Contract design and the structure of contractual intent

New York University Law Review

Volumn 84, Issue 4, 2009, Pages 1023-1104

  Kraus, Jody S ^a   Scott, Robert E ^b  

^a UNIVERSITY OF VIRGINIA   (United States)

^b Och Spine at New York Presbyterian Hospitals   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 70450100217     PISSN: 00287881     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (484)

1. In this Article, we characterize as formal any American contract doctrine that originated in the legal rules developed and strictly enforced by English common law courts. We will refer to the terms that a court would find by the standard application of formal contract doctrine to the evidence of the parties' agreement as the formal contract terms. Thus, the formal contract price term in this example is three percent above the published price index; the parties appear to have chosen this term, rather than a term directly entitling the seller to its actual costs plus three percent, as their contractual means of achieving their contractual end (providing the seller with a three percent profit). See infra pp. 119-21 (defining "formal contract law").
2. We characterize as equitable any American contract doctrine that originated from the principles developed and enforced by the English Court of Chancery. The historical purpose of these doctrines was to allow the chancellor to circumvent or override the common law rules whenever he believed doing so was necessary to avoid injustice. In the case of contracts, these doctrines typically treat as unjust any outcome that is dramatically misaligned with the parties' contractual ends. See infra pp. 119-22 (defining "equitable contract law").
3. The search for intention is a key doctrinal element in determining whether the parties have made a binding agreement, the meaning that attaches to the terms of that agreement, the default terms implied in that agreement, and whether the obligations of the parties are impliedly conditioned on unstated assumptions or expressly conditioned on stated events. In addition, the obligation to honor the intention of the parties is the key linkage between efficiency and autonomy, two of the major theoretical approaches to contract. ROBERT E. SCOTT & JODY S. KRAUS, CONTRACT LAW AND THEORY 23-29 (4th ed. 2007).
4. A recent exception to the lack of sustained analysis of the nature of contractual intent is Gregory Klass, Intent to Contract, 95 VA. L. REV. (forthcoming Oct. 2009).
5. These rights and duties comprise the contract terms that determine how and whether the parties must perform their contractual obligations as well as the consequences of nonperformance.
6. For a precise definition of "sophisticated economic actors" that limits the category to limited partnerships, professional partnerships, and firms organized in corporate form with five or more employees, see Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law, 113 YALE L.J. 541, 545 (2003). In principle, our thesis might also be applied to contracts between commercially unsophisticated parties or between commercially sophisticated and unsophisticated parties. But defending an extension of our thesis to such cases would require additional analysis to take into account a range of considerations, such as legal information asymmetry, cognitive error, and nonrepeat play contexts, which we do not undertake here.
7. Ex ante, parties have limited knowledge of the present and are uncertain about the future. Therefore, in order to decide on their particular contractual obligations, the parties must make assumptions about their present and future circumstances. Yet they also know that new information that comes to light during the term of their contract may reveal that their assumptions were erroneous. This justification for the two-stage regime thus rests on the premise that, by delegating to courts the historically equitable authority to modify formal contract terms, the parties can both rely on their formal contract terms but also rest safe in the assurance that, if their assumptions turn out to be false, a court will set aside the formal contract terms and craft substitute terms that better serve the parties' initial contractual ends in light of the new information available to the court.
8. The core of our argument supporting the claim that commercial parties prefer courts to adhere to formal contract terms absent an express indication otherwise is based on a theory of contract design explicated in Parts II and HI, infra. Our theory of contract design explains why commercial parties must be able to anticipate and control what portions of their agreements will be legally enforceable and the extent to which their agreements will be governed by rules ex ante or standards ex post.
9. For empirical support for the predictions of the theory, see infra notes 148-50, 194-98, 276-78 and accompanying text.
10. The literature has long recognized two complementary perspectives on enforcement. On the one hand, prospective litigation encourages compliance with those bargains that satisfy the prerequisites for legal enforcement. On the other hand, parties also face an array of informal or "relational" sanctions if they fail to honor their commitments. In many cases, these relational sanctions may do much of the enforcement work. See ROBERT E. SCOTT & PAUL B. STEPHAN, THE LIMITS OF LEVIATHAN: CONTRACT THEORY AND THE ENFORCEMENT OF INTERNATIONAL LAW 84-109 (2006) (discussing choice between formal and informal enforcement);
11. see generally Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 CAL. L. REV. 2005 (1987)
12. [hereinafter Scott, Conflict and Cooperation] (discussing potency of relational sanctions as means of enforcing agreements that are not legally enforceable);
13. Robert E. Scott, A Theory of Self-Enforcing Indefinite Agreements, 103 COLUM. L. REV. 1641 (2003)
14. [hereinafter Scott, Self-Enforcing Agreements] (same). We discuss the tradeoff between formal and relational enforcement in Part II.B, infra.
15. For discussion, see Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 YALE L.J. 814, 822-51 (2006).
16. See Scott, Self-Enforcing Agreements, supra note 9, at 1670-72 (describing experiments showing that reciprocal fairness rather than explicit sanctions can be used as enforcement device);
17. Robert E. Scott & Paul B. Stephan, Self-Enforcing International Agreements and the Limits of Coercion, 2004 WIS. L. REV. 551, 579-80
18. [hereinafter Scott & Stephan, Self-Enforcing International Agreements] (discussing experiments suggesting that coercion undermines reciprocity).
19. There is no sharp dichotomy between verifiable and nonverifiable conditions. As we discuss in detail in Part II.B.1, infra, the question is whether the benefits of using informal norms to enforce a difficult-to-prove condition (such as the level of effort needed to comply with a contractual commitment) are greater than the alternative of verifying compliance with a less accurate but more easily established proxy for the condition in question. The important point, however, is that informal enforcement mechanisms can take into account conditions that are hard to verify even where legal enforcement cannot. For example, parties to an agreement often can observe whether one party has exercised "best efforts" to perform its obligation, but it will be quite costly to marshal the evidence necessary to demonstrate this fact to a disinterested third party. Where this is true, exclusive reliance on legal enforcement can deprive parties of relational mechanisms that can promote better compliance at a lower cost.
20. We discuss the tradeoffs between ex ante rules and ex post standards in contract design in Part III.B.2, infra.
21. See Scott & Triantis, supra note 10, at 845 ("Given the court's superior information, the parties can expect that one or both of the proxies will be less noisy [at the time of trial] than the one that the parties would pick ex ante.").
22. The parties' objective is to select that combination of precise rules and vague standards that optimizes their total costs of contracting. Note that the parties' goal is not simply to minimize contracting costs; parties will incur additional contracting costs so long as those costs result in improvements in the parties' incentives to maximize the expected surplus from the contract. Thus, the parties' objective is to "maximize the incentive bang for the contracting-cost buck."
23. Id. at 823;
24. see also id. at 840-41 (illustrating concept with hypothetical example).
25. For a penetrating analysis of the role that rules and standards play in differentiating textualist and intentionalist statutory interpretation, see Caleb Nelson, What is Textualism?, 91 VA. L. REV. 347, 398-416 (2005).
26. J. H. BAKER, AN INTRODUCTION TO ENGLISH LEGAL HISTORY 12, 114 (4th ed. 2002). The third and oldest common law court was the Exchequer of Pleas.
27. Id. at 47. Because this court exercised a "relatively minor civil jurisdiction" during the fourteenth, fifteenth, and early sixteenth centuries, it is not essential to understanding the evolution of the divide between law and equity.
28. Id. at 48.
29. See infra notes 29-39 and accompanying text (describing approach of King's Bench and Common Pleas);
30. see also 2 E. ALLAN FARNSWORTH, FARNSWORTH ON CONTRACTS §§9.1, 9.5 (2d ed. 1998) (discussing exceptions to general rule that contractual duties are absolute).
31. See, e.g., DAVID J. IBBETSON, A HISTORICAL INTRODUCTION TO THE LAW OF OBLIGATIONS 28 (1999) (describing medieval action of debt according to which "a document under seal granting money from one person to another would be strictly enforced").
32. The Chancery had two kinds of jurisdiction: The first, denominated its "Latin side" because its forms and actions were written in Latin, was to make purely administrative rulings; the second, denominated its "English side" because its bills and pleadings were in English, was to adjudicate the bills of complaint that fell within the original jurisdiction of the King's council. BAKER, supra note 17, at 100-01. "It seems probable that the English jurisdiction was established in its distinct form during the reign of Richard II . . . . It was perhaps firmly settled while John of Waltham was master of the rolls (1381-86)."
33. Id. at 103.
34. See id. at 114 (discussing abolition of Chancery courts and fusion of law and equity).
35. FARNSWORTH, supra note 18, §6.9.
36. RESTATEMENT (SECOND) OF CONTRACTS ch. 11, introductory note at 309-10 (1981) ("Contract liability is strict liability. It is an accepted maxim that pacta sunt servanda, contracts are to be kept. The obligor is therefore liable in damages for breach of contract even if he is without fault and even if circumstances have made the contract more burdensome or less desirable than he had anticipated. . . . An extraordinary circumstance may make performance so vitally different from what was reasonably to be expected as to alter the essential nature of that performance. In such a case the court must determine whether justice requires a departure from the general rule that the obligor bear the risk that the contract may become more burdensome or less desirable.");
37. RESTATEMENT (SECOND) OF CONTRACTS ch. 6, introductory note at 379 ("The law of contracts supports the finality of transactions lest justifiable expectations be disappointed. This Chapter deals with exceptional situations in which the law departs from this policy favoring finality and allows either avoidance or reformation on the ground of mistake.");
38. see also 2 FARNSWORTH, supra note 18, §9.1.
39. Such uncertainty may be increased by the fact that "[i]n recent years, courts have shown increasing liberality in discharging obligors on the basis of [certain] extraordinary circumstances." RESTATEMENT (SECOND) OF CONTRACTS ch. 11, introductory note at 309-10 (1981).
40. For further discussion, see infra Part III and the court's analysis in Aluminum Co. of America v. Essex Group, Inc. (ALCOA), 499 F. Supp. 53 (W.D. Pa. 1980).
41. For example, in Part II.A.2, we argue that the court in Hunt Foods & Industries, Inc. v. Doliner, 270 N.Y.S.2d 937 (App. Div. 1966), misapplied the parol evidence and integration doctrines because it implicitly embraced equitable reasoning that equates the parties' contractual intent with their intended contractual ends instead of means.
42. As we explain in Part IV, the gravitational influence of equity on law reaches its zenith in the law of conditions, which explicitly directs courts to disregard formal doctrine in order to avoid the imposition of a forfeiture on one party, even if a neutral application of formal doctrine would otherwise produce a different result.
43. BAKER, supra note 17, at 53-54.
44. Id. at 54-55.
45. Id. at 55 ("A plantiff . . . had either to find a known formula to fit his case, or apply for a new one to be invented.").
46. See id. at 100 ("A late thirteenth-century writer describes [chancellors] as hearing petitions and complaints, which they determined by issuing writs; though by that time the discretion to invent new remedies was severely curtailed."). As explained, "[i]n the thirteenth century one possible response to a petition had been to allow a new form of original writ, and when that power was curtailed the bill might be referred to parliament for a legislative solution . . . ."
47. Id. at 102.
48. Id. at 98. As one historian has explained, the King "retained an overriding residuary power to administer justice outside the regular system; but the important limitation imposed on that power by the due-process legislation was that it could be invoked only where the common law was deficient, and never in matters of life, limb or property."
49. Id.
50. Id. ("By the end of the thirteenth century numerous petitions (or 'bills') were being presented to the king, asking for his grace to be shown in respect of some complaint.").
