Nonlegal sanctions in commercial relationships

Harvard Law Review

Volumn 104, Issue 2, 1990, Pages 375-466

  Charny, David ^a  

^a HARVARD LAW SCHOOL   (United States)

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EID: 0039548966     PISSN: 0017811X     EISSN: None     Source Type: Journal    
DOI: 10.2307/1341583     Document Type: Article

References (353)

1. 2, col. 1.
2. The bonds obliged RJR Nabisco to reset the interest rate so that the bonds would, in the opinion of the company's investment bankers, trade at their par value. The bonds had been trading substantially below par, however; because it appeared infeasible to reset the interest rate to achieve par value, the company might have defaulted on the bonds. The refinancing provided cash payments and convertible stock in exchange for the bonds. See id.
3. For a skeptical account of Kravis' junk bond activities, particularly with regard to RJR Nabisco, see B. BURROUGH & J. HELYAR, BARBARIANS AT THE GATE 100-01, 240-86 (1990).
4. See Katz v. Oak Indus., 508 A.2d 873, 879 (Del. Ch. 1986) (rejecting the implication of fiduciary duties to bondholders and holding that bondholders' rights are determined solely by express contract).
5. 2, col. 4 (reporting that Kravis believed that the refinancing would "reopen the capital markets to RJR").
6. By "standard rules" I refer to the familiar formal requirements of contract: consideration, offer and acceptance, a commitment that satisfies legal standards of "definiteness," and, for some transactions, a writing or a written filing with appropriate authorities. Throughout this Article, I refer to commitments that are enforced by nonlegal sanctions, but are not enforceable under these standard rules, as "nonlegal commitments." Of course, aside from the operation of the standard rules of contract, nonlegal commitments may be enforceable under doctrines such as promissory estoppel or restitution or under duties of good faith. This Article analyzes these "extracontractual" bases for enforcing nonlegal commitments.
7. For a description of standard banking practice, see Scott, A Relational Theory of Secured Financing, 86 COLUM. L. REV. 901, 948-50 (1986).
8. Compare Norwest Bank Billings v. Murnion, 210 Mont. 417, 427, 684 P.2d 1067, 1073 (1984) (holding that the parole evidence rule barred admission of consumers' and salespersons' oral agreement to modify the terms of a prior written agreement) with Honeywell v. Imperial Condominium Ass'n, 716 S.W.2d 75, 78 (Tex. Ct. App. 1986) (allowing a consumer to introduce promotional literature to prove a violation of the Texas Deceptive Trade Practices Act, TEX. Bus. & COM. CODE ANN. §§17.41-17.63 (Vernon 1987)). See generally Braucher, An Informal Resolution Model of Consumer Product Warranty Law, 1985 WIS. L. REV. 1405, 1407 (arguing that the legal system's method of enforcing product warranties is misplaced because it focuses on seldom-exercised legal rights); Macaulay, Bambi Meets Godzilla: Reflections on Contracts, Scholarship and Teaching vs. State Unfair and Deceptive Trade Practices and Consumer Proltctioa Statutes, 26 HOUS. L. REV. 575, 590 (1989) (noting that the common law's inconsistent approach to enforcing informal commitments in the consumer protection context has provided the impetus for state consumer protection regulation).
9. Compare Norwest Bank Billings v. Murnion, 210 Mont. 417, 427, 684 P.2d 1067, 1073 (1984) (holding that the parole evidence rule barred admission of consumers' and salespersons' oral agreement to modify the terms of a prior written agreement) with Honeywell v. Imperial Condominium Ass'n, 716 S.W.2d 75, 78 (Tex. Ct. App. 1986) (allowing a consumer to introduce promotional literature to prove a violation of the Texas Deceptive Trade Practices Act, TEX. Bus. & COM. CODE ANN. §§17.41-17.63 (Vernon 1987)). See generally Braucher, An Informal Resolution Model of Consumer Product Warranty Law, 1985 WIS. L. REV. 1405, 1407 (arguing that the legal system's method of enforcing product warranties is misplaced because it focuses on seldom-exercised legal rights); Macaulay, Bambi Meets Godzilla: Reflections on Contracts, Scholarship and Teaching vs. State Unfair and Deceptive Trade Practices and Consumer Proltctioa Statutes, 26 HOUS. L. REV. 575, 590 (1989) (noting that the common law's inconsistent approach to enforcing informal commitments in the consumer protection context has provided the impetus for state consumer protection regulation).
10. See U.C.C. §2-201 (1987). See generally Note, Promissory Estoppel, Equitable Estoppel and the Farmer as a Merchant: The 1973 Grain Cases and the UCC Statute of Frauds, 1977 UTAH L. REV. 59, 63-84 (surveying cases in which plaintiffs have sought enforcement of oral contracts between grain elevators and farmers despite their unenforceability under § 2-201).
11. Courts are divided over the question whether the Employee Retirement Income Security Act (ERISA), 29 U.S.C. §§ 1001-1461 (1988), preempts state-law claims that such commitments are enforceable. Compare Musto v. American Gen. Corp., 861 F.2d 897, 907, 910 (6th Cir. 1988) (holding that oral promises are not enforceable but leaving open the question whether informal written statements may modify ERISA plan documents), cert, denied, 109 S. Ct. 1745 (1989) and Straub v. Western Union Tel. Co., 851 F.2d 1262, 1265 (10th Cir. 1988) (holding that a promissory estoppel claim based on an oral promise was preempted by ERISA) with Ex Parte Ward, 448 So. 2d 349, 351 (Ala. 1984) (holding that ERISA does not preempt a state law claim for breach of contract) and Shaw v. Westinghouse Elec. Corp., 276 Pa. Super. 220, 227-30, 419 A.2d 175, 179-81 (1980) (same). See generally MacNeil, The Failure of Free Contract in the Context of Employer-Sponsored Retiree Welfare Benefits, 25 HARV. J. ON LEGIS. 213, 214-16, 232-34 (1988) (discussing employer modifications of retiree benefit plans). ,
12. See Bryan, Letters of Intent, Public Announcements and Insider Trading, in 1 BUSINESS ACQUISITIONS 121, 121-23 (J. Herz & C. Baller eds. 2d ed. 1981) (describing the role of Preliminary agreements); Freund, Letters of Intent, in CORPORATE AND COMMERCIAL FINANCE AGREEMENTS § 6.152, at 6-158 to 6-160 (S. Tomczak ed. 1984) (describing how recent changes in acquisition form affect the desirability of agreements in principle). Courts are split on whether these agreements are binding in the absence of an express disclaimer. Compare Pennzoil Co. v. Getty Oil Co., No. 7425 (Del. Ch. Feb. 6, 1984) (LEXIS, States library, Del. file) (finding that the Plaintiffs made a sufficient showing that the merger agreement was binding to obtain a preliminary injunction) with Reprosystem, B.V. v. SCM Corp., 727 F.2d 257, 265 (2d Cir.) holding that preliminary merger agreements did not constitute an enforceable contract), cert. desnied, 469 U.S. 828 (1984).
13. See Bryan, Letters of Intent, Public Announcements and Insider Trading, in 1 BUSINESS ACQUISITIONS 121, 121-23 (J. Herz & C. Baller eds. 2d ed. 1981) (describing the role of Preliminary agreements); Freund, Letters of Intent, in CORPORATE AND COMMERCIAL FINANCE AGREEMENTS § 6.152, at 6-158 to 6-160 (S. Tomczak ed. 1984) (describing how recent changes in acquisition form affect the desirability of agreements in principle). Courts are split on whether these agreements are binding in the absence of an express disclaimer. Compare Pennzoil Co. v. Getty Oil Co., No. 7425 (Del. Ch. Feb. 6, 1984) (LEXIS, States library, Del. file) (finding that the Plaintiffs made a sufficient showing that the merger agreement was binding to obtain a preliminary injunction) with Reprosystem, B.V. v. SCM Corp., 727 F.2d 257, 265 (2d Cir.) holding that preliminary merger agreements did not constitute an enforceable contract), cert. desnied, 469 U.S. 828 (1984).
14. See, e.g., A. OKUN, PRICES AND QUANTITIES: A MACROECONOMIC ANALYSIS 89 (1981) (stating that most employer commitments are not legally binding). Although about half of American jurisdictions have held that employment handbooks provide a basis for contract actions, see Gould, The Idea of the Job as Property in Contemporary America: The Legal and Collective Bargaining Framework, 1986 B.Y.U. L. REV. 885, 888 n.6, most courts have held that an express disclaimer suffices to defeat such a claim, see cases cited infra note 27.
15. See, e.g., A. OKUN, PRICES AND QUANTITIES: A MACROECONOMIC ANALYSIS 89 (1981) (stating that most employer commitments are not legally binding). Although about half of American jurisdictions have held that employment handbooks provide a basis for contract actions, see Gould, The Idea of the Job as Property in Contemporary America: The Legal and Collective Bargaining Framework, 1986 B.Y.U. L. REV. 885, 888 n.6, most courts have held that an express disclaimer suffices to defeat such a claim, see cases cited infra note 27.
16. It is important to distinguish the question whether the commitment is legally enforceable from the question whether the terms of the commitment are "explicit." A commitment might not be legally enforceable even though its terms are highly articulated. For example, the commitments established in an employment handbook that contains elaborate descriptions of benefits, pensions, work responsibilities and rules, seniority and hiring policies, and so forth are nonetheless remitted by the parties to nonlegal sanctions if the handbook is stamped prominently on its face with the common caveat, "this is not a contract" or "the company reserves the right to change these conditions at any time." Conversely, a scrawled memo, "car for $10,000," signed by the seller, may constitute a legally enforceable contract, even though virtually all the relevant contract terms are not articulated by the contract but rather are supplied by the background law of article 2 of the UCC.
17. RESTATEMENT (SECOND) OF CONTRACTS § 90 (1979).
18. For a careful discussion of the emergence and current predominance of the "objective theory" of contract, see Kabil Developments Corp. v. Mignot, 279 Or. 151, 154-57, 566 P.2d 505, 507-08 (1977).
19. Foley v. Interactive Data Corp., 47 Cal. 3d 654, 680, 765 P.2d 373, 387, 254 Cal. Rptr. 211, 225 (1988) (quoting Pugh v. See's Candies, Inc., 116 Cal. App. 3d 311, 327, 171 Cal. Rptr. 917, 925-26 (1981)). A large number of jurisdictions have adopted elements of this capacious approach to contract interpretation. See id. at 678-81, 765 P.2d at 385-88, 254 Cal. Rptr. at 223-26. A well-known example is Wagenseller v. Scottsdale Memorial Hospital, 147 Ariz. 370, 170 P.2d 1025 (1985), which based legal enforcement on an employer's "course of conduct and oral representations regarding [employment] policy." See id. at 383, 710 P.2d at 1038.
20. See, e.g., Woolley v. Hoffmann-LaRoche, Inc., 99 NJ. 284, 301-04, 491 A.2d 1257, 1266-68 (1985). In defense of this approach, the Woolley court argued: "If reliance is not presumed, a strict contractual analysis might protect the rights of some employees and not others." Id. at 304 n.10, 491 A.2d at 1268 n.10. For example, workers might not know of the existence of the promise or might have worked "without the slightest intention of putting forth that action as consideration for the employer's promise." Id. On this theory, the [employment] manual's job security provisions became binding the moment the manual was distributed. Anyone employed before or after became one of the beneficiaries of those provisions of the manual. . . . [E]mployees neither had to read it, know of its existence, or rely on it to benefit from its provisions any more than employees in a plant that is unionized have to read or rely on a collective-bargaining agreement in order to obtain its benefits. Id. at 305 n.10, 491 A.2d at 1268 n.10; see also Christensen v. Minneapolis Mun. Employees Retirement Bd., 331 N.W.2d 740, 747 (Minn. 1983) ("A conventional contract approach, with its strict rules of offer and acceptance, tends to deprive the analysis . . . of a needed flexibility.").
21. See, e.g., Thompson v. St. Regis Paper Co., 102 Wash. 2d 219, 229-30, 685 P.2d 1081, 1087 (1984) (en banc) (holding that contract formation must be premised on written promises in an employee handbook that objectively manifested an intent to treat employees according to its terms).
22. See RESTATEMENT (SECOND) OF CONTRACTS § 71(2) (1979).
23. C. FRIED, CONTRACT AS PROMISE 16 (1981). For expositional convenience, the discussion uses the headings "liberal" and "autonomy-based" as equivalent. Liberals may differ on their grounds for a commitment to autonomy, and some non-liberals may endorse the autonomybased theories that are analyzed under these headings, but these meta-theoretical concerns do not affect the text's analysis. See generally D. Charny, Hypothetical Bargains (1990) (unpublished manuscript on file at the Harvard Law School Library).
24. C. FRIED, CONTRACT AS PROMISE 16 (1981). For expositional convenience, the discussion uses the headings "liberal" and "autonomy-based" as equivalent. Liberals may differ on their grounds for a commitment to autonomy, and some non-liberals may endorse the autonomybased theories that are analyzed under these headings, but these meta-theoretical concerns do not affect the text's analysis. See generally D. Charny, Hypothetical Bargains (1990) (unpublished manuscript on file at the Harvard Law School Library).
25. The compatibility of liberalism with a range of interpretive methodologies finds a parallel in liberal theory's embrace of a richer and more contextualized view of the self in areas of moral choice other than contract. See, e.g., Fried, Liberalism, Community, and the Objectivity of Values (Book Review), 96 HARV. L. REV. 960, 963-66 (1983); Holmes, The Permanent Structure of Antiliberal Thought, in LIBERALISM AND THE MORAL LIFE 227, 237-39 (N. Rosenblum ed 1989); Stewart, Regulation in a Liberal State: The Role of Non-Commodity Values, 92 YALE L.J. 1537, 1563-65 (1983).
26. The compatibility of liberalism with a range of interpretive methodologies finds a parallel in liberal theory's embrace of a richer and more contextualized view of the self in areas of moral choice other than contract. See, e.g., Fried, Liberalism, Community, and the Objectivity of Values (Book Review), 96 HARV. L. REV. 960, 963-66 (1983); Holmes, The Permanent Structure of Antiliberal Thought, in LIBERALISM AND THE MORAL LIFE 227, 237-39 (N. Rosenblum ed 1989); Stewart, Regulation in a Liberal State: The Role of Non-Commodity Values, 92 YALE L.J. 1537, 1563-65 (1983).
27. The compatibility of liberalism with a range of interpretive methodologies finds a parallel in liberal theory's embrace of a richer and more contextualized view of the self in areas of moral choice other than contract. See, e.g., Fried, Liberalism, Community, and the Objectivity of Values (Book Review), 96 HARV. L. REV. 960, 963-66 (1983); Holmes, The Permanent Structure of Antiliberal Thought, in LIBERALISM AND THE MORAL LIFE 227, 237-39 (N. Rosenblum ed 1989); Stewart, Regulation in a Liberal State: The Role of Non-Commodity Values, 92 YALE L.J. 1537, 1563-65 (1983).
28. "Convention" refers to a set of norms generally followed by participants in a practice For contract theorists, the influential work is D. LEWIS, CONVENTION: A PHILOSOPHICAL STUDY (1969).
29. Even socially extant practices of interpretation (which Charles Fried, for example, implicitly embraces to support his relatively "thick," or context-focused, view of interpretation, sit C. FRIED, supra note 20, at 87) are to be preferred over other interpretive approaches only after further analysis: the legal system coherently could adopt conventions about interpreting promises that differed from those that govern in other areas of social life. I give a fuller account of the range of interpretive conventions available to liberals in D. Charny, supra note 20.
30. See, e.g., Continental Air Lines, Inc. v. Keenan, 731 P.2d 708, 711-12 (Colo. 1987) (en bane) (distinguishing criteria for enforcing an employee handbook's commitments under contract and promissory estoppel theories and enforcing the commitments under promissory estoppel). Subsequent cases, which have held that explicit disclaimers may defeat the promissory estoppel as well as the contract claims, have mitigated the impact of the Keenan rule. See, e.g., Therrien v. United Air Lines, Inc., 670 F. Supp. 1517, 1520-23 (D. Colo. 1987).
31. See, e.g., Fortune v. National Cash Register Co., 373 Mass. 96, 104-05, 364 N.E.2d 1251, 1257-58 (1977) (applying restitutionary norms from agency law to construe an implied duty of good faith).
32. See U.C.C. § 1-208 comment (1987) (stating that the "very nature [of demand instruments] Permits call at any time with or without reason"); see also Flagship Nat'I Bank v. Gray Distrib. Sys., 485 So. 2d 1336, 1340 (Fla. Dist. Ct. App.) (holding that § 1-208's "good faith" requirement does not override an express "on demand" contract term), aff'd, 497 So. 2d 1217 (Fla. 1986).
33. See, e.g., Dell v. Montgomery Ward & Co., 811 F.2d 970, 972-74 (6th Cir. 1987); Castiglione v. Johns Hopkins Hosps., 69 Md. App. 325, 339, 517 A.2d 786, 793 (1986).
34. See, e.g., Aiello v. United Air Lines, Inc., 818 F.2d 1196, 1200 (5th Cir. 1987) (holding that detailed procedures for discipline and discharge were legally enforceable despite a disclaimer); McLain v. Great Am. Ins., 208 Cal. App. 3d 1476, 1486-87, 256 Cal. Rptr. 863, 869 (1989) (holding that implications of a handbook and company policy overrode an express at-will term); cf. Kari v. General Motors Corp., 402 Mich. 926, 926, 282 N.W.2d 925, 925 (1978) (reversing summary judgment entered on the basis of a disclaimer).
35. See, e.g., Fortune, 373 Mass, at 104-05, 364 N.E.2d at 1257-58 (enforcing a good faith duty to pay commissions that would have been earned but for the wrongful termination, despite an explicit at-will term). But see Shapiro v. Wells Fargo Realty Advisors, 152 Cal. App. 3d 467, 482, 199 Cal. Rptr. 613, 621-22 (1984) (holding that an at-will term supersedes good faith duties). Employment law commentators differ sharply on the appropriate legal effect of contract provisions that disclaim liability. Compare Finkin, The Bureaucratization of Work: Employer Policies and Contract Law, 1986 WIS. L. REV. 733, 749-50 (expressing doubts about the merit of enforcing "boilerplate" disclaimers) with P. WEILER, GOVERNING THE WORKPLACE 54-55 (1990) (arguing that striking down disclaimers is "perverse" when it results in the imposition of more onerous liability on firms that have workplace policies that are favorable to employees).
36. See, e.g., Fortune, 373 Mass, at 104-05, 364 N.E.2d at 1257-58 (enforcing a good faith duty to pay commissions that would have been earned but for the wrongful termination, despite an explicit at-will term). But see Shapiro v. Wells Fargo Realty Advisors, 152 Cal. App. 3d 467, 482, 199 Cal. Rptr. 613, 621-22 (1984) (holding that an at-will term supersedes good faith duties). Employment law commentators differ sharply on the appropriate legal effect of contract provisions that disclaim liability. Compare Finkin, The Bureaucratization of Work: Employer Policies and Contract Law, 1986 WIS. L. REV. 733, 749-50 (expressing doubts about the merit of enforcing "boilerplate" disclaimers) with P. WEILER, GOVERNING THE WORKPLACE 54-55 (1990) (arguing that striking down disclaimers is "perverse" when it results in the imposition of more onerous liability on firms that have workplace policies that are favorable to employees).
