The Statute of Frauds and business norms: a testable game-theoretic model.

• Author: Johnston, Jason Scott
• Position: Symposium: Law, Economics, & Norms

INTRODUCTION

This Article uses models drawn from the theory of repeated games and evolutionary game theory to analyze the relationship between contract law and business norms. This relationship is central to modern, post-legal Realist contract and commercial law. To borrow from Grant Gilmore, one of the fundamental tenets underlying the Uniform Commercial Code ("Code") is that commercial legislation ought "to clarify the law about business transactions rather than to change the habits of the business community," to be "accurate and not to be original."(1) On this view, Article 2 of the Code does not provide judges with a set of rules, but instead directs them to find the law through "directed exploration of the 'fact-pattern of common life.'"(2) For the most part, Article 2 utilizes flexible standards such as commercial reasonableness and good faith which, at least in theory, allow judges "to reduce the gap between law and practice and to insure that decisions are practical and responsive to the needs, proven in the particular case, of the parties and the relevant business community."(3) Thus, while the Code itself does not and cannot provide actual data on business practices,(4) it nonetheless tells judges to attempt to mirror those practices or norms in resolving the disputes that come before them.

Multiple generations of legal scholars have now had an opportunity to analyze, interpret, criticize, and discuss Article 2. If one had no prior knowledge of the conventions and practices of legal scholarship,(5) one might well have anticipated that the first thing such scholars would have done would have been to initiate empirical investigation into actual business practices. One might also have expected to see more theoretical work exploring Article 2's underlying assumptions. It is, for instance, far from clear that the legal fact-finding process is such that judges will be accurate in determining actual commercial norms from the evidence presented to them in litigated disputes. After all, by the very fact that they are not settled, disputes that end up in protracted litigation and a reported decision are different in some way from the typical dispute. Given the limitations that might be expected to confront judges who try to discern actual commercial norms from the evidence presented in litigated disputes, one might expect to see rather extensive analysis of Article 2's fundamental underlying principle, which is that judges should attempt to make contract law mirror the norms immanent in everyday commercial life.

The existing body of commercial scholarship frustrates these expectations. There are some studies that attempt to discern actual commercial practice, typically through surveys of business people and lawyers concerned with contract administration.(6) Indeed, one of the most famous and oft-cited contracts articles of this century, Stewart Macaulay's Non-Contractual Relations in Business,(7) reports the results of such a survey. But without exception, these surveys ask open-ended questions regarding what business people do and whether they know about or are influenced by contract law in making their decisions. They do not theorize about when contract law might be important to business people and when it might not. They do not attempt to fashion sensible questions based on an empirically based background picture of the industry they study, but instead begin with presuppositions regarding practices that are based on the facts of reported decisions. Respondents in construction industry surveys,(8) for instance, are asked about bidding practices but never asked how often they actually bid jobs. Moreover, all types of construction are lumped together in these surveys, with no distinction drawn, for instance, between government contract jobs and those in the home-building trade. Chemical industry respondents are asked how they deal with allocation in times of shortage, but there is no attempt to correlate their responses with data on contract structure or other characteristics of the relationship that might allow a pattern to emerge.(9)

Still, despite their shortcomings, these survey-based studies are to be praised for at least attempting to provide some evidence regarding actual business practices. What is most remarkable about the body of commercial law scholarship is the paucity of studies that even attempt to find out what business people do. What do appear with great frequency in this literature are law review articles exploring the application of various Code provisions in reported decisions.(10) Such work has generated a number of folk beliefs regarding the performance of certain Code sections. It is, for instance, now taken for granted that many reported decisions involving the Statute of Frauds depict judges torturing the Statute to find that it does not apply.(11) Largely on this basis, elimination of the Code's Statute of Frauds (section 2-201) was supported by a majority of the Article 2 study commission.(12) Similarly, the large number and great variety of reported decisions involving the Code's proposed solution to the so-called "battle of the forms" (section 2-207) are taken as a clear indication that the section is a failure and that it ought to be reformed to look more like the Code as a whole.(13)

It may be that some of these folk beliefs happen to correspond to actual problems in the application of various Code provisions. But the beliefs themselves can be nothing more than reactions to reported decisions, and they cannot possibly purport to say anything about the larger universe of cases involving application of the contested provisions without a theory of how the disputes that end up in reported decisions relate to the universe of disputes. While some commentators, such as James J. White, do theorize in a general way about how reported decisions are unrepresentative,(14) they do not attempt to actually sharpen their general theories into more concrete and precise hypotheses regarding which sorts of disputes ought to be observed in reported decisions and what their appearance says about the larger universe.

Given what is in the literature, it is perhaps needless to note the complete absence of any studies systematically questioning the Code's underlying assumption that the law ought to mirror commercial norms. But this supposition generates an enormous set of interesting and unexplored questions: How might judicial misapprehension of norms affect the process by which norms evolve and are maintained in a large commercial community? Is it really appropriate to apply norms that evolve in the context of ongoing relationships--relationships governed primarily by extralegal sanctions--to the resolution of litigated disputes that the parties by definition did not anticipate? And what can be learned from disputes that are litigated to a reported decision? Can a hypothesis be generated that will both explain such disputes and say something useful about the desirability of trying to find commercial norms by which such disputes ought to be resolved?

This Article addresses the latter set of issues--those that involve how one might explain reported contract disputes and learn something from those disputes about the norms that contract law is designed to reflect. It does so by focusing on one norm in particular, the use of a written contract. Section 2-201 of the Uniform Commercial Code states the Statute of Frauds for contracts involving the sale of goods. According to this section of the Code, if such a contract involves the sale of goods exceeding $500 then it must be in writing to be enforceable.(15) For over one hundred years, this statutory writing requirement has been criticized as fundamentally at odds with business norms and as having no effect on business behavior. In the words of one of the giants of the common law, Justice Stephen, "[i]n the great mass of cases the contracting party is as unconscious of the existence of the Statute of Frauds as of the pressure of the atmosphere."(16) If Stephen is right, then in the Statute of Frauds for the sale of goods we have an example of dissonance between contract law and contract norm. But even if Stephen has correctly identified an empirical phenomenon--lots of parties disregarding the formality of a written contract even when it is required for enforceability--there remains the job of explanation and confirmation. That is, why do parties (at least some) seem so indifferent to the formal requirements of the law and the Statute of Frauds in particular? And how might one test such an explanation?

In explaining why contracting parties are indifferent to the Statute of Frauds's writing requirement, it does not suffice to avert to a general lack of sophistication. Lack of sophistication may explain why some parties fail to comply with the legal requirements for enforceability, but the attack on the Statute of Frauds in the sale of goods context is not so much that it is a trap for the unwary as that it departs from the normal practice of sophisticated, legally aware buyers and sellers. To explain this departure, one must explain why such legally sophisticated contracting parties would care so little about the requirements of legal enforceability.

The simplest explanation for such sophisticated indifference to the law is that the parties have extralegal ways of enforcing their agreements. More precisely, if the effectiveness of such extralegal enforcement methods does not depend upon the existence of a writing such as that required by the Statute of Frauds, then one would expect that when the parties rely primarily on extralegal enforcement they will not meet the writing requirement of the Statute of Frauds. Conversely, in situations where the parties anticipate legal enforcement at the time of contracting, one should expect to see a written contract when required by the Statute of Frauds. Put somewhat more broadly, one should expect to...