Legal ignorance and information-forcing rules.

Author:Verkerke, J.H.
Position:Abstract through I. The Pervasiveness of Information-Forcing Justifications, p. 899-931
 
FREE EXCERPT

ABSTRACT

People are often ignorant about the legal rules that govern the most common transactions in their lives. This Article analyzes one common regulatory response to our widespread legal ignorance. A surprisingly broad range of legal rules have the ostensible purpose of inducing sophisticated parties to draft express contract language that will inform their contractual partners about the legal rules governing a particular transaction. However, this "legal-information-forcing" objective often remains unrealized because people routinely sign contracts without reading and understanding their terms. In theory, courts could design information-forcing rules that would be truly informative. But recognizing the potential futility of attempts to inform many contracting parties about complex legal rules, this Article also develops and critiques several alternative justifications for "clause-forcing" rules that encourage sophisticated parties to draft express contract terms. Such terms could facilitate the activities of avid comparison shoppers, reviewers, and consumer advocates. Comprehensive written terms also may promote ex post legal clarity and thereby reduce the costs of resolving disputes. Finally, exculpatory clauses allow parties to contract out of the comparatively expensive legal system of dispute resolution in favor of a regime governed by informal social norms. On this account, clause-forcing rules encourage sophisticated drafting parties to signal their preference for a norm-governed relationship, and lawmakers then demarcate the boundary between law and norms by deciding whether to enforce exculpatory clauses. The normative desirability of these clause-forcing rules is unclear, but my exploration of these alternative justifications shows the conceptual poverty of accounts that presume express contract terms inform the majority of unsophisticated parties.

TABLE OF CONTENTS INTRODUCTION I. THE PERVASIVENESS OF INFORMATION-FORCING JUSTIFICATIONS A. Origins B. Information-Forcing Theory Applied to Legal Ignorance C. The Hadley Rule Revisited D. Some Additional Examples 1. Implied Just-Cause Employment Contracts 2. ERISA Rules 3. Other Disclaimers, Waivers, and Limitations of Liability II. THE PROBLEM WITH A LEGAL-INFORMATION-FORCING JUSTIFICATION A. The Persistence of Legal Ignorance B. Judicial and Scholarly Perspectives on Legal Ignorance 1. Disclosure Requirements 2. Boilerplate and Contracts of Adhesion 3. Academic Support for Legal-Information-Forcing Rules C. Designing Effective Express Contract Terms III. ALTERNATIVE RATIONALES FOR CLAUSE-FORCING DEFAULT RULES A. "Nudging" Parties to Make Better Choices B. Lowering Ex Ante Information Costs C. Ex Post Legal Clarity D. Opting for Norms Rather Than Law E. Some Potential Policy Implications CONCLUSION INTRODUCTION

People are often ignorant about the legal rules that govern the most common transactions in their lives. (1) Whether purchasing products and services, leasing real estate, obtaining insurance, borrowing money, or finding employment, many laypeople have a surprisingly poor grasp of basic legal principles. (2) Of course, this ignorance usually causes no harm. We buy what we need and work until retirement without becoming embroiled in legal disputes. But sometimes people involved in conflicts over defective products, unpaid insurance claims, loan defaults, or employment terminations must assert legal rights or defenses, and some of them ultimately resort to litigation. In circumstances like these, having too little legal knowledge can be dangerous. Legal ignorance potentially distorts important economic decisions. Without a clear understanding of their legal rights and responsibilities, some consumers will mistakenly agree to exculpatory contract terms. Borrowers will accept harsh credit terms. And employees will rely on illusory promises of job security.

Lawmakers have sometimes attempted to combat informational problems such as these by enacting rules that directly mandate disclosure. The federal Truth in Lending Act, for example, requires lenders to disclose interest rates and fees in a statutorily prescribed way. (3) Whenever an employer uses an outside firm to check a job applicant's background, it must disclose that fact and obtain consent from the applicant under provisions of the Fair Credit Reporting Act. (4) And regulations issued by the Securities and Exchange Commission compel issuers to publish exhaustive prospectuses when they offer stock for sale. (5) A voluminous scholarly literature debates whether the informational value of such mandated disclosures exceeds their cost. (6) My focus here, however, is not on these explicit disclosure regulations.