37. See cases cited infra note 256.
38. See C. FRIED, supra note 20, at 97 (stating that the test for duress is whether rights were violated).
39. See id. at 38 n. * ("[G]iven the consensual basis of contract as promise, the parties should in principle be free to exclude legal enforcement so long as this is not a fraudulent device to trap the unwary." (emphasis in original)). Again, however, the crucial issue is interpretive: "In a particular case it may be a difficult problem of interpretation whether such a purpose is fairly to be implied." Id.
40. See id. at 37-38 (noting gaps in common law enforcement of promises).
41. This sense of "voluntariness"has a moral component: the liberal would wish, for example, to set aside promises extracted by force or fraud.
42. See, e.g., C. FRIED, supra note 20, at 24-27 (distinguishing the "promise principle" from coexisting principles of reliance and restitution).
43. See id. at 24.
44. See Leroy Fibre Co. v. Chicago, M. & St. P. Ry., 232 U.S. 340 (1914).
45. See id. at 352-53 (Holmes, J., partially concurring). Coase, The Problem of Social Cost, 3 J.L. & ECON. 1 (1960), provides the influential modern reformulation of the argument in Justice Holmes' opinion. See generally Gjerdingen, The Politics of the Coase Theorem and Its Relationship to Modern Legal Thought, 35 BUFFALO L. REV. 871, 884-90 (1986) (reviewing the demise of conceptions of causation as a result of the Coase theorem); Epstein, A Theory of Strict Liability, 2 J. LEGAL STUD. 151, 160-89 (1973) (offering a theory to salvage traditional notions Of causation).
46. See id. at 352-53 (Holmes, J., partially concurring). Coase, The Problem of Social Cost, 3 J.L. & ECON. 1 (1960), provides the influential modern reformulation of the argument in Justice Holmes' opinion. See generally Gjerdingen, The Politics of the Coase Theorem and Its Relationship to Modern Legal Thought, 35 BUFFALO L. REV. 871, 884-90 (1986) (reviewing the demise of conceptions of causation as a result of the Coase theorem); Epstein, A Theory of Strict Liability, 2 J. LEGAL STUD. 151, 160-89 (1973) (offering a theory to salvage traditional notions Of causation).
47. See id. at 352-53 (Holmes, J., partially concurring). Coase, The Problem of Social Cost, 3 J.L. & ECON. 1 (1960), provides the influential modern reformulation of the argument in Justice Holmes' opinion. See generally Gjerdingen, The Politics of the Coase Theorem and Its Relationship to Modern Legal Thought, 35 BUFFALO L. REV. 871, 884-90 (1986) (reviewing the demise of conceptions of causation as a result of the Coase theorem); Epstein, A Theory of Strict Liability, 2 J. LEGAL STUD. 151, 160-89 (1973) (offering a theory to salvage traditional notions Of causation).
48. The benefit-based conception of promissory estoppel is explored in Farber & Matheson, Beyond Promissory Estoppel: Contract Law and the "Invisible Handshake," 52 U. CHI. L. REV. 903, 925-29 (1985).
49. For a lucid contemporary formulation of this doctrine, see Goldstick v. ICM Realty, 788 F.2d 456, 467 (7th Cir. 1986) (Posner, J.).
50. Woolley v. Hoffmann-LaRoche, Inc., 99 N.J. 284, 290-91, 491 A.2d 1257, 1260-61 (1985) (quoting Pierce v. Ortho Pharmaceutical Corp., 84 N.J. 58, 72, 417 A.2d 505, 511 (1980)).
51. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
52. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
53. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
54. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
55. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
56. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
57. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
58. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
59. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
60. The thesis that unifies communitarian strands of contract thought is that contract relations create a potential for abuse of power that should be controlled by imposing duties of good faith and by related doctrines of consideration and interpretation. P. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979), lays the historical foundations for the argument by showing that contractual liability was a late outgrowth of duties founded in tort or unjust enrichment. See id. at 139-93; see also M. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1790-1860, at 160-210 (1977) (presenting the move from fairness to consent as the unifying conception in transactional law). Three streams of thought have fed communitarian contract theory: first, the realist notion that contract formation inherently involves the exercise of economic and state power, see e.g., Hale, Bargaining, Duress, and Economic Liberty, 43 COLUM. L. REV. 603 (1943); Hale, Coercion and Distribution in a Supposedly Non-Coercive State, 38 POL. SCI. Q. 470 (1923); see also Dawson, Economic Duress - An Essay in Perspective, 45 MICH. L. REV. 253 (1947) (reinter-preting Hale's thesis to produce a doctrinal formulation based on balancing); second, empirical research suggesting that particular economic transactions are likely to involve abuses of power, see, e.g., Kessler, Automobile Dealer Franchises: Vertical Integration by Contract, 66 YALE L.J. 1135 (1957) (auto dealership contracts); Macaulay, Private Legislation and the Duty to Read - Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966) (consumer credit contracts); and, third, a general concern with legal control of bureaucratic discretion, see, e.g., Blades, Employment at Will vs. Individual Freedom: On limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404 (1967). Influential recent statements that illustrate the diverse political impulses behind communitarian contract thought include MacNeil, The Many Futures of Contracts, 47 S. CAL. L. REV. 691 (1974); and Unger, The Critical Legal Studies Movement, 96 HARV. L. REV. 561, 644-46 (1983).
61. See, e.g., Knapp, Judgment Call: Theoretical Approaches to Contract Decision-Making, 1988 ANN. SURV. AM. L. 307, 344-49 (describing how courts determine community norms by consulting nonlegal commitments).
62. See, e.g., Kennedy, Distributive and Paternalist Motives in Contract and Tort Law, with Special Reference to Compulsory Terms and Unequal Bargaining Power, 41 MD. L. REV. 563, 629-31 (1982) (arguing for enforcement of informal commitments to workers on redistributive and paternalist grounds).
63. See, e.g., Woolley v. Hoffmann-LaRoche, Inc., 99 N.J. 284, 292, 491 A.2d 1257, 1261 (1985) (identifying a social interest in protecting the employment relationship as grounds for uitervention "in addition to 'freedom' of contract").
64. Most striking is the burgeoning tort liability for breach of good faith duties, sometimes Premised explicitly on a finding of "unfair bargaining power." See, e.g., Wallis v. Superior Court, 160 Cal. App. 3d 1109, 1118, 207 Cal. Rptr. 123, 129 (1984) (noting "unequal bargaining Power" as a factor in tort liability).
65. See Epstein, In Defense of the Contract at Will, 51 U. CHI. L. REV. 947, 977-78 (1984); Harrison, The "New" Terminable-at-Will Employment Contract: An Interest and Cost Incident Analysis, 69 IOWA L. REV. 327, 331 (1984).
66. See Epstein, In Defense of the Contract at Will, 51 U. CHI. L. REV. 947, 977-78 (1984); Harrison, The "New" Terminable-at-Will Employment Contract: An Interest and Cost Incident Analysis, 69 IOWA L. REV. 327, 331 (1984).
67. For an exemplary discussion of the relationship between governmental action and developing norms of "private" conduct, see A. WOLFE, WHOSE KEEPER? SOCIAL SCIENCE AND MORAL OBLIGATION 159-84 (1989).
68. For an analysis of the forces of reciprocal gift-giving in the employment relationship, see Akerlof, Labor Contracts as Partial Gift Exchange, 97 Q.J. ECON. 543, 549-57 (1982).
69. See MacNeil, Values in Contract: Internal and External, 78 Nw. U.L. REV. 340, 368-69 (1983) (suggesting that legal regulation weakens the internal norms of behavior necessary to contract).
70. See R. BELLAH, R. MADSEN, W. SULLIVAN, A. SWIDLER & S. TIPTON, HABITS OF THE HEART: INDIVIDUALISM AND COMMITMENT IN AMERICAN LIFE 286-96 (1985) [hereinafter HABITS OF THE HEART] (noting the importance of voluntary communal association and responsibility). But see C. TAYLOR, SOURCES OF THE SELF: THE MAKING OF THE MODERN IDENTITY 508-09 (1989) (criticizing the overemphasis in HABITS IN THE HEART, supra, on the importance of immunity from state intervention).
71. See R. BELLAH, R. MADSEN, W. SULLIVAN, A. SWIDLER & S. TIPTON, HABITS OF THE HEART: INDIVIDUALISM AND COMMITMENT IN AMERICAN LIFE 286-96 (1985) [hereinafter HABITS OF THE HEART] (noting the importance of voluntary communal association and responsibility). But see C. TAYLOR, SOURCES OF THE SELF: THE MAKING OF THE MODERN IDENTITY 508-09 (1989) (criticizing the overemphasis in HABITS IN THE HEART, supra, on the importance of immunity from state intervention).
72. Richard Posner has advanced the most strenuous claims for a distinctive conception of wealth maximization as a normative principle. See Posner, The Ethical and Political Basis of the Efficiency Norm in Common Law Adjudication, 8 HOFSTRA L. REV. 487, 488-94 (1980); Posner, The Value of Wealth: A Comment on Dworkin and Kronman, 9 J. LEGAL STUD. 243, 251-52 (1980) (commenting on Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191 (1980); and Kronman, Wealth Maximization as a Normative Principle, 9 J. LEGAL STUD. 227 (1980)). The argument of this Article, however, does not depend on a strong claim for the value of wealth maximization. Rather, the argument analyzes the conduct of parties attempting to achieve gains from trade and then considers how, if at all, the costs borne by these parties could be reduced by various forms of judicial enforcement of commitments. The analysis therefore should be of interest to all who acknowledge that reducing transaction costs may be a plausible account of Parties' goals in transacting and that reduction of costs borne by transactors is one value that adjudication may serve.
73. Richard Posner has advanced the most strenuous claims for a distinctive conception of wealth maximization as a normative principle. See Posner, The Ethical and Political Basis of the Efficiency Norm in Common Law Adjudication, 8 HOFSTRA L. REV. 487, 488-94 (1980); Posner, The Value of Wealth: A Comment on Dworkin and Kronman, 9 J. LEGAL STUD. 243, 251-52 (1980) (commenting on Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191 (1980); and Kronman, Wealth Maximization as a Normative Principle, 9 J. LEGAL STUD. 227 (1980)). The argument of this Article, however, does not depend on a strong claim for the value of wealth maximization. Rather, the argument analyzes the conduct of parties attempting to achieve gains from trade and then considers how, if at all, the costs borne by these parties could be reduced by various forms of judicial enforcement of commitments. The analysis therefore should be of interest to all who acknowledge that reducing transaction costs may be a plausible account of Parties' goals in transacting and that reduction of costs borne by transactors is one value that adjudication may serve.
74. Richard Posner has advanced the most strenuous claims for a distinctive conception of wealth maximization as a normative principle. See Posner, The Ethical and Political Basis of the Efficiency Norm in Common Law Adjudication, 8 HOFSTRA L. REV. 487, 488-94 (1980); Posner, The Value of Wealth: A Comment on Dworkin and Kronman, 9 J. LEGAL STUD. 243, 251-52 (1980) (commenting on Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191 (1980); and Kronman, Wealth Maximization as a Normative Principle, 9 J. LEGAL STUD. 227 (1980)). The argument of this Article, however, does not depend on a strong claim for the value of wealth maximization. Rather, the argument analyzes the conduct of parties attempting to achieve gains from trade and then considers how, if at all, the costs borne by these parties could be reduced by various forms of judicial enforcement of commitments. The analysis therefore should be of interest to all who acknowledge that reducing transaction costs may be a plausible account of Parties' goals in transacting and that reduction of costs borne by transactors is one value that adjudication may serve.
75. Richard Posner has advanced the most strenuous claims for a distinctive conception of wealth maximization as a normative principle. See Posner, The Ethical and Political Basis of the Efficiency Norm in Common Law Adjudication, 8 HOFSTRA L. REV. 487, 488-94 (1980); Posner, The Value of Wealth: A Comment on Dworkin and Kronman, 9 J. LEGAL STUD. 243, 251-52 (1980) (commenting on Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191 (1980); and Kronman, Wealth Maximization as a Normative Principle, 9 J. LEGAL STUD. 227 (1980)). The argument of this Article, however, does not depend on a strong claim for the value of wealth maximization. Rather, the argument analyzes the conduct of parties attempting to achieve gains from trade and then considers how, if at all, the costs borne by these parties could be reduced by various forms of judicial enforcement of commitments. The analysis therefore should be of interest to all who acknowledge that reducing transaction costs may be a plausible account of Parties' goals in transacting and that reduction of costs borne by transactors is one value that adjudication may serve.
76. O. HOLMES, THE COMMON LAW (M. Howe ed. 1963).
77. Holmes argued that legal contract enforcement evolved from various forms of nonlegal sanctioning, such as hostage-taking and bond-posting. See id. at 195-98. Holmes' conception of legal evolution as implicitly rational arguably gives The Common Law's historical description a strong normative implication. Unlike Holmes' argument, however, my argument is not genealogical, see R. POSNER, THE PROBLEMS OF JURISPRUDENCE 239-40 (1990) (analyzing the "genealogical" nature of Holmes' argument), or evolutionary; it focuses instead on the current coexistence of legal and nonlegal sanctions in complex systems of commercial transaction, althought the model does have implications for the evolution of social norms.
78. A useful introduction to the literature is Kronman, Contract Law and the State of Nature, 1 J.L. ECON. & ORG. 1 (1985).
79. Epstein, Beyond Foreseeability: Consequential Damages in the Law of Contract, 18 J. LEGAL STUD. 105, 117-18 (1989), and Kornhauser, Reliance,
80. Epstein, Beyond Foreseeability: Consequential Damages in the Law of Contract, 18 J. LEGAL STUD. 105, 117-18 (1989), and Kornhauser, Reliance, Reputation, and Breach of Contract, 26 J.L. & ECON. 691, 693-98 (1983), argue that reputational pressures may effectively supplement or replace damage measurements.
81. See Scott, A Relational Theory of Default Rules for Commercial Contracts, 19 J. LEGAL STUD. 597, 613-15 (1990) (arguing that nonlegal pressures for transactors to make ex post adjustments explain otherwise puzzling aspects of mistake and impossibility doctrines) In particular, it is curious that the legal rules governing mistake and impossibility require adjustments to contract terms only in exceptional circumstances and without a full scale inquiry into the differential risk-bearing capacities of the transactors. See id. at 598-99. The best explanation for these rules appears to be that most transactors will renegotiate in light of changed circumstances, even without legal prodding, because they value the long-term relationship with a particular transacting partner and their reputation for flexibility in the market. Given these nonlegal pressures, a more complex set of legal rules would accrue little additional benefit and might lead to high litigation costs, erroneous court decisions, and contractual uncertainty. See id. at 613-15.
82. See supra pp. 381-86.
83. Economic models of the operation of bonds include Klein & Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. POL. ECON. 615 (1981); Telser, A Theory of Self-Enforcing Agreements, 53 J. Bus. 27 (1980); and Williamson, Credible Commitments: Using Hostages to Support Exchange, 73 AM. ECON. REV. 519 (1983). Recent research has offered models of reputational effects in "repeated games," situations in which individuals decide whether to transact again on the basis of a transactor's conduct in previous transactions. See, e.g., Fudenberg & Maskin, The Folk Theorem in Repeated Games with Discounting or with Incomplete Information, 54 ECONOMETRICA 533 (1986). The literature does not, however, include a detailed description of different types of bonds and the costs and benefits of their use; that is the focus of the present analysis. Reliance upon bonds to enforce private commitments is a fundamental consequence of the state's monopoly on the legitimate use of violence. If ex post use of physical coercion is unavailable to transactors, it is impossible, as an analytic matter, for them to establish an effective system of private enforcement except by requiring promisors to post a bond.
84. Economic models of the operation of bonds include Klein & Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. POL. ECON. 615 (1981); Telser, A Theory of Self-Enforcing Agreements, 53 J. Bus. 27 (1980); and Williamson, Credible Commitments: Using Hostages to Support Exchange, 73 AM. ECON. REV. 519 (1983). Recent research has offered models of reputational effects in "repeated games," situations in which individuals decide whether to transact again on the basis of a transactor's conduct in previous transactions. See, e.g., Fudenberg & Maskin, The Folk Theorem in Repeated Games with Discounting or with Incomplete Information, 54 ECONOMETRICA 533 (1986). The literature does not, however, include a detailed description of different types of bonds and the costs and benefits of their use; that is the focus of the present analysis. Reliance upon bonds to enforce private commitments is a fundamental consequence of the state's monopoly on the legitimate use of violence. If ex post use of physical coercion is unavailable to transactors, it is impossible, as an analytic matter, for them to establish an effective system of private enforcement except by requiring promisors to post a bond.
85. Economic models of the operation of bonds include Klein & Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. POL. ECON. 615 (1981); Telser, A Theory of Self-Enforcing Agreements, 53 J. Bus. 27 (1980); and Williamson, Credible Commitments: Using Hostages to Support Exchange, 73 AM. ECON. REV. 519 (1983). Recent research has offered models of reputational effects in "repeated games," situations in which individuals decide whether to transact again on the basis of a transactor's conduct in previous transactions. See, e.g., Fudenberg & Maskin, The Folk Theorem in Repeated Games with Discounting or with Incomplete Information, 54 ECONOMETRICA 533 (1986). The literature does not, however, include a detailed description of different types of bonds and the costs and benefits of their use; that is the focus of the present analysis. Reliance upon bonds to enforce private commitments is a fundamental consequence of the state's monopoly on the legitimate use of violence. If ex post use of physical coercion is unavailable to transactors, it is impossible, as an analytic matter, for them to establish an effective system of private enforcement except by requiring promisors to post a bond.
86. Economic models of the operation of bonds include Klein & Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. POL. ECON. 615 (1981); Telser, A Theory of Self-Enforcing Agreements, 53 J. Bus. 27 (1980); and Williamson, Credible Commitments: Using Hostages to Support Exchange, 73 AM. ECON. REV. 519 (1983). Recent research has offered models of reputational effects in "repeated games," situations in which individuals decide whether to transact again on the basis of a transactor's conduct in previous transactions. See, e.g., Fudenberg & Maskin, The Folk Theorem in Repeated Games with Discounting or with Incomplete Information, 54 ECONOMETRICA 533 (1986). The literature does not, however, include a detailed description of different types of bonds and the costs and benefits of their use; that is the focus of the present analysis. Reliance upon bonds to enforce private commitments is a fundamental consequence of the state's monopoly on the legitimate use of violence. If ex post use of physical coercion is unavailable to transactors, it is impossible, as an analytic matter, for them to establish an effective system of private enforcement except by requiring promisors to post a bond.
