Regulating opt-out: an economic theory of altering rules.

• Author: Ayres, Ian

ARTICLE CONTENTS I. INTRODUCTION A. Terminological Parallels B. Software Parallels C. Pedagogical Parallels D. Theory Parallels II. MINIMIZING COST VERSUS MINIMIZING ERROR A. Altering Rules Distinguished from Menus B. Minimizing Transaction Cost C. Transaction Cost/Error Tradeoff D. Transaction Cost/Error Tradeoff in Software Confirmations E. Modeling the Benefits and Costs of More Precise Altering Rules F. Strategies for Implementing Error-Reducing Altering Rules 1. Thought-Requiring Altering Rules 2. Clarity-Requiring Altering Rules 3. Altering Rules That Enhance Manifestations of Assent 4. Train-and-Test Altering Rules 5. Password Altering Rules 6. Reversibility III. STICKY DEFAULTS AS QUASI-MANDATORY RULES A. Numeric Example Comparing Relative Efficiency of Sticky Defaults B. Possible Applications of the Sticky Default Strategy IV. ALTERING PENALTIES A. Ex Post Penalties vs. Ex Ante (Lanham-Inspired) Safe Harbors B. Competition-Enhancing Altering Rules V. DISCRIMINATORY ALTERING RULES CONCLUSION: ALTERING RULES MATTER I. INTRODUCTION

A default-centric vision of contract law must provide answers for three core questions:

1) Should a particular rule be mandatory or contractible?

2) If contractible, what should the default be? And finally,

3) If contractible, how should contractors be able to contract around the default? (1)

The history of modern contract theory can be seen as marching sequentially through these three questions. In the first stage, academics asked whether legal rules should be default or mandatory but paid little attention to the second or third questions. (2) At the time, it was implicitly or explicitly assumed that the answer to the second question was that efficient default rules should be set so as to provide the types of contractual provisions that the parties would have contracted for themselves.

Rob Gertner and I (both following and followed by a host of others) helped to complicate the answer to the second question by suggesting a number of reasons why optimal default setting should diverge from the simple majoritarian or hypothetical contracting approach. (3) This second stage of analysis has been in full bloom for more than two decades-with hundreds of articles explicitly considering whether "information-forcing" or "penalty" defaults might be preferable to various alternatives. (4)

The progress that has been made in theorizing how best to set default rules is all to the good. But it is long past time that we turn our attention to the third core question of a default-centric approach to contract law. It is time to ask the "how" question. How should the law regulate parties' means of contracting around a default? What should be the necessary and sufficient conditions for displacing the legal consequences of a default rule, default rights and duties, with some other legal consequences? (5)

Contract theory is at a stage of development with regard to this third question that parallels in several aspects the moment in the early 1980s when we began thinking about the second question. The parallels concern linguistics and pedagogy as well as an absence of explicit theories and the reliance on half-articulated folk theorems.

1. Terminological Parallels

   It has been difficult to ask the third question of how best to displace a default in part because we are still linguistically impoverished, in ways that are reminiscent of the verbal conventions of twenty-five years ago governing what we now think of as the default/mandatory dichotomy. It is hard to believe, but in the early 1980s there was not a well-accepted terminology for distinguishing between rules that could be contracted around and those that could not. Almost no one used (or even knew that Karl Llewellyn had used) the terms "iron" and "yielding" rules to describe the mandatory/default dichotomy. (6) Contract articles that proposed or defended particular legal rules rarely mentioned whether the proposal was privately contractible or not. When the default concept was mentioned, authors were forced to express the idea with a variety of nonstandard phrases, including background rules, backstop rules, andjus dispositivum. (7)

