|Contract Theory and the Limits of Contract Law|
|Alan Schwartz and Robert E. Scott [View as PDF]|
113 Yale L.J. 541 (2003)
This Article sets out a normative theory to guide decisionmakers in the regulation of contracts between firms. Commercial law for centuries has drawn a distinction between mercantile contracts and others, but modern scholars have not systematically pursued the normative implications of this distinction. We attempt to cure this neglect by setting out the theoretical foundations of a law merchant for our time. Firms contract to maximize expected surplus, and the state permits markets to function because markets maximize social welfare. Thus, there is a correspondence of interest between firms and the state, which implies that, when externalities are absent, the state should implement the preferences of firms regarding the rules that regulate their contracting behavior.
A contract law for firms would differ in three major respects from current contract law. First, such a law would have far fewer default rules and standards than current contract law contains. The high level of generality on which much contract law is written (e.g., a party must behave "reasonably") creates unacceptable moral hazard for parties subject to it. Thus, firms in theory should, and in practice commonly do, contract out of much of the law most of the time. The primary effect of today's law, therefore, is to raise transaction costs without altering substantive behavior--an effect that a law with fewer default rules and standards would avoid. Second, a contract law for firms would contain a default theory of interpretation that would require courts to base interpretations primarily on the written texts of agreements. The costs of incorrect interpretations that such a theory creates, we argue, would be more acceptable to firms than the costs that the courts' current interpretive practices create. Third, the law would contain almost no mandatory rules. To summarize, a modern law merchant would be much smaller than current contract law; would truncate broad judicial searches for parties' true intentions when interpreting their agreements; and would accord parties much more freedom to write efficient contracts than now exists.