87. Economists speak of relationship-specific "assets." The term "asset" encompasses any "prospective advantage," that is, any opportunity to gain a future income stream. Note that what makes the sanction "nonlegal" is the party's ability to confiscate or destroy the asset without obtaining a judgment in a judicial proceeding and without facing subsequent judicial review of the merits of his decision that the commitment was breached. In other respects, of course, the parties' rights in the assets may depend upon a background system of tort and property law.
88. See Huberman & Kahn, Limited Contract Enforcement and Strategic Renegotiation, 78 AM. ECON. REV. 471, 471-76 (1988); see also Benjamin, The Use of Collateral to Enforce Debt Contracts, 16 ECON. INQUIRY 333, 354 (1978) (noting that "even assets that are worthless to a creditor in the event of default can be valuable as a form of collateral"); Hess, The Use of Collateral to Enforce Debt: Profit Maximization, 23 ECON. INQUIRY 349, 349-56 (1985) (extending and modifying Benjamin's analysis).
89. See Huberman & Kahn, Limited Contract Enforcement and Strategic Renegotiation, 78 AM. ECON. REV. 471, 471-76 (1988); see also Benjamin, The Use of Collateral to Enforce Debt Contracts, 16 ECON. INQUIRY 333, 354 (1978) (noting that "even assets that are worthless to a creditor in the event of default can be valuable as a form of collateral"); Hess, The Use of Collateral to Enforce Debt: Profit Maximization, 23 ECON. INQUIRY 349, 349-56 (1985) (extending and modifying Benjamin's analysis).
90. See Huberman & Kahn, Limited Contract Enforcement and Strategic Renegotiation, 78 AM. ECON. REV. 471, 471-76 (1988); see also Benjamin, The Use of Collateral to Enforce Debt Contracts, 16 ECON. INQUIRY 333, 354 (1978) (noting that "even assets that are worthless to a creditor in the event of default can be valuable as a form of collateral"); Hess, The Use of Collateral to Enforce Debt: Profit Maximization, 23 ECON. INQUIRY 349, 349-56 (1985) (extending and modifying Benjamin's analysis).
91. See generally Scott, Rethinking the Regulation of Coercive Creditor Remedies, 89 COLUM. L. REV. 730, 741-44 (1989) (presenting a "cooperative bargaining" model of self-help repossession). Self-help would be a nonlegal sanction if the creditor could seize the property without first going to court - a power restricted, but not eliminated, by constitutional cases beginning with Sniadach v. Family Finance Corp., 395 U.S. 337, 341-42 (1969), and by Federal Trade Commission regulation, see FTC Credit Practices Rule, 16 C.F.R. §444 (1990), upheld, American Fin. Servs. Ass'n v. F.T.C., 767 F.2d 957 (D.C. Cir. 1985), cert, denied, 475 U.S. 1011 (1986) - and without subsequent judicial review of the claim of default. For critiques of the constitutional and administrative restrictions, see Schwartz, The Enforceability of Security Interests in Consumer Goods, 26 J.L. & ECON. 117, 117-21 (1983) (arguing that reasons commonly given to restrict creditor repossessions - that repossession is wasteful because creditors do not maximize the proceeds of the sale of repossessed property, that creditors abuse this right to repossess, and that repossession destroys the debtor's personal autonomy - do not justify limiting repossession rights); Scott, supra, at 756-61 (arguing that nonlegal sanctions prevent abuse of a creditor's power to repossess household goods).
92. See generally Scott, Rethinking the Regulation of Coercive Creditor Remedies, 89 COLUM. L. REV. 730, 741-44 (1989) (presenting a "cooperative bargaining" model of self-help repossession). Self-help would be a nonlegal sanction if the creditor could seize the property without first going to court - a power restricted, but not eliminated, by constitutional cases beginning with Sniadach v. Family Finance Corp., 395 U.S. 337, 341-42 (1969), and by Federal Trade Commission regulation, see FTC Credit Practices Rule, 16 C.F.R. §444 (1990), upheld, American Fin. Servs. Ass'n v. F.T.C., 767 F.2d 957 (D.C. Cir. 1985), cert, denied, 475 U.S. 1011 (1986) - and without subsequent judicial review of the claim of default. For critiques of the constitutional and administrative restrictions, see Schwartz, The Enforceability of Security Interests in Consumer Goods, 26 J.L. & ECON. 117, 117-21 (1983) (arguing that reasons commonly given to restrict creditor repossessions - that repossession is wasteful because creditors do not maximize the proceeds of the sale of repossessed property, that creditors abuse this right to repossess, and that repossession destroys the debtor's personal autonomy - do not justify limiting repossession rights); Scott, supra, at 756-61 (arguing that nonlegal sanctions prevent abuse of a creditor's power to repossess household goods).
93. The loss of a trading partner is costly, however, only if it is expensive to find a new partner. Thus, if search and transaction-initiation costs are negligible, there is no relationship-specific prospective advantage. For general models of repeat deals, see R. SUGDEN, THE ECONOMICS OF RIGHTS, CO-OPERATION AND WELFARE 104-11 (1986); Kreps, Milgrom, Roberts & Wilson, Rational Cooperation in the Finitely Repeated Prisoners' Dilemma, 27 J. ECON. THEORY 245, 245-47 (1982). Cf. E. RASMUSEN, GAMES AND INFORMATION 88-89 (1989) (analyzing breakdowns in repeated games).
94. The loss of a trading partner is costly, however, only if it is expensive to find a new partner. Thus, if search and transaction-initiation costs are negligible, there is no relationship-specific prospective advantage. For general models of repeat deals, see R. SUGDEN, THE ECONOMICS OF RIGHTS, CO-OPERATION AND WELFARE 104-11 (1986); Kreps, Milgrom, Roberts & Wilson, Rational Cooperation in the Finitely Repeated Prisoners' Dilemma, 27 J. ECON. THEORY 245, 245-47 (1982). Cf. E. RASMUSEN, GAMES AND INFORMATION 88-89 (1989) (analyzing breakdowns in repeated games).
95. The loss of a trading partner is costly, however, only if it is expensive to find a new partner. Thus, if search and transaction-initiation costs are negligible, there is no relationship-specific prospective advantage. For general models of repeat deals, see R. SUGDEN, THE ECONOMICS OF RIGHTS, CO-OPERATION AND WELFARE 104-11 (1986); Kreps, Milgrom, Roberts & Wilson, Rational Cooperation in the Finitely Repeated Prisoners' Dilemma, 27 J. ECON. THEORY 245, 245-47 (1982). Cf. E. RASMUSEN, GAMES AND INFORMATION 88-89 (1989) (analyzing breakdowns in repeated games).
96. See Klein & Leffler, supra note 59, at 615-16; Kornhauser, supra note 56, at 695; Shapiro, Premiums for High Quality Products as Returns to Reputations, 98 Q.J. ECON. 659, 662-66 (1983); Telser, supra note 59, at 35-36.
97. Sociological studies include S. EISENSTADT & L. RONIGER, PATRONS, CLIENTS AND FRIENDS: INTERPERSONAL RELATIONS AND THE STRUCTURE OF TRUST IN SOCIETY (1984); Lewis & Weingert, Trust as a Social Reality, 63 SOC. FORCES 967, 968-74 (1985); and Sutton & Callahan, The Stigma of Bankruptcy: Spoiled Organizational Image and Its Management, 30 ACAD. MGMT. J. 405, 412-22 (1987). Cf. R. FRANK, CHOOSING THE RIGHT POND: HUMAN BEHAVIOR AND THE QUEST FOR STATUS 1-16 (1985) (developing a model describing how a person's concerns about his economic status affect his behavior).
98. Sociological studies include S. EISENSTADT & L. RONIGER, PATRONS, CLIENTS AND FRIENDS: INTERPERSONAL RELATIONS AND THE STRUCTURE OF TRUST IN SOCIETY (1984); Lewis & Weingert, Trust as a Social Reality, 63 SOC. FORCES 967, 968-74 (1985); and Sutton & Callahan, The Stigma of Bankruptcy: Spoiled Organizational Image and Its Management, 30 ACAD. MGMT. J. 405, 412-22 (1987). Cf. R. FRANK, CHOOSING THE RIGHT POND: HUMAN BEHAVIOR AND THE QUEST FOR STATUS 1-16 (1985) (developing a model describing how a person's concerns about his economic status affect his behavior).
99. Sociological studies include S. EISENSTADT & L. RONIGER, PATRONS, CLIENTS AND FRIENDS: INTERPERSONAL RELATIONS AND THE STRUCTURE OF TRUST IN SOCIETY (1984); Lewis & Weingert, Trust as a Social Reality, 63 SOC. FORCES 967, 968-74 (1985); and Sutton & Callahan, The Stigma of Bankruptcy: Spoiled Organizational Image and Its Management, 30 ACAD. MGMT. J. 405, 412-22 (1987). Cf. R. FRANK, CHOOSING THE RIGHT POND: HUMAN BEHAVIOR AND THE QUEST FOR STATUS 1-16 (1985) (developing a model describing how a person's concerns about his economic status affect his behavior).
100. Sociological studies include S. EISENSTADT & L. RONIGER, PATRONS, CLIENTS AND FRIENDS: INTERPERSONAL RELATIONS AND THE STRUCTURE OF TRUST IN SOCIETY (1984); Lewis & Weingert, Trust as a Social Reality, 63 SOC. FORCES 967, 968-74 (1985); and Sutton & Callahan, The Stigma of Bankruptcy: Spoiled Organizational Image and Its Management, 30 ACAD. MGMT. J. 405, 412-22 (1987). Cf. R. FRANK, CHOOSING THE RIGHT POND: HUMAN BEHAVIOR AND THE QUEST FOR STATUS 1-16 (1985) (developing a model describing how a person's concerns about his economic status affect his behavior).
101. Conscience and class degradation as punitive mechanisms against the bourgeois business-person were an obsession of nineteenth-century novelists. See, e.g., G. ELIOT, MIDDLEMARCH (1874) (respectable Middlemarchers ostracize Bulstrode); W. HOWELLS, THE RISE OF SILAS LAPHAM (1885) (conscience gnaws at Mr. Lapham).
102. Conscience and class degradation as punitive mechanisms against the bourgeois business-person were an obsession of nineteenth-century novelists. See, e.g., G. ELIOT, MIDDLEMARCH (1874) (respectable Middlemarchers ostracize Bulstrode); W. HOWELLS, THE RISE OF SILAS LAPHAM (1885) (conscience gnaws at Mr. Lapham).
103. See, e.g., H. LEIBENSTEIN, INSIDE THE FIRM: THE INEFFICIENCIES OF HIERARCHY 44-47, 52-57 (1987) (presenting a formal game theory model of corporate culture).
104. See Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 AM. SOC. REV. 55, 60-62 (1963).
105. Macaulay's data can also be interpreted as demonstrating that the prospect of a lawsuit deterred breach, even though actual suits were rare.
106. A further example is that manufacturers often extend credit to consumers even though high litigation costs and judgment-proof defaulters may make it impractical to obtain recovery through legal remedies. The incentive for consumers to repay is largely reputational: consumers want to maintain a good credit rating. Note that commitments may be premised upon legal sanctions that apply to individuals other than the breaching party or that award damages to individuals other than the victim of the breach. For example, construction companies may post bonds by paying insurance companies or other bonding agencies. The victim of the breach can sue the surety directly. See, e.g., Miller Act, 40 U.S.C. § 270 (1988). The construction companies themselves may be judgment proof, so that only their concern for reputation - both with insurance companies and with potential future contractors - deters breach.
107. See, e.g., Lazear & Moore, Incentives, Productivity, and Labor Contracts, 99 Q.J. ECON. 275, 276-77 (1984); Shapiro & Stiglitz, Equilibrium Unemployment as a Worker Discipline Device, 74 AM. ECON. REV. 433, 433 (1984). As discussed below, the vague and open-ended nature of this commitment is characteristic of the types of commitments subject to nonlegal rather than legal sanctions. See infra pp. 403-05.
108. See, e.g., Lazear & Moore, Incentives, Productivity, and Labor Contracts, 99 Q.J. ECON. 275, 276-77 (1984); Shapiro & Stiglitz, Equilibrium Unemployment as a Worker Discipline Device, 74 AM. ECON. REV. 433, 433 (1984). As discussed below, the vague and open-ended nature of this commitment is characteristic of the types of commitments subject to nonlegal rather than legal sanctions. See infra pp. 403-05.
109. For an economic model of how worker-management interaction determines the "effort level," see Leibenstein, Intra-Firm Effort Decisions and Sanctions: Hierarchy versus Peers, in HANDBOOK OF BEHAVIORAL ECONOMICS: BEHAVIORAL MICROECONOMICS 213, 219-22 (B. Gilad & S. Kaish eds. 1986).
110. Without these sanctions, the threat of termination might not induce employees to work hard, if workers could move relatively costlessly from one job to another and were happier to do a poor or mediocre job than a good one. The firm could reward good performance through promotions, bonuses, and so on, but it is difficult for a firm with imperfect information about workers' performance to construct a system of worker incentives without using penalties as well rewards. See, e.g., Malcomson, Work Incentives, Hierarchy, and Internal Labor Markets, 92 J. POL. ECON. 486, 486-87 (1984).
111. In addition to the obvious direct costs of looking for another job, "search costs" include the income during the period of unemployment and the uncertainties that a worker faces at the Prospect of new employment.
112. Often these fees are labeled "reimbursements" to the company for such expenses as training costs and transportation. For analytic comments on the recent trend towards the use of such fees, see Hart & Holmström, The Theory of Contracts, in ADVANCES IN ECONOMIC THEORY, FIFTH WORLD CONGRESS 71, 111-12 (T. Bewley ed. 1987).
113. The groundbreaking analysis is Lazear, Why Is There Mandatory Retirement?, 87 J. POL. ECON. 1261, 1264 (1979). Although it is now generally accepted that workers in long-term jobs have implicit deferred compensation arrangements, the precise structure of the deferral remains in dispute. For a brief discussion of the debate, see Note, Employer Opportunism and the Need for a Just Cause Standard, 103 HARV. L. REV. 510, 520-23 (1989). For a more formal statement of differing models, see Rosen, Implicit Contracts: A Survey, 23 J. ECON. LITERATURE 1144, 1149-70 (1985).
114. The groundbreaking analysis is Lazear, Why Is There Mandatory Retirement?, 87 J. POL. ECON. 1261, 1264 (1979). Although it is now generally accepted that workers in long-term jobs have implicit deferred compensation arrangements, the precise structure of the deferral remains in dispute. For a brief discussion of the debate, see Note, Employer Opportunism and the Need for a Just Cause Standard, 103 HARV. L. REV. 510, 520-23 (1989). For a more formal statement of differing models, see Rosen, Implicit Contracts: A Survey, 23 J. ECON. LITERATURE 1144, 1149-70 (1985).
115. The groundbreaking analysis is Lazear, Why Is There Mandatory Retirement?, 87 J. POL. ECON. 1261, 1264 (1979). Although it is now generally accepted that workers in long-term jobs have implicit deferred compensation arrangements, the precise structure of the deferral remains in dispute. For a brief discussion of the debate, see Note, Employer Opportunism and the Need for a Just Cause Standard, 103 HARV. L. REV. 510, 520-23 (1989). For a more formal statement of differing models, see Rosen, Implicit Contracts: A Survey, 23 J. ECON. LITERATURE 1144, 1149-70 (1985).
116. That a pension vests only after a fixed term of service (five years under ERISA) and that the retiree's pension is generally calculated as a percentage of his earnings in his final year or years with the firm increase this effect. Each pension credit a worker earns is worth less the earlier he leaves his job. For an empirical demonstration, see Ippolito, The Labor Contract and True Economic Pension Liabilities, 75 AM. ECON. REV. 1031, 1037-41 (1985). See also R. IPPOLITO, PENSIONS, ECONOMICS AND PUBLIC POLICY 233 (1986) (discussing the relationship between "legal" and "ongoing" pension liabilities).
117. That a pension vests only after a fixed term of service (five years under ERISA) and that the retiree's pension is generally calculated as a percentage of his earnings in his final year or years with the firm increase this effect. Each pension credit a worker earns is worth less the earlier he leaves his job. For an empirical demonstration, see Ippolito, The Labor Contract and True Economic Pension Liabilities, 75 AM. ECON. REV. 1031, 1037-41 (1985). See also R. IPPOLITO, PENSIONS, ECONOMICS AND PUBLIC POLICY 233 (1986) (discussing the relationship between "legal" and "ongoing" pension liabilities).
118. For a perceptive economic analysis of workers' sentiments for colleagues and institutions, see Akerlof, supra note 49, at 548-51.
119. See P. WEILER, supra note 29, at 70 n.43.
120. Instability or high turnover of the labor force causes substantial losses to a firm. See Mitchell & Kimbell, Labor Market Contracts and Inflation, in WORKERS, JOBS, AND INFLATION 199, 216 n.39 (N. Baily ed. 1982) (estimating that, as of 1979, turnover costs ranged from $2000 to $10,000 for each worker who quit).
121. See J. COLEMAN, FOUNDATIONS OF SOCIAL THEORY 558-60 (1990).
122. Suggestive evidence of the combined effect of these pressures on firm behavior can be found, for example, in the willingness of some large firms to adjust pensions to compensate for inflation and other contingencies, even for workers who have already retired. See Bodie, Light, Mørck & Taggart, Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation, in ISSUES IN PENSION ECONOMICS 15, 37-38 (Z. Bodie, J. Shoven & D. Wise eds. 1987). There is no similarly direct evidence, however, of the effect of these pressures on firms' decisions to fire workers.
123. For a description of the scope of current union contracts, see P. WEILER, supra note 29, at 187-89.
124. See, e.g., Fair Labor Standards Act, 29 U.S.C.A. § 206 (West 1978 & Supp. 1990).
125. See Employee Retirement Income Security Act, 29 U.S.C. §§ 1001-1461 (1988).
126. See, e.g., Occupational Safety and Health Act, 29 U.S.C. §§ 651-678 (1988).
127. See< e.g., Civil Rights Act of 1964, 42 U.S.C. §§ 2000e to 2000e-17 (1988).
128. For an explanation of the conception of "rationality" used here, see infra note 174.
129. This definition extends to nonlegal commitments Holmes' celebrated definition of a contract as any agreement "to pay a compensatory sum unless the promised event comes to pass" Holmes, The Path of the Law, 10 HARV. L. REV. 457, 462 (1897).
130. The costs of purchasing reliable information from a third party reflect not only the direct payments, but also the need to verify the reliability of the third party or to discount appropriately the value of the information provided.
131. This is the familiar argument for contract when there are relationship-specific investments. See, e.g., O. WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM 52-56, 72-78 (1985); Klein, Crawford & Alchian, Vertical Integration, Appropriable Rents and the Competitive Contracting Process, 21 J.L. & ECON. 297, 302-07 (1978). Hart & Holmström, supra note 75, at 129-30, provide a formal model of the intuition explained informally in the text. As Hart and Holmström explain, one cannot obtain an efficiency advantage from an ex ante price adjustment made in anticipation of opportunism, because the manufacturer can cancel the effect of the initial adjustment by subsequently charging a correspondingly higher price for repair parts. See id. at 130.
