The return of bargain: an economic theory of how standard-form contracts enable cooperative negotiation between businesses and consumers.

Author:Johnston, Jason Scott
Position:Boilerplate: Foundations of Market Contracts Symposium
 
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INTRODUCTION I. FROM CONTRACTS OF ADHESION TO MARKET ASSENT II. BARGAINING AROUND STANDARD-FORM TERMS: SOME EVIDENCE A. Hospital Bills B. Consumer Credit Cards C. Home-Mortgage and Home-Equity Lending D. The Rent-to-Own Industry E. Retail Sales Return Policies F. Only the Tip of the Iceberg: Can Everything Be Renegotiated? III. EXPLAINING OBSERVED BEHAVIOR: DESIGNING STANDARD-FORM TERMS THAT ARE MEANT TO BE FORGIVEN A. Discretionary Forgiveness as Ex-post Customer Screening B. Individualized versus Algorithmic Renegotiation C. Discretionary Benefits and the Potential Instability of Consumer Screening through Two-Part Standard-Form Contracts IV. THE VALUE OF DISCRETION: DISTRIBUTIONAL ISSUES IN THE REGULATION OF STANDARD-FORM CONTRACTS AND THEIR RENEGOTIATION V. STANDARD-FORM TERMS AND THE DOCTRINAL CONTROL OF FIRM OPPORTUNISM A. The Complexity of Opportunism B. Doctrinal Implications VI. STANDARD-FORM CONTRACTS OPTING OUT OF CIVIL LIABILITY AS DETERMINANTS OF THE VIABILITY OF THE DISCRETIONARY BENEFITS EQUILIBRIUM A. The Pathologies of Contemporary American Civil Liability B. Cooperative Relationships Are More Likely in the Shadow of Arbitration than under the Risk of Civil Liability APPENDIX: EX-POST VERSUS EX-ANTE SCREENING OF OPPORTUNISTIC BORROWERS INTRODUCTION

Among attorneys, judges, and legal academics, there is virtual consensus that the widespread use by business firms of standard-form contracts in their dealings with consumers has completely eliminated bargaining in consumer contracts. I believe that this perception is false, that rather than precluding bargaining and negotiation, standard-form contracts in fact facilitate bargaining and are a crucial instrument in the establishment and maintenance of cooperative relationships between firms and their customers. On this view, which I elaborate below, firms use clear and unconditional standard-form contract terms not because they will insist upon those terms, but because they have given their managerial employees the discretion to grant exceptions from the standard-form terms on a case-by-case basis. In practice, acting through its agents, a firm will often provide benefits to consumers who complain beyond those that its standard form obligates it to provide, and it will forgive consumer breach of standard-form terms. Firms do this because they have an interest in building and maintaining cooperative, value-enhancing relationships with their customers. Were firms legally required to extend such benefits or forgiveness--as would result either from judicial invalidation of the tough standard-form performance terms or legislatively mandated generous standard-form performance terms--then both firms and their customers would be worse off.

Most of my analysis here is concerned with standard-form terms of performance: contract terms that set out, for example, the amounts and repayment dates on a consumer loan, or an airline passenger's rights to be upgraded to a first-class seat. While my main concern is with such standard-form performance terms, I also discuss what may be called standard-form breakdown terms--terms that determine where and how an "endgame" dispute over breach of the performance terms will be resolved. (1) Unlike performance terms, which firms intend to forgive or expand upon when so doing is consistent with building and maintaining valuable customer relationships, breakdown terms are not meant to be varied, since breakdown signals that no mutually beneficial customer relationship exists. Moreover, the optimal breakdown terms are those that maximize the firm's incentives to pursue discretionary, cooperative tailoring of its customer relationships. By systematically overcompensating consumers with large claims against business firms, and undercompensating those who have relatively small claims against such firms, the civil justice system blunts or eliminates such incentives. By offering a more predictable and more uniform schedule of damages, private arbitration can offer a form of endgame dispute resolution that allows firms to focus more on business value and less on litigation risk in negotiating the terms of their ongoing consumer relationships.