51. Id. ("Already in the fourteenth century the petitioning of the king by bill, seeking a remedy as of grace, was so common that such business had to be referred to special sessions of the council or parliament . . . .").
52. Id.
53. Id.
54. Id. at 101.
55. Id.
56. Id. at 99, 101.
57. Id.
58. see also id. at 101-02 ("The Chancery may have been thought an appropriate place to furnish new remedies because of its traditional supervision of the issue of original writs. A plaintiff applying for an original writ was in a sense making a petition in Chancery."). Before the end of the thirteenth century, the Chancery always had the power to create a new writ that would provide a form of action suitable to a plaintiffs complaint. But when the plaintiffs claim was based on idiosyncratic facts rendering existing forms inadequate, rather than a common complaint for which no form of action existed, the Chancery sought an ad hoc solution rather than the creation of a new form of action.
59. Id. at 102.
60. Id. at 101.
61. Id. at 117.
62. Id. at 102.
63. See id. at 102-03 (noting that Chancery operated "a court of conscience" that was "free from the rigid procedures" of common law courts).
64. Id. at 102;
65. see also id. at 325 ("Under the harsh logic of the common law it was 'better to suffer a mischief to one man than an inconvenience to many, which would subvert the law.'" (quoting Waberly v. Cockerel, (1542) 73 Eng. Rep. 112, 113 (K.B.))).
66. Id. at 104. In its earliest incarnation, the procedure in Chancery was the antithesis of the procedure in common law courts: No writ was necessary, multiple issues could be joined, evidence was taken free of formal rules, decisions were made by a chancellor rather than a jury, the court was always open, and trials could take place anywhere (including the chancellor's home).
67. Id. at 103.
68. Glaston v. Abbot of Crowland (1330),
69. reprinted in SOURCES OF ENGLISH LEGAL HISTORY: PRIVATE LAW TO 1750, at 252 (J.H. Baker & S.F.C. Milsom eds., 1986)
70. [hereinafter SOURCES OF ENGLISH LEGAL HISTORY].
71. Id.
72. Id.
73. Fishacre v. Kirkham (1289),
74. reprinted in 112 SELDEN SOCIETY 322 (1996).
75. BAKER, supra note 17, at 324-25
76. (citing Glaston, reprinted in 98 SELDEN SOCIETY 665 (1982), supra note 46, at 252;
77. Donne v. Cornwall, Y.B. 1 Hen. 7, fol. 14v, Pasch, pl. 2 (1486), reprinted in SOURCES OF ENGLISH LEGAL HISTORY, supra note 46, at 255).
78. BAKER, supra note 17, at 325.
79. Id. at 103 (footnote omitted).
80. See id. at 104 (explaining that chancellor "could order bonds and other writings t be cancelled where they would only serve unjust ends").
81. Waberley v. Cockerel, (1542) 73 Eng. Rep. 112, 113 (K.B.).
82. See BAKER, supra note 17, at 104 ("In Chancery each case turned on its own facts, and the chancellor did not interfere with the general rules observed in courts of law. The decrees operated in personam; they were binding on the parties in the cause, but were not judgments of record binding anyone else.");
83. see also id at 202 ("So long as chancellors were seen as providing ad hoc remedies in individual cases, there was no question of their jurisdiction bringing about legal change or making law.").
84. See id. at 202 ("In Chancery the just remedy was provided not by changing the law but by avoiding its effect in the special circumstances of particular cases.").
85. Councillors and chancellors viewed themselves as "reinforcing the law by making sure that justice was done in cases where shortcomings in the regular procedure, or human failings, were hindering its attainment by due process. They came not to destroy the law, but to fulfil it."
86. Id. at 102.
87. See id. at 103 (observing that Chancery was "free from the rigid procedures" of common law courts and could "coerce[ ]" defendants "into doing whatever conscience required in the full circumstances of the case").
88. The common law courts were not wholly insensitive to the illegitimate use of legal doctrines, however.
89. For example, the common law of contracts refused to enforce contracts supported by illegal or immoral consideration. IBBETSON, supra note 19, at 211.
90. In Jurisdictional Competition and the Evolution of the Common Law, 74 U. CHI. L. REV. 1179 (2007), Daniel Klerman argues that competition between common law courts led to simple, pro-plaintiff rules because judges were paid, in part, by court fees, and plaintiffs chose the forum in which to bring their claims. Chancery therefore attracted disgruntled defendants who petitioned it to enjoin or otherwise interfere with common law suits. Because Chancery faced no real competition, it had no incentive to reduce costs through simplification of doctrine. Klerman argues that all the equitable doctrines of American contract law, other than those granting injunctive relief, resulted from Chancery's exercise of original jurisdiction in order to compete against common law courts for business.
91. See Robert E. Scott, Chaos Theory and the Justice Paradox, 35 WM. & MARY L. REV. 329, 334-36 (1993) (noting that common law "dilemma" led to "formal separation of courts of law and equity" and discussing overlapping jurisdictions of these courts).
92. In 1616, James I issued a decree confirming the chancellor's jurisdiction to entertain suits in equity even after judgments in law had been handed down on the same matters. James I's decree remained in effect until it was declared illegal in 1670. BAKER, supra note 17, at 108-09.
93. As Baker explains, The essence of equity as a corrective to the rigour of law was that it should not be tied to rules. If, on the other hand, no consistent principles whatever were observed, parties in like cases would not be treated alike; and equality was a requisite of equity. As John Selden quipped in the mid-seventeenth century, if the measure of equity was the chancellor's own conscience, one might as well make the standard measure of one foot the chancellor's foot.
94. Id. at 109.
95. During the seventeenth century, equitable doctrines began to congeal into formal rules, although their objective was still to provide alternatives and exceptions to the common law. "By 1676 a chancellor could repudiate the idea that equity had any dependence on his own inner conscience: '[T]he conscience by which I am to proceed is merely civilis et politica, and tied to certain measures.' Thus equity hardened into law."
96. Id. at 110 (footnote omitted);
97. accord Scott, supra note 61, at 336.
98. Although equity still operated to blunt and sometimes circumvent the common law, within its own rules "even the Chancery would sooner suffer a hardship than a departure from known rules." BAKER, supra note 17, at 110.
99. Id. at 110-11.
100. Ironically, by the nineteenth century, the Chancery had developed a set of procedures more arcane and burdensome than the common law procedures it originally sought to mitigate. The resulting administrative delay, combined with corruption born of the Chancery's practice of paying clerks on a fee basis rather than a salary, ultimately led to the Chancery's demise. See id. at 111-12 (explaining major practical defects that developed in Chancery). Soon thereafter law and equity were merged.
101. Id. at 114.
102. Judicature Act, 1873, 36 & 37 Vict., c. 66, §.25(11) (Eng.),
103. reprinted in CHALONER W. CHUTE, EQUITY UNDER THE JUDICATURE ACT 209 (1874) ("[I]n all matters . . . in which there is any conflict or variance between the Rules of Equity and the Rules of the Common Law with reference to the same matter, the Rules of Equity shall prevail.").
104. IBBETSON, supra note 19, at 222.
105. Id. at 203-04.
106. Id. at 208-09.
107. Id. at 71-72.
108. Id. at 223-25.
109. Id. at 228;
110. see also Taylor v. Caldwell, (1863) 122 Eng. Rep. 309, 314 (K.B.) (holding that "a condition is implied that the impossibility of performance arising from the perishing of the person or thing shall excuse the performance").
111. The English common law precursor to the American fraud-in-the-execution doctrine prohibited enforcement of agreements procured by one party misleading the other as to the contents of a writing under seal. See IBBETSON, supra note 19, at 72.
112. Id. at 87-90.
113. Id. at 229-32.
114. See 2 FARNSWORTH, supra note 18, § 12.12 (discussing Vertue v. Bird, (1677) 84 Eng. Rep. 1000, 86 Eng. Rep. 200 (K.B.), to illustrate avoidability doctrine).
115. The common law applied "to documents a rule of construction that the words had to be given their ordinary meaning." Id. at 226.
116. BAKER, supra note 17, at 324-25.
117. IBBETSON, supra note 19, at 203. In general, equity evolved contract doctrines designed to provide far broader protection against perceived fraud than the common law provided. In particular, the core equitable contract doctrines provided relief where an agreement was not fully voluntary or informed.
118. Id. at 208.
119. This doctrine first required that a defrauded party bring a deceit action in trespass, then allowed the action to be brought as trespass on the case, and finally permitted it to be brought in assumpsit. See BAKER, supra note 17, at 329-39. As an action outside of contract, it required the defrauded party to allege that his contractual partner intentionally breached a confidence or intentionally misrepresented present facts in order to induce the defrauded party to enter into the agreement (the equivalent of the modern defense of fraud-in-the-inducement). By the time the action could be brought in assumpsit, however, its intentional component had been discarded, thus laying the foundation for the contemporary doctrine of warranty liability.
120. See id. at 331-33, 337.
121. The equitable defenses of negligent or innocent misrepresentation were the precursors to the contemporary doctrines of fraudulent and material misrepresentation. See IBBETSON, supra note 19, at 208;
122. see also RESTATEMENT (SECOND) OF CONTRACTS §§ 162, 164 (1981). Strictly speaking, neither contemporary contract nor tort imposes liability or provides relief for negligent misrepresentation, save in rare cases in which promissory estoppel is invoked to serve that purpose.
123. Robert E. Scott, Hoffman v. Red Owl Stores and the Myth of Precontractual Reliance, 68 OHIO ST. L.J. 71, 92 (2007). But the contemporary doctrines of fraudulent and material misrepresentation in the Restatement conceivably could be construed to void contracts induced by negligent misrepresentation. RESTATEMENT (SECOND) OF CONTRACTS §162(1)(b), (c) (1981). Originally, the equitable anti-fraud doctrines operated to bar relief for promisees but did not affect the promisor's right to sue at law.
124. See IBBETSON, supra note 19, at 209.
125. The equity defense of wrongful silence was the precursor to the contemporary nondisclosure doctrine. For examples of cases discussing the equity defense of wrongful silence, see Broderick v. Broderick, (1713) 24 Eng. Rep. 369 (Ch.), and Chesterfield v. Janssen, (1751) 28 Eng. Rep. 82 (Ch.).
126. See IBBETSON, supra note 19, at 208 ("Central to the Chancery's intervention was the power to relieve against fraud . . . . The most obvious case of this was where one person deliberately made a false statement in order to lure another into a bargain, but it could extend much further than this: a representation by conduct might equally constitute fraud, as might a representation by silence.");
127. see also RESTATEMENT (SECOND) OF CONTRACTS §§161, 164 (1981).
128. IBBETSON, supra note 19, at 210.
129. Id. at 206, 213;
130. see also BAKER, supra note 17, at 320 ("The scope of specific performance was unclear, and plaintiffs seeking such a remedy were drawn into the Chancery.").
131. The common law capacity doctrine was confined to prohibiting enforcement of agreements made by women and infants. Equity provided a more expansive capacity defense based on impaired mental capacity, including drunkenness in certain circumstances. The common law duress doctrine was limited to voiding agreements procured by serious violence or imprisonment. Equity expanded duress to include undue influence. IBBETSON, supra note 19, at 209.
132. See id. at 210-11 (explaining that Chancery and common law courts were concerned with one party "taking unfair advantage" of another and "were quick to sniff out any whiff of illegality"). Although both the common law and equity refused to enforce illegal contracts, equity went further to refuse enforcement of contracts it deemed to be against public policy.