132. This is the familiar argument for contract when there are relationship-specific investments. See, e.g., O. WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM 52-56, 72-78 (1985); Klein, Crawford & Alchian, Vertical Integration, Appropriable Rents and the Competitive Contracting Process, 21 J.L. & ECON. 297, 302-07 (1978). Hart & Holmström, supra note 75, at 129-30, provide a formal model of the intuition explained informally in the text. As Hart and Holmström explain, one cannot obtain an efficiency advantage from an ex ante price adjustment made in anticipation of opportunism, because the manufacturer can cancel the effect of the initial adjustment by subsequently charging a correspondingly higher price for repair parts. See id. at 130.
133. Of course, the parties do not entirely determine which sanctions are in play. For example, the manufacturer's reputation may inevitably suffer to some degree if it sells shoddy products. When some nonlegal sanctions are inherent in the commercial landscape, the parties' decision becomes whether to supplement this market discipline with legally enforceable guarantees or to increase the manufacturer's economic stake in its reputation and thereby invite consumers to rely upon nonlegal sanctions to a greater extent than they otherwise would.
134. See U.C.C. § 2-314 (1987). To keep the example simple, I assume that all legal sanctions are "contractual," that is, that product liability tort suits are not available to enforce quality guarantees. A reader who objects to this assumption can, alternatively, think of a product, such as compact discs, whose defects are extremely unlikely to cause physical injuries that would be actionable in tort.
135. See U.C.C. § 2-316(2) (1987) (permitting the manufacturer to exclude or modify implied, warranties by a conspicuous written disclaimer). Empirical data indicate that manufacturers generally disclaim or limit warranties. See Priest, A Theory of the Consumer Product Warranty, 90 YALE L.J. 1297, 1319-47 (1981). For an enthusiastic endorsement of these disclaimers, see Epstein, Unconscionability: A Critical Reappraisal, 18 J.L. & ECON. 293, 309-11 (1975).
136. See U.C.C. § 2-316(2) (1987) (permitting the manufacturer to exclude or modify implied, warranties by a conspicuous written disclaimer). Empirical data indicate that manufacturers generally disclaim or limit warranties. See Priest, A Theory of the Consumer Product Warranty, 90 YALE L.J. 1297, 1319-47 (1981). For an enthusiastic endorsement of these disclaimers, see Epstein, Unconscionability: A Critical Reappraisal, 18 J.L. & ECON. 293, 309-11 (1975).
137. See F. SCHERER, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 378-79 (2d ed. 1980); see also Landes & Posner, Trademark Law: An Economic Perspective, 30 J.L. & ECON. 265, 268-73 (1987) (listing purposes served by trademarks). Bonds often serve functions besides sanctioning. For example, advertising and the use of trademarks not only serve as bonds, but also directly inform consumers about a particular product or even about their own preferences about that product. They also provide information through signalling. See F, SCHERER, supra, at 378-79; Landes & Posner, supra, at 291-96.
138. See F. SCHERER, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 378-79 (2d ed. 1980); see also Landes & Posner, Trademark Law: An Economic Perspective, 30 J.L. & ECON. 265, 268-73 (1987) (listing purposes served by trademarks). Bonds often serve functions besides sanctioning. For example, advertising and the use of trademarks not only serve as bonds, but also directly inform consumers about a particular product or even about their own preferences about that product. They also provide information through signalling. See F, SCHERER, supra, at 378-79; Landes & Posner, supra, at 291-96.
139. Product diversification may increase the "value" of the manufacturer's reputationl bond, because a reduction of reputation due to unreliable commitments on one product may affect sales of others.
140. See Shavell, Damage Measures for Breach of Contract, 11 BELL J. ECON. 466, 472-87 (1980); Shavell, The Design of Contracts and Remedies for Breach, 99 Q.J. ECON. 121, 132-47 (1984) [hereinafter Shavell, Design of Contracts].
141. See Shavell, Damage Measures for Breach of Contract, 11 BELL J. ECON. 466, 472-87 (1980); Shavell, The Design of Contracts and Remedies for Breach, 99 Q.J. ECON. 121, 132-47 (1984) [hereinafter Shavell, Design of Contracts].
142. See Shavell, Damage Measures for Breach of Contract, 11 BELL J. ECON. 466, 472-87 (1980); Shavell, The Design of Contracts and Remedies for Breach, 99 Q.J. ECON. 121, 132-47 (1984) [hereinafter Shavell, Design of Contracts].
143. That is, the party to a commitment enforced by nonlegal sanctions will breach if the benefits of breach to it exceed the costs imposed by sacrifice of its bond. The promisor's conduct will be optimal, from the perspective of the parties taken jointly, if costs imposed on the promisor by sacrifice of the bond equal the costs that breach imposes on the victim. In contrast, if the costs imposed by sacrifice of the bond are below those caused to the victim of breach, the breacher will breach suboptimally - that is, in instances when its benefits from breach are less than the costs imposed upon the promisee by breach, but greater than those costs imposed upon the promisor by sacrifice of the bond. The difficulties here involve the drafting and administrative costs - in particular, the costs of setting a bond that will actually equal ex post losses from breach - to which the analysis turns in the next section.
144. The consumer might be able to recover when it can be shown that the manufacturer was the "cheapest cost-avoider" even as to the consumer's negligent use of the product. But either sanctioning system, properly designed, achieves the optimal level of reliance even in this situation. Cf. Cooter, Unity in Tort, Contract, and Property: The Model of Precaution, 73 CALIF. L. REV. 1, 29-45 (1985) (surveying common law methods for dealing with the problem of inducing optimal precaution in the conduct of victims).
145. Thus, sanctions that fail to compensate the promisee serve only the function of minimizing informational costs or inducing optimal conduct ex post, not of shifting risk from the promisee to the promisor. Cf. Polinsky, Risk Sharing Through Breach of Contract Remedies, 12 J. LEGAL STUD. 427 (1983) (describing how contract remedies shift risk). The consumer who prefers ex Post compensation to ex ante savings can purchase insurance from a third party. For example, automobile and homeowners' insurance provide coverage for some consequences of defective consumer products, and credit-card companies now offer warranty protections on products Purchased with their cards. Of course, if the manufacturer is a more efficient insurer than are third parties, the savings from the product price reduction will not cover insurance costs; but, in that case, the manufacturer would offer a commitment to compensate, backed by either legal or nonlegal sanctions.
146. See id. at 430-33.
147. See supra note 95.
148. This type of cost is explored below, particularly for the case of labor markets. See infra PP. 417-18, 422-24.
149. In a sense, absolute indifference is a sign that the transactor has broken no commitment. For example, it is counterintuitive - indeed, fictional - to think that a futures trader who "settles up" on, say, a corn futures contract has breached a commitment to deliver corn. The norm by which the conduct is judged simply internalizes the Holmesian conception that the commitment is to "perform or pay damages." Holmes, supra note 89, at 462.
150. I use the term "drafting" broadly to include all means by which parties state commitments, including casual or informal statements, courses of dealing, and usages of trade. Costs that arise from imperfect drafting - litigation and inefficient ex post conduct - I consider below as "administrative" and "incentive" costs.
151. See, e.g., U.C.C. § 2-304 (1987) (terms of payment); id. § 2-305 (price); id. § 2-309 (time of delivery).
152. See id. § 2-201 & comment 1 (providing that the statute of frauds is satisfied by a writing that evidences a contract, specifies a quantity, and is signed by the party to be charged).
153. Commentators have argued that consumers often do not bother to read the form, see Rakoff, Contracts of Adhesion: An Essay in Reconstruction, 96 HARV. L. REV. 1173, 1229 (1983), which of course further reduces drafting costs.
154. An example is the elaborate agreement that must be completed prior to a corporate acquisition. For an analysis of these agreements from the perspective of financial theory, see Gilson, Value Creation by Business Lawyers, 94 YALE L.J. 239 (1984).
155. See Priest, supra note 94, at 1307-19.
156. See supra note 95.
157. Consumers will often discover a breach without costly monitoring because the fact of breach - failure to deliver a product or product misfunction, for example - will be fairly obvious. Similarly, workers readily may detect some on-the-job breaches, although subtle job safety hazards or depredations of workers' pensions may remain undetected without careful monitoring. After discovery of the breach, the common law system (and the system of private rights of action under some federal statutes) allows the victim of the breach unilaterally to initiate an enforcement action simply by filing a lawsuit. In some contexts, however, detection is costly. For example, capital suppliers - investors and lenders - must expend large sums monitoring firms in order to detect breach.
158. See J. WILLIAMS, THE ECONOMIC FUNCTION OF FUTURES MARKETS §§ 1.1-.2, at 4-10 (1986) (describing the procedures through which futures clearinghouses settle accounts). Ironically, one reason that these systems may work so smoothly is that compliance with the damages enforcement mechanism is enforced, at least in part, through nonlegal sanctions. See infra pp. 410-12.
159. Of course, as taxpayers, transactors bear most of the costs of legal enforcement systems. But they bear these costs whether or not they transact in a way that uses legal enforcement. Nonlegal sanctioning systems differ in that transactors must pay the costs of setting up the systems only if they actually transact: transactors bear the cost of setting up the nonlegal sanctioning regime in a manner analogous to taxpayers' incurring an excise tax.
160. Destruction of a bond's economic value may create value by deterring future breaches. If the system is rational, the deterrence value to transactors as a group exceeds the value lost when collateral is seized.
161. Recall that contract sanctions optimally are set equally to the reasonable promisee's losses from breach. See supra text accompanying note 98.
162. See Macaulay, An Empirical View of Contract, 1985 WIS. L. REV. 465, 469-70.
163. Analogously, in some circumstances, one appeal of a lender's right to seize collateral purchased with the loan, see U.C.C. § 9-312(3), (4) (1987), is that the collateral in effect sets the value of the bond equal to damages from breach, provided that the collateral has the same value in the hands of the creditor as it does in the hands of the debtors. Unfortunately, as we have seen, that situation creates further problems. See supra p. 407; infra pp. 421-24.
164. These points are simple corollaries of the theory of efficient breach. They have been explored in detail in the context of penalty clauses. See Goetz & Scott, Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 COLUM. L. REV. 554, 558-77 (1977); see also Clarkson, Miller & Muris, Liquidated Damages v. Penalties: Sense or Nonsense?, 1978 WIS. L. REV. 351 (arguing that a valid distinction exists between penalty clauses and enforceable damage clauses); Muris, Opportunistic Behavior and the Law of Contracts, 65 MINN. L. REV. 521, 580-88 (1981) (contending that damages clauses that act as a penalty create an incentive to engage in opportunistic behavior); Rea, Efficiency Implications of Penalties and Liquidated Damages, 13 J. LEGAL STUD. 147 (1984) (comparing the economic results of enforcing penalty clauses with those of liquidated damages clauses).
165. These points are simple corollaries of the theory of efficient breach. They have been explored in detail in the context of penalty clauses. See Goetz & Scott, Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 COLUM. L. REV. 554, 558-77 (1977); see also Clarkson, Miller & Muris, Liquidated Damages v. Penalties: Sense or Nonsense?, 1978 WIS. L. REV. 351 (arguing that a valid distinction exists between penalty clauses and enforceable damage clauses); Muris, Opportunistic Behavior and the Law of Contracts, 65 MINN. L. REV. 521, 580-88 (1981) (contending that damages clauses that act as a penalty create an incentive to engage in opportunistic behavior); Rea, Efficiency Implications of Penalties and Liquidated Damages, 13 J. LEGAL STUD. 147 (1984) (comparing the economic results of enforcing penalty clauses with those of liquidated damages clauses).
166. These points are simple corollaries of the theory of efficient breach. They have been explored in detail in the context of penalty clauses. See Goetz & Scott, Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 COLUM. L. REV. 554, 558-77 (1977); see also Clarkson, Miller & Muris, Liquidated Damages v. Penalties: Sense or Nonsense?, 1978 WIS. L. REV. 351 (arguing that a valid distinction exists between penalty clauses and enforceable damage clauses); Muris, Opportunistic Behavior and the Law of Contracts, 65 MINN. L. REV. 521, 580-88 (1981) (contending that damages clauses that act as a penalty create an incentive to engage in opportunistic behavior); Rea, Efficiency Implications of Penalties and Liquidated Damages, 13 J. LEGAL STUD. 147 (1984) (comparing the economic results of enforcing penalty clauses with those of liquidated damages clauses).
167. These points are simple corollaries of the theory of efficient breach. They have been explored in detail in the context of penalty clauses. See Goetz & Scott, Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 COLUM. L. REV. 554, 558-77 (1977); see also Clarkson, Miller & Muris, Liquidated Damages v. Penalties: Sense or Nonsense?, 1978 WIS. L. REV. 351 (arguing that a valid distinction exists between penalty clauses and enforceable damage clauses); Muris, Opportunistic Behavior and the Law of Contracts, 65 MINN. L. REV. 521, 580-88 (1981) (contending that damages clauses that act as a penalty create an incentive to engage in opportunistic behavior); Rea, Efficiency Implications of Penalties and Liquidated Damages, 13 J. LEGAL STUD. 147 (1984) (comparing the economic results of enforcing penalty clauses with those of liquidated damages clauses).
168. By enabling the parties to use contract terms that they otherwise could not use, arbitration effect enables parties to make commitments that they otherwise could not make. For example, diamond sellers cannot commit themselves to deliver a gem of a specified quality unless the third-party decisionmaker can verify the quality of the diamond in cases in which quality is disputed. Thus, arbitration enables parties to obtain the advantages of making commitments that would otherwise be unenforceable. For a discussion of these advantages, see supra pp. 398-99.
169. Diamond traders offer their desire for secrecy as one explanation for their hostility to litigation. See L. Bernstein, The Choice Between Public and Private Law: The Diamond Industry's Preference for Extra-Legal Contracts and a Private Law System of Dispute Resolution 29 (1990) (Harvard Law School Program in Law and Economics Discussion Paper No. 72) (forthcoming 21 J. LEGAL STUD. (1992)).
170. Diamond traders offer their desire for secrecy as one explanation for their hostility to litigation. See L. Bernstein, The Choice Between Public and Private Law: The Diamond Industry's Preference for Extra-Legal Contracts and a Private Law System of Dispute Resolution 29 (1990) (Harvard Law School Program in Law and Economics Discussion Paper No. 72) (forthcoming 21 J. LEGAL STUD. (1992)).
171. See id. at 20-22; see also; Simpson, Contracts for Cotton to Arrive: The Case of the Two Ships Peerless, II CARDOZO L. REV. 287, 321-23 (1989) (describing reliance on arbitration in a cotton brokers' association). Indeed, a remarkable feature of organized commodities markets with sophisticated transactors is the extent to which commitments can proceed without any legal contracting at all. For example, wheat futures markets thrived in nineteenth-century Chicago, even though wheat futures contracts were illegal. See J. WILLIAMS, supra note 113, § 5.2 at 154-56.
172. See Note, supra note 9, at 61-63. Under the statute of frauds, a contract for the sale of goods worth over $500 is enforceable only if written. See U.C.C. § 2-201 (1987).
173. Of course, expulsion does not compensate the victim of breach, but features of the enforcement system generally mitigate this difficulty. First, because expulsion effectively deters a party from refusing to honor the arbitrator's judgment, only rarely will the breacher not pay compensation as ordered. Second, as noted above, risk-neutral transactors would be indifferent as to whether or not the sanctioning system provided compensation. See supra pp. 401-02. In particular, active professional traders are indifferent to the risk of losing compensation in any Particular trade: they "diversify" the risk of noncompensation because each trade is only a small part of their total business.
174. See, e.g., N.Y. CIV. PRAC. L. & R. § 7501 (McKinney 1980).
175. For a critical review of the history of courts' hostility to arbitration, see 6A A. CORBIN, CONTRACTS § 1433, at 388-95 (1952).
176. See generally New York Arbitration Act, N.Y. CIV. PRAC. L. & R. § 7511(b) (McKinney 1980 (stating grounds for courts' vacating arbitrators' awards); id. § 7511(c) (stating grounds for courts' modifying awards). In particular, courts remain equivocal about the extent to which arbitrators may depart from established contract law, particularly on damages. Compare, e.g., Garrity v. Lyle Stuart, Inc., 40 N.Y.2d 354, 356-57, 353 N.E.2d 793, 794-95, 386 N.Y.S.2d 831, 832-33 (1976) (setting aside an arbitrator's punitive damages award) with John T. Brady & Co. v. Form-Eze Sys., 623 F.2d 261, 264 (2d Cir. 1980) (declining to set aside an arbitrator's award because the record of the arbitral proceeding provided an insufficient basis for inferring that damages award was not based on actual damages suffered and was therefore punitive). Thus, even under the current, more tolerant approach to arbitral decisionmaking, parties may find it necessary to have recourse to nonlegal enforcement if they wish to use damages measures different from those of the common law.
177. Clearly, this conclusion assumes that the parties are risk-neutral and that third-party and paternalist concerns with insolvency are handled by an independent corpus of bankruptcy law
178. See L. Bernstein, supra note 121, at 41-42. Indeed, the rules of the diamond trade developed from Talmudic law. See id.
179. See Landa, A Theory of the Ethnically Homogeneous Middleman Group: An Institutional Alternative to Contract Law, 10 J. LEGAL STUD. 349, 349-50, 355-61 (1981).
180. See Simpson, supra note 122, at 304.
181. That is, a given piece of information about a committing party may cause some transactors to decide that the party is much less reliable than previously believed, although the same information may not cause other transactors to change their initial judgments. The total impact on reputation is the aggregate of these individual judgments; as each judgment changes, the total value for reputation moves over a range of possible values.
182. See, e.g., Jackson & Kronman, Secured Financing and Priorities Among Creditors, 88 YALE L.J. 1143, 1149-50 (1979); Levmore, Monitors and Freeriders in Commercial and Corporate Settings, 92 YALE L.J. 49, 52-53 (1982); Scott, supra note 62, at 744-46.
183. See, e.g., Jackson & Kronman, Secured Financing and Priorities Among Creditors, 88 YALE L.J. 1143, 1149-50 (1979); Levmore, Monitors and Freeriders in Commercial and Corporate Settings, 92 YALE L.J. 49, 52-53 (1982); Scott, supra note 62, at 744-46.
184. Like the covenants discussed in the text, the strategy of protecting the creditor by taking a security interest is costly and of limited effectiveness. Indeed, despite an extensive scholarly literature, our understanding of when rational parties should incur the costs of taking a security interest - rather than adjust the price of capital or other contract terms - remains incomplete. For recent discussions, see, for example, Schwartz, A Theory of Loan Priorities, 18 J. LEGAL STUD. 209, 243-47 (1989); and Scott, supra note 7, at 905-11.
185. See generally Smith & Warner, On Financial Contracting: An Analysis of Bond Covenants, 7 J. FIN. ECON. 117 (1979) (describing types of bond clauses and their economic functions).