My analysis of both standard-form performance and standard-form breakdown terms generates some advice for courts employing common law contract doctrines. Courts should presume that standard-form contract terms are a valid and enforceable part of the bargain between business firms, their customers, and their employees. At the same time, however, courts must recognize that opportunistic firms will use standard forms to renege on promises to offer the tailored and flexible forgiveness and accommodation offered by good firms. To prevent such behavior, courts should enforce additional promises or concessions made by agents of the firm that go beyond standard-form obligations, provided that there is clear evidence that such promises were actually made. Courts should also ensure that standard-form arbitration clauses do indeed offer uniform and predictable remedies, rather than no remedies at all.

Part II of this Article presents empirical evidence demonstrating that firms routinely grant their agents the authority to exercise their discretion to forgive the breach of and extend benefits beyond standard-form consumer-contract terms. Such a strategy of using ex-ante clear and unconditional standard-form contract obligations together with discretionary ex-post forgiveness or ex-post benefit conferral comprises what I call a "two-part standard-form contract." Part III develops an economic, game-theoretic explanation for such two-part standard-form contracts, how firms determine the optimal combination of standard-form terms and ex-post discretion, and why they could not accomplish the same socially desirable strategic goal if they were not permitted to exercise the discretion to vary standard-form terms. Part IV discusses the model's implications for traditional legal concerns about the distributive impact of standard-form consumer contracts. Part V explains implications for doctrines that determine the enforceability of promises that vary or add to the terms of standard-form contracts. Part VI analyzes how standard-form breakdown terms determine the viability of the optimal two-part standard-form contract. I begin in Part I with a brief intellectual history of academic and judicial thinking about standard-form contracts.

  1. FROM CONTRACTS OF ADHESION TO MARKET ASSENT

    As Friedrich Kessler famously observed over sixty years ago, (2) the late-nineteenth-century development of mass production and mass distribution of consumer goods brought with it the standardized mass-consumer contract. (3) Just like consumer goods, standardized contracts are mass marketed. On the traditional story told by legal scholars, (4) a firm's attorneys write the terms of these contracts, which then accompany the sale of all the firm's products (or, increasingly, services). Between the consumer and the sales agent (or retailer), there is no bargaining over the terms of such contracts. They are automatically bundled together with the sale of the good or service.

    In its core doctrines, the common law of contracts was already well developed when standardized consumer contracts appeared on the scene. One of those core doctrines is that a legally enforceable contract requires "a manifestation of mutual assent to the exchange," (5) or, in somewhat more colloquial terms, an agreement. Induced from a body of case law dealing largely with non-standard, negotiated transactions, the common law's paradigm for the "manifestation of mutual assent" is that of a bargaining process which culminates when one party makes an offer that the other finally accepts. (6)

    The paradigmatic standardized consumer transaction does not, however, involve an individualized negotiation over price and other terms, but rather the posting of set prices for goods and services with standardized (albeit typically varying) characteristics. In the modern economy, consumer sales occur not through the haggling and dickering of the market bazaar, but rather through the cool, calm efficiency of mass retailing. While it is possible to uncover (create?) an "offer" and "acceptance" pattern even in common, standardized consumer transactions, it must be conceded that those sales do not emerge from the kind of individualized bargaining process that gave rise to the offer and acceptance paradigm. While common-law judges understood that mass production and marketing brought consumers a once unimaginable diversity of products and services delivered by producers who were pressured by constant competition to keep prices and costs down, they found it hard to see how consumers were legally assenting to the standard-form contract used in such a world. Indeed, judges and legal scholars viewed market-driven uniformity in standard-form contract terms with alarm, perceiving that even in reasonably competitive markets, consumers often had no choice of contract terms, so that a consumer's apparent contractual assent to such terms was really "but a subjection more or less voluntary to terms dictated by the stronger party, terms whose consequences are often understood only in a vague way, if at all." (7) Uniform standardized contracts became subject to the epithet "contracts of adhesion." (8)

    By the 1970s, both courts and commentators had reached a virtual consensus regarding the evil of form contracts. As recounted by George Priest, (9) academic commentators viewed standard-form consumer-product warranties variously as a form of fraud (10) or as evidence that consumer product manufacturers had unbridled discretion to draft standard-form terms such as warranties simply to minimize their costs. (11) Courts across the country followed the New Jersey Supreme Court's famous decision in Henningsen v. Bloomfield Motors, Inc. (12) refusing to enforce the terms of a standard-form warranty...

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