VISIONS OF CONTRACT THEORY

Vol. 17 No. 10 (October, 2007) pp.783-787

VISIONS OF CONTRACT THEORY: RATIONALITY, BARGAINING, AND INTERPRETATION, by Larry A. DiMatteo, Robert A. Prentice, Blake D. Morant, and Daniel D. Barnhizer. Durham: Carolina Academic Press, 2007. 276pp. Cloth. $45.00. ISBN: 9781594602177.

Reviewed by Andrew T. Hayashi, Department of Economics and Boalt Hall School of Law, University of California, Berkeley. Email: ahayashi [at] berkeley.edu.

While VISIONS OF CONTRACT THEORY is “intended to be a holistic product of scholarly cooperation,” because Larry DiMatteo, Robert Prentice, Blake Morant, and Daniel Barnhizer, partitioned the landscape of contract theory according to their areas of expertise, the book is marked by radical shifts in tone and balance. After an introductory chapter outlining the authors’ view that “all the theories of contract offer insight,” and rejecting “the idea that one metaprinciple, or theory, can explain all of contract law,” Prentice devotes three chapters to, rather uncharitably, describing and criticizing the Law and Economics program and “Behavioral Decision Theory” (BDT). In sharp contrast, Chapter 5 presents Barnhizer’s largely descriptive, but balanced and comprehensive survey of the role of bargaining power in contract theory, while in Chapter 6 he presents the original thesis that a legal conception of bargaining power may be useful in helping define the class of agreements which ought to be regulated by the law of contracts. In Chapter 7, DiMatteo provides a careful, descriptive account of the jurisprudence of Karl N. Llewelyn and Ronald Dworkin, but one that requires much more of the reader in terms of abstract thinking and that is somewhat jarring coming on the heels of the previous essays. Chapter 8 introduces DiMatteo’s novel theory of contract interpretation, which attempts to “bridge the contextual and conceptual mind-sets” of Llewelyn and Dworkin. Veering back from the high theory of Chapters 7 and 8, the book’s final chapter presents Morant’s discussion of various perceived weaknesses in classical contract theory with an emphasis on its lack of contextual sensitivity, particularly with respect to the effects of power and discrimination in contracting environments, criticisms rooted in the traditions of Critical Legal Studies, Critical Race Theory, and Feminist Legal Theory.

Because VISIONS OF CONTRACT THEORY is so broad in scope, and diverse in content and style, I suspect that every reader will find some of the descriptions and analyses helpful, illuminating, and provocative, while finding others somewhat less so. However, there is no question that the book meets its aim of serving as a general reference on contract theory, and it is full of useful citations.

In my view, Barnhizer’s novel use of the concept of bargaining power, to demarcate the classes of transactions properly regulated by the law of contracts from those which are not, is especially interesting and worthy of further development. Prentice’s survey of the history of the Law and Economics [*784] movement also warrants some discussion, for provoking important questions about prospects of he Law and Economics and BDT research programs.

Chapter 6 is entitled “Bargaining Power as Contract Theory” and contains a new and interesting use of bargaining power to describe the contours of contract law. Barnhizer suggests that a two-part test applied to the character and distribution of bargaining power across classes of transactions can explain why certain agreements are subject to the comparatively hands-off regime of contract law, while other agreements are subject to more intrusive regulatory structures. On this account, transactions in which the parties (1) each possess bargaining power, that is (2) legally cognizable, are subject to contract law. A party possesses bargaining power when she has the power to influence the outcome of the bargain. Although this is a plausible definition of bargaining power, an operational definition is, and always has been, lacking. In light of the subtle ways in which power can be held and exercised, it is very difficult to point to objective features of the parties or the bargaining environment that uniquely determine the allocation of bargaining power.

An important motivation for Barnhizer’s theory is the recognition that, in any individual context, the distribution and sources of bargaining power may be subtle, elusive, and complicated. He is very pessimistic about the ability of judges to discern the distribution of bargaining power, asserting that the “[r]egulation of private agreements on the basis of perceived inequalities of bargaining power is, at least to some degree, incoherent and indeterminate” (p.123). This is an important point. In addition to the fact that power relationships are often subtle and complex, we should expect that judges, like anyone else, are susceptible to psychological biases that may cause them to pay attention to certain manifestations of power and neglect others.

