The role of fault in contract law: unconscionability, unexpected circumstances, interpretation, mistake, and nonperformance.

• Author: Eisenberg, Melvin Aron

It is often asserted that contract law is based on strict liability, not fault. This assertion is incorrect. Fault is a basic building block of contract law, and pervades the field. Some areas of contract law, such as unconscionability, are largely fault based. Other areas, such as interpretation, include sectors that are fault based in significant part. Still other areas, such as liability for nonperformance, superficially appear to rest on strict liability, but actually rest in significant part on the fault of breaking a promise without sufficient excuse. Contract law discriminates between two types of fault: the violation of strong moral norms, such as the prohibition of deception, and the violation of somewhat weaker moral norms, such as the requirement of due care. In some areas of contract law, one type of fault dominates. Where both types of fault are relevant, one party's violation of a strong moral norm will normally override the other party's violation of a weaker moral norm. Fault is pervasive in contract law because it should be. One part of the human condition is that we hold both policy and moral values; law cannot escape this condition. Moreover, if moral obligation and fault were removed from contract law, the contracting system would be much less efficient. The efficiency of the contracting system rests on a tripod whose legs are legal remedies, reputational effects, and the internalization of social norms--in particular, the moral norm of promise keeping. All three legs are necessary to ensure the reliability, and therefore the efficiency, of the contracting system.

INTRODUCTION

The Second Restatement of Contracts states: "Contract liability is strict liability. It is an accepted maxim that pacta sunt servanda, contracts are to be kept. The obligor is therefore liable in damages for breach of contract even if he is without fault...." (1) Similarly, Farnsworth's treatise states that "contract law is, in its essential design, a law of strict liability, and the accompanying system of remedies operates without regard to fault." (2) These statements, and many others like them, are incorrect.

As a normative matter, fault should be a building block of contract law. One part of the human condition is that we hold many moral values concerning right and wrong. Contract law cannot escape this condition. Accordingly, the basic principle that tells us how to make the best possible rules of contract law--or any law, for that matter--must accommodate not only policy and empirical propositions, but also moral values, including values concerning various types of fault. This principle is as follows:

First. If, but only if, appropriate conditions are satisfied, and subject to appropriate constraints, the law should effectuate the objectives of parties to promissory transactions.

Second. The rules that determine the conditions to, and the constraints on, the legal effectuation of the objectives of parties to promissory transactions, and the way in which those objectives are to be ascertained, should consist of those rules that best take into account all relevant moral, policy, and empirical propositions.

Based on this principle, it should not be surprising that fault is a pervasive element in contract law. Some areas of contract law, such as unconscionability, are almost entirely fault based. Other areas, including interpretation, include sectors that are fault based in significant part. Still other areas, such as liability for nonperformance, might superficially appear to be based on strict liability, but can best be understood as resting in significant part on fault.

In this Article, I will discuss some important areas of contract law in which fault should and does figure very heavily. The point is not to exhaust the areas in which fault should and does play an important role, but to illustrate how contract law is fault based to a significant extent, and to examine the different ways in which fault figures in contract law.

Fault comes in different flavors and degrees. For contract-law purposes, fault can be divided into the violation of strong moral norms, such as the norm against lying, and the violation of somewhat weaker moral norms--in particular, the norm that an actor should give due regard to the legitimate interests of others. The major type of contract-law fault in the latter category is negligence, or lack of due care. In this Article I will discuss the role of different kinds of fault in five important areas of contract law: unconscionability, unexpected circumstances, interpretation, mistake, and liability for nonperformance.

1. UNCONSCIONABILITY

   One of the most important developments in modern contract law is the emergence of the principle that an unconscionable contract or term is unenforceable. (3) Traces of that principle can be found in some older cases, (4) and equity courts have long reviewed contracts for fairness when equitable relief was sought, (5) but unconscionability was not a recognized principle under classical contract law. The position of contract law changed radically beginning in the 1960s, following the lead of section 2-302 of the Uniform Commercial Code, which provides that if any contract or contract clause is unconscionable, a court may refuse to enforce the contract or clause or limit the application of the clause to avoid an unconscionable result. Section 2302 was adopted by almost every state, and the principle it embodies has been embraced in other uniform acts, (6) the Second Restatement of Contracts, (7) the Second Restatement of Property, (8) and the case law. (9) However, the meaning and reach of the unconscionability principle is still not fully established.

   Early on, an effort was made to reconcile the unconscionability principle with the bargain principle--the principle of classical contract law that bargains are enforceable according to their terms, without regard to fairness. (10) A major step in this direction was a distinction, drawn by Arthur Left and later adopted by many courts and commentators, between procedural and substantive unconscionability. (11) Essentially, Left defined procedural unconscionability as fault or unfairness in the bargaining process, and substantive unconscionability as fault or unfairness in the bargaining outcome, even if unaccompanied by unfairness of process. (12)

   Procedural unconscionability is easy to reconcile with the bargain principle. That principle rests in significant part on the predicate that private actors are the best judges of their own utility. This predicate, however, only justifies the application of the bargain principle where both parties act voluntarily and are fully informed and the bargaining process is fair. Where the bargaining process is unconscionable--unfair--a major predicate of the bargain principle is not satisfied, and that principle therefore cannot properly be applied to enforce the contract.

   In contrast, it may seem difficult to reconcile the bargain principle with a regime that allows judicial review of contracts for pure substantive unconscionability, because under such a regime a contract could be found unconscionable even if the bargaining process was fair. Accordingly, the effect, if not the purpose, of the distinction between procedural and substantive unconscionability was to suggest that purely substantive unconscionability should be insufficient to render a contract unconscionable.

   The distinction between procedural and substantive unconscionability is useful, but it takes us only so far, and in some ways clouds the relevant issues. Often the distinction will be artificial, because unfairness in the bargaining process will be significant only if the resulting bargain is unfair. Conversely, under some circumstances extracting an unfair contract will be unfair in itself. Finally, the distinction does not address the crucial question, how should it be determined whether a contract is procedurally or substantively unconscionable?

   The answer is that with the possible exception of pure substantive unconscionability, two elements--a predicate and a principle--should figure in a determination of unconscionability. The predicate is the nature of the market on which the contract was made. Contracts made on competitive markets will rarely be unconscionable. However, when contracts are made off-market or on markets that are not competitive, the stage is set for unconscionability. The principle is that unconscionability normally turns on whether the contract involved moral fault on the part of the promisee. Regardless of the nature of the market on which a contract is made, a contract will not be unconscionable without the element of moral fault.

   1. Markets

      In this Article, I will use the term "competitive market" to mean a market that is either perfectly or reasonably competitive. A perfectly competitive market has four characteristics: a homogeneous commodity; perfect, cost-free, and readily available information; productive resources that are sufficiently mobile that pricing decisions readily influence their allocation; and participants whose market share is so small that none can affect the terms on which the commodity is sold, so that each participant takes those terms as given. (13) A reasonably competitive market is a market whose characteristics approximate those of a perfectly competitive market. There are relatively few perfectly competitive markets, but many reasonably competitive markets.

      Now assume a perfectly competitive market, and let the parties to a bargain be S, a plaintiff-seller, and B, a defendant-buyer. Given the conditions of a perfect market, the contract price will be the market price. This price will rarely if ever be unconscionable, since in our society a perfectly competitive market is generally regarded as a fair mechanism to set prices because: (1) By normal measures of value, the contract price will be equal to the benefit S has agreed to confer upon B...