Should the law ignore commercial norms? A comment on the Bernstein conjecture and its relevance for contract law theory and reform.

• Author: Johnston, Jason Scott
• Position: Response to article by Lisa Bernstein in this issue, p. 1724 - Symposium: Regulation by Litigation, Sponsored by Wiggin & Dana

Professor Bernstein's study (1) of the interaction between private law and norms in the cotton industry is the latest installment in her ongoing investigation into the relationship between law and norms in trades ranging from the diamond market to grain and feed markets. Her incredibly detailed and thorough exploration of private lawmaking and commercial norms -- and their interaction -- stands as one of the most significant contributions to contract and commercial law scholarship made in the last half-century. The cotton industry study upon which I focus in this Comment not only reports fascinating findings about dispute resolution practices, but also presents a number of intriguing and complementary theoretical insights into those practices. Bernstein's empirical findings call into question some of the fundamental results in the economic analysis of contract law, such as the theory that expectation damages induce efficient breach of contract. Her central induction from her discoveries about cotton industry practices is that the best way for the law to encourage the development of extralegal norms of commercial reasonableness and the enforcement of those norms via commercial reputation may be, paradoxically, to make those norms irrelevant in formal dispute resolution. This hypothesis -- which I dub the "Bernstein Conjecture" -- suggests that the underlying methodological supposition in Article 2 of the Uniform Commercial Code -- that the law should mirror or reflect actual commercial norms -- may in fact be destructive of the very norms it seeks to incorporate. This is no small implication. For this reason, after beginning with a few methodological quibbles, the bulk of this Comment focuses on the Bernstein Conjecture. I first develop an informal but quite general analysis of the role of the law in deterring commercial opportunism, and I then focus more precisely on identifying the social and market context in which the Bernstein Conjecture is likely to hold.

1. METHODOLOGY AND SIGNIFICANCE

   1. A Peculiar, but Important, Empiricism

      Bernstein's paper is laudably ambitious. She explains the strategic logic behind the cotton industry's mix of private lawmaking institutions and nonlegal sanctions, and she theorizes about the lessons that may be drawn from the cotton industry for commercial law more generally. The paper nicely integrates theory with evidence. This ambitious integration, however, also tends at times to obscure the fascinating empirical questions and answers provided by Bernstein's study. Regardless of whether one is persuaded that Bernstein has really succeeded in explaining cotton industry practices, the empirical evidence that she has uncovered about those practices has some very important implications for contract law.

      Before discussing the implications of Bernstein's findings, a brief methodological digression is in order. Bernstein's empirical data is primarily qualitative. It consists of recorded interviews with cotton industry traders (apparently done mostly over the telephone) and arbitration case files. Her characterization of the data is likewise qualitative. Sometimes this kind of characterization of the data is inconsequential. For instance, she says that many years ago, prior arbitration opinions were "sometimes" mentioned as guiding authority but today are "rarely" mentioned. (2) Bernstein does not tell us precisely what she means by "sometimes" and "rarely." The reader is left to infer that these terms are being used in a relative sense, relative to the frequency with which one might expect to see references to prior opinions in the published judicial decisions. The vague descriptors "sometimes" and "rarely" do not cause any trouble for Bernstein here, primarily because the role of precedent in cotton industry arbitration is peripheral to Bernstein's main claims about arbitration's function in the cotton industry.