133. See id. at 211-12.
134. The penalty doctrine voids any contract clause providing for liquidated damages in excess of the parties' actual or expected compensatory damages. "In the sixteenth century the Chancery began to mitigate this by issuing injunctions against the enforcement of penalties in an initially limited range of situations . . . ." IBBETSON, supra note 19, at 150.
135. By the seventeenth century liability in contract was seen as absolute, in the sense that, once the parties had reached an agreement, they would in principle be held to it unless the defendant could point to duress, fraud, or some other vitiating factor. Consistently with this position, the courts' remedies would normally give effect to the agreement . . . . This principle was subject to the important qualification that the courts would not enforce penalties. The origins of this lie in the Chancery practice of the late fifteenth century . . . . Id. at 213. Penalties were also forbidden by the statutes of 1669 and 1705.
136. BAKER, supra note 17, at 325
137. . For discussion of the evolution of the contemporary penalty doctrine, see Robert E. Scott & George G. Triantis, Embedded Options and the Case Against Compensation in Contract Law, 104 COLUM. L. REV. 1428, 1440-45 (2004).
138. BAKER, supra note 17, at 202-03. The forfeiture doctrine sets aside implied and express conditions.
139. See RESTATEMENT (SECOND) OF CONTRACTS § 229 (1981) ("Excuse of a Condition to Avoid Forfeiture: To the extent that the non-occurrence of a condition would cause disproportionate forfeiture, a court may excuse the non-occurrence of that condition unless its occurrence was a material part of the agreed exchange.");
140. see also id. § 225 cmt. a ("Where discharge would produce harsh results, this . . . effect may be avoided by rules of interpretation or of excuse of conditions." (citation omitted));
141. id. § 227, cmt. b-c. We discuss the inherent tension between formal law and equity embedded in the forfeiture doctrine in Part IV.B, infra.
142. See, e.g., JOSEPH STORY, COMMENTARIES ON EQUITY JURISPRUDENCE, §§ 153-157 (W.E. Grigsby ed., 1884) (explaining that courts of equity allow parol evidence to modify contracts upon clear evidence of mistake).
143. Even before the Statute of Frauds was passed, equity had created the part performance exception to the common law writing requirement. IBBETSON, supra note 19, at 203 n.4. The equitable doctrine of part performance continued to apply after the statute took effect. BAKER, supra note 17, at 350.
144. See, e.g., Aluminum Co. of Am. v. Essex Group, Inc. (ALCOA), 499 F. Supp. 53 (W.D. Pa. 1980) (finding that unpredictable increase of electricity costs entitled seller to reformation of long-term contract when seller stood to lose amount in excess of sixty million dollars).
145. See, e.g., Hunt Foods & Indus., Inc. v. Doliner, 270 N.Y.S.2d 937 (App. Div. 1966) (looking to parol evidence rather than written contract for evidence of parties' intent);
146. Corthell v. Summit Thread Co., 167 A. 79 (Me. 1933) (holding that although company had sole discretion to determine amount of payment for inventions per contract terms, company owed reasonable compensation for inventions).
147. For further discussion, see infra Part II.A.2 and infra Part IV.C.1.
148. RESTATEMENT (SECOND) OF CONTRACTS §§ 152, 153 (1981).
149. See infra Part III.A for a discussion of the equitable doctrines of mistake, excuse, and frustration in the specific context of ALCOA.
150. Indeed, some scholars applaud the role of equity in contract adjudication. See, e.g., Melvin A. Eisenberg, The Responsive Model of Contract Law, 36 STAN. L. REV. 1107 (1984) (rejecting formalism in favor of "responsive" contract law that mirrors individualized and subjective approach of equity).
151. SCOTT & KRAUS, supra note 3, at 541.
152. See id. (noting that parol evidence rule allows parties to agree not to introduce "extrinsic evidence" in court).
153. See infra text accompanying notes 129-33 (discussing possible motivations of parties in Hunt Foods).
154. See SCOTT & KRAUS, supra note 3, at 542-43 (reviewing how common law and Uniform Commercial Code identify terms of agreement in contract).
155. See Charles J. Goetz & Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Interactions Between Express and Implied Contract Terms, 73 CAL. L. REV. 261, 273 (1985) (explaining that plain meaning rule prohibits external evidence from being used to interpret terms of contract if terms appear unambiguous in document);
156. Schwartz & Scott, supra note 6, at 584-90.
157. See Goetz & Scott, supra note 102, at 316-17. ("[S]killful use of the [plain-meaning] presumption by courts will, over time, increase the supply of officially recognized invocations and other express conventions.").
158. See infra text accompanying notes 109-21 (discussing one court's analysis of whether terms "consistent" and "contradict" in Uniform Commercial Code's parol evidence rule should be treated as synonymous).
159. 270 N.Y.S.2d 937 (App. Div. 1966).
160. Id. at 939.
161. Id.
162. Id. at 939-940 & n.1 ("While article 2 of the Uniform Commercial Code which contains this section does not deal with the sale of securities, this section applies to article 8, dealing with securities. ... All parties and Special Term so regarded it." (applying 1966 version of U.C.C.)).
163. Id. at 940.
164. Id. (emphasis added);
165. see also U.C.C. § 2-202 (amended 2003) (stating essentially same rule as that articulated in Hunt Foods).
166. Hunt Foods, 270 N.Y.S.2d at 940.
167. Id.
168. The question of whether the proffered evidence is consistent with the writing does not arise until a court has first determined that the agreement is at least partially integrated. The court in Hunt Foods never expressly found the agreement to be partially integrated. Instead, the court claimed that, under then comment 3 to U.C.C. §2-202, the parties would not have necessarily included the condition in their writing and the court appeared to conclude implicitly that the writing was therefore not fully integrated with respect to the condition.
169. Id.
170. see also U.C.C. §2-202 cmt. 3 (amended 2003) (containing current version of comment relied on in Hunt Foods). Ideally, the Hunt Foods court would first have found expressly that the parties intended the written option term as their final expression of that term before turning to the question of whether the condition contradicts that term. If the court did not believe the agreement was partially integrated, then there would be no need to exclude the evidence of the condition even if it did contradict the written option term.
171. Hunt Foods, 270 N.Y.S.2d at 940.
172. Id.
173. U.C.C. §2-202(b) (amended 2003).
174. Id.
175. This "two step" interpretation of the U.C.C.'s test for admissibility under §2-202 was adopted by the court in Snyder v. Herbert Greenbaum & Associates, 380 A.2d 618, 623 (Md. Ct. Spec. App. 1977).
176. Hunt Foods, 270 N.Y.S.2d at 940.
177. Id. The Code now embodies this in comment 3. U.C.C. §2-202 cmt. 3 (amended 2003).
178. Hunt Foods, 270 N.Y.S.2d at 940.
179. Id.
180. The opinion also provides the barest suggestion that the court might have believed that the oral statement was admissible as evidence that the written agreement, even if fully integrated, was subject to an oral condition precedent. Under the rule of Pym v. Campbell, (1856) 119 Eng. Rep. 903 (K.B.), courts have allowed oral evidence offered to prove that a fully integrated agreement never came into existence because it was subject to an oral condition precedent.
181. Id. at 905. The Restatement admits such evidence on the ground that it proves the agreement was not fully integrated.
182. See RESTATEMENT (SECOND) OF CONTRACTS §217 cmt. b (1981).
183. But see 2 FARNSWORTH, supra note 18, §7.4, at 231 n.8 (arguing Restatement explanation is inferior to account that holds agreement is valid but admits oral statement as evidence that agreement did not take effect). The Hunt Foods court concluded that "the alleged oral condition precedent cannot be precluded as a matter of law or as factually impossible." 270 N.Y.S.2d at 940. Some commentators have stated that the court's holding therefore should be interpreted as treating the alleged oral statement as evidence that the agreement did not take effect because it was subject to an oral condition that never occurred.
184. See, e.g., 2 FARNSWORTH, supra note 18, §7.4, at 231 & n.9 (noting that qualification of parol evidence rule has been "read into UCC 2-202 even though that section contains no specific language on the point."). Even on this view, however, evidence of the oral condition precedent is admissible only if it does not contradict an express term of the written agreement.
185. See, e.g., Intercontinental Monetary Corp. v. Performance Guars., Inc., 705 F. Supp. 144,149 (S.D.N.Y. 1989) ("[T]he parol evidence rule does not bar proof of every orally established condition precedent, but only of those which in a real sense contradict the terms of the written agreement."
186. (quoting Hicks v. Bush, 225 N.Y.S.2d 34, 37 (1962)));
187. see also 2 FARNSWORTH, supra note 18, §7.4, at 232 (stating that extrinsic evidence is inadmissible if it contradicts written term). 122 By making the argument that the alleged oral condition would merely lessen the effect of the written option, the court implicitly held that the written option standing alone should properly be interpreted as creating an unconditional option. Other courts have held that a written option that fails to state expressly whether it is conditional may be subject to an interpretive default rule that treats it as unconditional absent evidence that the parties intended it to be conditional.
188. See, e.g., Masterson v. Sine, 436 P.2d 561, 565 (Cal. 1968) ("The fact that there is a written memorandum [creating an option] . . . does not necessarily preclude parol evidence rebutting a term that the law would otherwise presume."). Such a court would not have reason to treat oral evidence that such a written option is conditional as inconsistent with the written option term. Instead, the oral evidence would be admissible as evidence that the parties opted out of the interpretive default rule.
189. See id.
190. This test was found in comment 3 to §2-202 prior to the 2003 Amendments to Article 2. The pre-Amendment version remains current law in all jurisdictions that have adopted the U.C.C. In the 2003 amended version of Article 2, the same test for integration is found in comment 3. U.C.C. §2-202 cmt. 3 (amended 2003).
191. Courts have long recognized that a writing can be found to be a total integration even in the absence of a merger clause.
192. See, e.g., Mitchill v. Lath, 160 N.E. 646, 648 (N.Y. 1928) (excluding evidence of separate oral agreement and adding to terms of deed that appeared complete on its face despite absence of merger clause);
193. see also SCOTT & KRAUS, supra note 3, at 541-43 (discussing tests for total integration in absence of merger clause).
194. Hunt Foods, 270 N.Y.S.2d at 940.
195. Id. at 939.
196. Id.
197. If Doliner had concluded that Hunt Foods had agreed to a legally enforceable oral condition but had insisted on excluding the condition from the writing in order to preserve the possibility of denying the condition later, then Doliner obviously would not have acceded to Hunt Foods's demand.
198. See SCOTT & STEPHAN, supra note 9, at 88-94;
199. Schwartz & Scott, supra note 6, at 557;
200. Scott, Conflict and Cooperation, supra note 9, at 2039-42;
201. Scott, Self-Enforcing Agreements, supra note 9, at 1680-1682
202. See Avner Greif, Informal Contract Enforcement: Lessons from Medieval Trade, in 2 THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 287,287 (Peter Newman ed., 1998) ("[I]nformal contract enforcement institutions . . . are a product of the larger economic, cultural, social and political processes of which they are an integral part.");
203. Janet T. Landa, A Theory of the Ethnically Homogeneous Middleman Group: An Institutional Alternative to Contract Law, 10 J. LEGAL STUD. 349,350-52 (1981) (finding that "invisible codes of ethics, embedded in the personalized exchange relations among the members of the [ethnically homogenous middleman group] function as constraints against breach of contract" and that "a rational trader will enter into particularistic exchange relations with traders . . . whom he knows to be trustworthy and reliable in honoring contracts").
