Behavioral Science and Consumer Standard Form Contracts

• Author: Shmuel I. Becher
• Position: Assistant Professor, The College of Management Academic Studies&-- School of Law
• Pages: 117-180

Shmuel I. Becher; Assistant Professor, The College of Management Academic Studies&amp-- School of Law. LL.B., Tel Aviv University (2001); LL.M (2003), J.S.D. (2005), Yale Law School. Many thanks to Benjamin Alarie, Ian Ayres, Yaron Back, Amichai Cohen, Mary Davis, Henry Hansmann, Daniel Markovits, Jeffery Rachlinski, Alan Schwartz and the participants of the Yale Law School Graduate Seminar, the Hebrew University Faculty of Law Seminar, the Bar Ilan University Faculty of Law Seminar, and the Haifa University Faculty of Law Seminar for comments on earlier drafts. I also acknowledge the generous financial support of Yale Law School and the Fulbright Program.

Page 117

Introduction

Can insights drawn from behavioral economics point to inherent failures in the market for consumer contracts and explain their origins? The underlying thesis of this Article is that behavioral economics should have a central role in demonstrating and understanding the inadequacies of current approaches to consumer standard form contracts ("SFCs") and in forming the law that should govern them.

Contracts are binding promises¹ that result in legal relationships.² Contracts play a central role in people¥s legal experiences and interactions with one another. Many of our most important personal and everyday relationships involve contracts or are governed by them.³

The most pervasive kind of contract is the consumer standard form contract. Consumer contracts account for the vast majority of everyday transactions between firms (as sellers) and consumers (as Page 118 buyers).⁴ The ubiquity of consumer SFCs cannot be exaggerated. One enters an SFC by opening a bank account, purchasing software on the web, renting a safe deposit box in a bank, or engaging in countless other day-to-day activities. This Article sets its focus on this kind of contract.

However omnipresent, SFCs depart from the classic paradigm of contract law in various conspicuous ways, and some of these departures are assumed to pose serious challenges to traditional analysis of contract law. SFCs are not a result of a negotiation process: they are offered on a "take-it-or-leave-it" basis; they do not require a "meeting of the minds"; and they are rarely read by the promisee (i.e., the consumer). In most instances, therefore, SFCs reflect sellers¥ informational advantage over consumers ("obligational asymmetric information"). In turn, consumers who are misinformed about the SFCs they enter might accept poor deals.⁵

Although the departures and problems associated with SFCs are well recognized, many decades of controversy have failed to produce a satisfying (let alone accepted) approach as to the proper legal treatment of consumer contracts.⁶ This Article argues that a considerable part of this failure is due to the fact that important and relevant social science insights regarding consumers¥ behavior are widely overlooked.

Page 119

Much of contract law assumes that people know what they want and thus are the best judges of their own utility.⁷Nonetheless, the application of behavioral economics insights to consumer contracts calls this fundamental notion into question. Given the cognitive limitations of ordinary people, consumers as a class frequently violate the rational-maximizing-expected-utility function that contract law theory ordinarily attributes to contracting parties. In other words, presuming the efficiency of form contract terms might be misguided due to fundamental behavioral failures on the part of consumers.

The social science literature dealing with consumers¥ decision making is relatively well developed. There is, nonetheless, a serious gap in the legal application of this literature addressing SFCs. One of the troubling consequences of this gap is the prevalence of unfair and inefficient SFC provisions. More profoundly, this gap in legal understanding means that current approaches to SFCs are fundamentally flawed and bound to result in erratic and sometimes unjust conclusions.

Therefore, the underlying theme of this Article is that cognitive biases and consumers¥ actual behavioral patterns have central roles-both descriptively and normatively-in the law of SFCs. This Article explains how psychological phenomena contribute (i) to consumers¥ tendency not to read SFCs even when by doing so they fail to maximize their utility; (ii) to consumers¥ inability to correctly evaluate contract terms once they do read them; and (iii) to sellers¥ ability to manipulate consumers.

The contribution of this discussion is twofold: First, this Article expands our understanding regarding the inadequacies of current approaches to SFCs and the harm that consumers are exposed to when actual behavioral patterns are ignored. Second, this Article suggests valuable insights into the ways in which the design issues associated with the alternative proposed solution ought to be approached. However, it should be clear that this Article remains silent with respect to the challenge of portraying in detail a Page 120 superior mechanism aimed at dealing with SFCs. This design issue is a completely distinct project, which I address separately.⁸

The behavioral phenomena discussed in this Article are mainly based on behavioral economics models.⁹ These models are an important tool in understanding some of the limits of economics and its ability to predict human behavior. Part I of this Article presents a brief explanation of these models and their general application to law.

Thereafter, this Article presents four specific behavioral patterns, each of which is particularly relevant to standard form contracting practices. The first is that buyers usually face SFCs only at the very end of a lengthy shopping process. The general assertion in this context is that at this late stage consumers are unlikely to ascribe to contract terms the full meaning or importance they deserve. This is the focus of Part II, where psychological phenomena such as the sunk cost effect, cognitive dissonance, the confirmation bias, and the low-ball technique are applied.

Second, empirical evidence supports the assertion that people have limited ability to rationally evaluate prospects of future contingencies and risks. Part III links this general failure to some typical clauses frequently incorporated in SFCs. Individuals¥ inability to accurately evaluate low probabilities, the availability cascade, and the prevalence of self-serving biases such as overoptimism and over-confidence serve as important starting points in this discussion.

The third behavioral pattern results from the environment that typically accompanies the offer and acceptance of consumer contracts. In many instances consumers sign (or otherwise enter into) SFCs under unfavorable circumstances. This prevents consumers from engaging in reasonable, let alone optimal, deliberation. The analysis of the behavioral effects of pressure and the attendant emotional stress as they relate to SFCs stands at the heart of Part IV.

Page 121

The last behavioral failure addressed in this Article is the phenomenon dubbed "information overload." Generally speaking, individuals¥ limited ability to process information undermines optimal contracting. Part V critically evaluates the different approaches to the relevancy of information overload, demonstrating how and why it can negatively affect the likelihood of efficient terms arising in SFCs.

I A Brief Preface To Behavioral Law & Economics

For many years, law and economics has been-and clearly still is-one of the most influential and dominant prisms through which law is scrutinized, explored, and studied.¹⁰ Law and economics is a particularly powerful tool since it relies on a theory that aspires to elegantly predict human behavior and responses to incentives that the law can create and offer.¹¹ The behavioral theory behind law and economics is the longstanding economics model of rational choice theory, which has expanded beyond its original field.¹²

Page 122

Law and economics has been challenged from various perspectives.¹³ One repeated criticism is that traditional law and economics relies on some simplifying assumptions about human behavior and human decision making process which are neither accurate nor valid in many situations. According to this line of argument, people deviate, in systematic ways, from what is supposed (by standards of efficiency) to be rational behavior.¹⁴

Behavioral law and economics scholars postulate the idea that human deviation from rationality should not be limited and narrowed to economic market failures. According to behavioral law and economics proponents, there are many other circumstances where people deviate, in a systematic and predictable way, from what is expected by economics to be a rational behavior. Slightly restated, behavioral academics argue that rational-choice theory neglects to acknowledge some important aspects of human behavior.¹⁵ Overlooking those aspects, the argument goes, can lead to...