186. See Gilson & Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549, 592-613 (1983); Melnick & Plaut, Loan Commitment Contracts, Terms of Lending, and Credit Allocation, 41 J. FIN. 425, 431-35 (1986).
187. See Gilson & Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549, 592-613 (1983); Melnick & Plaut, Loan Commitment Contracts, Terms of Lending, and Credit Allocation, 41 J. FIN. 425, 431-35 (1986).
188. Courts may have considerable difficulty assessing the conflicting information they do receive. Cf. Bebchuk & Kahan, Fairness Opinions: How Fair Are They and What Can Be Done About It?, 1989 DUKE L.J. 27, 46-53 (criticizing current judicial evaluations of investment bankers' fairness opinions).
189. Hearsay rules, see, e.g., FED. R. EVID. 801-806, would exclude much of the speculative evidence upon which bond market monitors rely in the ordinary course of business. Although courts may consider expert conclusions based on such evidence, they are barred from considering the evidence itself. See, e.g., FED. R. EVID. 703.
190. Hearsay rules, see, e.g., FED. R. EVID. 801-806, would exclude much of the speculative evidence upon which bond market monitors rely in the ordinary course of business. Although courts may consider expert conclusions based on such evidence, they are barred from considering the evidence itself. See, e.g., FED. R. EVID. 703.
191. Classic statements of this view of markets are Arrow, Toward a Theory of Price Adjustment, in THE ALLOCATION OF ECONOMIC RESOURCES 41 (1959); and Hayek, The Use of Knowledge in Society, 35 AM. ECON. REV. 519 (1945).
192. Classic statements of this view of markets are Arrow, Toward a Theory of Price Adjustment, in THE ALLOCATION OF ECONOMIC RESOURCES 41 (1959); and Hayek, The Use of Knowledge in Society, 35 AM. ECON. REV. 519 (1945).
193. The estimates are not entirely independent because many traders may base their decisions on what they think other traders will do, rather than on the security's value. A classic - albeit exaggerated - expression of the point is Keynes' beauty-contest metaphor. See J. KEYNE GENERAL THEORY OF EMPLOYMENT, INTEREST, AND MONEY 156 (1936) ("[W]e devote of intelligences to anticipating what average opinion expects the average opinion to be . . . .").
194. The problem is analyzed in the law of evidence in terms of statistical proof of injury For example, a franchisor who annually terminates 50% of all franchisees on grounds inadequate performance is probably either making mistaken hiring decisions, making mistake firing decisions, or simply sponsoring a failing franchise operation. Nonetheless, except grounds of statistical inference, that discharge rate by itself would not support a claim that the termination decision was unjust in any individual case, even if the other two possibilities were proven not to obtain. See Shaviro, Statistical-Probability Evidence and the Appearance Justice, 103 HARV. L. REV. 530, 533-42 (1989).
195. See supra pp. 395-97.
196. Workers may vary the effort that they put into their jobs in response to the employer's breach of commitment. See P. WEILER, supra note 29, at 147-49. But worker misbehavior is a cumbersome and socially costly way of enforcing the employer's commitments.
197. The evidence regarding workers' knowledge about the jobs they accept and the factors important to the acceptance decisions is surprisingly incomplete. What evidence there is suggests that workers are generally poorly informed and learn most relevant information only after substantial experience at the job. See, e.g., W. VISCUSI, RISK BY CHOICE 63-69 (1986); Viscusi & O'Connor, Hazard Warnings for Workplace Risks: Effect on Risk Perceptions, Wage Rates, and Turnover, in LEARNING ABOUT RISK: CONSUMER AND WORKER RESPONSES TO HAZARD INFORMATION 98, 101-09 (W. Viscusi & W. Magat eds. 1987) (arguing that rates of workers' intention to quit show that workers are poorly informed ex ante about safety hazards). Although there is suggestive evidence about reputational pressures on pension funding, see supra note 82, these pressures seem more likely to result from the firm's concern for its reputation among workers already at the firm, rather than among prospective workers. Reputational sanctions, however, may have considerable effectiveness even if a large number of workers are uninformed. See Schwartz & Wilde, Intervening in Markets on the Basis of imperfect Information: A Legal and Economic Analysis, 127 U. PA. L. REV. 630, 640-51 (1979).
198. The evidence regarding workers' knowledge about the jobs they accept and the factors important to the acceptance decisions is surprisingly incomplete. What evidence there is suggests that workers are generally poorly informed and learn most relevant information only after substantial experience at the job. See, e.g., W. VISCUSI, RISK BY CHOICE 63-69 (1986); Viscusi & O'Connor, Hazard Warnings for Workplace Risks: Effect on Risk Perceptions, Wage Rates, and Turnover, in LEARNING ABOUT RISK: CONSUMER AND WORKER RESPONSES TO HAZARD INFORMATION 98, 101-09 (W. Viscusi & W. Magat eds. 1987) (arguing that rates of workers' intention to quit show that workers are poorly informed ex ante about safety hazards). Although there is suggestive evidence about reputational pressures on pension funding, see supra note 82, these pressures seem more likely to result from the firm's concern for its reputation among workers already at the firm, rather than among prospective workers. Reputational sanctions, however, may have considerable effectiveness even if a large number of workers are uninformed. See Schwartz & Wilde, Intervening in Markets on the Basis of imperfect Information: A Legal and Economic Analysis, 127 U. PA. L. REV. 630, 640-51 (1979).
199. The evidence regarding workers' knowledge about the jobs they accept and the factors important to the acceptance decisions is surprisingly incomplete. What evidence there is suggests that workers are generally poorly informed and learn most relevant information only after substantial experience at the job. See, e.g., W. VISCUSI, RISK BY CHOICE 63-69 (1986); Viscusi & O'Connor, Hazard Warnings for Workplace Risks: Effect on Risk Perceptions, Wage Rates, and Turnover, in LEARNING ABOUT RISK: CONSUMER AND WORKER RESPONSES TO HAZARD INFORMATION 98, 101-09 (W. Viscusi & W. Magat eds. 1987) (arguing that rates of workers' intention to quit show that workers are poorly informed ex ante about safety hazards). Although there is suggestive evidence about reputational pressures on pension funding, see supra note 82, these pressures seem more likely to result from the firm's concern for its reputation among workers already at the firm, rather than among prospective workers. Reputational sanctions, however, may have considerable effectiveness even if a large number of workers are uninformed. See Schwartz & Wilde, Intervening in Markets on the Basis of imperfect Information: A Legal and Economic Analysis, 127 U. PA. L. REV. 630, 640-51 (1979).
200. For evidence of workers' use of "rationalization" and wishful thinking to avoid acknowledging job hazards, see Anderson, Values, Risks and Market Norms, 17 PHIL. & PUB. AFF. 54, 60-63 (1987). See also Tversky & Kahneman, Rational Choice and the Framing of Decisions, 59 J. BUS. 67, 76-78 (1986) (discussing the influence of perceived alternatives on how outcomes are evaluated).
201. For evidence of workers' use of "rationalization" and wishful thinking to avoid acknowledging job hazards, see Anderson, Values, Risks and Market Norms, 17 PHIL. & PUB. AFF. 54, 60-63 (1987). See also Tversky & Kahneman, Rational Choice and the Framing of Decisions, 59 J. BUS. 67, 76-78 (1986) (discussing the influence of perceived alternatives on how outcomes are evaluated).
202. See R. FREEMAN & J. MEDOFF, WHAT DO UNIONS DO? 21 (1984). Note that causation may run either way. It may be that workers who have made such investments are inclined to form or join unions; alternatively, the formation of unions may lead workers to be more willing to accept contract terms requiring a high level of firm-specific investment.
203. See supra pp. 410-12.
204. See, e.g., Summers & Summers, When Financial Markets Work Too Well: A Cautious Case for a Securities Transfer Tax, 3 J. FIN. SERVICES RES. 261, 270-71 (1989) (suggesting that current costs of operating the financial markets - $53 billion for the New York Stock Exchange alone - outweigh the markets' social benefits).
205. A subsidiary prerequisite to effective monitoring in dispersed markets may be a background system of public regulation of information disclosures. Generally, government institutes regulation to ensure that claims communicated
206. See supra pp. 407, 413.
207. For an economic model demonstrating that employers have an incentive to fire qualified workers as they grow older, see Note, supra note 76, at 518-23.
208. If sanctions are perfectly set and the worker is well-informed, he may realize that he can resist this threat with impunity. In the face of limited information and drafting costs, however, the worker may not be well-situated to call the employer's bluff. Apart from opportunism, the decision to fire may reflect vindictiveness, prejudice about race or gender, or simply pleasure in the arbitrary exercise of power. Although the firm derives no benefit from such conduct, its systems for controlling such behavior by its agents are bound to be imperfect: a system that perfectly enforced employees' duties toward others in the workplace would require expenditures that exceeded the benefits to the firm of "perfect" decisionmaking. Employee discharge cases thus often involve claims that fellow employees acted wrongfully rather than claims that question the firm's employment policies. In these cases, the terminated employee sues his co-worker or supervisor for tortious interference with a contractual relationship. See, e.g., Langer v. Becker, 176 Ill. App. 3d 745, 749-51, 531 N.E.2d 830, 832-34 (1988); Gram v. Liberty Mut. Ins. Co., 384 Mass. 659, 663-64, 429 N.E.2d 21, 24-25 (1981); Mailhiot v. Liberty Bank & Trust Co., 24 Mass. App. 525, 528-29, 510 N.E.2d 773, 777 (1987).
209. The same type of opportunism is much more difficult to coordinate in a competitive market. Although a single bank may be able to threaten to repossess collateral or a small group of physicians may be able to organize a boycott of one of their colleagues, it is generally very difficult to close off unjustifiably a transactor's complete access to competitive capital or product Markets because, under competitive conditions, transactors cannot coordinate and enforce such a boycott.
210. See supra p. 397. There is, however, little evidence that workers are well informed about the hiring and firing practices of various firms in the market. See supra note 144.
211. For example, the contract may provide for a "condition of satisfaction," a provision that allows the promisee to declare that it is dissatisfied with performance, and therefore that breach has occurred, without documenting breach of a specific commitment. Presumably, the limited nature of judicial review in this situation reduces the costs (particularly error costs) to the parties of judicial intervention. And, as an analytic matter, it should be much easier for courts to determine the reasonableness of a claim of dissatisfaction with reference to a requirement of performance than it would be to come to an independent, de novo determination of whether the promisor complied with that requirement. An important example is the provision granting the lender a right to accelerate payment of a loan or require collateral "at will" or "when he deems himself insecure." The UCC permits acceleration "only if [the lender] in good faith believes that the prospect of payment or performance is impaired." U.C.C. § 1-208 (1987). In effect, then, the UCC provides for limited judicial review of the en der's decision For debate about the scope of this review, see Reid v. Key Bank of Southern Maine, Inc., 821 F.2d 9, 15-16 (Ist Cir. 1987); and Watseka First National Bank v. Ruda, 175 Ill. App. 3d 753, 756-57, 531 N.E.2d 28, 30-31 (1988).
212. See supra p. 396.
213. See sources cited supra note 119.
214. See H. LEIBENSTEIN, supra note 67, at 99-102; Akerlof, supra note 49, at 549-51
215. See Williamson, Comment, in CORPORATE TAKEOVERS: CAUSES AND CONSEQUENCES 61, 64-66 (A. Auerbach ed. 1989) [hereinafter CORPORATE TAKEOVERS].
216. See C. PERROW, COMPLEX ORGANIZATIONS: A CRITICAL ESSAY 58-65 (1986) (reviewing the literature).
217. The fate of Eastern Airlines' workers in the hands of Frank Lorenzo is a telling example. See A. BERNSTEIN, GROUNDED: FRANK LORENZO AND EASTERN AIRLINES 54-93, 197-213 (1990). Although competitive pressures eventually might have caused layoffs or benefits cuts as Eastern's oligopoly surplus disappeared, management could have engineered these cuts by cooperation with the unions rather than by union-busting. Cf. Williamson, supra note 159, at 61-64 (analyzing the sharing of oligopoly surplus and subsequent competitive losses between firms and workers).
218. This self-justifying or self-perpetuating feature of local cultures exemplifies the familiar phenomenon of "adaptive preferences." See J. ELSTER, SOUR GRAPES: STUDIES IN THE SUB-VERSION OF RATIONALITY 109-40 (1983).
219. See supra note 46.
220. See J. DERTOUZOS, E. HOLLAND & P. EBENER, THE LEGAL AND ECONOMIC CONSE-QUENCES OF WRONGFUL TERMINATION at ix (1988) (estimating that the annual average cost of wrongful discharge suits is only $2.56 per worker). When criteria other than the direct cost of litigation are considered, however, wrongful discharge suits appear more costly. See id. (noting that only about half of the total costs of suit goes to compensating discharged workers, while the other half goes to lawyers); Note, supra note 76, at 527 (arguing that administrative costs from suits are high relative to payouts for workers).
221. Affected personnel policies may include a reluctance to fire workers who perform inade-quately, a shift from use of full-time to part-time workers or outside contractors, and an increase in documentation and bureaucratization of employment decisions. See J. DERTOUZOS, E. HOL-LAND & P. EBENER, supra note 164, at 1-2.
222. Judge Learned Hand expressed the underlying conception in the celebrated case of James Baird Co. v. Gimbel Bros., Inc., 64 F.2d 344 (2d Cir. 1933): "The [plaintiff] had a ready escape from [its] difficulty by insisting upon a contract . . . ; and in commercial transactions it does not in the end promote justice to seek strained interpretations in aid of those who do not protect themselves." Id. at 346.
223. Except for ray discussion of "trust," see infra pp. 441-44, I also assume that there are no externalities.
224. The shift from nonlegal to legal sanctions would also have no effect on the optimal amount of reliance. See supra pp. 400-01 (showing that both nonlegal and legal sanctions can obtain optimal levels of reliance). The argument in the text assumes that contract damages assess the full costs of breach against the breaching party. If not, the legal sanction would underdeter breach and the parties might use nonlegal sanctions to supplement the deterrence accomplished by law.
225. Recall that contract law compensates the victim of breach for net loss of expectancy. If a nonlegal bond redounds to the benefit of the victim, its value would be deducted from the damages awarded legally. For example, if a construction company forfeits a $1000 bond to a landowner upon breach of a contract, that amount would be deducted from the owner's subsequent damage recovery. If the loss were $1000, the bond would compensate the landowner for all damages, and recovery in a subsequent lawsuit would be $o. Generally, even if the courts undertook to enforce a commitment that the parties intended to enforce only by forfeiture of the bond, the availability of legal enforcement would have no effect when the posted bond is equal to the cost of breach and therefore fully compensates the victim. Legal enforcement of a nonlegal commitment overdeters breach, however, when the bond is not paid to the victim. The reason is that, under standard damage rules, the bond would not be deducted from the damages that the victim of breach would collect. Suppose, for example, that the $1000 bond is forfeited to a third party and that the parties intended this arrangement to be the sole remedy for breach. Legal enforcement then imposes a total penalty equal to twice actual costs of breach: the company forfeits the $1000 bond and pays $1000 in actual damages to the landowner. Consequently, the construction company will comply with the commitment even in some circumstances when breach would be efficient - that is, when breach would save the construction company more than $1000 but less than $2000.
226. Note, though, that such a rule cannot redistribute in future transactions: well-informed promisors subject to explicit contract sanctions will increase the price of the transaction accordingly.
227. For more detailed analysis of the costs of dispensing with requirements of form, see infra P. 455.
228. That is, if the background rule is "legal enforcement," it costs $100 to add a disclaimer. if the background rule is "no legal enforcement," it costs $100 to add a provision that authorizes legal enforcement.
229. If the costs of moving one way or another differ, it is not the number of transactions, but the total costs imposed on transactors by each background rule, that is decisive.
230. Of course, the meaning of "rationality" is complex and deeply contested. For the present argument, "rationality" means considerably more than conduct that, taken transaction-by-transaction, advances a consistent set of preferences held by the transactor. Rather, "rationality" in the present context encompasses what is sometimes understood as judgment or prudence. See J. ELSTER, SOLOMONIC JUDGEMENTS: STUDIES IN THE LIMITATIONS OF RATIONALITY 7-35 (1989); M. SLOTE, BEYOND OPTIMIZING: A STUDY OF RATIONAL CHOICE 47-81 (1989); Kronman, Practical Wisdom and Professional Character, 4 SOC. PHIL. & POL'Y 203, 208-11 (1988).
231. Of course, the meaning of "rationality" is complex and deeply contested. For the present argument, "rationality" means considerably more than conduct that, taken transaction-by-transaction, advances a consistent set of preferences held by the transactor. Rather, "rationality" in the present context encompasses what is sometimes understood as judgment or prudence. See J. ELSTER, SOLOMONIC JUDGEMENTS: STUDIES IN THE LIMITATIONS OF RATIONALITY 7-35 (1989); M. SLOTE, BEYOND OPTIMIZING: A STUDY OF RATIONAL CHOICE 47-81 (1989); Kronman, Practical Wisdom and Professional Character, 4 SOC. PHIL. & POL'Y 203, 208-11 (1988).
232. Of course, the meaning of "rationality" is complex and deeply contested. For the present argument, "rationality" means considerably more than conduct that, taken transaction-by-transaction, advances a consistent set of preferences held by the transactor. Rather, "rationality" in the present context encompasses what is sometimes understood as judgment or prudence. See J. ELSTER, SOLOMONIC JUDGEMENTS: STUDIES IN THE LIMITATIONS OF RATIONALITY 7-35 (1989); M. SLOTE, BEYOND OPTIMIZING: A STUDY OF RATIONAL CHOICE 47-81 (1989); Kronman, Practical Wisdom and Professional Character, 4 SOC. PHIL. & POL'Y 203, 208-11 (1988).
233. Although some readers may have a conception of "poor judgment" different from that presented here, the term provides a useful label for the transactor who responds to regulation in the way described in the text. Throughout this Article, I use the term "poor-judgment transactor" in this narrow sense.
234. To the extent that borrowers understand this, lenders in competitive markets might Provide the information voluntarily, even without regulation, because the information would attract borrowers. In a market of rational transactors, nonetheless, regulation would be justified if Public-goods problems resulted in a suboptimal level of disclosure. See, e.g., Easterbrook & Fischel, supra note 149, at 680-96 (discussing the public-goods argument for mandatory securities disclosures). On balance, for simple calculations such as interest rates, it seems likely that regulation is justified - if at all - by transactors' poor judgment rather than by collective goods problems with providing information to rational transactors. This discussion assumes that all transactors in the market are rational. In a mixed market of rational and poor-judgment transactors, the effects of regulation are more complex. See infra P 446.