204. As Alan Schwartz and Robert E. Scott have noted: [R]eputations work best in small trading communities, especially those with ethnically homogenous members [or other cooperation-inducing structures], where everything that happens soon becomes common knowledge, and boycotts of bad actors are easy to enforce. Reputational sanctions also can be effective in industries that can establish trade associations; the associations become a form of collective memory regarding the contracting behavior of their members.
205. Schwarte & Scott, supra note 6, at 557. For a discussion of formalist contract enforcement by a private system of merchant courts established by the National Grain and Feed Association, resulting in part from a recognition of the role of extralegal, reputational sanctions,
206. see generally Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code's Search for Immanent Business Norms, 144 U. PA. L. REV. 1765 (1996) [hereinafter Bernstein, Merchant Law].
207. See also Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 MICH. L. REV. 1724 (2001) [hereinafter Bernstein, Private Commercial Law] (discussing importance of reputation-based nonlegal sanctions in cotton industry).
208. See Schwartz & Scott, supra note 6, at 557 ("Reputation ... will induce performance when a single contract partner's boycott would not.").
209. Reputations are difficult to establish in large, heterogeneous economies in which particular contracting parties are anonymous and ongoing relationships inevitably come to an end. When parties come to realize that the relationship is soon to terminate (say, when the promisor contemplates retirement or otherwise withdraws from the trading community), the threat that the other party will no longer deal with the promisor is insufficient in and of itself to induce performance.
210. See Benjamin Klein, Why Hold-Ups Occur: The SelfEnforcing Range of Contractual Relationships, 34 ECON. INQUIRY 444, 447-50 (1996) (discussing conditions for self-enforcing contracts);
211. Scott, Conflict and Cooperation, supra note 9, at 2039-2049 (same).
212. Experimental evidence shows that a preference for reciprocity-the willingness to reward cooperation and to punish selfishness-can motivate cooperation even in armslength interactions between complete strangers.
213. See generally Ernst Fehr & Klaus M. Schmidt, A Theory of Fairness, Competition, and Cooperation, 114 Q.J. ECON. 817, 818 (1999) [hereinafter Fehr & Schmidt, A Theory of Fairness] ("[I]n addition to purely selfinterested people, there are a fraction of people who are also motivated by fairness considerations.");
214. Ernst Fehr, Simon Gächter & Georg Kirchsteiger, Reciprocity as a Contract Enforcement Device: Experimental Evidence, 65 ECONOMÉTRICA 833, 833 (1997) ("[Reciprocal behavior may cause an increase in the set of enforceable contracts and may thus allow the achievement of nonnegligible efficiency gains.");
215. David K. Levine, Modeling Altruism and Spitefulness in Experiments, 1 REV. ECON. DYNAMICS 593,594 (1998) (examining quantitative implications of "the theory" that "fairness plays a role in individual decision making");
216. Matthew Rabin, Incorporating Fairness into Game Theory and Economics, 83 AM. ECON. REV. 1281,1282 (1993) (discussing "a game-theoretic framework for incorporating [reciprocity] into a broad range of economic models"). For a review of literature discussing how fairness considerations "shape the behavior of people in important economic domains,"
217. see Ernst Fehr & Klaus M. Schmidt, Theories of Fairness and Reciprocity-Evidence and Economic Applications 3-4 (Ctr. for Econ. Studies & Ifo Inst, for Econ. Research, Working Paper No. 403, 2000;
218. Univ. of Zurich, Inst, for Empirical Research in Econ., Working Paper No. 75, 2001), available at http://ssrn.com/abstract= 255223. For discussion of how reputation and reciprocity serve as "effective means of self enforcement" of agreements,
219. see Scott & Stephan, Self-Enforcing International Agreements, supra note 11, at 565-566
220. SCOTT & STEPHAN, supra note 9, at 22-23.
221. Scott, Self-Enforcing Agreements, supra note 9, at 1667-1672
222. Scott, Self-Enforcing Agreements, supra note 9, at 1688-1692
223. Fehr & Schmidt, A Theory of Fairness, supra note 133, at 817-18;
224. see also Fehr, Gächter & Kirchsteiger, supra note 133, at 833 ("[Reciprocal behavior may cause an increase in the set of enforceable contracts and may thus allow the achievement of nonnegligible efficiency gains.");
225. Ernst Fehr & Armin Falk, Psychological Foundations of Incen-lives (Inst, for the Study of Labor, Working Paper No. 507, 2002), available at http://ssrn .com/abstract-id=294287 ("[Reciprocity induces agents to cooperate voluntarily with the principal if the principal treats them kindly.").
226. See generally Rabin, supra note 133 (incorporating individual's feelings about whether individual is being treated fairly into game theory);
227. Martin Dufwenberg & Georg Kirchsteiger, A Theory of Sequential Reciprocity, 47 GAMES & ECON. BEHAV. 268 (2003) (developing model to describe reciprocity in context of sequential games);
228. Fehr & Schmidt, A Theory of Fairness, supra note 133, at 818 (analyzing conflicting evidence and developing model to explain why "[s]ome pieces of evidence suggest that many people are driven by fairness considerations, other pieces indicate that virtually all people behave as if completely selfish, and still other types of evidence suggest that cooperation motives are crucial");
229. David K. Levine, Modeling Altruism and Spitefulness in Experiments, 1 REV. ECON. DYNAMICS 593 (1998) (proposing simpler model than Rabin's based on altruism);
230. Armin Falk & Urs Fischbacher, A Theory of Reciprocity (Ctr. for Econ. Studies & Ifo Inst, for Econ. Research, Working Paper No. 457, 2001), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=203115 (presenting formal theory of reciprocity).
231. Scott, Self-Enforcing Agreements, supra note 9, at 1688-1692
232. Id.
233. To be sure, the crowding-out phenomenon is complex. A number of studies have confirmed the crowding-out hypothesis in single iteration experiments, where the parties must choose either nonlegal or legal enforcement. In these studies, the choice of legal enforcement uniformly suppresses the evidence of reciprocity that is found in the alternative scenario of no legal enforcement.
234. See generally Iris Bohnet, Bruno S. Frey & Steffen Huck, More Order with Less Law: On Contract Enforcement, Trust, and Crowding, 95 AM. POL. SCI. REV. 131,131,141 (2001) ("Individuals perform a contract when enforcement is strong or weak but not with medium enforcement probabilities: Trustworthiness is 'crowded in' with weak and 'crowded out' with medium enforcement.");
235. Fehr, Gächter & Kirchsteiger, supra note 133;
236. Bruno S. Frey & Reto Jegen, Motivation Crowding Theory, 15 J. ECON. SURVEYS 589, 596-606 (2001) (surveying experimental evidence suggesting that introduction of monetary penalties and other financial incentives can decrease individuals' willingness to work together and behave reciprocally);
237. Bruno S. Frey & Matthias Benz, Motivation Transfer Effect (June 12, 2001) (unpublished manuscript, available at http://www.iew.unizh.ch/home/benz/ downloads/MTE.pdf) (finding that economic incentives reduce intrinsic motivation, including desire to cooperate and follow social norms, even with respect to conduct not subject to incentive mechanism). But recent experiments also show that, where there is some probability that the same buyers and sellers will continue transacting in the next period, legal enforcement that is limited to the verifiable dimensions of the agreement actually enhances cooperation in those dimensions of the agreement that are nonverifiable.
238. See Sergio G. Lazzarini, Gary J. Miller & Todd R. Zenger, Order with Some Law: Complementarity Versus Substitution of Formal and Informal Arrangements, 20 J.L. ECON. & ORG. 261, 261 (2004) ("[BJy enforcing contractible exchange dimensions, contracts facilitate the self-enforcement of noncontractible dimensions.").
239. It is important to keep in mind that legal disputes only arise when the informal modes of enforcement have broken down. Litigated cases, therefore, offer little evidence of the power of reciprocity, reputation, and other informal mechanisms in enforcing the agreements between commercial parties that never reach litigation.
240. Alternatively, if the Hunt Foods court were to be interpreted as having treated the oral statement as evidence of a condition precedent to the agreement's taking effect, see supra note 121, the court should have held that the condition was not admissible because it contradicted the express option in the agreement.
241. See Edward A. Bernstein, Law & Economics and the Structure of Value Adding Contracts: A Contract Lawyer's View of the Law & Economics Literature, 74 OR. L. REV. 189, 227-28 (1995) (discussing tradeoffs between legal and relational means of enforcement);
242. Bernstein, Merchant Law, supra note 130, at 1788-89 (same);
243. David Charny, Nonlegal Sanctions in Commercial Relationships, 104 HARV. L. REV. 373, 391-426 (1990) (same);
244. Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 AM. SOC. REV. 55, 60-65 (1963) (discussing pervasive use of relational enforcement in sample of business contracts);
245. Ronald J. Mann, Verification Institutions in Financing Transactions, 87 GEO. L.J. 2225,2249-52 (1999) (discussing tradeoffs between legal and relational means of enforcement);
246. John McMillan & Christopher Woodruff, Private Order Under Dysfunctional Public Order, 98 MICH. L. REV. 2421, 2458 (2000) (same).
247. See, e.g., Eric A. Posner, The Parol Evidence Rule, the Plain Meaning Rule, and the Principles of Contractual Interpretation, 146 U. PA. L. REV. 533, 534 (1998) (distinguishing two polar positions: "hard-PER," where "the court generally excludes extrinsic evidence and relies entirely on the writing," and "soft-PER," where "the court gives weight both to the writing and to the extrinsic evidence").
248. See generally Robert A. Hillman, The "New Conservatism" in Contract Law and the Process of Legal Change, 40 B.C. L. REV. 879, 881-88 (1999) (identifying shift in contract law in favor of written contracts over "alleged oral, less formal representations or agreements" and predicting shift in judicial interpretation away from "new conservative" outlook toward more liberal approach to contract interpretation);
249. Ralph James Mooney, The New Conceptualism in Contract Law, 74 OR. L. REV. 1131, 1132-35 (1995) (identifying difference between hard and soft interpretive regimes and arguing that hard regimes tend to benefit already powerful and wealthy class). For a discussion of approaches to choosing a hard or soft interpretive regime,
250. see SCOTT & KRAUS, supra note 3, at 596-597
251. See, e.g., Morgan Stanley High Yield Sec, Inc. v. Seven Circle Gaming Corp., 269 F. Supp. 2d 206,220 (S.D.N.Y. 2003) (denying defendant's claim of unsatisfied oral condition precedent and enforcing written contract when contract said "this Agreement is [the signing party's] legal, valid and binding obligation enforceable against it in accordance with its terms" (alteration in original));
252. Intershoe, Inc. v. Bankers Trust Co., 571 N.E.2d 641, 642, 644 (N.Y. 1991) (excluding parol evidence where writing appeared to embody parties' final agreement unambiguously); Mitchill v. Lath, 160 N.E. 646, 647-48 (N.Y. 1928) (upholding four-corners presumption and excluding evidence of collateral agreement to land-sale contract).
253. Geoffrey P. Miller, Bargaining on the Red-Eye: New Light on Contract Theory 40 (N.Y. Univ. Law & Econ. Working Papers, Paper No. 131, 2008), available at http://lsr .nellco.org/nyu/lewp/papers/131;
254. see, e.g., Morgan Stanley, 269 F. Supp. 2d at 214 ("Under New York law a contract which appears complete on its face is an integrated agreement as a matter of law."). In addition, merger clauses are given virtually conclusive effect in New York.