Instead, this Article analyzes a different regulatory response to our widespread legal ignorance. It explores how the law encourages sophisticated parties to provide legal information to the comparatively poorly informed individuals with whom they do business. Many rules in surprisingly diverse fields of law impose unfavorable default terms on sellers, employers, insurers, and other comparatively sophisticated parties, but allow those parties to opt out of these default terms by drafting contract terms that meet certain standards for clarity. Thus, for example, a clear statement disclaiming the implied warranty of merchantability negates that default provision of the Uniform Commercial Code. (7) Likewise, an employer can defeat most implied contract claims of unjust discharge by requiring new employees to sign an express confirmation of at-will status. (8)

I argue here that we can best understand these and other rules as particular instances of an approach that contract theorists have dubbed "information-forcing" or "penalty defaults."* 9 Originating in modern scholarly efforts to justify the famous rule of Hadley v. Baxendale, the information-forcing framework uses an unfavorable default to redress problems of asymmetric information between the parties to a contract. (10) Lawmakers select a default rule that disadvantages the better informed party. In order to escape the unfavorable default, the informed party must disclose information to her less well-informed contractual partner. The canonical information-forcing default in Hadley thus limits a party's consequential damages for breach unless she discloses any special circumstances that may cause unusual losses. (11)

This concept extends quite naturally from information about potential consequential losses from breach to situations in which the parties have an asymmetric understanding of the legal rules governing their relationship. Unfavorable default rules encourage legally sophisticated parties to contract expressly for their preferred terms. At least in theory, these express contract terms could inform unsophisticated parties about the law. Many courts and legislators have formulated default rules with legal-information-forcing concerns such as these in mind. (12) Judges worry, for example, that workers will overestimate the extent of their contractual protection against discharge. (13) In response, courts have adopted default rules of interpretation that encourage employers to contract expressly for an at-will relationship. (14) Similarly, the drafters of the Uniform Commercial Code sought to protect consumers who might otherwise misunderstand the extent of their rights against the seller of a defective product. (15) Section 2-316 thus establishes a warranty of merchantability as a default term, and permits sellers to avoid granting that warranty only by including a sufficiently clear disclaimer in the sales documents. (16) As one might expect, employers and product manufacturers routinely opt out of these default rules. (17) They craft express contract language that simultaneously protects their interests and, at least in theory, informs consumers and workers of the legal rule that will govern their relationship.

As these examples illustrate, legal-information-forcing rules have a common structure. First, the ostensible purpose of the rule is to encourage legally sophisticated parties to inform comparatively unsophisticated parties about their legal rights and obligations. Second, each is a default term designed to favor the interests of the unsophisticated party. Finally, the overwhelming majority of sophisticated parties respond to the rule by contracting around the default, adding language to the contract that better protects the interests of the drafter. What therefore distinguishes a legal-information-forcing rule from other defaults is (1) its goal of dispelling legal ignorance, (2) the fact that the rule initially favors the less sophisticated party, and (3) the frequency of opt-outs.

Rules of this type are remarkably ubiquitous. (18) I argue, however, that there are good reasons to doubt that many achieve their goal of informing unsophisticated parties about the law. These rules instead generate a profusion of boilerplate language in largely unread contract documents. In fact, most people fail most of the time to read most of the terms in the contracts they sign. (19) As a result, a legal-information-forcing strategy seems unlikely to succeed.

We can easily imagine regulatory innovations designed to make the contracting process more informative. Lawmakers could impose procedural requirements for opting out of the default rule in an attempt to force laypeople to pay more attention to specific terms. (20) For example, many courts emphasize considerations such as typographical prominence, separate signing, and linguistic clarity in deciding whether to enforce terms that displace a legal-information-forcing default. (21) Lawmakers could adopt even more aggressive approaches, such as requiring an oral recitation of all or part of the contract, quizzing parties about their understanding of key contract terms, or perhaps mandating the participation of an attorney in certain transactions. Careful empirical study...

To continue reading

FREE SIGN UP