurance, thus making insurance itself a legal category. However, courts in some of the more recent decisions in insurance cases have categorized it as tort law. These, plus decisions concerning other industries, are the “relational torts” I treat in Chapter 4. Thus, reasonable expectations and relational torts complement each other. Relational torts are the largely judge-made public laws that govern producerconsumer relationships in the respects that we cannot reasonably expect the consumer to understand. Relational torts are only “largely” judge made, because legislatures have also made some of them.

Concerns

Like any major new development, reasonable expectations has given rise to concerns. One that people frequently express to me, although I have only occasionally seen it in print,96 is that the principle gives a court too much discretion. Reasonable expectations will not resolve many of the questions that will arise, because the questions will involve matters that consumers do not understand. The court will therefore have to resolve them, without legislation or anything else to guide it. But a person who believes that reasonable expectations gives a court too much discretion must logically believe that insurance law, the law of debtor-creditor relationships, and every other part of the common law give courts too much discretion—and have been doing so for some ten centuries.

People have also expressed concerns to me about the effect reasonable expectations may have on the use of standard forms. If consumers will get their reasonable expectations regardless of the terms in the forms they sign, won’t forms become useless? If forms become useless, won’t producers stop using them? And if producers stop using them, won’t everyone suffer from the loss of the efficiencies they make possible? Standard forms reduce transaction costs and increase the predictability of legal obligations. Granted that producers have abused the bargaining power the forms give them, still, won’t reasonable expectations, by rendering the forms useless. throw the baby out with the bathwater?

If reasonable expectations will result in less use of standard forms, it has not yet discernibly done so, and as of the mid-1990s, it has been in effect for insurance contracts for over twenty years. The insurance experience

may not be a fair test, however, for despite the spread of the principle, there are still many jurisdictions it has not reached. An insurer can still expect to benefit in many jurisdictions from policy provisions that insureds will not read. If one is to fairly address the concern, one must assume that the principle has become so universally established that a producer cannot expect to benefit from contractual provisions that conflict with reasonable expectations almost anywhere. Will producers then still use standard forms? If not, will the reductions in transaction costs and increased predictability of legal obligations that standard forms provide be lost?

Producers are likely to continue to use standard forms. First of all, they need them in order to inform consumers about their products. For example, insurers need to provide insureds with statements of their insurance coverage, the coverage limits, and what they should do if a covered loss occurs. Automobile manufacturers need to inform purchasers of automobiles of what they must do to maintain their warranty rights throughout the warranty period. Producers need forms in order to provide such information whether or not the information constitutes a legally enforceable obligation.

If reasonable expectations are to attach to ends rather than means, producers will continue to need forms to state the means. The example I used to illustrate the ends-means distinction in the use of reasonable expectations also illustrates this necessity. The lender needed a form in order to state the formula for determining the variable interest rate. Otherwise, the lender and the borrower would have to negotiate the variation every time market rates materially changed, and if they could not agree, a court presumably would have to determine it for them. Stating a formula in the form is obviously much more efficient. The lender only has to prove that the formula serves the end of providing an interest rate fair to both parties if the borrower challenges it, which he will do only rarely.

I noted earlier that to the extent the consumer’s reasonable expectations do not determine the outcome of the case, the court will have to decide it on the basis of the parties’ and the industry’s needs and public policy. Producers will presumably continue to use forms for provisions that reflect their and their industries’ needs and their views on the relevant public policy considerations. For example, the insurance policy in Weber included provisions limiting the insurer’s liability to “accidents” and denying its liability for an insured’s intentionally harmful conduct. These provisions reflected both the needs of the insurer and the insurance industry and the public policy considerations upon which the court relied in deciding the case.

Producers will also presumably continue to use standard forms to give specific content to the consumer’s reasonable expectations. For example, even if reasonable purchasers of fire insurance would expect a requirement of prompt notification of fire damage, they might not have a clear idea of what period of time is deemed to be prompt. The policy could resolve

the uncertainty by specifying a certain number of days. The same would be the case for the times for making warranty claims under contracts for the sale of goods.