255. See Tempo Shain Corp. v. Bertek, Inc., 120 F.3d 16,21 (2d Cir. 1997) ("Ordinarily, a merger clause provision indicates that the subject agreement is completely integrated, and parol evidence is precluded from altering or interpreting the agreement.");
256. Jarecki v. Louie, 745 N.E.2d 1006, 1009 (N. Y. 2001) ("The purpose of a merger clause is to require the full application of the parol evidence rule in order to bar the introduction of extrinsic evidence .... The merger clause accomplishes this purpose by evincing the parties' intent that the agreement 'is to be considered a completely integrated writing.'");
257. Norman Bobrow & Co. v. Loft Realty Co., 577 N.Y.S.2d 36,36 (App. Div. 1991) ("Parol evidence is not admissible to vary the terms of a written contract containing a merger clause.").
258. Masterson v. Sine, 436 P.2d 561, 564 (Cal. 1968) (admitting parol evidence to vary terms of deed on ground that "[e]vidence of oral collateral agreements should be excluded only when the fact finder is likely to be misled");
259. Pac. Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co., 442 P.2d 641, 645 (Cal. 1968) ("[Rational interpretation requires at least a preliminary consideration of all credible evidence offered to prove the intention of the parties.");
260. see also Susan J. Martin-Davidson, Yes, Judge Kozinski, There Is a Parol Evidence Rule in California-The Lessons of a Pyrrhic Victory, 25 Sw. U. L. REV. 1 (1995) (examining California cases raising issue of admissibility of extrinsic evidence and concluding that parol evidence jurisprudence represents one of most confused and incoherent areas of law in California);
261. Miller, supra note 146, at 41-42 ("If... the extrinsic evidence reveals ambiguity, then the court may consider all such extrinsic evidence as may be relevant to interpreting the contract."). Martin-Davidson found the following after examining California cases: The cases in the study did not confirm the accusation that California has abandoned the parol evidence rule. On the other hand, neither did they suggest that the rule is alive and well. Instead, they supported a different accusation: that the parol evidence rule persists in California like a neomort maintained on permanent life-support as a ready source of transplant organs. The many standard but incompatible formulations of the parol evidence rule are ready as needed in this on-going and inconclusive battle. One faction is fighting in defense of the written word while its many enemies insist that a written agreement is not "all they wrote."
262. Martin-Davidson, supra, at 9.
263. Theodore Eisenberg & Geoffrey P. Miller, The Flight to New York: An Empirical Study of Choice of Law and Choice of Forum Clauses In Publicly-Held Companies' Contracts 4-5 (N.Y. Univ. Law & Econ. Working Papers, Paper No. 124, 2008), available at http://lsr.nellco.org/nyu/lewp/papers/124.
264. Id. at 19, 34. Delaware was a distant second to New York, with about 15% of the parties choosing its law. No other state accounted for even 10% of the choices of law.
265. Id. at 19.
266. Id. at 19 tbl.2, 23 tbl.5.
267. 499 F. Supp. 53 (W.D. Pa. 1980).
268. See Alan Schwartz, Relational Contracts in the Courts: An Analysis of Incomplete Agreements and Judicial Strategies, 21 J. LEGAL STUD. 271, 271-72 (1992) (describing passivity of courts in contract-excuse cases). For a case rejecting ALCOA'S reasoning,
269. see Atlas Corp. v. United States, 895 F.2d 745, 750 (Fed. Cir. 1990).
270. See infra text accompanying notes 160-71 for a discussion of the doctrine of mistake and the reasoning of the court in ALCOA.
271. The contract between ALCOA and Essex is analyzed in detail in VICTOR GOLDBERG, FRAMING CONTRACT LAW: AN ECONOMIC PERSPECTIVE 348-369 (2006).
272. Clause 28 of the ALCOA-Essex contract provides: In the event that any index referred to in paragraph 8 and 9 hereof is discontinued, no longer published in the sources indicated or become [sic] unavailable, the parties shall agree on a comparable substitute index and if they are unable to agree [on] the selection of a substitute index, the selection of a comparable substitute index shall be submitted to arbitration ....
273. Id. at 354.
274. Id. at 353.
275. Aluminum Co. of Am. v. Essex Group, Inc. (ALCOA), 499 F. Supp. 53,59 (W.D. Pa. 1980).
276. The price term also failed to properly index the fixed-demand charge representing ALCOA's capital investment in the smelter.
277. GOLDBERG, supra note 154, at 356.
278. ALCOA, 499 F. Supp. at 59;
279. GOLDBERG, supra note 154, at 355.
280. ALCOA, 499 F. Supp. at 60-78. The court based its analysis of the three doctrines on the relevant provisions in the Uniform Commercial Code and the Restatement (Second) of Contracts.
281. See, e.g., U.C.C. §2-615 (amended 2003) (containing current version of excuse by failure of presupposed conditions doctrine similar to that relied on in ALCOA); RESTATEMENT (SECOND) OF CONTRACTS §§151-154 (1981) (mistake);
282. id. §261 (discharge by supervening impracticability);
283. id. §265 (discharge by supervening frustration).
284. Ultimately, the new contract price "would have meant that in 1979 ALCOA would have received about 11 cents per pound more than it would have absent the modification."
285. GOLDBERG, supra note 154, at 357.
286. ALCOA, 499 F. Supp. at 60 (emphasis added) (quoting 3 ARTHUR LINTON CORBIN, CORBIN ON CONTRACTS §605, at 643 (1960)).
287. Id. at 61.
288. Id. at 63. The requirement that the mistaken belief must concern a fact that exists at the time of the agreement serves to distinguish the law of mistake from the law of excuse. While the mistake doctrine voids agreements based on mistaken assumptions about matters of fact that exist at the time of formation, it is designed not to apply to cases in which parties make mistaken predictions about the future, such as erroneous assumptions about future market conditions or their future financial situations. RESTATEMENT (SECOND) OF CONTRACTS §152 cmt. b (1981). The ALCOA court therefore could only use the mistake doctrine as a ground for reformation by characterizing the parties' mistake about the future functioning of the price index as a mistake concerning a fact in existence at the time of the contract's formation.
289. ALCOA, 499 F. Supp. at 60.
290. Id. at 68. As the court noted, "Essex first asserts that ALCOA expressly or implicitly assumed the risk that the WPI-IC would not track ALCOA'S non-labor production costs. Essex asserts that ALCOA drafted the index provision . . . and that ALCOA'S officials knew of the inherent risk that the index would not reflect cost changes." Id.
291. Id.
292. Alan Greenspan's actual role in developing the price term is a matter of some dispute. In its brief to the Third Circuit, Essex claimed that "[c]ontrary to the trial court's finding, George [Alcoa's key negotiator] testified that Alan Greenspan . .. was not consulted by Alcoa in connection with [the] Contract."
293. GOLDBERG, supra note 154, at 361 (quoting Brief of Appellant at 16 n.9, Aluminum Co. of Am. v. Essex Group, Inc., No. 80-1604 (3d Cir. 1980)).
294. ALCOA, 499 F. Supp. at 69.
295. Id. at 70.
296. Id. at 67-70 (explaining that ALCOA did not assume risk expressly, through common understanding or trade usage, according to general policies, or through conscious ignorance).
297. See generally RESTATEMENT (SECOND) OF CONTRACTS §154 (1981) (stating that party assumes risk of mistake by agreement of parties, conscious treatment of limited knowledge with respect to mistake-related facts as sufficient, or reasonable allocation by court). In applying this provision to the facts of the case, the court first rejected the argument that, by not including a floor in the price term, ALCOA expressly or implicitly agreed to bear the risk that the escalator might rise too slowly. 499 F. Supp. at 68. The court found that ALCOA considered the possibility that a floor might be necessary too remote to put into the contract. The court also rejected Essex's argument that the contract should be interpreted against its drafter, ALCOA, because according to the court, that interpretive maxim is only appropriate when there is ambiguity or a policy concern, neither of which were present in the case.
298. Id. at 69. As to whether ALCOA assumed the risk by proceeding in the face of conscious ignorance of the risk, the court said that the test is not whether they were aware at some level that uncertainty existed, but rather whether they believed the uncertainty was limited (which ALCOA did).
299. Id. at 69,70. Finally, the court noted that there was no reason to allocate the risk to ALCOA, nor did customary dealing call for ALCOA to assume the risk.
300. Id. at 67.
301. The court also considered impracticability and frustration, which have the same basic doctrinal requirements as mistake, but focus on the hardship imposed on the plaintiff.
302. ALCOA, 499 F. Supp. at 70-71 ("In broad outline the doctrines of impracticability and of frustration of purpose resemble the doctrine of mistake."). The court found for ALCOA on both of these grounds based on its $60 million expected loss resulting from the failure of the index.
303. Id. at 70-78.
304. The court applied its findings on the mistake issue to the impracticability issue, finding that the nonoccurrence of the event (and the nonexistence of the fact) that caused the impracticability was a basic assumption on which the contract was made. The difficulty envisioned in the impracticability doctrine, according to the court, must be extreme and unreasonable: In this case, the loss was so significant in absolute size and proportion to the value of the contract that it altered the essential nature of performance.
305. Id. at 72-74.
306. Id. at 63.
307. Id.
308. RESTATEMENT (SECOND) OF CONTRACTS §152 (1981).
309. Id. §261.
310. Id. §265.
311. GOLDBERG, supra note 154, at 369.
312. See id. at 363 (describing problems in designing cost-based contracts).
313. The following analysis of the tradeoff between rules and standards in contract design draws on the discussion in Scott & Triantis, supra note 10, at 822-856 (discussing first, in Part I, differences in costs between front and back ends of contracting, and second, in Part II, how parties decide between precise and vague contract terms).
314. According to Goldberg, Warrick was the only Alcoa smelter that relied on coal for its electric power. The remainder used hydroelectric power, power provided by [the Tennessee Valley Authority], or natural gas. The costs of all of Alcoa's other smelters did not rise with the price of oil. So, while Warrick was Alcoa's low cost plant when it was built, the changing fuel prices made it far and away the highest cost plant, post-1973.
315. GOLDBERG, supra note 154, at 356.
316. SCOTT & KRAUS, supra note 3, at 390.
317. See, e.g., U.C.C. §2-305(1) (amended 2003) ("The parties if they so intend may conclude a contract for sale even if the price is not settled. In such a case the price is a reasonable price at the time for delivery if: (a) nothing is said as to the price; (b) the price is left to be agreed by the parties and they fail to agree; or (c) the price is to be fixed in terms of some agreed market or other standard as set or recorded by a third person or agency and it is not so set or recorded.").
318. The advantage of contractual rules is that the parties themselves know better than the courts what their objectives are and presumably can specify a proxy that best enhances contractual incentives. Moreover, by making proof of the price term trivial, a rule reduces the expected costs of adjudication. The chief disadvantage of a rule is that it might not achieve the objective the parties intended. Like all rules, a precise price term, no matter how sophisticated, is likely to be over- or under-inclusive over a large range of possible future circumstances.
319. The contract does not explicitly state that it was intended to mimic a cost-plus contract while avoiding familiar difficulties with cost-plus agreements; "[n]onetheless, the structure of the agreement makes it quite clear that the intent was to make the contract cost-based."
320. GOLDBERG, supra note 154, at 363. To be sure, the agreed-upon indexing formula in the contract had many other problems, in addition to the failure of the WPI-IC to track carbon-based fuel costs.
321. See id. at 363-365 But the mere fact that commercial parties design an ex ante rule badly does not justify judicial action to rewrite a precise contract term ex post. Indeed, one of the major reasons for inserting caps and floors in such indices is to guard against other risks, in addition to the risk of low-probability/highimpact states of the world. Among those risks is the risk of formulation error by the parties themselves.