   This same lack of basic terminology hinders the ability to attack the third question. We don't really know what to call rules that govern how one contracts around the default. I propose that we call them "altering rules." Altering rules are the necessary and sufficient conditions for displacing a default legal treatment with some particular other legal treatment. I use the term "altering" not because the contractors alter the default, but because by complying with an altering rule contractors can alter the legal consequences. (8) There will be different altering rules for each alternative to the default. An altering rule in essence says that if contractors say or do this, they will achieve a particular contractual result. The title refers to "regulating opt-out" in the sense of regulating how contractors can opt out of the default legal consequences. As used here, the process of opting out of or away from a default is simultaneously the process of opting into some non-default consequence. Altering rules thus regulate both opt-in and opt-out. (9)

   An altering rule is a necessary condition if the altering rule specifies that a sine qua non for the parties' achieving an alternative treatment is to include a particular set of words or processes. For example, section 2-316 of the Uniform Commercial Code (UCC) ordains that "to exclude or modify the implied warranty of merchantability ... the language [of the contract] must mention merchantability." (10) Necessary altering rules specify the exclusive means of achieving particular non-default alternatives. In other contexts, however, altering rules allow multiple, nonexclusive means of displacement-any one of which would be sufficient to achieve a particular non-default alternative. Indeed, in most contexts there are multiple routes to achieve each particular alternative non-default legal consequence. The very same section of the UCC that ordains that disclaimers "must mention merchantability" goes on to provide a sufficient altering rule that might be used as a disclaimer alternative: "Language to exclude all implied warranties of fitness is sufficient if it states, for example, that 'There are no warranties which extend beyond the description on the face hereof.'" (11)

   Altering rules, like defaults, can vary in terms of their specificity, with the result that we could have "altering standards" as well as "altering rules." (12) As with other aspects of law, an altering standard would be a set of displacement conditions that were not as clearly specified ex ante. (13) An altering standard, for example, might allow displacement of a default only if the contract language expresses an alternative intent that would be "reasonably understandable by a member of the interpretive community." In contrast, a requirement that particular magic words must be used would constitute an altering rule. For simplicity, the remainder of this Article refers to "altering rules" rather than "altering rules or standards," but the reader should bear in mind that standards at times will be the more appropriate choice.

   Like defaults, altering rules can be created by statute or common law. When a judicial decision, such as Baird v. Gimbel or Drennan v. Star Paving, determines that a particular contractual attempt is insufficient to displace a default, (14) that decision is helping to specify the contours of altering rules. When the UCC says that an offer invites acceptance by any reasonable means "[u]nless otherwise unambiguously indicated by the language or circumstances," (15) it is helping to specify the contours of altering rules. Like defaults, altering rules can also be created by administrative agencies. For example, the Internal Revenue Service through its regulations (16) and revenue procedures (17) is a major source of altering rules. In addition, the illustrations and examples of restatements and uniform laws are an important source of altering rules-particularly providing examples of what is and is not sufficient. (18)

   Like defaults, altering rules can be untailored or tailored. Untailored altering rules provide an off-the-rack mechanism that any set of contracting parties can use to displace a default. In contrast, tailored altering rules provide different displacement conditions for different parties. For example, a Thai restaurant that I frequent seems to require non-Asian customers to use more and different English words than Asian customers to obtain truly spicy food. (19) The altering rules of the restaurant are tailored because different customers have to do different things to displace the non-spicy default.

2. Software Parallels

   To fully describe an altering rule, one must know whether the altering rules are themselves mutable. That is, one must know whether it is possible for contractual parties to establish a meta or overarching contract that changes what is necessary and sufficient to contract around a default. Just as contractual parties are able to change the default legal meaning of silence, (20) the law might allow contractual parties to change the mechanism by which they contract around a default. For example, in the cotton industry, the signatories to the Southern Mill Rules can provide for shipment "within fourteen business days from date of sale" merely by including the phrase "for prompt shipment" in their contract. (21) More generally, trade usage, course of dealing, and even course of performance might provide opportunities for private parties to displace what would otherwise be the altering rules governing their contract. (22)

   The possible mutability of altering rules in contract law parallels the mutability of some altering rules in computer software. As we will see in a later Section analyzing Microsoft's User Experience (UX) Interaction Guidelines...