235. See, e.g., American Home Improvement Co. v. Maclver, 105 N.H. 435, 437-38, 201 A.2d 886, 887 (1964).
236. Legal regulation of this commitment may thus produce social benefits.
237. For analysis of the distributional issues in this context, see infra pp. 440-41.
238. Recall that, to develop these basic principles, the discussion assumed that the decisionmaker can act cheaply and rationally: the question for the decisionmaker, then, is whether there is any legally enforceable term that would be more efficient than the parties' nonlegal commitments. The further difficulties that courts would face in supplying the efficient terms are considered as the framework is applied to common law and regulatory doctrines. See infra pp. 446-66.
239. This type of regulation is again Pareto superior: all transactors are at least as well off as before, and some transactors are better off.
240. The principle that the law may improve the contracting process by supplying terms to which the parties would wish to consent but could not draft themselves has been applied formally to the standard rules of contract law, such as damages and excuse, see, e.g., Shavell, Design of Contracts, supra note 97, at 147, and has spawned an extensive literature on the role of contracting costs in the formulation of legal rules. For recent general work, see, for example, Ayres & Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989); Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820 (1989); Clark, Contracts, Elites, and Traditions in the Making of Corporate Law, 89 COLUM. L. REV. 1703 (1989); and Gillette, Commercial Relationships and the Selection of Default Rules for Remote Risks, 19 J. LEGAL STUD. 535 (1990). This approach has not, however, been applied to the problems that I discuss here. For a fuller consideration of its conceptual underpinnings than is possible here, see D. Charny, supra note 20.
241. The principle that the law may improve the contracting process by supplying terms to which the parties would wish to consent but could not draft themselves has been applied formally to the standard rules of contract law, such as damages and excuse, see, e.g., Shavell, Design of Contracts, supra note 97, at 147, and has spawned an extensive literature on the role of contracting costs in the formulation of legal rules. For recent general work, see, for example, Ayres & Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989); Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820 (1989); Clark, Contracts, Elites, and Traditions in the Making of Corporate Law, 89 COLUM. L. REV. 1703 (1989); and Gillette, Commercial Relationships and the Selection of Default Rules for Remote Risks, 19 J. LEGAL STUD. 535 (1990). This approach has not, however, been applied to the problems that I discuss here. For a fuller consideration of its conceptual underpinnings than is possible here, see D. Charny, supra note 20.
242. The principle that the law may improve the contracting process by supplying terms to which the parties would wish to consent but could not draft themselves has been applied formally to the standard rules of contract law, such as damages and excuse, see, e.g., Shavell, Design of Contracts, supra note 97, at 147, and has spawned an extensive literature on the role of contracting costs in the formulation of legal rules. For recent general work, see, for example, Ayres & Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989); Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820 (1989); Clark, Contracts, Elites, and Traditions in the Making of Corporate Law, 89 COLUM. L. REV. 1703 (1989); and Gillette, Commercial Relationships and the Selection of Default Rules for Remote Risks, 19 J. LEGAL STUD. 535 (1990). This approach has not, however, been applied to the problems that I discuss here. For a fuller consideration of its conceptual underpinnings than is possible here, see D. Charny, supra note 20.
243. The principle that the law may improve the contracting process by supplying terms to which the parties would wish to consent but could not draft themselves has been applied formally to the standard rules of contract law, such as damages and excuse, see, e.g., Shavell, Design of Contracts, supra note 97, at 147, and has spawned an extensive literature on the role of contracting costs in the formulation of legal rules. For recent general work, see, for example, Ayres & Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989); Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820 (1989); Clark, Contracts, Elites, and Traditions in the Making of Corporate Law, 89 COLUM. L. REV. 1703 (1989); and Gillette, Commercial Relationships and the Selection of Default Rules for Remote Risks, 19 J. LEGAL STUD. 535 (1990). This approach has not, however, been applied to the problems that I discuss here. For a fuller consideration of its conceptual underpinnings than is possible here, see D. Charny, supra note 20.
244. The principle that the law may improve the contracting process by supplying terms to which the parties would wish to consent but could not draft themselves has been applied formally to the standard rules of contract law, such as damages and excuse, see, e.g., Shavell, Design of Contracts, supra note 97, at 147, and has spawned an extensive literature on the role of contracting costs in the formulation of legal rules. For recent general work, see, for example, Ayres & Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989); Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820 (1989); Clark, Contracts, Elites, and Traditions in the Making of Corporate Law, 89 COLUM. L. REV. 1703 (1989); and Gillette, Commercial Relationships and the Selection of Default Rules for Remote Risks, 19 J. LEGAL STUD. 535 (1990). This approach has not, however, been applied to the problems that I discuss here. For a fuller consideration of its conceptual underpinnings than is possible here, see D. Charny, supra note 20.
245. See Hadfield, Problematic Relations: Franchising and the Law of Incomplete Contracts, 42 STAN. L. REV. 927, 948-55 (1990). One study found that all franchise contracts in the fast-food industry gave the franchisor a termination right, frequently for violation of any condition of the agreement. See id. at 939-40.
246. The franchisor may threaten termination to extract payments from franchisees or may in fact terminate the franchises to implement a cheaper system of direct distribution. Although generally permitted by franchise contracts and by the common law, such terminations have been a target of statutory and administrative regulation. See, e.g., Kealey Pharmacy & Home Care Servs. v. Walgreen Co., 761 F.2d 345, 350 (7th Cir. 1985) (holding that a Wisconsin statute forbade a franchisor from terminating a franchise in order to substitute its own store); Carlos v. Philips Business Sys., 556 F. Supp. 769, 775-77 (E.D.N.Y.), aff'd per curiam, 742 F.2d 1432 (2d Cir. 1983) (holding that New Jersey and Connecticut statutes prevented a franchisor from canceling exclusivity provisions of franchise agreements). The argument in the text provides a rigorous justification for such regulatory intervention, which is often described as the self-serving product of franchisee interest-group politics. See, e.g., Goetz & Scott, Principles of Relational Contracts, 67 VA. L. REV. 1089, 1132 (1981).
247. Franchisees have often, but generally unsuccessfully, sought to premise legal liability on informal assurances or commitments made by franchisors. These assurances are often given when the franchisee asks questions about franchisor policy or about contract provisions that deal with termination. See, e.g., Boat & Motor Mart v. Sea Ray Boats, Inc., 825 F.2d 1285, 1288 (9th Cir. 1987); Entre Computer Centers, Inc. v. FMG of Kansas City, Inc., 819 F.2d 1279, 1281-82 (4th Cir. 1987); Consumers Petroleum Co. v. Texaco, Inc., 804 F.2d 907, 909-10 (6th Cir. 1986) (interpreting the Petroleum Marketing Practices Act, 15 U.S.C. §§ 2801-2841 (1988)); Vaughn v. General Foods Corp., 797 F.2d 1403, 1405-06 (7th Cir. 1986); cf. Van Tassel v. McDonald Corp., 159 Mich. App. 745, 752, 407 N.W.2d 6, 9 (1987) (dismissing a fraud action because statements were mere "puffing").
248. Indeed, at least in theory, the market - here, prospective franchisees and their investment advisers - may be better informed about the justifiability of past terminations than courts could be. See Klein, Transaction Cost Determinants of "Unfair" Contractual Arrangements, 70 AM. ECON. REV. PAPERS & PROC. 356, 360 (1980). There is, however, virtually no documentation of the actual operation of reputational sanctions in franchise markets.
249. For discussions of why companies choose to franchise or use direct outlets in various markets, see Brickley & Dark, The Choice of Organizational Form: The Case of Franchising, 18 J. FIN. ECON. 401, 410-19 (1987); and Norton, An Empirical Look at Franchising as an Organizational Form, 61 J. BUS. 197, 211 (1988).
250. For discussions of why companies choose to franchise or use direct outlets in various markets, see Brickley & Dark, The Choice of Organizational Form: The Case of Franchising, 18 J. FIN. ECON. 401, 410-19 (1987); and Norton, An Empirical Look at Franchising as an Organizational Form, 61 J. BUS. 197, 211 (1988).
251. The analysis may be illustrated with a numerical example. Suppose there is a small Possibility that the nonlegal sanctioning system will break down and allow the franchisor to act opportunistically. Assume that the expected cost to the franchisee of this residual opportunism is $50, while the expected benefit to the franchisor is $25. A legally enforceable contract clause could prevent opportunism altogether, protecting the parties, taken jointly, from an expected loss of $25. Suppose, however, that drafting the contract clause costs $35. The parties will then rationally rely upon nonlegal sanctions rather than draft the clause, even though the nonlegal sanctions leave open opportunities for conduct against which the parties would prefer to protect themselves. Intervention by courts is efficient if it can accomplish the effects of the contract clause - that is, if it can save $25 - for less than $25. If, for example, the intervention imposes prospective error and litigation costs of $10, courts should adopt a rule of intervention: the courts' policy creates a $15 net gain for the parties. (This analysis sets aside any costs that intervention imposes on non-transactors. See infra pp. 441-43. At first glance, it might appear that the franchisor would not want to ban opportunism because, on the numbers here, the ban would deprive the franchisor of $25. This impression, however, ignores the important fact that both parties benefit from maximizing the joint expected gains from the relationship. In this example, the rational franchisee would not enter a relationship in which the franchisor retained the right to act opportunistically unless the franchisor paid an extra $50 to compensate the franchisee's expected losses. Because the franchisor's benefit from this right is only $25, retaining the right actually imposes on the franchisor a net cost of $25. The franchisor would prefer to bind itself not to act opportunistically and would therefore favor ex post legal intervention, if drafting the appropriate contract clause were not cost-effective ex ante. Note that legal intervention would not prevent efficient breach of the franchise contract. If the franchisor's benefits from the breach were $80, it could still breach, pay the franchisee $50 in legally enforced damages, and pocket the difference.
252. For a general survey of contracting practices in franchise relationships, see Hadfield, supra note 183, at 927-47.
253. The classic analysis of "shopping" for contract terms is Schwartz & Wilde, Intervening in Markets on the Basis of Imperfect Information: A Legal and Economic Analysis, 127 U. PA. L. REV. 630 (1979). As Schwartz and Wilde demonstrate, "shopping" by informed transactors way cause optimal terms to be provided for all transactors in the market, even if some transactors are imperfectly informed, because sellers (or, in this case, franchisors) will compete for informed buyers (franchisees). See id. at 650. This mechanism may be imperfect in the present context, however. As explained in the text, the high costs of obtaining information about some types of contingencies may mean that few, if any, franchisees are well enough informed to induce emergence of optimal terms. Further, collective action problems could cause transactors to expend a suboptimal amount to develop contract terms. Although franchisees as a group would find it cost-effective to purchase information about franchisors' form contracts, no individual franchisee would do so, because the benefit to that franchisee from the information would not justify the cost, particularly when there is a small probability that the franchisee can successfully negotiate for improved terms.
254. A transactor needs to have a fair amount of information to make the correct decision about how much to invest in gathering information.
255. Cf- Kennedy, supra note 44, at 601-02 (describing the case of "competitive pathology" in consumer markets).
256. In contrast, under a legal regime that intervened when high drafting costs led parties to rely on nonlegal commitments, well-informed transactors readily could opt-out of the regulatory regime with a fairly simple contract term. I analyze further this important asymmetry in judicially implied background terms in D. Charny, supra note 20.
257. As I explain below, see infra pp. 460-63, current good-faith doctrine is at once over- and under-inclusive in dealing with the problem of enforcing nonlegal commitments. For that reason, parties would hesitate to incorporate that doctrine into contracts and might have good reason to modify it in those jurisdictions that presumptively apply the duty of good faith to all contracts.
258. See Hadfield, supra note 183, at 943 (emphasizing the asymmetry in franchise contract obligations).
259. Cf. id. at 962 (citing survey evidence indicating that most franchisors seek inexperienced franchisees).
260. This intervention would also make exploitative franchisors worse off to the extent that it deprives them of profits from opportunism and would make the poor-judgment franchisees correspondingly better off. The argument in the text assumes that this distributive impact is not a reason to oppose regulation. Presumptively, the transfer from franchisees to franchisors accomplishes no net social gain, and there is no reason to think that franchisors are plausible candidates for a socially endorsed mechanism by which they may extract wealth from franchisees.
261. Cf. Hoffman v. Red Owl Stores, Inc., 26 Wis. 2d 683, 686-91, 133 N.W.2d 267, 268-71 (1905) (involving a prospective franchisee who liquidated a profitable business and incurred a variety of costs and losses in reliance on informal assurances from the franchisor).
262. See supra note 197.
263. In particular, this argument assumes that the clever and naive franchisees are generally equivalent except in their ability to bargain for contract terms; otherwise, a contracting situation in which the two are compensated at the same rate will not persist. If clever franchisees are better businesspersons in other respects, they may leave the market when their compensation is reduced; alternatively, franchisors may stop contracting with naive franchisees who are being overcompensated for their generally meager business skills or may devise some other means of maintaining a compensation differential, which may negate the redistributive effect.
264. Indeed, confiscation of the income earned by transactional cleverness might be condemned by some liberals as unjust. See R. NOZICK, ANARCHY, STATE, AND UTOPIA 167-73, 213-19 (1975) (arguing that redistribution of wealth from "natural" talents violates moral side constraints on public action).
265. See infra pp. 444-45.
266. See, e.g., Kennedy, supra note 44, at 566-68 (describing "pervasive inequalities" in the background social order as a prerequisite to analysis).
267. For example, the elimination of differential returns based on arbitrary or unearned distinctions is the key to the conception of justice developed by John Rawls. See J. RAWLS, A THEORY OF JUSTICE 310-32 (1971). Others would view gains awarded to shrewd bargainers as justly earned. See supra note 201. See generally L. WEINREB, NATURAL LAW AND JUSTICE 184-223 (1987) (discussing the implications of conceptions of justice for claims of entitlement).
268. For example, the elimination of differential returns based on arbitrary or unearned distinctions is the key to the conception of justice developed by John Rawls. See J. RAWLS, A THEORY OF JUSTICE 310-32 (1971). Others would view gains awarded to shrewd bargainers as justly earned. See supra note 201. See generally L. WEINREB, NATURAL LAW AND JUSTICE 184-223 (1987) (discussing the implications of conceptions of justice for claims of entitlement).
269. See, e.g., Farber & Matheson, supra note 39, at 927-28; Kennedy, Form and Substance in Private Law Adjudication, 89 HARV. L. REV. 1685, 1718 (1976); Williams, Alchemical Notes: Reconstructing Ideals From Deconstructed Rights, 22 HARV. C.R.-C.L.L. REV. 401, 406-08 (1987). See generally A. GIDDENS, THE CONSEQUENCES OF MODERNITY 83-92 (1990) (arguing that the question of how to promote systems of trust is crucial in modern bureaucratized social orders).
270. See, e.g., Farber & Matheson, supra note 39, at 927-28; Kennedy, Form and Substance in Private Law Adjudication, 89 HARV. L. REV. 1685, 1718 (1976); Williams, Alchemical Notes: Reconstructing Ideals From Deconstructed Rights, 22 HARV. C.R.-C.L.L. REV. 401, 406-08 (1987). See generally A. GIDDENS, THE CONSEQUENCES OF MODERNITY 83-92 (1990) (arguing that the question of how to promote systems of trust is crucial in modern bureaucratized social orders).
271. See, e.g., Farber & Matheson, supra note 39, at 927-28; Kennedy, Form and Substance in Private Law Adjudication, 89 HARV. L. REV. 1685, 1718 (1976); Williams, Alchemical Notes: Reconstructing Ideals From Deconstructed Rights, 22 HARV. C.R.-C.L.L. REV. 401, 406-08 (1987). See generally A. GIDDENS, THE CONSEQUENCES OF MODERNITY 83-92 (1990) (arguing that the question of how to promote systems of trust is crucial in modern bureaucratized social orders).
272. See Farber & Matheson, supra note 39, at 926-30.
273. See Williams, supra note 205, at 408.
274. See supra p. 428.
275. See Zeckhauser, The Muddled Responsibilities of Public and Private America, in AMERICAN SOCIETY: PUBLIC AND PRIVATE RESPONSIBILITIES 45, 58-59 (W. Knowlton & R. Zeckhauser eds. 1986) (discussing "reputational externality").
276. See, e.g., Akerlof & Dickens, The Economic Consequences of Cognitive Dissonance, 72 AM. ECON. REV. 307, 309 (1982) (noting that evaluation of evidence depends on how the evaluator frames the issue).
277. For example, stakeholders that see informal commitments breached in other firms as a result of hostile takeovers may abandon their own relationships with prospective takeover targets or attempt to negotiate more costly legal protections. See Schleifer & Summers, Breach of Trust in Hostile Takeovers, in CORPORATE TAKEOVERS, supra note 159, at 33, 45-46. There is no evidence, however, that stakeholders wrongly revise their estimates in response to breaches by other acquirors.
278. See supra p. 428.
279. See Kronman, Mistake, Disclosure, Information, and the Law of Contracts, 7 J. LEGAL STUD. 1, 1-27 (1978) (describing the incentive effects of mistake doctrine); Levmore, Securities and Secrets: Insider Trading and the Law of Contracts, 68 VA. L. REV. 117, 144-58 (1982) (describing the incentive effects of disclosure requirements). The effect of legal regulation on incentives to acquire information exemplifies a more general paradox: the better informed market participants tend to be, the more the market adjusts prices and terms of trade to incorporate individuals' information and preferences, and so the less is each individual trader's incentive to gather additional information. See, e.g., Grossman & Stiglitz, On the Impossibility of Informationally Efficient Markets, 70 AM. ECON. REV. 393 (1980). The complex interactive effects of providing information in different markets make hazardous the sort of generalizations that Kronman and Levmore offer to justify the law's current bias against relief from contract on grounds of mistake and disclosure requirements.
280. See Kronman, Mistake, Disclosure, Information, and the Law of Contracts, 7 J. LEGAL STUD. 1, 1-27 (1978) (describing the incentive effects of mistake doctrine); Levmore, Securities and Secrets: Insider Trading and the Law of Contracts, 68 VA. L. REV. 117, 144-58 (1982) (describing the incentive effects of disclosure requirements). The effect of legal regulation on incentives to acquire information exemplifies a more general paradox: the better informed market participants tend to be, the more the market adjusts prices and terms of trade to incorporate individuals' information and preferences, and so the less is each individual trader's incentive to gather additional information. See, e.g., Grossman & Stiglitz, On the Impossibility of Informationally Efficient Markets, 70 AM. ECON. REV. 393 (1980). The complex interactive effects of providing information in different markets make hazardous the sort of generalizations that Kronman and Levmore offer to justify the law's current bias against relief from contract on grounds of mistake and disclosure requirements.
281. See Kronman, Mistake, Disclosure, Information, and the Law of Contracts, 7 J. LEGAL STUD. 1, 1-27 (1978) (describing the incentive effects of mistake doctrine); Levmore, Securities and Secrets: Insider Trading and the Law of Contracts, 68 VA. L. REV. 117, 144-58 (1982) (describing the incentive effects of disclosure requirements). The effect of legal regulation on incentives to acquire information exemplifies a more general paradox: the better informed market participants tend to be, the more the market adjusts prices and terms of trade to incorporate individuals' information and preferences, and so the less is each individual trader's incentive to gather additional information. See, e.g., Grossman & Stiglitz, On the Impossibility of Informationally Efficient Markets, 70 AM. ECON. REV. 393 (1980). The complex interactive effects of providing information in different markets make hazardous the sort of generalizations that Kronman and Levmore offer to justify the law's current bias against relief from contract on grounds of mistake and disclosure requirements.