322. 415 F. Supp. 429 (S.D. Fla. 1975).
323. Id. at 432.
324. Scott & Triantis, supra note 10, a 843.
325. Eastern Air Lines, 415 F. Supp. at 433 (quoting contract).
326. Id. at 440.
327. Note that the parties in ALCOA included such a clause in their contract. See supra note 155.
328. By their own terms, these doctrines apply only to losses resulting from a "basic assumption" the parties shared that turns out to be wrong because of "circumstances not within the contemplation of the parties at the time of contracting." U.C.C. §2-615 cmt. 1 (amended 2003). Given that ALCOA and Essex negotiated over and agreed to an express price ceiling, their belief that the price index would not malfunction cannot qualify as a basic assumption under the mistake or excuse doctrines.
329. See generally George G. Triantis, Contractual Allocations of Unknown Risks: A Critique of the Doctrine of Commercial Impracticability, 42 U. TORONTO L.J. 450 (1992) (chal-lenging assumption that contracting parties are unable to rationally manage and allocate risks of unanticipated events). Triantis argues: While an unknown risk cannot be priced and allocated specifically, it can be priced and allocated as part of the package of a more broadly framed risk. For example, consider a party who agrees to transport a shipment of goods for a fixed fee. The risk of a nuclear accident in the Middle East that causes a dramatic decrease in the production of oil and a consequent increase in its price might not be foreseen. As a result, this risk cannot be allocated explicitly in the contract. However, the broader risk of a large increase in the price of oil for any reason can be. Therefore, there is no gap to be filled by the doctrine of impracticability: [T]he risk of nuclear accident, though unforeseen, is allocated implicitly. Instead, the doctrine alters the contractual allocation of the risk and its proponents must advance a rationale for the reallocation.
330. Id. at 452.
331. Miller, supra note 146;
332. see also Eisenberg & Miller, supra note 148, at 21, 27 (providing empirical evidence showing parties choose New York law in about 46% of contracts studied while choosing California law in less than 8% of contracts even though parties choose California as place of business more frequently than New York).
333. Miller, supra note 146, at 37-39.
334. Id. at 37;
335. see also Nash v. Kornblum, 186 N.E.2d 551, 553 (N.Y. 1962) (finding that mistake must be shown by clear and convincing evidence);
336. Lacoparra v. Bellino, 745 N.Y.S.2d 693, 694 (App. Div. 2002) (same);
337. Jossel v. Meyers, 629 N.Y.S.2d 9,10-11 (App. Div. 1995) ("Where the parties have made an instrument as they intended it should be, and the instrument expresses the transaction as it was understood and designed to be made, then the party who had an opportunity to know the contents of the instrument cannot obtain cancellation or reformation because he misunderstood the legal effect. . . .").
338. Miller, supra note 146, at 38;
339. see also CAL. CIV. CODE §§1550, 1565, 1580 (West 1982) ("Consent is not mutual, unless the parties agree upon the same thing in
340. Miller, supra note 146, at 38-39.
341. See CAL. CIV. PROC. CODE, §1856(e), (g) (West 2007) (setting out exceptions to rule excluding parole evidence); Casa Herrera, Inc. v. Beydoun, 83 P.3d 497, 502 (Cal. 2004) (finding that parol evidence rule "does not.. . prohibit the introduction of extrinsic evidence 'to explain the meaning of a written contract... [if] the meaning urged is one to which the written contract terms are reasonably susceptible'"
342. (quoting BMW of N. Am., Inc. v. New Motor Vehicle Bd., 209 Cal. Rptr. 50, 57 n.4 (Ct. App. 1984))). Note also that "[r]eformation is liberally available in California if mistake is shown, provided that the changed terms do not affect substantial rights of third parties."
343. Miller, supra note 146, at 39. The California Civil Code states that, When, through fraud or a mutual mistake of the parties, or a mistake of one party, which the other at the time knew or suspected, a written contract does not truly express the intention of the parties, it may be revised on the applica-tion of a party aggrieved, so as to express that intention, so far as it can be done without prejudice to rights acquired by third persons, in good faith and for value. CAL. CIV. CODE §3399 (West 1997).
344. See, e.g., U.C.C. §2-202 (amended 2003) (evidence not admissible to prove additional terms consistent with express terms of fully integrated writing); id. §2-208(2) (express terms control course of performance, course of dealing, and usage of trade); RESTATEMENT (SECOND) OF CONTRACTS §215 (1981) (evidence of prior or contemporaneous agreements or negotiations not admissible to contradict term of writing); id. §216(1) (evidence of consistent additional term not admissible to supplement fully integrated agreement).
345. See Goetz & Scott, supra note 102, at 281-83 (arguing that express terms are signals that enable parties to opt out of implied default terms and to supplement defaults with additional customized terms);
346. Schwartz & Scott, supra note 6, at 584-589 (asserting that maximizing party control over express terms promotes efficient contracting).
347. See SCOTT & KRAUS, supra note 3, at 543-45, 578-602 (discussing differences between "plain meaning" and "contextual" modes of interpretation); Schwartz & Scott, supra note 6, at 584 (arguing that most parties would prefer plain meaning interpretation because it would "(1) reduce contracting costs; (2) minimize the opportunities for strategic behavior; (3) reduce the risk of judicial error; and (4) expand the set of efficient contracts parties could write"). For discussion, see cases cited supra notes 145-147
348. See, e.g.. Pac. Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co., 442 P.2d 641, 646 & n.9 (Cal. 1968) (finding context evidence admissible to show that promise to indemnify plaintiff against "all loss, damage, expense and liability" does not require defendant to indemnify plaintiff for injuries to plaintiffs property); In re Soper's Estate, 264 N.W. 427,431-433 (Minn. 1935) (finding context evidence admissible to show that reference to "wife" in will does not mean person to whom testator was legally married).
349. For example, in Černohorsky v. Northern Liquid Gas Co., the court said: The language of a contract must be understood to mean what it clearly expresses. A court may not depart from the plain meaning of a contract where it is free from ambiguity. In construing the terms of a contract, where the terms are plain and unambiguous, it is the duty of the court to construe it as it stands, even though the parties may have placed a different construction on it. 68 N.W.2d 429, 433 (Wis. 1955) (citation omitted).
350. For more cases exemplifying the plain meaning view, see 11 SAMUEL WILLISTON, A TREATISE ON THE LAW OF CONTRACTS §30:6, at 82-83 n.38 (4th ed. 1999).
351. Pac. Gas & Elec. Co., 442 P.2d at 646 n.8 ("Extrinsic evidence has often been admitted ... on the stated ground that the contract was ambiguous. This statement of the rule is harmless if it is kept in mind that the ambiguity may be exposed by extrinsic evidence that reveals more than one possible meaning." (citation omitted)). Even if a court concludes that an express term has a plain meaning, it can narrow or expand that meaning in order to vindicate the parties' contractual ends.
352. See, e.g., Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772, 780 (9th Cir. 1981) (holding that trade usage and course of performance evidence could vary normal meaning of "price protection" clause);
353. Brunswick Box Co. v. Coutinho, Caro & Co., 617 F.2d 355, 359 (4th Cir. 1980) (holding that evidence of course of performance could vary normal meaning of "F.A.S." term in written contract).
354. RESTATEMENT (SECOND) OF CONTRACTS §224 (1981). The event on which the promise is conditioned is "largely within the control of the obligor (the homeowner's honest satisfaction with the paint job), the obligee (the insured's furnishing proof of loss), or a third person (the bank's approval of the mortgage application), or is largely beyond the control of anyone (damage as a result of fire)."
355. 2 FARNSWORTH, supra note 18, §8.2, at 395.
356. Renovest Co. v. Hodges Dev. Corp., 600 A.2d 448,452-53 (N.H. 1991) ("[W]hen the parties expressly condition their performance upon the occurrence or non-occurrence of an event, rather than simply including the event as one of the general terms of the contract, the parties' bargained-for expectation of strict compliance should be given effect.");
357. see also Nielsen v. Provident Sav. Life Assurance Soc'y, 66 P. 663, 665 (Cal. 1901) ("[C]onditions[,] . . . when made, must be construed and enforced . . . according to the expressed understanding of the parties making them. It is not for the courts to dispense with such limitations and conditions, nor by judicial legislation to insert a different contract from that deliberately made by the parties.").
358. JOHN EDWARD MURRAY, JR., MURRAY ON CONTRACTS §102(A), at 641 (4th ed. 2001);
359. see also, e.g., Naftalin v. John Wood Co., 116 N.W.2d 91,100 (Minn. 1962) ("[It is a] well-recognized principle that forfeitures are not favored either in law or equity. ... One claiming forfeiture carries a heavy burden of establishing his right thereto by clear and unmistakable proof.");
360. Stevenson v. Parker, 608 P.2d 1263,1267-68 (Wash. Ct. App. 1980) ("This court has held the general doctrine that forfeitures are not favored in the law, and that courts should promptly seize upon any circumstance ... that would indicate an election or an agreement to waive the harsh, and at times unjust, remedy of forfeiture ....").
361. The Restatement defines "forfeiture" as the denial of compensation for losses the promisee incurs when "[t]he non-occurrence of a condition of [the promisor's duty ... cause[s] the [promisee] to lose his right to the agreed exchange after he has relied substantially on the expectation of that exchange . . . ." RESTATEMENT (SECOND) OF CONTRACTS §227 cmt. b (1981).
362. RESTATEMENT (SECOND) OF CONTRACTS §227 cmt. b (1981) ("The policy favoring freedom of contract requires that, within broad limits ... the agreement of the parties should be honored even though forfeiture results.");
363. id. §226 cmt. c ("[T]o the extent that the parties have, by a term of their agreement, clearly made an event a condition, they can be confident that a court will ordinarily feel constrained strictly to apply that term ....");
364. id. §229 cmt. a ("[I]f the term that requires the occurrence of the event as a condition is expressed in unmistakable language, the possibility of forfeiture will not affect the interpretation of that language.");
365. see also Gillman v. Bally Mfg. Corp., 670 A.2d 19, 21 (N.J. Super. Ct. App. Div. 1996) ('"[E]quity's jurisdiction in relieving against a forfeiture is to be exercised with caution ... [A] court of equity will not interfere to substitute a different and more liberal agreement' than that which existed between the parties."
366. (quoting Dunkin' Donuts of Am. v. Middletown Donut Corp., 495 A.2d 66, 74 (N.J. 1985) and, Fox v. Haddon Twp, 45 A.2d 193,196 (N.J. Ch. 1945))).
367. See, e.g., Bornholdt v. S. Pac. Co., 327 F.2d 18, 20 (9th Cir. 1964) ("A condition involving a forfeiture must be strictly interpreted against the party for whose benefit it is created-Where there are two possible constructions, one of which leads to a forfeiture and the other avoids it, the rule of law is well settled ... that the construction which avoids forfeiture must be made if it is at all possible." (citing CAL. CIV. CODE §1442 (West 2007)));
368. Kalina v. Eckert, 497 A.2d 1384, 1385 (Pa. Super. Ct. 1985) ("[A] provision will not be construed to result in a forfeiture unless no other reasonable construction is possible.");
369. Leitner v. Lonabaugh, 402 P.2d 713, 720 (Wyo. 1965) ("Even as a general rule conditions, if possible, are to be construed 'so as not to operate as a forfeiture of the rights of the parties.'"
