Mistake and disclosure in a model of two-sided informational inputs.

• Author: Borden, Michael J.

1. INTRODUCTION II. CURRENT LAW AND COMMENTARY A. The Doctrine B. The Commentary 1. Kronman's Approach 2. Levmore's Contribution 3. Scheppele III. TWO MODELS: AN EXAMINATION OF THE ONE-SIDED MODEL AND A COMPARISON WITH THE ENRICHED MODEL A. The One-Sided Model B. The Two-Sided Model C. An Explanation of Why the Structure of the One-Sided Model Necessitates the Kronman-Levmore Approach IV. RULE (EFFICIENCY) ANALYSIS IN THE MODEL OF TWO-SIDED INFORMATIONAL INPUTS A. Optimal Dishonesty in the Two-Sided Model B. Word to the Wise in the Two-Sided Model 1. Scenario One: 2. Scenario Two: Effect of a Word to the Wise Rule on Seller's Incentive to Invest in Information C. Some Observations about Efficiency under a Word to the Wise Rule D. The Valuation Quandary V. A DIFFERENT NORMATIVE PERSPECTIVE VI. FINAL THOUGHTS A. Comparison Between the Rules B. Form of Transaction VII. CONCLUSION I. INTRODUCTION

   This paper will examine some theoretical aspects of contractual nondisclosure and the related doctrine of unilateral mistake. These two legal rubrics are conceptually similar; (1) each is concerned with the degree to which parties must communicate their understandings about the nature of the contract into which they are about to enter. If one party fails to reveal enough information, the other party may enter into the agreement under a misunderstanding and consequently may attempt to avoid contractual liability on the basis of mistake or on a theory of nondisclosure. The law of contracts clearly attaches a great deal of importance to ensuring that contracting parties have a mutual understanding about their agreement--a meeting of the minds (2)--for that is the cornerstone of mutual assent. Indeed, one of the foundational theoretical goals of contract doctrine is to establish rules of law that will induce parties to reveal information that will reduce the cost of contracting and minimize the negative effects of breach. This "information forcing" concept has received substantial attention by many leading scholars as the animating principle behind the rule of Hadley v. Baxendale, (3) which limits consequential damages to those that are foreseeable (i.e., those that have been communicated by the party seeking damages). (4)

   Yet there are, naturally, times when forcing parties to reveal their private information is not desirable. The very nature of market transactions dictates that trade is on one level the result of a seller who values his goods less highly than the buyer. While in cases where both parties enjoy full information, this disparity in valuation is often caused by circumstances affecting the relative need of the parties for the good--a pharmacist would not sell his last bottle of aspirin if he were suffering a migraine. In many other cases, the disparity can be explained by the fact that one party knows something the other doesn't know--the seller of a used car may know that the oil had never been changed for the first 50,000 miles. The buyer of a parcel of swamp land may know that the local government is in the early planning stages of a drainage and development project that will greatly enhance the land's value. Sometimes the law requires full disclosure, while at other times it does not. (5) This ambivalence about disclosure results in a tension which occasionally expresses itself in disputes over whether or not a party to a contract had lived up to his disclosure obligations, and whether, as a result of incomplete information, the less well-informed party is entitled to relief in the form of rescission.

   This article focuses on the commentary the law of buyer nondisclosure has generated in the last 30 years, (6) in particular a 1978 article by Professor Anthony Kronman (7) and a 1982 article by Professor Saul Levmore. (8) Kronman argued that, when a buyer of a good has discovered heretofore unknown information about that good as a result of a deliberate search, the law should not impose a duty to disclose that information lest the buyer forfeit to the seller the profit of his search and be stripped of his incentive to generate the socially beneficial information. (9) Levmore took Kronman's analysis as a starting point and concluded that the protection buyers with specialized information needed could not be provided by the "silence-is-golden" rule Kronman proposed. (10) Levmore argued that in order to protect such a buyer's ability to capitalize on his private information, and thus preserve future parties' incentive to develop socially beneficial information, a rule of "optimal dishonesty" was required; such a rule would permit the buyer to lie during negotiations, an action that would otherwise constitute fraud. (11) In Part II, I will describe the doctrinal backdrop against which Kronman and others were working and will explain their arguments in greater detail.