      More troublesome is her qualitative characterization of private law adjudication in cotton arbitration proceedings. Bernstein repeatedly characterizes as "formalistic" the reasoning in cotton arbitration decisions. (3) She claims that although parties' briefs "often make arguments based on good faith ... , notions of good faith and fairness do not appear to affect case outcomes." (4) She says that even though one set of formal trade rules (the Southern Mill Rules -- "SMRs" -- that govern merchant-to-mill transactions) explicitly directs arbitrators to look to industry custom to fill gaps in contracts, "unlike courts[,] ... arbitrators are reluctant to find that gaps exist and they do not permit custom to trump or vary trade rules or explicit contractual provisions." (5) Another important set of formal trade rules (those of the Memphis Cotton Exchange -- "MCE" -- governing contracts between traders) is silent on the role of custom, but she says that arbitrators in this system do not actually take custom into account, as evidenced by the fact that custom is mentioned only three times in MCE opinions over the 1944-1991 period. (6) Similarly, she finds custom mentioned in only four of the forty-two B.A. opinions over the 1929-1951 period. (7) Bernstein in fact cites the ninety-one instances in which cotton arbitrators apparently did attempt to craft split-the-difference, compromise results because they felt that such a result was fair. (8) It is difficult to judge the significance of these opinions, just as it is difficult to assess her report that custom is infrequently mentioned in arbitral opinions. The problem is that the comparison between the court system and cotton industry arbitration is left unquantified: there is no comparison between, for instance, the rate at which courts refer to custom in cotton arbitration versus the rate in some sample of judicial opinions applying Article 2 of the Uniform Commercial Code.

      Yet Bernstein clearly means to contrast the way cotton arbitrators decide cases under formal industry trade rules with the way in which courts decide cases under the Uniform Commercial Code: cotton industry arbitrators steadfastly and formalistically follow bright-line trade rules, while courts applying Article 2 roam about through a jungle of oral testimony about industry and relational norms on a Quixotian search for commercial "reasonableness." These are very important but also very broad qualitative characterizations. They are, moreover, the sort of qualitative judgments that define traditional, doctrinal legal scholarship. With the proliferation in recent years of "interdisciplinary" legal scholarship -- law and economics, law and behavioral economics, law and norms, law and society, law and history, law and critical theory, and so on -- doctrinal scholarship has fallen rather out of fashion. Doctrinal scholarship is perceived by many cutting-edge legal academics as sorely lacking in "rigor." In at least one crucial way, however, doctrinal analysis is really very scientific. Because they are interested mostly in persuading the reader that a particular recent opinion was sensible or foolish and ought to have limited or vast precedential effect, doctrinal scholars usually find it necessary to talk about judicial opinions at great length. Even in the text of their articles, they really get into the guts of opinions, often quoting long passages. At the end (or even before the end if the reader does not have the stamina to get that far), the reader is in a pretty good position to assess the strength of the author's interpretive characterization.

      Without getting into hermeneutic fine points, one can see how conventional doctrinal scholarship facilitates interpretive critique and thus enables a kind of qualitative verification process. One wishes that Bernstein's description of cotton industry disputing practices were equally amenable to critique. As it is, the reader does not really have a baseline -- qualitative or quantitative -- against which to assess her claims regarding the empirical superiority of the cotton industry's private law system to the Article 2 public law system.

      There is, of course, the obvious functionalist argument that because cotton industry participants continue to use their own private law system rather than public legal system, they must find it superior. Below, I shall have more to say about the validity and implications of this kind of survival-of-the-fittest line of reasoning about alternative legal systems. (9) My present point is that Bernstein's methodology -- an essentially qualitative analysis of case file and interview data -- does not permit empirical evaluation of the relative efficiency of alternative dispute resolution systems. She presents data on the infrequency of arbitrated disputes in the cotton industry from which one can reasonably conclude, as she does, that the vast majority of disputes in that industry are resolved informally. But the vast majority of commercial contract disputes are also resolved informally and without litigation in the public legal system. Without some sense of contract dispute resolution in those industries that for whatever reason do not have their own private legal system, it is difficult, if not impossible, to draw comparative lessons from Bernstein's findings.

      Bernstein's study is tremendously valuable, not for comparative purposes, but in revealing features of the cotton industry's private law system that neither standard doctrinal nor quantitative empirical work could uncover. Formal cotton industry trade rules are silent about the implied duty of good faith (10) and make course of performance and course of dealing between contracting parties irrelevant to an arbitrator's determination of their intentions. (11) The industry has adopted a simple and inflexible measure of damages given by the difference between contract and market price plus a one-half cent per pound penalty. (12) Failure to comply with an arbitral award is grounds for expulsion from cotton shippers'...