370. (quoting Pac.-Wyo. Oil Co. v. Carter Oil Co., 226 P. 193, 198 (Wyo. 1924))).
371. Courts use general principles of interpretation to identify and distinguish conditions and duties. RESTATEMENT (SECOND) OF CONTRACTS §226 cmt. a (1981). In addition, courts have developed specialized principles for resolving interpretive questions regarding conditions.
372. See id. ("There are also some special standards of preference that are of particular applicability to conditions, and these are set out in §227."). The ex ante version of the antiforfeiture norm falls into this second category.
373. A contractual provision similar to this appears in Inman v. Clyde Hall Drilling Co., 369 P.2d 498,499 n.2, 500 (Alaska 1962) (finding that provision is not "unfair or unreasonable"). Employment contracts often contain such provisions to give the employer the opportunity to settle disputes and take measures to prevent ongoing or future violations of contractual or statutory provisions.
374. A court might also interpret the language as creating both a promise and a condition, in which case the employee's failure to satisfy the contract terms not only relieves the employer of liability but also subjects the employee to liability for breach of her promise.
375. The Restatement explains: Since the intentions of the parties must be taken as of the time the contract was made, the test is whether a particular interpretation would have avoided the risk of forfeiture viewed as of that time, not whether it will avoid actual forfeiture in the resolution of a dispute that has arisen later. RESTATEMENT (SECOND) OF CONTRACTS §227 cmt. b (1981).
376. See id. §229 ("To the extent that the non-occurrence of a condition would cause disproportionate forfeiture, a court may excuse the non-occurrence of that condition unless its occurrence was a material part of the agreed exchange.").
377. See, e.g., Knarston v. Manhattan Life Ins. Co., 73 P. 740,741 (Cal. 1903) ("[T]he right to declare a forfeiture, being a matter entirely for the benefit of a lessor or vendor, can be, even by parol, effectually waived by either.")
378. Bielski v. Wolverine Ins. Co., 150 N.W.2d 788, 790 (Mich. 1967) ("[W]aivers [of contract clause requiring arbitration as condition precedent to suit] need not be expressed in terms, but may be implied by the acts, omissions, or conduct of the insurer or its agents authorized in such respect.");
379. Cochran v. Grebe, 578 S.W.2d 351,354 (Mo. Ct. App. 1979) ("Forfeitures are highly disfavored by the law and the courts are therefore quick to find a waiver or estoppel in a case [producing hardship].");
380. Miraldi v. Life Ins. Co., 356 N.E.2d 1234,1236 (Ohio Ct. App. 1971) (stating that law does not favor forfeiture and that waiver will be inferred whenever it reasonably can be from facts);
381. Brown v. Powell, 648 N.W.2d 329,333 (S.D. 2002) ("Because forfeitures of land sale contracts are highly disfavored by the law, courts are generally quick to find a waiver of conditions alleged as a basis for a claim of breach.").
382. See RESTATEMENT (SECOND) OF CONTRACTS §228 (1981) ("When it is a condition of an obligor's duty that he be satisfied with respect to the obligee's performance or with respect to something else, and it is practicable to determine whether a reasonable person in the position of the obligor would be satisfied, an interpretation is preferred under which the condition occurs if such a reasonable person in the position of the obligor would be satisfied.").
383. See id. §228 cmt. b ("When, as is often the case, the preferred interpretation [i.e. relying on an objective standard] will reduce the obligee's risk of forfeiture,... there is an additional argument in its favor.").
384. See id. §228 cmt. a ("If the agreement leaves no doubt that it is only honest satisfaction that is meant and no more, it will be so interpreted, and the condition does not occur if the obligor is honestly, even though unreasonably, dissatisfied.").
385. 167 A. 79 (Me. 1933).
386. Id. at 80.
387. Id. By "reasonable recognition," the parties apparently meant reasonable compensation.
388. Id. at 81 ("No contention is made that the term 'reasonable recognition,' as used in the contract under consideration, means other than reasonable compensation ....").
389. Id. at 82.
390. See id. at 80-81.
391. Id. at 81.
392. Id. at 80.
393. Id.
394. See RESTATEMENT (SECOND) OF CONTRACTS §77 cmt. a (1981) ("Words of promise which by their terms make performance entirely optional with the 'promisor' do not constitute a promise. . . . Where the apparent assurance of performance is illusory, it is not consideration for a return promise.");
395. 1 SAMUEL WILLISTON, THE LAW OF CONTRACTS §43 (1921) ("One of the commonest kind of promises too indefinite for legal enforcement is where the promisor retains an unlimited right to decide later the nature or extent of his performance. This unlimited choice in effect destroys the promise and makes it merely illusory.").
396. Paul v. Rosen, 122 N.E.2d 603 (Ill. App. Ct. 1954);
397. Wickham & Burton Coal Co. v. Framers' Lumber Co., 179 N.W. 417, 419-20 (Iowa 1920);
398. Strong v. Sheffield, 39 N.E. 330 (N.Y. 1895).
399. Corthell could have sued in restitution for a quantum valebant recovery of the value of the inventions he turned over to Summit Thread. But in our view, a court that properly ruled against recovery in contract would for the same reasons deny recovery in restitution on the ground that Corthell accepted the risk that Summit Thread would retain his inventions without paying him for them.
400. Corthell, 167 A. at 82.
401. Id. The court offered no reason to believe that the literal interpretation of the word "entirely" (as meaning entirely) was a technical definition, rather than the simple plain meaning of the language the parties used. As defendant argued in its brief, "if the basis and amount of recognition lies entirely with the defendant at all times, it lies with the defendant now, not with the plaintiff and not with any third party or parties, not even with a court of law."
402. Brief for the Defendant at 15, Corthell, 167 A. 79 (docket no. not available) (on file with the New York University Law Review).
403. Corthell, 167 A. at 80 (noting that contract includes following clause: "All of the above is to be interpreted in good faith on the basis of what is reasonable . .. ").
404. Id. at 82.
405. U.C.C §1-304 (amended 2003); RESTATEMENT (SECOND) OF CONTRACTS §205 (1981).
406. See RESTATEMENT (SECOND) OF CONTRACTS §76 cmt. d (1981) ("Words of promise do not constitute a promise if they make performance entirely optional with the purported promisor. ... [T]here may be consideration if forbearance from causing the condition to occur would itself have been consideration if it alone had been bargained for.").
407. See, e.g., Mattei v. Hopper, 330 P.2d 625, 627-28 (Cal. 1958) (finding that "promisor's duty to exercise his judgment in good faith [was] adequate consideration to support the contract" and that it prevented contract from "nullifying the consideration otherwise present in the promises exchanged");
408. Seymour Grean & Co. v. Grean, 82 N.Y.S.2d 787, 788-89 (App. Div. 1948) (per curiam) (finding that employment contract was not illusory because promisor was required to render substantial services and to act in good faith).
409. Corthell, 167 A. at 80, 82.
410. The explanation for the court's apparent failure to appreciate why reasonable commercial parties might rationally choose relational enforcement over legal enforcement mirrors our analysis in Part II.B.2, supra, of the court's decision in Hunt Foods.
411. Recent scholarship argues against the standard assumption underlying traditional contract theory literature that information is either verifiable or not. In fact, information falls along a continuum of verifiability; where a piece of information falls on that continuum is a function of both its inherent character and the contingent rules of contract interpretation and evidence law.
412. See Scott & Triantis, supra note 10, at 825-26 (noting that verifiability of contractual obligations at trial are highly context-specific and endogenous to judicial process).
413. Corthell's early inventions were "bobbin control adjuncts" and "guarding attachments for thread caps." Brief of the Plaintiff at 4, Corthell, 167 A. 79 (docket no. not available) (on file with the New York University Law Review).
414. Corthell sought compensation for four inventions. His first invention was a minor variation on the "King Spool" on which Summit Thread spooled the thread it sold. Brief for the Defendant, supra note 232, at 16.
415. Corthell maintained that the principal value of this invention was that it effected "the continuation of th[e] King Spool patent." Brief of the Plaintiff, supra note 241, at 20. He did not claim that the value of this invention was attributable to any increase in the spool's practical value. Indeed, Corthell was prepared to concede that the invention had never been used, let alone sold. The second invention consisted of "an adjunct to sewing machine shuttles to be attached to bobbins."
416. Brief for the Defendant, supra note 232, at 20. However, "[Summit Thread] never sold bobbins."
417. Id. at 21. The third invention consisted "of celluloid discs ... to be attached to certain sewing machine shuttles."
418. Id. at 6. According to Summit Thread's brief, "[i]nsofar as the discs were distributed to the public it was a gratuitous distribution."
419. Id. at 30. And the fourth invention consisted of "paper or celluloid discs to be attached to all bobbins used by [Summit Thread]."
420. Id. at 31. Corthell maintained that the value of this invention was its unrealized potential to allow Summit Thread to attach a disc to the bobbins it manufactured and distributed to its customers without violating a patent by one of Summit Thread's competitors.
421. Brief of the Plaintiff, supra note 241, at 22-23. The invention was never patented and neither Summit Thread nor any other company manufactured or used it, apart from one made for an experimental trial, which failed.
422. Brief for the Defendant, supra note 232, at 32.
423. Corthell, 167 A. at 80.
424. See infra note 250 (explaining why Summit Thread is sophisticated commercial party).
425. See Scott, Self-Enforcing Agreements, supra note 9, at 1682-83 (discussing apparently widespread prevalence of "comfort agreements" in which parties use legally unenforceable agreements to learn about each side's propensity to reciprocate). Recall that the experimental evidence shows that a preference for reciprocity can motivate cooperation even in arm's length interactions. This evidence shows that many people behave in a reciprocal manner by responding cooperatively to generous acts, and, conversely, punishing noncooperative behavior. The observed preference for reciprocity is heterogeneous.
426. Scott & Stephan, Self-Enforcing International Agreements, supra note 11, at 565-66 (discussing reciprocity theory and concluding that "this is a heterogeneous world where some people exhibit reciprocal fairness and others are selfish" and that "[t]aking all the experiments together ... the fraction of fair subjects ranges from forty to sixty percent as does the fraction of subjects who are selfish");
427. see also Fehr, Gachter & Kirchsteiger, supra note 133, at 850 (noting that "reciprocal motivations have important implications for the enforcement of contracts" and that "[i]n view of the powerful behavioral impact and efficiency consequences of reciprocity... it seems doubtful that one can design optimal incentive contracts on the basis of a neglect of reciprocal motivations");
428. Fehr & Schmidt, supra note 133, at 818 ("Some pieces of evidence suggest that many people are driven by fairness considerations[;] other pieces indicate that virtually all people behave as if completely selfish....").
429. When parties contemplate making a series of contracts, neither party will breach an early contract if the gains from that breach are lower than the expected profits from future contracts that a breach would eliminate. See supra note 131 and accompanying text.
430. Moreover, if Summit Thread's promise is interpreted as illusory and therefore unenforceable, any return promise made by Corthell would likewise be unenforceable. See RESTATEMENT (SECOND) OF CONTRACTS §§17, 18, 71 (1981) (establishing key doctrine that promise unsupported by return promise or performance is unenforceable).
431. See supra Part II.B.1 (analyzing parties' motivations in Hunt Foods v. Doliner, 270 N.Y.S.2d 937 (App. Div. 1966)).
432. Moreover, Corthell could limit the risk of Summit Thread's breach of their informal agreement by reducing his efforts to develop future inventions until Summit Thread paid him the reasonable value of inventions as he produced them seriatim.
