Is Contract Law Necessary?
Title: Is Contract Law Necessary?
Author: SCHWARTZ, Alan
Series/Report no.: EUI MWP LS; 2010/04
This Lecture argues that much of the contract law in the cases (the US, the UK and Canada) and in the codes (Europe and Latin America) is unnecessary. To say that a law is unnecessary is to say that it does not perform a useful social function. The argument below thus sets out the functions that contract laws today are thought to serve, and then shows that many of those functions either should not be performed at all or should be performed by institutions other than courts. Also, the unnecessary functions increase transaction costs because parties must contract away from or otherwise adjust to them. It is helpful at the outset to set out the argument’s domain. First, the argument applies to sophisticated parties, who usually are firms. Firms have enough at stake, and possess or can get sufficient expertise, to create written contracts. For these same reasons, firms often litigate over deals that do not work out. As a consequence, contract law primarily regulates transactions between firms. Second, the argument applies to the law that courts enforce. The common law is judge made. European Civil Codes are written on high levels of abstraction, and so much of the living law in Europe also is judge made. It also is helpful to set out the norm that governs the argument. Western law is formally committed to the norm of freedom of contract; parties can make their own deals. An immediate implication of this commitment is that parties should be free to alter or reject parts of the state supplied contract law that do not advance the parties’ interests. Western contract law follows this implication, at least in its formal statement. Thus, almost every provision of the US Uniform Commercial Code can be varied by agreement of the parties, and few sections of Civil Codes are explicitly made mandatory. It is customary to refer to rules parties can vary or avoid as defaults. A contract law is largely composed of defaults. An apparent, but controversial, implication of the ubiquity of defaults holds that defaults should reflect majoritarian party preferences. If parties can vary or reject laws they dislike, then supplying parties with laws they dislike cannot advance any social goal. This simple point raises the question what do parties like. Firms contract to maximize gains from trade. As a simple example, if sellers have a comparative advantage at repairing defective machines, then the privately negotiated contract will require the seller to repair. But if defects sometimes are the result of buyer misuse, then the repair obligation will be carefully qualified. Parties in this circumstance will reject or alter a state supplied warranty that is not carefully qualified. This analysis leads to the syllogism that governs this Lecture: (i) A contract law should implement the preferences over rules that firms typically have; (ii) Firms prefer rules that maximize their expected surplus from trade: that is, firms prefer efficient rules; (iii) Therefore, a contract law should contain only efficient rules. Few contract law rules, it is argued below, can satisfy an efficiency test. Before reaching the argument, it will be helpful to illustrate the institutional limitation noted above. Monopoly power is inefficient. This justifies the antitrust laws, which attempt to deter or curb monopoly power. Suppose then that a firm, arguably possessing monopoly power, qualifies its obligation to repair defective machines. Should a court strike the qualification if a buyer sues to obtain broader protection? This Lecture argues not. If the source of the seller’s market power remains, the seller probably will supply buyers with repair clauses, or substitute other clauses, that buyers prefer less. Eliminating monopoly power is useful; judicial regulation of a monopolist’s contracts is not.
This lecture was delivered on 17 March 2010. Alan Schwartz, Sterling Professor of Law; Professor of Management, Yale University
Type of Access: openAccess