The equitable dimension of contract.

• Author: Smith, Henry E.
• Position: 'Contract as Promise' at 30: The Future of Contract Theory

1. INTRODUCTION

   Contract theory has long been preoccupied with the common law. Contracts is taught in the first year of law school along with the other "common law subjects." The rise of the modern view of contracts as involving mutually dependent undertakings--as opposed to the earlier independent covenants model--was carried out by the common law courts. Contracts are usually enforced with damages, the classic common law remedy. From proto-realists like Holmes, through the realists and their successors in law and economics, theorists have emphasized the law and downplayed the special role of equity, as developed over the centuries by Chancery and building on a tradition of thought going back at least to aristotle. Equity is treated either with disdain as useless moralizing or with impatience as a mere proto-version of freewheeling contextualized inquiry that the law courts should be engaging in without artificial constraints of a separate "equity." Whether they have been antimoralists, formalists, realists, or consequentialists, commentators have been quite unified in their preference for contract law over equity.

   This orientation to the common law, narrowly conceived, is even true of Charles Fried's landmark book Contract as Promise, (1) which did much to bring a moral approach to contracts back into the spotlight. In this Essay I will argue that Fried conceded too much to the conventional exclusive focus on the common law, but that once we recapture an older tradition of equity, the central role of morality in contracts comes more clearly into view. Equity is the missing dimension from contract theory.

   This older tradition uses equity as a structured safety valve to deal with the opportunism arising from the simple structures of the common law. At the same time, equity as a safety valve can be justified on both deontological and consequentialist approaches to contract law. Thus, the Kantian and utilitarian views of contract can converge at the descriptive level. If so, then the disagreement between promise theorists like Fried and legal economists is a foundational rather than a descriptive one.

2. PROMISE AND THE MORALITY OF THE COMMON LAW

   Fried's great innovation was to place contract on a moral footing. More specifically, as his title reflects, Fried argues for the centrality of the moral obligation of promise to the law of contract. To do so, he must explain why not all promises are enforced, and why the law does not allow an unconstrained and therefore "tyrannical" direct implementation of judicial views on morality through courts' remedial responses to contract.

   Fried was not writing on a blank slate, even if it was one from which morality had largely been erased. Two currents made a morals-based theory of contract implausible at the time he wrote. On the one hand, starting with proto-realists like Holmes, some had grown skeptical of traditional and a priori moral notions in the law and sought to put them on a more objective footing. (2) on the other, the realists and their successors saw a need for a wider version of morality, to include social and class justice and distributive concerns, rather than corrective justice or personal morality. (3) Such expansive notions could then be part of the greater context to which realist courts could and should respond when deciding in common law mode. Interestingly, modern law and economics, which is often taken as a main counterpoint to Fried's Kantian theory of contract, partakes somewhat of both of these currents. In law and economics, notions of fairness are often (but not always) dismissed as fussy ex post thinking that gets in the way of more generalizable rules that can better guide ex ante behavior with proper incentives. (4) At the same time, much of traditional law and economics incorporates a version of utilitarianism and cost-benefit analysis that tends, despite some attention to administrative cost, to treat contextual information as presumptively relevant, although more recently, especially in contracts, a new formalism has emerged--to which i will return. Thus, to argue for the morality of promising--a matter of personal morality and an important but not all-encompassing social institution--faced challenges from all sides.

   I will argue that Fried did not go far enough in challenging the classical and realist legacy, and that there is another dimension of contract theory that even he leaves out of the picture: the dimension of equity. Before turning to what I mean--and what contract law used to mean--by "equity," let me pick among the shards of equity to be found in the thinking of Fried and his opponents.

   Modern commentators tend to use Holmes as a jumping-off point or a foil-- in Fried's case the latter. To Holmes, contract, like the rest of the common law, had to be shorn of its moral baggage:

   Nowhere is the confusion between legal and moral ideas more manifest than in the law of contract. Among other things, here again the so called primary rights and duties are invested with a mystic significance beyond what can be assigned and explained. The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it,--and nothing else. If you commit a tort, you are liable to pay a compensatory sum. If you commit a contract, you are liable to pay a compensatory sum unless the promised event comes to pass, and that is all the difference. But such a mode of looking at the matter stinks in the nostrils of those who think it advantageous to get as much ethics into the law as they can. (5) Holmes thought this was of a piece with the law ridding itself of subjective moral notions. Holmes did analogize breach of contract to a tort, (6) so it is not clear he really believed that one had an option to perform or pay, but the notion of breach is an objective and nonmoral one, as he advocated likewise for the law of torts. This thin view of contractual obligation has carried over into law and economics, most famously in the controversy over efficient breach, which adopts the "option" view of Holmes's famous passage. I do not propose to get deeply into the question of efficient breach here, other than to note that commentators tend to agree that explicit options should generally be respected. (7) Disagreement starts when the question becomes the possible presence of implicit options, and when unforeseeable circumstances arise. Partly this is a matter of the sociology of the institution of contract and promising, to the extent that the expectations are not created by the law itself. I return to this larger issue later.

   Back to Holmes. Holmes did not think morality was irrelevant to the shaping of the law, or that law was purely autonomous, but he did approve of what he saw as the law as becoming more and more couched in objective, policy-oriented terms. But this left Holmes a little uncomfortable with the role of equity, and rightly so. After his famous perform-or-pay passage quoted earlier and a further discussion of an opinion by that paragon of law and foe of equity, Lord Coke, (8) Holmes goes on to say:

   I have spoken only of the common law, because there are some cases in which a logical justification can be found for speaking of civil liabilities as imposing duties in an intelligible sense. These are the relatively few in which equity will grant an injunction, and will enforce it by putting the defendant in prison or otherwise punishing him unless he complies with the order of the court. But I hardly think it advisable to shape general theory from the exception, and I think it would be better to cease troubling ourselves about primary rights and sanctions altogether, than to describe our prophecies concerning the liabilities commonly imposed by the law in those inappropriate terms. (9) To Holmes, equity was an anomaly and exceptional, and its role was to be downplayed--and contrasted with law, which was better understood as "a body of dogma enclosed within definite lines." (10) As we will see, something can be exceptional in practice without being anomalous or unimportant. Equity is one of those somethings.

   For the realists and their successors, equity has remained as marginal as it was for Holmes. The realists doubted the value of the limits on and separateness of equity and wanted to carry the equitable impulse much further by making the law more responsive to context. (11) The final fusion of equity happened during the legal realist era. Courts were given flexible procedures originating in equity, most notably in the Federal Rules of Civil Procedure. (12) on the substantive side, common law courts were urged to consider policy context in an unconstrained way. Older ideas of equity, including even Roscoe Pound's notion of equity as a "safety valve," met with realist criticism. (13) At the opposite end of the spectrum, modern formalists have reasserted some formalism in contracts, (14) and have even decried equity and the fairness-oriented judicial intervention they see as its natural outgrowth. Often this has taken the form of skepticism about ex post judicial reasoning and expansive approaches to promissory estoppel, unconscionability, the penalty doctrine, and substantive unfairness more generally. (15) Some have even identified this super-contextualism and fairness-based discretionary reasoning with the traditions of the courts of equity. (16) Their purpose is not to praise, but rather the new formalists would be inclined to agree with Selden that equity in its supposed arbitrariness is like the "Chancellor's foot." (17)

   Against this backdrop, Fried does not make much of equity. His promise principle has antecedents in the rule-oriented classical theory of contract, and Fried believes that classical contract theorists were too stingy about their response to mistake, frustration, and good faith. (18) Fried spends several chapters explaining how a somewhat more generous approach to excuse and the like is...