433. See, e.g., Stanadyne Corp., Deere & Co. and Stanadyne Corp. Long Term Agreement (Form 10-K, Exhibit 10.15), at §IV.F (Mar. 28, 2002), available at http://www .secinfo.com/dRsjx.33q.chtm. The contract between Deere and Stanadyne is not legally enforceable because it does not actually require that the parties do anything. Although the contract does refer to anticipated levels of Deere purchases, Stanadyne does not have to produce any parts, and if it does produce them, Deere is under no obligation to take them. Thus, the promises are illusory. The parties in the Deere-Stanadyne contract could easily have written a legally enforceable supply contract. The parsimonious conclusion is that they chose to avoid legally enforceable commitments and instead chose to rely largely on relational enforcement: [T]he Deere-Stanadyne contract resembles a more famous contract that, over the years, has been the focus of a great deal of academic attention: the General Motors-Fisher Body supply contract for the supply of auto bodies to GM in the 1920s. As Victor Goldberg has recently shown, the General Motors-Fisher Body supply contract was, in truth, legally unenforceable [because GM's promise was illusory].
434. Ronald J. Gilson, Charles F. Sabel & Robert E. Scott, Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration, 109 COLUM. L. REV. 431, 477 (2009)
435. (citing Victor P. Goldberg, Lawyers Asleep at the Wheel? The GM-Fisher Body Contract, 17 INDUS. & CORP. CHANGE 1071, 1076 (2008)). GM and Fisher Body apparently chose to rely on a variety of relational mechanisms instead of legal enforcement.
436. See supra notes 148-50 and accompanying text.
437. See, e.g., Vt. Teddy Bear Co. v. 538 Madison Realty Co., 807 N.E.2d 876, 879 (N.Y. 2004) ("When interpreting contracts, we have repeatedly applied the 'familiar and eminently sensible proposition of law [ ] that, when parties set down their agreement in a clear, complete document, their writing should ... be enforced according to its terms.' " (alterations in original));
438. In re Wallace v. 600 Partners Co., 658 N.E.2d 715, 717 (N.Y. 1995) (stating that plain meaning rule imparts stability to commercial and property transactions "where commercial certainty is a paramount concern").
439. See supra notes 147-50 and accompanying text.
440. RESTATEMENT (SECOND) OF CONTRACTS §229 (1981).
441. See, e.g.,
442. id. §371;
443. E. ALLAN FARNSWORTH, 3 FARNSWORTH ON CONTRACTS §§12.19, 12.20a (3d ed. 2004).
444. For discussion of forfeitures, see cases cited in note 207 supra.
445. 129 N.E. 889 (N.Y. 1921). The Restatement omits facts critical to the outcome of the actual case. See discussion of those differences infra note 261.
446. RESTATEMENT (SECOND) OF CONTRACTS §229 cmt. b, illus. 1 (1981).
447. Note that under §229, the court can excuse the condition only if the parties regarded the condition as nonmaterial at the time of formation. The mere fact that the actual failure to satisfy the condition does not materially affect the promisor's interests ex post is irrelevant.
448. Id. §229 cmt. c. The question is not whether "the actual non-occurrence [of the condition that Reading pipe must be used] happened to involve a departure that was not a material part of the agreed exchange, [but rather whether] the occurrence of the condition was a material part of that exchange."
449. Id.
450. Id. §229 cmt. b, illus. 1.
451. This point is underscored by an analysis of the other illustrations in Restatement §229. For example, consider the second illustration of §229, based on Del. Steel Co. v. Clamar S.S. Corp., 378 F.2d 386 (3d Cir. 1967). RESTATEMENT (SECOND) OF CONTRACTS §229 cmt. b, illus. 2 & reporter's note (1981). This illustration, in which a carrier receives only oral notice of damaged cargo when the contract requires written notice, implies that express conditions should be subject to a "no prejudice" standard: They should not be enforced if their purpose has been served by other means.
452. Id. §229 cmt. b, illus. 2. But §229 does not, in fact, permit courts to set conditions aside based on a purely ex post "no prejudice" standard. As we have seen, the doctrine requires that the condition not have been regarded as material by the parties at the time of formation. In this case, the parties had ample reason ex ante to regard the condition as a material component of their agreement. The third, fourth, and fifth illustrations of §229 each constitute variations on the theme of excusing the timing of the occurrence of a condition.
453. Id. §229 cmt. c, illus. 3-5. The Restatement says that a court may excuse the nonoccurrence of a condition "during the period of time in which it would otherwise have to occur, if it concludes that the time of its occurrence is not a material part of the agreed exchange. This conclusion is sometimes summed up by the phrase that 'time is not of the essence.'"
454. Id. §229 cmt. c (1981) (citations omitted). Even if parties expressly condition an obligation on a timing requirement and expressly state that the timing requirement is of the essence, equitable doctrine permits a court to set aside the condition in order to prevent a forfeiture.
455. See Holiday Inns of Am., Inc. v. Knight, 450 P.2d 42,43-45 (Cal. 1969) (excusing failure to comply with timing requirement where contract expressly made timing requirement essential but enforcement of condition would have caused forfeiture);
456. RESTATEMENT (SECOND) OF CONTRACTS §229 cmt. c, illus. 4 (1981) (based on Holiday Inns of America).
457. It is also possible that B had other, atypical reasons for preferring the brand. Perhaps he was skeptical of claims that other brands were "just as good." Or perhaps he had an emotional, reputational, or business reason for preferring Reading brand pipe over pipe of equivalent quality. To be sure, in the actual case, Kent's payment obligations were conditioned not just on the use of Reading brand pipe, but on Jacob & Youngs' exact conformity with all the specifications in the building plans. See SCOTT & KRAUS, supra note 3, at 71 (excerpting original contract language). That fact makes both of the above accounts questionable. Indeed, because the condition applied to all specifications rather than just a few, Jacob & Youngs might plausibly be seen as having actually enforced the condition as written but as having interpreted the express condition to require the installation of Reading quality, rather than Reading brand, pipe. So interpreted, Jacob & Youngs did not breach and actually satisfied the condition. The facts in the illustration, however, state only that B's payment obligation is conditioned on the use of Reading brand pipe. On the facts so described, there is no justification either for interpreting the condition to require installation of Reading quality pipe or for setting aside the condition.
458. See RESTATEMENT (SECOND) OF CONTRACTS §84 cmts. a & b (1981) (discussing waiver rationale for rule that promise to perform despite nonoccurrence of condition is generally binding);
459. 2 FARNSWORTH, supra note 18, §8.5 (describing excuse of condition by waiver).
460. 478 S.W.2d 8 (Mo. Ct. App. 1972). Waiver by election bars the promisor from defending its own failure to perform on the ground that the promisee had previously failed to satisfy a condition of the promisor's prior performance.
461. SCOTT & KRAUS, supra note 3, at 656. Waiver by estoppel bars the promisor from refusing to perform on the ground that the promisor had, implicitly or explicitly, waived not only in the past but in the future as well.
462. Id.
463. 478 S.W.2d at 9-10. The court described the commercial parties to this dispute as follows: [P]laintiff L. C. Fritts d/b/a B & C Leasing Service (the landlord) sought restitution of certain leased premises, to wit, a tract in Springfield and the business building situate thereon, together with double the monthly rents and profits of said premises, because (so it was alleged in plaintiffs petition filed on January 9,1970) "the lease ... was terminated at January 1,1970, for failure of defendant [Cloud Oak Flooring Company, a corporation, the lessee-tenant] to pay the rental reserved." Plaintiff-landlord appeals from the judgment for defendant-tenant.
464. Id. at 9 (citation omitted).
465. According to the court, Paragraph 25 [of the contract] stated that no failure of the landlord to exercise any power given him under the lease, or to insist upon strict compliance by the tenant with its obligations thereunder, and no custom or practice of the parties at variance with the terms of the lease should constitute a waiver of the landlord's right to demand exact compliance with the terms thereof. [P]aragraph 26 [of the contract] declared that "[t]ime is of the essence of this agreement."
466. Id. at 10.
467. Id. at 10.
468. Id. at 10-11.
469. Id. at 11.
470. Id. at 13.
471. Id.
472. Id at 14 (quoting 3A ARTHUR LINTON CORBIN, CORBIN ON CONTRACTS: A COMPREHENSIVE TREATISE ON THE WORKING RULES OF CONTRACT LAW §763, at 531 (1960)).
473. See Pa. Ave. Dev. Corp. v. One Parcel of Land, 670 F.2d 289,292-94 (D.C. Cir. 1981) (granting commercial tenant larger share of condemnation award so as to prevent forfeiture, notwithstanding explicit terms of condemnation clause).
474. For discussion, see Victor P. Goldberg, Thomas H. Merrill & Daniel Unumb, Bargaining in the Shadow of Eminent Domain: Valuing and Apportioning Condemnation Awards Between Landlord and Tenant, 34 UCLA L. Rev. 1083, 1120-25 (1987).
475. The argument here parallels our argument above that, in Hunt Foods, Doliner might rationally have agreed to give Hunt Foods an unconditional option subject to the legally unenforceable condition that Hunt Foods will not exercise its option unless Doliner shops its bid. See supra Part II.B. Thus, the landlord's commitment is relationally enforceable because typically he will be a repeat player with an interest in preserving his reputation and social esteem. In addition, as we explained above, "[experimental evidence shows that a preference for reciprocity-the willingness to reward cooperation and to punish selfishness-can motivate cooperation even in arms-length interactions between complete strangers."
476. See supra note 133. Finally, because commercial real estate attorneys who represent landlords are repeat players in their locality, they can bond their clients' nonlegal commitments with their reputations.
477. See, e.g., E. I. du Pont de Nemours & Co. and EarthShell Corp., Alliance Agreement art. 12(h), at 7 (July 25, 2002), http://contracts.onecle. com/earthshell/dupont.collab.2002 .07.25.shtml. The Agreement reads: The Parties' legal obligations under this Alliance Agreement are to be determined from the precise and literal language of this Alliance Agreement and not from the imposition of state laws attempting to impose additional duties of good faith, fair dealing or fiduciary obligations that were not the express basis of the bargain at the time this Agreement was made. The Parties are sophisticated business entities with legal counsel that have been retained to review the terms of this Alliance Agreement and the Parties represent that they have fully read this Alliance Agreement, and understand and accept its terms.
478. Id.
479. Bernstein, Private Commercial Law, supra note 130, at 1735-37 (describing formalistic approach adopted by cotton industry arbitration tribunals);
480. see generally Bernstein, Merchant Law, supra note 130 (describing formalistic adjudicative methods of National Grain and Feed Association arbitrators and why merchants find this approach to adjudication preferable).
481. See Eisenberg & Miller, supra note 148, at 19,34 (discussing study showing over 40% of parties in large data base preferred New York for choice of law and choice of forum clauses as against only 8% and 7% selecting California for choice of law and choice of forum clauses, respectively).
482. Miller, supra note 146, at 5. In addition to identifying the preference in New York for strict interpretation of plain language in commercial contracts, a preference for a "hard" parol evidence rule, and reluctance to grant relief on grounds of mistake or excuse, Miller reports that "the trend of recent New York cases has been to enforce forfeitures in the absence of some other grounds for invalidity, such as unconscionability."
483. Id. at 25 n.139 (citing Fifty States Mgmt. Corp. v. Pioneer Auto Parks, Inc., 389 N.E.2d 113, 115 (N.Y. 1979) (enforcing provision in lease contract providing for forfeiture by tenant of all possessory rights upon failure to tender rent payments for two months)).
484. Id. at 1.