282. Disclosure requirements, however, should be structured to protect trade secrets. See Levmore, supra note 213, at 139-40.
283. See supra pp. 439-41.
284. See supra pp. 426-29.
285. See supra p. 429.
286. The classic discussion of the relation of contract principles to promissory estoppel is Henderson, Promissory Estoppel and Traditional Contract Doctrine, 78 YALE L.J. 343 (1969). Restatements of the issues from the vantage point of critical theory include Dalton, An Essay in the Deconstruction of Contract Doctrine, 94 YALE L.J. 997, 1083-95 (1985); and Feinman, Critical Approaches to Contract Law, 30 UCLA L. REV. 829, 854-56 (1983). Recent surveys of the state of the doctrine include Barnett & Becker, Beyond Reliance: Promissory Estoppel, Contract Formalities, and Misrepresentations, 15 HOFSTRA L. REV. 443 (1987); Farber & Matheson, supra note 39; Kostritsky, A New Theory of Assent-Based Liability Emerging Under the Guise of Promissory Estoppel: An Explanation and Defense, 33 WAYNE L. REV. 895 (1987); and Metzger & Phillips, The Emergence of Promissory Estoppel as an Independent Theory of Recovery, 35 RUTGERS L. REV. 472 (1983).
287. The classic discussion of the relation of contract principles to promissory estoppel is Henderson, Promissory Estoppel and Traditional Contract Doctrine, 78 YALE L.J. 343 (1969). Restatements of the issues from the vantage point of critical theory include Dalton, An Essay in the Deconstruction of Contract Doctrine, 94 YALE L.J. 997, 1083-95 (1985); and Feinman, Critical Approaches to Contract Law, 30 UCLA L. REV. 829, 854-56 (1983). Recent surveys of the state of the doctrine include Barnett & Becker, Beyond Reliance: Promissory Estoppel, Contract Formalities, and Misrepresentations, 15 HOFSTRA L. REV. 443 (1987); Farber & Matheson, supra note 39; Kostritsky, A New Theory of Assent-Based Liability Emerging Under the Guise of Promissory Estoppel: An Explanation and Defense, 33 WAYNE L. REV. 895 (1987); and Metzger & Phillips, The Emergence of Promissory Estoppel as an Independent Theory of Recovery, 35 RUTGERS L. REV. 472 (1983).
288. The classic discussion of the relation of contract principles to promissory estoppel is Henderson, Promissory Estoppel and Traditional Contract Doctrine, 78 YALE L.J. 343 (1969). Restatements of the issues from the vantage point of critical theory include Dalton, An Essay in the Deconstruction of Contract Doctrine, 94 YALE L.J. 997, 1083-95 (1985); and Feinman, Critical Approaches to Contract Law, 30 UCLA L. REV. 829, 854-56 (1983). Recent surveys of the state of the doctrine include Barnett & Becker, Beyond Reliance: Promissory Estoppel, Contract Formalities, and Misrepresentations, 15 HOFSTRA L. REV. 443 (1987); Farber & Matheson, supra note 39; Kostritsky, A New Theory of Assent-Based Liability Emerging Under the Guise of Promissory Estoppel: An Explanation and Defense, 33 WAYNE L. REV. 895 (1987); and Metzger & Phillips, The Emergence of Promissory Estoppel as an Independent Theory of Recovery, 35 RUTGERS L. REV. 472 (1983).
289. The classic discussion of the relation of contract principles to promissory estoppel is Henderson, Promissory Estoppel and Traditional Contract Doctrine, 78 YALE L.J. 343 (1969). Restatements of the issues from the vantage point of critical theory include Dalton, An Essay in the Deconstruction of Contract Doctrine, 94 YALE L.J. 997, 1083-95 (1985); and Feinman, Critical Approaches to Contract Law, 30 UCLA L. REV. 829, 854-56 (1983). Recent surveys of the state of the doctrine include Barnett & Becker, Beyond Reliance: Promissory Estoppel, Contract Formalities, and Misrepresentations, 15 HOFSTRA L. REV. 443 (1987); Farber & Matheson, supra note 39; Kostritsky, A New Theory of Assent-Based Liability Emerging Under the Guise of Promissory Estoppel: An Explanation and Defense, 33 WAYNE L. REV. 895 (1987); and Metzger & Phillips, The Emergence of Promissory Estoppel as an Independent Theory of Recovery, 35 RUTGERS L. REV. 472 (1983).
290. The classic discussion of the relation of contract principles to promissory estoppel is Henderson, Promissory Estoppel and Traditional Contract Doctrine, 78 YALE L.J. 343 (1969). Restatements of the issues from the vantage point of critical theory include Dalton, An Essay in the Deconstruction of Contract Doctrine, 94 YALE L.J. 997, 1083-95 (1985); and Feinman, Critical Approaches to Contract Law, 30 UCLA L. REV. 829, 854-56 (1983). Recent surveys of the state of the doctrine include Barnett & Becker, Beyond Reliance: Promissory Estoppel, Contract Formalities, and Misrepresentations, 15 HOFSTRA L. REV. 443 (1987); Farber & Matheson, supra note 39; Kostritsky, A New Theory of Assent-Based Liability Emerging Under the Guise of Promissory Estoppel: An Explanation and Defense, 33 WAYNE L. REV. 895 (1987); and Metzger & Phillips, The Emergence of Promissory Estoppel as an Independent Theory of Recovery, 35 RUTGERS L. REV. 472 (1983).
291. The classic discussion of the relation of contract principles to promissory estoppel is Henderson, Promissory Estoppel and Traditional Contract Doctrine, 78 YALE L.J. 343 (1969). Restatements of the issues from the vantage point of critical theory include Dalton, An Essay in the Deconstruction of Contract Doctrine, 94 YALE L.J. 997, 1083-95 (1985); and Feinman, Critical Approaches to Contract Law, 30 UCLA L. REV. 829, 854-56 (1983). Recent surveys of the state of the doctrine include Barnett & Becker, Beyond Reliance: Promissory Estoppel, Contract Formalities, and Misrepresentations, 15 HOFSTRA L. REV. 443 (1987); Farber & Matheson, supra note 39; Kostritsky, A New Theory of Assent-Based Liability Emerging Under the Guise of Promissory Estoppel: An Explanation and Defense, 33 WAYNE L. REV. 895 (1987); and Metzger & Phillips, The Emergence of Promissory Estoppel as an Independent Theory of Recovery, 35 RUTGERS L. REV. 472 (1983).
292. RESTATEMENT (SECOND) OF CONTRACTS § 90 (1979).
293. In these cases, as in many promissory estoppel cases that arise from commercial transactions, the facts that support the plaintiffs' promissory estoppel claims might support colorable contract claims as well. If the reliance is "bargained for," it might count as consideration for the promise. See, e.g., Barnett & Becker, supra note 218, at 481-85; Henderson, supra note 218, at 345-50. A distinct promissory estoppel argument helps the plaintiff in two types of cases. First, the plaintiff may have recourse solely to promissory estoppel because unmet formal requirements bar contract enforcement. Second, the plaintiff may have no contract argument because he cannot show that his acts in reliance count as "bargained for" consideration - that is, that they were "sought by the promisor in exchange for the promise." RESTATEMENT (SECOND) OF CONTRACTS § 71(2) (1979).
294. See, e.g., Vastoler v. American Can Co., 700 F.2d 916, 919-20 (3d Cir. 1983); Landro v. Glendenning Motorways, Inc., 625 F.2d 1344, 1355 (8th Cir. 1980).
295. See supra pp. 430-32, 439-40.
296. A court could also hold that the commitment was not a "promise" within the scope of promissory estoppel doctrine if the promisee accurately appreciated the probability that the promise would not be kept. This analysis would be strained, however, because the courts should hold the same commitment to be a "promise" if the promisee misapprehended the probability that the commitment would be kept and if rational transactors would have, given the correct probability, preferred a legally enforceable term.
297. For example, courts often invoke promissory estoppel to bind a bidder to a mistaken bid upon which the plaintiff - the recipient of the bid - relied. The landmark case is Drennan v. Star Paving Co., 51 Cal. 2d 409, 333 P.2d 757 (1958) (Traynor, J.). See also Allen M. Campbell Co., General Contractors v. Virginia Metal Indus., Inc., 708 F.2d 930, 931-34 (4th Cir. 1983) (applying promissory estoppel and surveying the case law). Courts have ignored several features of these cases. First, nonlegal pressures appear generally to induce the bidder to perform even when the bid is too low. See Schultz, The Firm Offer Puzzle: A Study of Business Practice in the Construction Industry, 19 U. CHI. L. REV. 237, 267-69 (1952) (presenting survey data indicating that bidders for construction contracts perform even if bids were much too low); Note, Another Look at Construction Bidding and Contracts at Formation, 53 VA. L. REV. 1720, 1734-35 (1967) (same). Although bidders cite "ethical" concerns, not reputational pressures, as reasons for honoring the bid, see Schultz, supra, at 268, reputational pressures probably are important as well, because bid recipients state that they will not accept bids from subcontractors who are "untrustworthy" or have "poor reputations," Note, supra, at 1739. Second, the recipients recognize that there is a small probability that each bid is mistaken and, in turn, an even smaller probability that the recipient would lose the "benefit of the bargain," both because the bidder may nonetheless perform and because the recipient can shop around for other bids. See Schultz, supra, at 260. On these facts, there are no grounds for legal intervention under the framework that I propose. The strongest argument for enforcement of the bids is that legal enforceability is the efficient term, but one that high bargaining costs prevent the parties from reaching. The argument has two components. First, the efficient term is that the bidder is liable even when the bid is mistaken, because that term induces bidders to take care in preparing their bids. Second, parties cannot bargain for this term because it is cumbersome to complete contract formalities for each of the hundreds of bids that might be submitted. Neither component of the argument is powerful enough to justify courts' use of promissory estoppel doctrine. It is not clear a priori that strict liability for bidders (rather than negligence) is the best rule, or that it would not be efficient to put some duty of verification on the recipient of the bid; further, in many contexts, bidders could cheaply adopt the purportedly efficient strict liability term by forming an option contract, as under U.C.C. § 2-205 (1987). Viewed in that light, it is particularly perverse for courts to endorse promissory estoppel theories for written offers that readily could have been formulated as option contracts. See E.A. Coronis Assocs. v. M. Gordon Constr. Co., 90 N.J. Super. 69, 216 A.2d 246 (1966) (exemplifying the perverse approach).
298. For example, courts often invoke promissory estoppel to bind a bidder to a mistaken bid upon which the plaintiff - the recipient of the bid - relied. The landmark case is Drennan v. Star Paving Co., 51 Cal. 2d 409, 333 P.2d 757 (1958) (Traynor, J.). See also Allen M. Campbell Co., General Contractors v. Virginia Metal Indus., Inc., 708 F.2d 930, 931-34 (4th Cir. 1983) (applying promissory estoppel and surveying the case law). Courts have ignored several features of these cases. First, nonlegal pressures appear generally to induce the bidder to perform even when the bid is too low. See Schultz, The Firm Offer Puzzle: A Study of Business Practice in the Construction Industry, 19 U. CHI. L. REV. 237, 267-69 (1952) (presenting survey data indicating that bidders for construction contracts perform even if bids were much too low); Note, Another Look at Construction Bidding and Contracts at Formation, 53 VA. L. REV. 1720, 1734-35 (1967) (same). Although bidders cite "ethical" concerns, not reputational pressures, as reasons for honoring the bid, see Schultz, supra, at 268, reputational pressures probably are important as well, because bid recipients state that they will not accept bids from subcontractors who are "untrustworthy" or have "poor reputations," Note, supra, at 1739. Second, the recipients recognize that there is a small probability that each bid is mistaken and, in turn, an even smaller probability that the recipient would lose the "benefit of the bargain," both because the bidder may nonetheless perform and because the recipient can shop around for other bids. See Schultz, supra, at 260. On these facts, there are no grounds for legal intervention under the framework that I propose. The strongest argument for enforcement of the bids is that legal enforceability is the efficient term, but one that high bargaining costs prevent the parties from reaching. The argument has two components. First, the efficient term is that the bidder is liable even when the bid is mistaken, because that term induces bidders to take care in preparing their bids. Second, parties cannot bargain for this term because it is cumbersome to complete contract formalities for each of the hundreds of bids that might be submitted. Neither component of the argument is powerful enough to justify courts' use of promissory estoppel doctrine. It is not clear a priori that strict liability for bidders (rather than negligence) is the best rule, or that it would not be efficient to put some duty of verification on the recipient of the bid; further, in many contexts, bidders could cheaply adopt the purportedly efficient strict liability term by forming an option contract, as under U.C.C. § 2-205 (1987). Viewed in that light, it is particularly perverse for courts to endorse promissory estoppel theories for written offers that readily could have been formulated as option contracts. See E.A. Coronis Assocs. v. M. Gordon Constr. Co., 90 N.J. Super. 69, 216 A.2d 246 (1966) (exemplifying the perverse approach).
299. See, e.g., Vastoler, 700 F.2d at 919-20; Landro, 625 F.2d at 1355; Oates v. Teamster Affiliates Pension Plan, 482 F. Supp. 481, 489 (D.D.C. 1979).
300. Apparently what the court meant is: "when the promise is made to induce a future return performance by the promisee." Otherwise, the statement, taken literally, would make all promises enforceable.
301. Oates, 482 F. Supp. at 489.
302. In a recent comprehensive survey of the case law, Farber and Matheson argued that it should be sufficient for recovery that the promisor made a "credible" promise based on his own "economic benefit." Farber & Matheson, supra note 39, at 929-34. They endorse, on that ground, decisions such as those criticized in the last two subsections. See id. at 929-31. The analysis here reveals that the "economic benefit" test is overinclusive. It would entitle a promisee to recover when he clearly understood the odds that nonlegal sanctions would fail and, nonetheless, on the basis of those odds decided not to place the promise in enforceable form. The test thus ignores the possibility that the transactors might make and rely upon commitments when both parties rationally accept the risk that the commitments will be breached without legal consequence. Furthermore, the test would permit the promisee to recover even if he ?f8 suffered no loss from the transaction. To the extent that Farber and Matheson have described the approach that courts now take, see id. at 907-24, it seems that courts have taken a sharp turn in the wrong direction. Two grounds outside the scope of the present analysis might justify the economic benefit test. First, it may be that detriment is so frequent, but so hard to prove, that courts should dispense with any requirement of proof. The case for this proposition has not, however, been well established. Second, the economic benefit test might be justified on noninstrumental moral grounds. Farber and Matheson suggest, for example, that a party who has obtained a benefit by making a commitment should be, as a matter of justice, required to adhere to that commitment. See id. at 936-37. But, even as a principle of justice, this claim is subject to criticism from the perspective that I have developed. As noted above, neither liberal nor communitarian principles can plausibly endorse enforcement of nonlegal commitments without a theory of nonlegal sanctions. In particular, the liberal would view the restitutionary (benefit) argument with some suspicion - the benefits that the committing parties receive are presumably voluntarily conferred and thus, in the liberal morality of restitution, create no obligation to compensate. See supra PP- 385-86. Similarly, a communitarian theorist would want to explain why transactors who confer benefits on the basis of nonlegal sanctions cannot be said to have made a rational ex ante determination that the transaction was fair to them, given the probability, to which they would have adverted, that nonlegal sanctions might break down. See supra pp. 387-89. The strongest response is, as Farber and Matheson suggest, an appeal to the social value of trust, which has been discussed above. See supra pp. 441-44.
303. The promise should be one "which the promisor should reasonably expect to induce action or forbearance on the part of the promisee . . . ." RESTATEMENT (SECOND) OF CONTRACTS § 90 (1979).
304. See, e.g., Wheeler v. White, 398 S.W.2d 93, 96 (Tex. 1985) (allowing enforcement when the promisee "acts to his detriment in reasonable
305. In pension cases, for instance, courts may find an equitable estoppel when the promisor knew that the promisee would rely and knew or should have known that the promisor would not keep his commitment. See, e.g., Kahn v. Keystone Resources, Inc., 575 F. Supp. 1084, 1093 (W.D. Pa. 1983). It is irrelevant under this formulation whether the promisee's reliance is "reasonable."
306. For example, the franchisor may be better informed than the franchisee about the future investments that the franchisee will have to make to maintain the business.
307. Although it would be more desirable to articulate the risk-shifting rationale directly rather than speak in terms of "foreseeability," the latter term is the traditional, though often criticized, rubric for this inquiry. See Posner & Rosenfeld, Impossibility and Related Doctrines in Contract Law: An Economic Analysis, 6 J. LEGAL STUD. 83, 88-97, 98-100 (1977).
308. On the most basic view, publicly held corporations should be risk-neutral because shareholders can diversify by holding shares in numerous corporations. See, e.g., Mayer & Smith, On the Corporate Demand for Insurance: Evidence from the Reinsurance Market, 63 J. BUS. 19, 19 (1990). Nonetheless, corporate managers may behave as if shareholders were risk-averse, and such behavior may be socially efficient or at least desireable from the shareholders' perspective. See, e.g., id. at 20-23. See generally H. Hansmann & R. Kraakman, The Uneasy Case for Limiting Shareholder Liability for Corporate Torts 43-45 (Oct. 1990) (unpublished manuscript on file at the Harvard Law School Library) (discussing corporate risk-aversion in the context of limited liability rules). Corporate managers could, however, then purchase liability insurance to cover corporate losses in suits on nonlegal commitments, as the potential liability would be restricted to a relatively small set of transactions and so would fall well within an uisurance range. See id. at 45. In contrast, it is difficult to imagine a comparable insurance Policy offered to individual workers, franchisees, or borrowers to protect them from opportunistic conduct by their transactional partners.
309. On the most basic view, publicly held corporations should be risk-neutral because shareholders can diversify by holding shares in numerous corporations. See, e.g., Mayer & Smith, On the Corporate Demand for Insurance: Evidence from the Reinsurance Market, 63 J. BUS. 19, 19 (1990). Nonetheless, corporate managers may behave as if shareholders were risk-averse, and such behavior may be socially efficient or at least desireable from the shareholders' perspective. See, e.g., id. at 20-23. See generally H. Hansmann & R. Kraakman, The Uneasy Case for Limiting Shareholder Liability for Corporate Torts 43-45 (Oct. 1990) (unpublished manuscript on file at the Harvard Law School Library) (discussing corporate risk-aversion in the context of limited liability rules). Corporate managers could, however, then purchase liability insurance to cover corporate losses in suits on nonlegal commitments, as the potential liability would be restricted to a relatively small set of transactions and so would fall well within an uisurance range. See id. at 45. In contrast, it is difficult to imagine a comparable insurance Policy offered to individual workers, franchisees, or borrowers to protect them from opportunistic conduct by their transactional partners.
