Interest Groups, Contracts, and Interest Analysis - Erin O'hara and Larry E. Ribstein

• Citation: Vol. 48 No. 2
• Publication year: 1997

Interest Groups, Contracts and Interest Analysisby Erin O'Hara^* and

Larry E. Ribstein^**

Interest analysis does not stand up well under economic analysis. Richard Posner has noted that the territorial approach to choice-of-law rules reflected in the First Restatement enabled states at least roughly to exercise their comparative regulatory advantages.¹ Moreover, a system of rules enables parties to better predict the outcomes of disputes. This better facilitates settlement than a standard as difficult to apply as interest analysis. Most fundamentally, trying to determine the interest of a state separate from the generally conflicting private interests of politicians, voters, and other elements of the political process is utterly foreign to contemporary public choice economics. In fact, the seemingly outmoded First Restatement approach generally makes better economic sense, among other reasons because, as discussed below in Part II, it enables states to limit the effectiveness of rent-seeking through interest group bargains. Though the First Restatement rules are imperfect and rest on a questionable theoretic foundation, they are not as arbitrary as advocates of interest analysis think.

Part I argues, in light of public choice theory, that interest analysis increases the inefficiency of laws by enhancing interest groups' ability to extract benefits from less powerful out of state groups. Part II proposes to respond to this problem with a version of the First Restate- ment rule-based approach, modified so as to better foster interstate competition by enabling parties to choose their governing law to a greater extent than any existing choice-of-law approach permits. Part III applies our analysis to some of the cases discussed in this Sympo-sium.

I. The Problem: Public Choice Theory and Interest Analysis

Interest analysts claim to be primarily concerned with facilitating the state's interest in passing a law. As David Currie points out, this is really a matter of statutory interpretation.² Traditional interest analysis assumed that all laws had one or more of three primary purposes: 1) protecting defendants; 2) compensating plaintiffs; and 3) regulating conduct.³ This analysis fails to take into account many potential interests that a state might have and to recognize that most states attempt to balance (albeit in different ways) the same concerns. However, this artificial approach at least allowed some ex ante predictability regarding the outcomes of disputes.

Courts applying interest analysis attempt to discern in light of the legislature's purpose whether it would have wanted the law applied to the facts of a particular multistate dispute. But public choice theory shows that the legislature's real intent cannot easily be gleaned by concocting some hypothetical public purpose. Laws may instead promote the wealth or utility of strong interest groups that can organize cheaply and effectively to raise and spend money and other political resources.⁴ These groups may not be the public, or even the majority, but rather small minorities whose members share the burdens as well as benefits of political action because they overcome members' temptations to "free ride" on the work and money of others.⁵ Thus, laws may not be efficient even in the limited "Kaldor-Hicks"⁶ sense that the proponent group's gains from the law outweigh losses to the rest of society.⁷

Interest analysis not only ignores public choice theory but may, in the light of this theory, exacerbate the problem of inefficient laws. At some point the "tax" imposed on weaker interest groups becomes so large that it exceeds the cost of organizing voters in opposition to the law.⁸ But, where the losers reside outside the enacting state, they lose their voting weapon (although, to be sure, other forms of political pressure can cross state lines), which makes it harder for them to overcome the winner's inherent advantage. Interest analysis makes it more likely that laws will be applied against such outsiders. For example, suppose state C has few manufacturers and wants to impose more products liability than is optimal (i.e., more than consumers would be willing to buy). The legislature may pass the law in the absence of voting pressure from those aligned with manufacturers. Interest analysis helps promote this result by ensuring application of the law by state C courts to local consumers, but not necessarily against local manufacturers, most of whose customers may live outside the state. Even if the court is willing to apply local law to an out of state plaintiff, the latter may be deterred from taking advantage of the bias by the need to travel and hire local counsel. Thus, interest analysis facilitates inefficient laws by imposing the costs of those laws on people and firms who have no direct vote.⁹

Interest analysis poses difficulties even when legislation is Kaldor-Hicks efficient. Consider, for example, Oregon's spendthrift law,¹⁰ which was applied in Lilienthal v. Kaufman,¹¹ a case discussed in this Symposium. As pointed out by Richard Posner in his defense of the First Restatement, state laws serve the differing environments of the various states.¹² This is obviously true of speed limits, but might even be true of spendthrift laws. Suppose that spendthrift laws make sense in rural areas where most contracting is between parties who know one another and therefore know whether the other party is a spendthrift. In contrast, spendthrift laws may be less suited to large communities because anonymity allows spendthrifts to take advantage of sellers who have no advance notice that they are dealing with a spendthrift. Thus, a relatively rural state such as Oregon may protect its spendthrifts, while a state with more large urban communities such as California may not. Lilienthal, by allowing an Oregon spendthrift to reach into a more urban state to take advantage of a California creditor, was arguably an inefficient application of an otherwise efficient law.

In sum, interest analysis causes two fundamental types of problems. First, interest analysis may increase the likelihood of rent-seeking legislation. Second, where different state laws are efficient in different environments, interest analysis impedes states' abilities to effectuate their comparative regulatory advantages.

II. The Solution: A Modified First Restatement Approach

The original Restatement of Conflicts (the "First Restatement")¹³ has been denounced by most modern choice-of-law scholars as an arbitrary set of rules based on unsound theory.¹⁴ The initial theoretical justification for the First Restatement is, indeed, faulty. But the First Restatement does offer a promising starting point, particularly in light of public choice theory, if it is modified to make better use of parties' contracts regarding choice of law.

The First Restatement is premised on the theory that substantive legal...