Finally, producers will continue to need forms to fix the consumer’s reasonable expectations, either to fix them with greater certainty or to fix them differently from what they otherwise would have been. Of course if a producer is to use forms for this purpose, it must bring them to the consumer’s attention before the consumer purchases the product, and they must be understandable. Insurers commonly use application forms in this manner, for example. The forms state the kind or kinds of insurance being offered in simple terms and provide boxes for the consumer to check to indicate his choices.

However, although producers will undoubtedly continue to use forms, forms will be less effective for determining the producer’s legal obligations. So it might seem that the producer’s legal obligations will be less predictable. Such a result is unlikely, however. The predictability of legal obligations that forms supposedly provided before the development of reasonable expectations is largely a myth. The doctrine of contra proferentem always undercut it, and since the 1960s producers have also had to contend with the doctrine of unconscionability. Further, if goods are involved, Sections 2-207, 2-316, and 2-719 of the Code are relevant, and their effects can be unpredictable. Reasonable expectations should ultimately achieve greater predictability by largely replacing these less comprehensive and often unpredictable laws with a single, clear principle.

Division of Labor between Jury and Judge

The rule has long been that the court determines the meaning of a written instrument as a matter of law, despite the more general rule that juries determine questions of fact, and the fact that meaning is largely a factual question.97 (The meaning of a contract is not entirely a factual question, because laws, such as the objective theory of contracts and the parol evidence rule, can also influence it.) There is an equally well established exception to this rule, however. If the meaning of the written instrument depends on extrinsic evidence, and credibility is an issue with respect to that evidence, the jury decides at least the credibility issue and often also the meaning of the instrument. The Restatement (Second) of Contracts proposes to expand this exception to allow juries to decide the meaning of written instruments whenever the meaning depends upon a choice of reasonable inferences to be drawn from extrinsic evidence, even if credibility is not an issue.98 Even without the Restatement’s proposed liberalization, one could argue that juries ought to determine reasonable expectations

when they are derived entirely from extrinsic evidence. In C & J, for example, the court derived the reasonable expectations from the common meaning of “burglary.” The common meaning of a word depends exclusively on extrinsic evidence.

Nevertheless, the practice, apparently without exception, is to treat reasonable expectations as a question of law for the court’s determination. Four of my research assistants examined all the decisions involving reasonable expectations they could find in a single jurisdiction. None of them found a decision in which the jury determined the reasonable expectations. The practice is a wise one. Determinations of reasonable expectations will not constitute precedents unless courts make the determinations, and unless there are precedents, people will have to litigate the same questions over and over again. Jury determinations are not precedents, and even if they were, appellate courts, which create most precedents, do not use juries. Moreover, the kinds of facts required for determining reasonable expectations are generally just as accessible to an appellate court as they would be to a jury. They rarely depend on credibility, and they rarely relate just to the case at hand. C & J again makes a good illustration. Nothing made the common meaning of “burglary” any different for the parties to the case than it would have been for any reasonable person in any situation.

The traditional credibility exception should apply for reasonable expectations, however, just as it applies for determining the meanings of written instruments. For example, if the consumer claimed that the person who sold him the product said something about it that influenced his reasonable expectations, the jury should decide whether the salesperson really said it, and if so, whether it really influenced the consumer’s reasonable expectations as he claimed. Juries are as justified in deciding credibility issues in reasonable expectations cases, as they are in cases involving the meaning of written instruments. Such decisions rarely require any technical or special knowledge of the product or industry. Such decisions do not become precedents. Appellate courts are not generally competent to redetermine them on a written record. Under the U.S. Constitution and most state constitutions, a party is entitled to have a jury make such a decision if the case is otherwise one in which a party is entitled to a jury trial.

The Effect of Special Knowledge

Keeton and Widiss ask in their treatise whether insurance purchasers who know something to their disadvantage that a purchaser generally would not know, ought to be required to accept the disadvantage because they reasonably expected it. They answer in the negative, presenting several arguments. Consumers should never be disadvantaged by their special knowl-