310. See supra pp. 444-45.
311. From the transactor's viewpoint, precautions are cost-justified up to the point at which the benefits of further assurance of legal enforceability are outweighed by the costs of further precautions. However, the benefits of further assurance depend, from the transactor's perspective, on the background rule that courts will apply in deciding whether to excuse failure to comply with formalities. Courts should set requirements for the level of precaution, therefore, that achieve the optimal level of compliance for transactors taken as a group. The text gives a brief intuitive description of this solution; a more formal analysis is beyond the scope of this Article.
312. For example, in Wheeler v. White, 398 S.W.2d 93 (Tex. 1965), the lender induced the Borrower to rely on a form contract, drafted by the lender, that proved too indefinite to enforce. See id. at 94-95.
313. See supra pp. 439-40.
314. Fuller, Consideration and Form, 41 COLUM. L. REV. 799 (1941).
315. See id. at 813-14, 819.
316. A poor-judgment transactor in this situation might still press the arguments noted above. See supra p. 448.
317. See supra pp. 448-49.
318. See supra pp. 380-81.
319. See, e.g., Sharon Steel Corp. v. Chase Manhattan Bank, 691 F.2d 1039, 1048 (2d Cir. 1982) (indicating that extrinsic evidence should always be excluded), cert, denied, 460 U.S. 1012 (1983); Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504, 1514 (S.D.N.Y. 1989) (applying the parol evidence rule to exclude such statements); Harris v. Union Elec. Co., 622 S.W.2d 239, 246-50 (Mo. Ct. App. 1981) (same).
320. See supra pp. 414-16.
321. In some cases, bondholders seek protection from transactional innovations - new types of transactions that diminish the probability that the bonds will be repaid or deprive bondholders of rights that the contract seemed to have granted. For example, in Pittsburgh Terminal Corp. v. Baltimore & Ohio Railroad, 680 F.2d 933 (3d Cir. 1982), cert, denied, 459 U.S. 1056 (1983), the contract required that the borrower give notice to convertible debentureholders of some types of dividends but did not require notice before a spinoff of subsidiary stock, see id. at 936-39, a transaction uncommon in 1955, when the debentures were issued. In Metropolitan Life Insurance Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504 (S.D.N.Y. 1989), the court rejected the argument that the bondholders could not have anticipated a leveraged buyout for a company as large as Nabisco. See id. at 1511-14. For such cases, the prospect of judicial intervention removes the incentive for the parties to incur the costs to develop clauses to cover these risks. Cf. Bratton, The Economics and Jurisprudence of Convertible Bonds, 1984 WIS. L. REV. 667, 687-88 (describing possible innovations in anti-dilution clauses of convertible debentures). Evolution of the "standard form" bond contract would be stymied, as lawyers would not develop clauses to cover some new risks, but instead would leave them to be addressed by creative judicial interpretations.
322. For example, some courts have interpreted the duty of good faith to require the bank to give notice to the borrower before taking a specified action - a requirement that could be readily included in the explicit terms of a loan contract, See, e.g., K.M.C. Co. v. Irving Trust Co., 757 F.2d 752, 759 (6th Cir. 1985) (holding that the good faith duty requires notice); In re Martin Specialty Vehicles, Inc., 87 Bankr. 752, 766 (Bankr. D. Mass. 1988) (holding notice to be an aspect of good faith conduct); Alaska Statebank v. Fairco, 674 P.2d 288, 292 (Alaska 1983) (holding that the course of dealings and oral statements during negotiations created a duty to give notice before the repossession of collateral). Similarly, a. requirement of good faith for precipitating payment of a demand note in effect applies to these notes the duties that the parties may easily incorporate into the note with an acceleration clause under U.C.C. § 1-208 (1987). See, e.g., Reid v. Key Bank of S. Me., Inc., 821 F.2d 9, 13-15 (ist Cir. 1987) (interpreting demand instruments to include an implied good faith restriction on demand for payment); First Nat'1 Bank in Libby v. Twombly, 213 Mont. 66, 72-74, 689 P.2d 1226, 1229-30 (1984) (interpreting a demand note to allow an action for punitive damages and attorneys' fees when the UCC's covenant of good faith was breached). But see Centerre Bank of Kansas City, N.A. v. Distributors, Inc., 705 S.W.2d 42, 47-48 (Mo. Ct. App. 1985) (holding that the good faith restriction would add a term that the parties would have included had they wished it to apply).
323. See Jackson, The Fresh-Start Policy in Bankruptcy Law, 98 HARV. L. REV. 1393, 1404-14 (1985) (describing cognitive distortions that lead to excessive borrowing).
324. See Lott & Myers, Secured Lending, in THE BANKERS' HANDBOOK 622, 622-49 (W. Baughn & C. Walker eds. 1978) (discussing steps that banks should take to protect themselves when security is threatened with impairment).
325. For example, many businesspersons may not realize that a bank can use their checking account as an offset against any debts owed to the bank; rather, they tend to assume that the checking account is their "property." See, e.g., Spencer Cos. v. Chase Manhattan Bank, N.A., 81 Bankr. 194, 197 (Bankr. D. Mass. 1987).
326. Although capital markets are generally competitive at the stage at which the individual businessperson initially shops for a lending relationship, once the loan is made he becomes locked into the relationship. Initiating a new relationship with a different bank may be quite costly; other banks may be hesitant to accept a borrower with a history of difficulties; and the legal liabilities from the first relationship may be substantial and may include provisions that obstruct further borrowing, including collateralization of key assets and restrictions on further borrowing. Cutting off credit may therefore cripple the business.
327. See, e.g., K.M.C. Co. v. Irving Trust Co., 757 F.2d 752, 760-63 (6th Cir. 1985); State Nat'l Bank of El Paso v. Farah Mfg. Co., 678 S.W.2d 661, 680-90 (Tex. Ct. App. 1984).
328. Some cases speak of the relationship as fiduciary or quasi-fiduciary. Compare Commercial Cotton Co. v. United Cal. Bank, 163 Cal. App. 3d 511, 516, 209 Cal. Rptr. 551, 554 (1985) (finding the relationship between a depositor and a bank to be at least "quasi-fiduciary") with Steinberg v. Northwestern Nat'l Bank of Rochester, 238 N.W.2d 218, 219 (Minn. 1976) (finding no fiduciary duty to a sophisticated businessperson) and Thugpen v. Locke, 363 S.W.2d 247, 253 (Tex. 1962) (same). The label is misleading, however, because the relationship does not carry with it the full panoply of fiduciary norms, such as avoidance of conflicts of interest, full disclosure, and the duty to maximize the beneficiary's benefits.
329. By emphasizing reliance rather than transactional capacity, the courts make the same mistake in this context that they have made in developing promissory estoppel doctrine. See supra pp. 447-51.
330. See Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 HARV. L. REV. 369, 369-73 (1980); see also Gillette, Limitations on the Obligation of Good Faith, 1981 DUKE L.J. 619, 621-26, 643-47 (arguing that the concept of good faith is overbroad and internally incoherent); Summers, The General Duty of Good Faith - Its Recognition and Conceptualization, 67 CORNELL L. REV. 810, 821-24 (1982) (arguing that "good faith" has diverse meanings but is determinate in context).
331. See Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 HARV. L. REV. 369, 369-73 (1980); see also Gillette, Limitations on the Obligation of Good Faith, 1981 DUKE L.J. 619, 621-26, 643-47 (arguing that the concept of good faith is overbroad and internally incoherent); Summers, The General Duty of Good Faith - Its Recognition and Conceptualization, 67 CORNELL L. REV. 810, 821-24 (1982) (arguing that "good faith" has diverse meanings but is determinate in context).
332. See Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 HARV. L. REV. 369, 369-73 (1980); see also Gillette, Limitations on the Obligation of Good Faith, 1981 DUKE L.J. 619, 621-26, 643-47 (arguing that the concept of good faith is overbroad and internally incoherent); Summers, The General Duty of Good Faith - Its Recognition and Conceptualization, 67 CORNELL L. REV. 810, 821-24 (1982) (arguing that "good faith" has diverse meanings but is determinate in context).
333. See In re Martin Specialty Vehicles, 87 Bankr. 752, 764-67 (Bankr. D. Mass. 1988) (finding a requirement of good faith and fair dealing when initiating foreclosure on a demand note); First Nat'l Bank in Libby v. Twombly, 213 Mont. 66, 72-74, 689 P.2d 1226, 1229-30 (1984). For a counterexample from bondholders' litigation, see Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504, 1515-22 (?.D.N.Y. 1989) (rejecting bondholders' attempts to enforce informal commitments on grounds of good faith). But cf. Bratton, The Interpretation of Contracts Governing Corporate Debt Relationships, 5 CARDOZO L. REV. 371, 390-92 & n.68 (1984) (criticizing cases construing bond provisions for ignoring "contextual evidence").
334. See H. Hansmann & R. Kraakman, Hands-Tying In Principal-Agent Relationships: Venture Capital Financing, Publishing Contracts, and Academic Tenure 1-13 (June 1989) (unpublished manuscript) (forthcoming 7 J.L. ECON. & ORG. (1991)) (presenting an economic model for when such contracts are efficient). For example, the duty of good faith has been held to limit at-will termination of employment contracts, see, e.g., Fortune v. National Cash Register Co., 373 Mass. 96, 104-05, 364 N.E.2d 1251, 1257-58 (1977), and payment-on-demand clauses in loans, see, e.g., Reid v. Key Bank of S. Me., Inc., 821 F.2d 9, 13-15 (Ist Cir. 1987).
335. See H. Hansmann & R. Kraakman, Hands-Tying In Principal-Agent Relationships: Venture Capital Financing, Publishing Contracts, and Academic Tenure 1-13 (June 1989) (unpublished manuscript) (forthcoming 7 J.L. ECON. & ORG. (1991)) (presenting an economic model for when such contracts are efficient). For example, the duty of good faith has been held to limit at-will termination of employment contracts, see, e.g., Fortune v. National Cash Register Co., 373 Mass. 96, 104-05, 364 N.E.2d 1251, 1257-58 (1977), and payment-on-demand clauses in loans, see, e.g., Reid v. Key Bank of S. Me., Inc., 821 F.2d 9, 13-15 (Ist Cir. 1987).
336. Cf. Fischel, The Economics of Lender Liability, 99 YALE L.J. 131, 142-46 (1990) (criticizing State National Bank of El Paso v. Farah Manufacturing Co., 678 S.W.2d 661 (Tex. Ct. App. 1984), by arguing that hands-tying arrangements are not efficient as bonding mechanisms for default clause). The court should also consider, of course, whether the parties omitted the term from the contract because they intended not to be bound by it.
337. The leading case is Zilg v. Prentice-Hall Publishing Co., 717 F.2d 671 (2d Cir. 1983) Winter, J.), cert, denied, 466 U.S. 938 (1984).
338. See H. Hansmann & R. Kraakman, supra note 257, at 25-29 (analyzing this contractual situation in terms of economic efficiency).
339. See Cohen, For Authors, the Key Words Are in the Book Contracts, N. Y. Times, Aug. 27, 1990, at D1, col. 1 (describing the trend toward the use of such terms).
340. For example, in Pittsburgh Terminal Corp. v. Baltimore & Ohio Railroad, 680 F.2d 933 (3d Cir. 1982), cert, denied, 459 U.S. 1056 (1983), see supra note 246, the court held that the railroad had an implied duty to give notice before a spin-off. See 680 F.2d at 940-42. Although the decision is questionable from the perspective of encouraging optimally the development of new contract terms, the decision is clearly correct to the extent that it rests on the conclusion that bondholders who bargained for the dividend notices explicit in the contract would have, if properly informed, bargained for notice of a spin-off. In contrast, Broad v. Rockwell, 642 F.2d 929 (5th Cir.), cert, denied, 454 U.S. 965 (1981), rejected the bondholders' claim that the good faith duty prohibited a merger with cash payout when bondholders lost equity conversion rights as a result. See id. at 957-58. The court correctly concluded that holders of equity conversion rights might have contracted to bear the risk that the equity would be liquidated by merger. See id. at 956-60.
341. See supra pp. 454-55.
342. See Automobile Dealers' Day in Court Act, 15 U.S.C. § 1222 (1988); Petroleum Marketing Practices Act, id. § 2804.
343. See Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, 16 C.F.R. § 436 (1990).
344. See, e.g., DEL CODE ANN. tit. 6, § 2552(b) (1974) (prohibiting "unjust" termination); VA. CODE ANN. § 13.1-564 (1989) (requiring "reasonable cause").
345. See, e.g., DEL CODE ANN. tit. 6, § 2552(b) (1974) (prohibiting "unjust" termination); VA. CODE ANN. § 13.1-564 (1989) (requiring "reasonable cause").
346. See Kealey Pharmacy & Home Care Servs. v. Walgreen Co., 761 F.2d 345, 349-50 (7th Cir. 1985); Paradee Oil Co. v. Phillips Petroleum Co., 320 A.2d 769, 775-77 (Del. Ch. 1974), aff'd, 343 A.2d 610 (Del. 1975); Westfield Centre Serv., Inc. v. Cities Serv. Oil Co., 158 N.J. Super. 455, 462-66, 386 A.2d 448, 452-54 (1978). Analogously, courts have taken a dim view of shifts from exclusive to nonexclusive distributorships. See Carlos v. Philips Business Sys., 556 F. Supp. 769, 775-77 (E.D.N.Y.) (applying New York and Connecticut law), aff'd, 742 F.2d 1432 (2d. Cir. 1983); Executive Business Sys. v. Philips Business Sys., [1980-1983 Transfer Binder] Bus. Franchise Guide (CCH) ¶ 7703, at 12,773 (E.D.N.Y. 1981) (applying New Jersey law).
347. See, e.g., R.L.M. Assocs. v. Carter Mfg. Corp., 356 Mass. 718, 248 N.E.2d 646 (1975) (holding the termination of a franchise to be in bad faith); Shell Oil Co. v. Marinello, 63 N.J. 402, 408-09, 307 A.2d 598, 601-02 (1973) (unconscionability), cert, denied, 415 U.S. 920 (1974).
348. Employee Retirement Income Security Act, 29 U.S.C. §§ 1001-1461 (1988).
349. The employer must specify which employees are covered by a pension plan in the Plan Document, kept on file at the Department of Labor. See id. §§ 1022-1024. The Document is authoritative against all conflicting statements or representations by the firm to workers. See, e.g., Musto v. American Gen. Corp., 861 F.2d 897, 910 (6th Cir.), cert, denied, 109 S. Ct. 1745 (1988); Moore v. Metropolitan Life Ins. Co., 856 F.2d 488, 492 (2d Cir. 1988).
350. Plaintiffs in pension cases have sought to enforce oral representations under state law by invoking promissory estoppel. Compare, e.g., Straub v. Western Union Tel. Co., 851 F.2d 1262, 1264 (ioth Cir. 1988) (holding that promissory estoppel claims are preempted by ERISA) and Salomon v. Transamerica Occidental Life Ins. Co., 801 F.2d 659, 660 (4th Cir. 1986) (same) and Gadsby v. Health Ins. Admin., Inc., 168 Ill. App. 3d 460, 472-73, 522 N.E.2d 865, 872-73 (1988) (holding an oral commitment unenforceable even after the issuance of an insurance identification card) with Ex parte Ward, 448 So. 2d 349, 351 (Ala. 1984) (holding that a promissory estoppel claim was not preempted when the claim did not "trespass against any interests protected by ERISA") and Shaw v. Westinghouse Elec. Corp., 276 Pa. Super. 220, 227-30, 419 A.2d 175, 179-80 (1980) (same) and Hepler v. CBS, Inc., 39 Wash. App. 838, 847, 696 P.2d 596, 602 (holding that a fraud claim was not preempted), cert, denied, 474 U.S. 946 (1985). Alternatively, plaintiffs may contend that oral representations created a contract. Compare Nevill v. Shell Oil Co., 835 F.2d 209, 212 (9th Cir. 1987) (holding that state breach of contract claims are preempted) and Pane v. RCA Corp., 667 F. Supp. 168, 172 (D.N.J. 1987) (same) with Golen v. Chamberlain Mfg. Corp., 139 Ill. App. 3d 53, 57-58, 487 N.E.2d 121, 125 (1986) (holding that a state claim was not preempted if the impact on an ERISA plan is "tangential") and Welsh v. Northern Telecom, Inc., 85 N.C. App. 281, 289, 354 S.E.2d 746, 751 (1987) (same).
351. See Clark, The Four Stages of Capitalism: Reflections on Investment Management Treatises, 94 HARV. L. REV. 561, 571-73 (1981) (discussing "consumer protection" purposes served by ERISA).
352. For example, in many cases, plaintiffs claim to have relied on casual oral or written representations about plan coverage. These representations prove later to be inconsistent with the formal terms of the plan, as filed with the Department of Labor. The facts of these cases suggest that workers and firms simply did not advert at all to the question of legal enforceability at the time that the representations were made or were mistaken about the accuracy of the representations made. See, e.g., Nachwalter v. Christie, 805 F.2d 956, 958-61 (11th Cir. 1986) (holding that oral statements by a plan trustee cannot create legal liability); Kolentus v. Avco Corp., 798 F.2d 949, 958 (7th Cir. 1986) (holding that misstatements in plan summary booklets are not grounds for promissory estoppel liability when the booklets warn employees to consult the actual plan documents); Gadsby v. Health Ins. Admin., Inc., 168 Ill. App. 3d 460, 464-65, 522 N.E.2d 864, 867-68 (1988) (rejecting a promissory estoppel claim by an employee who was given a health insurance identification card, whose claims were processed, and whose wife was told that he was covered). Facts suggestive of deliberate fraud or gross misconduct may justify a different approach. See, e.g., Perry v. PIE Nationwide, Inc., 872 F.2d 157, 158-59, 162 (6th Cir. 1989) (holding that ERISA does not preempt a suit to enforce oral commitments on fraud or promissory estoppel theories); Zittrouer v. Uarco Inc. Group Benefit Plan, 582 F. Supp. 1471, 1475 (N.D. Ga. 1984) (holding that booklet misstatements create liability when they are fraudulent or grossly negligent).
353. No doubt courts that resist plaintiffs' arguments are influenced by the sweeping language of ERISA's preemption clause, which preempts state law claims that "relate to any employee benefit plan." 29 U.S.C. § 1144(a) (1988); see also Metropolitan Life Ins. Co. v. Taylor, 481 U.S. 58, 62-63 (1987) (construing the preemption clause broadly). Despite the apparent breadth of its language, the statutory conception of "relation" must be understood in light of the purposes and policies of the statute. Courts have enforced commitments under state law, despite purported preemption, see, e.g., Ex parte Ward, 448 So. 2d 349, 351-52 (Ala. 1984), and by developing a body of federal common law, see e.g., Holliday v. Xerox Corp., 555 F. Supp. 51, 55 (E.D. Mich.) (applying "federal common law of contract"), aff'd, 732 F.2d 548 (7th Cir.), cert, denied, 469 U.S. 917 (1984).