Promissory autonomy, imperfect courts, and the immorality of the expectation damages default.

• Author: Triantis, George
• Position: 'Contract as Promise' at 30: The Future of Contract Theory

INTRODUCTION

To a generation of law students, lawyers, and legal scholars, Contract as Promise (1) has provided a liberal theory of contract that explains fundamental features of contract law and provides a normative foundation for evaluating the legal doctrine. as is well known by now, the promissory theory of contracts justifies the legal enforcement of contracts in terms of respect for individual freedom and autonomy to make binding commitments. The touchstone of contractual analysis from this perspective is the intent of the promisor. Together with other moral theories of promising, this perspective on contract law has generated voluminous scholarship. Thirty years after the book's publication, I am unlikely to shed new light on the merits of the perspective. rather, I take the occasion of this symposium as an opportunity to explore how economic analysis since the book's publication might elaborate its thesis.

Significant insights have been made in the theory of incomplete contracts, particularly with respect to the existence and consequences of imperfect information. one might speculate as to how a hypothetical new edition of Contract as Promise, published today, might address the effect of imperfect information on the making and enforcement of promises. Working within or at least consistently with Professor Fried's perspective, this essay revisits the justification for expectation (compensatory) damages in light of two observations: (a) judicial determinations are costly and prone to error, and (b) parties have various motivations for promising beyond promoting reliance and collaboration (notably, credit and insurance). In light of this heterogeneity, I suggest that fully compensatory expectation damages may be preferred by no more than a plurality of contracting parties. in addition, the legitimacy given to expectation damages under various moral theories, such as the promissory principle, as well as the instrumental doctrine of efficient breach, in fact increases the cost of opting out and undermines the promissory autonomy they are thought to vindicate. In passing, I also take issue with the categorical distinction that Professor Fried and other moral theorists draw between contractual conditions and contract remedies, particularly damages. Damages, whether judicially measured or liquidated by contract, should be viewed as substitutes for conditions. Thus, if the parties are morally free to condition their promises, they should also be free to set their own level of damages or to let the court impose them by default.

1. INTERPRETATION AND INTERPOLATION

   To create a contract, the promisor invites a court to enforce her promise (or some part of it). In the event of a subsequent dispute between promisor and promisee, the court must determine (a) whether a legally binding promise has been made, and (b) the content of the promise. The promissory language of the promisor is the basis for both decisions, (2) but the language may be vague, ambiguous, or incomplete. Professor Fried distinguishes between two tasks facing the court: interpretation (determining what the promisor had in mind) and interpolation (filling the gap left by the absence of intention). (3)

   in interpreting the promise, the court may imply elements from the circumstances. Professor Fried provides the example of a sale of a bolt for use in a machine, after which the bolt fails and damages the machine. He writes that

   it is a fair implication of the simple-seeming original transaction that manufacturer not only delivered and promised to transfer good title to the bolt, but promised at the same time that the bolt would do the job it was meant to do. ... [B]uyer justifiably relied on manufacturer ... because of the (implied) promise or warranty, and of course it is a primary function of promises to induce reliance. (4) Although there may be other grounds for liability, Professor Fried brings the implied warranty of fitness in this case under the promissory theory. Fried advocates interpreting the promisor's intent "against the background of normal practices and understandings in that kind of transaction." (5) In fact, he goes farther when he argues "we can also see the absurdity of the desire of some classical contract theorists to limit the interpretive scrutiny of the promise to the four corners of the document itself." (6) The promissory principle directs courts and scholars to examine contracting patterns empirically.

   Where the parties have not established an intention, there is a gap. Courts must fill the gap (or interpolate) somehow in order to enforce the promise; if they fail to do so, they undermine the liberty of the individual to promise. In an insightful discussion of the relationship between the promissory principle and contract default rules, Richard Craswell argues that the moral theory has no implication for the content of background rules. He writes:

   The principle of individual freedom is ... unhelpful, for it implies only that individuals should be left free to change whatever default rule the law adopts as a starting point. ... [S]ome other value must be invoked to explain why one starting point ought to be picked by the law in preference to another. (7) This value might be economic efficiency, for which transaction costs play a significant role. However, as suggested below, transaction costs are also relevant in the manner in which they promote or constrain contractual freedom and autonomy.

   Alternative gap-fillers do not all have equal normative weight under the promissory theory. While Professor Fried argues that the judicial gap-filling (or interpolation) function does not flow directly from his promissory theory, he believes the function can be congenial to the theory in two respects. First, it should be consistent with the promisor's broad intent for the common enterprise. (8) Second, it should not interfere with the promisor's freedom to remove the gap and establish an alternative intention at the time of the promise. These desiderata track the analysis of majoritarian default rules in more recent contracts scholarship: the value of such a default depends on the probability that parties would have (hypothetically) consented to the provision if they had taken the time to consider the provision and the cost to the others of opting out (or being bound by it). (9)

   By referring to gap-filling as interpolation of the promisor's intent, Professor Fried suggests that the court should tailor the terms it imposes to the circumstances of the parties. Tailored defaults are more likely than untailored majoritarian defaults (provisions reflecting what most parties would have agreed to) to be consistent with the general enterprise of the parties. (10) Both kinds of defaults reduce the cost of promising and thereby promote individual liberty to make promises by making it less costly to do so. (11) Untailored defaults, however, leave the parties with a choice between incurring the additional transaction costs necessary to agree to a different term ex ante and being bound by one they would not choose. The fact that untailored defaults are less costly to apply ex post than tailored interpolation is an advantage in the eyes of welfare economists, but it should also be relevant to promissory theory to the extent that the promisor anticipates bearing a portion of litigation costs.

   Thus, as in the analysis of the choice between rules and standards, (12) the comparative net welfare benefits of tailored and untailored gap-fillers depend on the heterogeneity of circumstances, the cost of specifying a rule ex ante, and the cost of applying a standard to facts ex post. The balance is context dependent. The promisor may make the choice herself and adopt standards or rules (or some combination) in her promise. (13) If the choice is not express, the court may interpret the promise as implying one or the other. And, if required to interpolate, the court must decide on a meta-default governing interpretation and interpolation of substantive terms.

   The next section turns briefly to the significance of imperfect courts-- specifically, the impact of costly and error-prone judicial determinations--to promissory intent. in this environment, contracting parties decide what promises to ask courts to enforce and whether to specify the substantive terms themselves or leave the court to enforce default provisions. The promissory principle requires that the defaults (a) be easy to opt out of and (b) reflect what a majority of parties would want under the circumstances. Section iii then argues that neither the current default of expectation damages, nor specific performance, satisfies those requirements.

2. TRANSACTION COSTS AND THE PROMISSORY THEORY OF CONTRACT

   Transaction costs, including costs arising from imperfect information, are central in much of the contemporary economic analysis of contracts and contract law. Contract theorists have paid considerable attention recently to the problem of judicial verification of the parties' agreement and the realized state of the world. For example, if a court seeks to interpret an agreement on the basis of background understandings, this process involves costly evidence production and weighing, as well as the risk of erroneous judicial outcomes. At first blush, these concerns appear to be of secondary importance to non-instrumentalists. They are very significant, however, to a...