   Kronman's analysis formed the bedrock of what has become a fairly settled area of contracts scholarship, at least among law and economics scholars. (12) I do not intend to challenge the insights he and Levmore have contributed. (13) Instead, I will demonstrate in Part III that the model upon which these and other modern scholars have based their discussions of buyer nondisclosure is structurally limited, and I will attempt to extend their analysis by introducing and examining a richer model. (14) I will then address the question of which legal rule is the most appropriate to govern the enriched model. I will conclude that in my model, preserving the buyer's incentive to invest in information does not necessarily require the rule Levmore suggested (Optimal Dishonesty)--a rule that, to some extent, offends traditional contract doctrine and theories of contract that are rooted in morality. (15) Further, by emphasizing the communicative or signaling effects of silence, I will suggest that in many contexts, the Silence is Golden rule is conceptually unstable and should not be addressed as a distinct rule in my analysis. (16)

   In Part IV, I will compare the efficiency of Levmore's rule to a rule requiring minimal truthful disclosure (which I term a "Word to the Wise" rule) in the context of my model. I will argue that in this model, a Word to the Wise rule is just as efficient as, or only slightly less efficient than a rule of Optimal Dishonesty. But I will not limit my analysis of the appropriate disclosure rule to considerations of efficiency. This article departs from the theoretical monism inherent in economic analysis and often adhered to in autonomy-based contract theory. Instead, I offer a pluralistic approach to the problem this article explores. (17) Thus, in Part V, I discuss whether any compelling reason outside the realm of efficiency militates in favor of a Word to the Wise rule. Finally, I will offer my conclusion that in a model of two-sided informational inputs, a Word to the Wise rule is the better rule, given a multitude of considerations, including efficiency, longstanding contract doctrine, fairness and a perspective from intellectual property theory.

2. CURRENT LAW AND COMMENTARY

   1. The Doctrine

      Unilateral mistake and inadequate disclosure have long been available as the basis of an attack on the enforcement of contracts. (18) While some commentators have suggested that the law of contracts traditionally never allowed relief to a party on the basis of a unilateral mistake, (19) Corbin's treatise explains that the law of contracts has never been so rigid as to categorically exclude the claims of parties who have entered into a contract under a mistaken notion about the identity or value of the asset being bought or sold. (20) Many cases have illustrated this point, (21) ranging from the celebrated United States Supreme Court case of Laidlaw v. Organ (22) which concerned a seller's mistake as to the value of a quantity of tobacco, to more recent cases involving misapprehensions about the value of paintings, (23) real property, (24) baseball cards (25) and construction bids. (26)

      The simplest of these cases are those involving clerical mistakes in the compilation of bids by general contractors. In these cases, courts have allowed bidders to avoid contracts where, because of transcription or arithmetic errors, they have committed themselves to providing goods and services at prices below their fair market value. (27) These cases have been decided either on the ground that there was no meeting of the minds or that it would be unconscionable to enforce a contract based on such an error, often taking into account whether the non-mistaken party had detrimentally relied on the bid. (28)

      Similarly unproblematic have been nondisclosure cases involving home sale transactions where the property contained some hidden defect unknown to the buyer until after the completion of the transaction. (29) The classic example involves the sale of a home which turns out to be infested with termites. The seller is held to have a duty to disclose because the condition was "clearly latent--not readily observable upon reasonable inspection." In an oft-cited example of such a case, Obde v. Schlemeyer, the court grounded its decision on considerations of "justice, equity and fair dealing." (31)

      Somewhat more difficult cases of unilateral mistake and nondisclosure have involved the sale of a good by a merchant, where the item sold was worth substantially more than the seller thought. An interesting example of such a case, and a wellspring of American jurisprudence on buyer nondisclosure, is Laidlaw v. Organ. (32) Laidlaw involved a dispute over the sale of a load of tobacco in 1815 just as the War of 1812 was drawing to a close. One result of the War had been a naval blockade of New Orleans which severely limited the volume of trade in and out of the city. Organ, a New Orleans tobacco dealer, had obtained advance notice of the signing of the Treaty of Ghent, which formally ended the War and signaled the lifting of the blockade. (33) Hours before the news was...