Ex tempore contracting.

• Author: Verstein, Andrew
• Position: Abstract through II. Locating Ex Tempore Contracting A. Construction 1. Ex Ante/Ex Post, p. 1869-1901

Abstract

This Article argues that a cornerstone assumption of contemporary contracts scholarship is misleading and limited. Leading academic commentary explicitly assumes that contractual responsibilities are determined in the following way: parties determine many of their duties ex ante, by specifying terms at the time of contract formation, and leave the rest of the terms vague, for a court to specify ex post if any should prove important. This ex ante / ex post dichotomy is the guiding framework in attempts to understand contract design and interpretation. For example, parties use terms like "merchantable" quality when the cost of being more specific up front is higher than the cost of relying on a court to later elaborate its meaning. Yet this dichotomy obscures a third, "real-time" approach to contracting: parties frequently leave terms unspecified and delegate ongoing determination to someone other than a court. This Article identifies this phenomenon, which can be called--as opposed to ex ante and ex post--"ex tempore" contracting.

Using a unique cache of data only recently made available, this Article explores ex tempore contracting through a novel dispute management system now prevalent in the construction industry called a "dispute board." These expert panels radically reduce the cost and frequency of litigation by determining the parties' responsibilities whenever the parties wish, including in the course of performance. Ex tempore contracting is not merely a dispute resolution system for the construction industry. Ex tempore contracting is also essential to the massive financial derivatives market and countless other transactions. This Article develops important insights for judicial interpretation of contracts and the scholarly analysis thereof. For example, the possibility of ex tempore contracting casts doubt on the wisdom of information-forcing penalty defaults and urges courts to enforce ex tempore contracting clauses much more often than they currently do.

TABLE OF CONTENTS INTRODUCTION I. CONTRACTUAL COMPLETENESS A. Ex Ante and Ex Post Contracting B. Ex Tempore Contracting 1. Timing of Choice 2. Identity of Chooser II. LOCATING EX TEMPORE CONTRACTING A. Construction 1. Ex Ante / Ex Post 2. Ex Tempore & Dispute Boards B. Credit Derivatives III. THEORIZING EXTEMPORE CONTRACTING A. Supporting Interim Institutions B. Frustrating Penalty Defaults C. Prospective Applications CONCLUSION TABLES INTRODUCTION

This Article argues that the dominant view of contract design and interpretation is fundamentally limited and misleading. This view is that parties have precisely two options with respect to any given future circumstance: clearly specify their responsibilities to one another at contract formation or leave their responsibilities vague, relying on a court to determine them after performance. (1) For example, a construction contract could specify the use of Reading brand pipe in exchange for $77,000. (2) This ex ante contracting approach involves thorough negotiation and drafting. Alternatively, ex post contracting enlists a court to later specify an incomplete contract by calling for "merchantable" pipe in exchange for a "reasonable" fee, and then litigating whether the tendered pipe or payment met the contractual requirement. Concerning interpretation, scholars generally advise courts to interpret in whatever way helps parties to lower the sum of those two costs. (3)

Though intuitive and widely accepted, the ex ante / ex post dichotomy leaves out a third, "real-time" approach to contracting, in which a third-party agent specifies the contract for the parties. Following the language of ex ante, which means "before the fact," and ex post, which means "after the fact," this Article introduces "ex tempore," which means "in the moment."

Parties utilize ex tempore contracting techniques when they draft largely incomplete agreements at contract formation but provide a means for ongoing completion in the course of performance. For example, parties might include a vague term, such as "merchantable" or "reasonable," but then stipulate that a certain individual shall define that term as the need may arise. This approach allows the parties to have clarity of obligation at or around performance, avoiding costly disputes while economizing on front-end costs.

Though largely unnoticed, ex tempore contracting is extremely widespread in some industries. The construction industry, which employed 6 percent of all Americans (12 percent if production, hauling, and distribution of equipment and materials are included) prior to the recent economic downturn and contributed 8 percent to GDP, (4) stands at the forefront of ex tempore contracting. It is now common practice for construction contractors to draft incomplete contracts and entrust a cadre of neutral experts, the dispute board, to make decisions whenever a given issue becomes salient. Such boards answer questions the parties have not specified, such as: "Is there a duty to help the contractor find qualified employees?" (5) or "Does the contract require the owner to audit and review the subcontractor's costs before disputing them?" (6) Dispute boards are becoming the norm in construction contracts because of their startling effectiveness in improving projects; in an industry in which 25 percent of projects lead to disputes, (7) dispute boards resolve 98 percent of claims brought before them. (8)

Likewise, the credit derivatives market, constituting a titanic $27 trillion in notional value, (9) has turned to ex tempore contracting to allow agile and effective contracting in a time of economic and regulatory change. Complex derivatives routinely include seemingly vague terms combined with techniques for achieving instantaneous clarification. For example, many owners of Greek bonds had protected themselves against the risk of nonpayment by entering into credit default swaps (CDS). (10) These insurance-like derivatives offered payment to the bondholders if Greece were to renege on its obligations. (11) As Greece grew increasingly reluctant to pay its debts, bondholders did not look to the contract text nor to a court to determine whether they were entitled to payment under the CDS. Instead, a committee of the dominant trade association, the International Swaps and Derivatives Association (ISDA), had authority to rapidly clarify entitlements and define the word "default." (12) Few have noticed the quasi-adjudicative role played by ISDA, which has proven invaluable in facilitating the use of credit default swaps and, at times, reducing systemic risk. Fewer still have noticed that one can best understand this function as an expression of ex tempore contracting. (13)

Despite the prevalence of ex tempore contracting, courts, parties, and scholars have been slow to recognize its significance. As a result, courts misunderstand and frustrate parties' contractual choices and disrupt the usefulness of ex tempore contracting. For example, courts sometimes mistakenly characterize ex tempore contracting as mere mediation (14) and thereby permit parties to frustrate the ex tempore determination process, say, by refusing to select board members (15) or even to attend at all. (16)

At a more abstract level, the failure to notice ex tempore contracting has led scholars to overestimate their understanding of contract design and judges' ability to improve it with simple changes in interpretation techniques. For example, courts sometimes apply penalty defaults in cases of contractual silence in order to cause parties to...