On the other hand, Barnhizer is optimistic that, while legal decision-makers cannot be trusted to determine the allocation of bargaining power in an individual case, accurate generalizations can be made about the arrangement of bargaining power in a typical case in a class of transactions. For instance, although there might exist a situation in which a large insurer is in a weaker bargaining position than the insured, this is typically not the case, and it is within the judicial and legislative areas of expertise to determine and recognize when such relationships typically are characterized by an imbalance of bargaining power in one direction or the other.

The second condition that must be satisfied if a class of agreements is to fall within the ambit of contract law is that the power relationship between the parties is legally cognizable. Legally cognizability requires that the rules governing the parties’ power relations can be applied to other parties similarly situated and are “credible to outside observers who regularly reassess the authority of courts to determine those issues” (p.131). This condition requires that the power relationship between the [*785] parties be fairly uncomplicated and well understood by legal decision-makers, and also introduces an interesting quasi-democratic feature to the test, since the only classes of promises which are enforced under contract law are those in which there is popular agreement about the nature of the rules of power in a given transaction type. On the one hand, this is a plausible explanation of how certain agreements have come to fall within the purview of contract law while others have not. Courts will have a hard time assuming or asserting what the public views as obviously untrue. Barnhizer suggests that legal doctrines relying on notions of unequal bargaining power emerged from the untenability of LOCHNER-era contract doctrine, which relied on the view that competent parties to a transaction possessed equal bargaining power. In the face of a potential credibility crisis, the legally cognized rules of power were reconfigured to admit asymmetries in the distribution of power.

However, as a normative criterion for deciding which classes of promises to enforce under contract law and which to relegate to a more intrusive regime, the merits of Barnhizer’s test are less obvious. In particular, if one believes that agreements arising out situations of asymmetric bargaining power ought to be enforced in certain circumstances, then Barnhizer’s test appears too broad. Parties with very little bargaining power might be better off bound by their agreements than have it be known ex ante by their prospective counterparty that they are risky trading partners. Secondly, if it is in fact within the institutional expertise of the courts and legislature to determine the nature of bargaining power within classes of transactions, it may not be a good thing to further require that the power relationship they identify persuade “outside observers.” Consumer protection groups are likely to perceive (or at least claim to perceive) bargaining power to be allocated one way, while industry groups are likely to perceive it another. A useful clarification of this test would identify the universe of “outside observers” whose opinions count.

As a descriptive account of contract law, Barnhizer’s thesis is a fine contribution that I hope will be developed in future work. Although I do not find the application of “Bargaining Power as Contract Theory” to promissory estoppel and donative promises especially persuasive (indeed, Barnhizer’s view that promissory reliance could itself constitute bargaining power seems only to highlight the fact that “bargaining power” could use a much more rigorous definition), I do not doubt that his test could explain a great deal of the sorting of transaction types between contract law and other, more intrusive regimes. As a normative theory, I suspect that it is somewhat incomplete insofar as it does not take into account economic efficiency consequences at all in deciding whether promises made in the shadow of asymmetric bargaining power should be enforceable. Although economic efficiency should not become the sole preoccupation of contract law, it ought to be given some weight in the development of doctrine.

A survey of contract theory scholarship can hardly omit the contributions made [*786] by the Law and Economics literature and those contemporary researchers who operate within that broad framework but incorporate more realistic assumptions about human psychology into their analysis. Thus, Prentice devotes two chapters to a description and critique of Law and Economics and BDT. His survey is fairly comprehensive but excludes certain recent developments in the field which will likely be of interest to law students and researchers, the target audience of the book.

Covering such a vast literature in a general reference work, as this book is intended to be, necessarily entails some simplification. Nonetheless, many of Prentice’s assertions about what economists believe and assume about the appropriate role of contract doctrine seem overbroad in light of developments in the last decade. Prentice acknowledges that there is some diversity within the field; yet, one still comes away with a rather monolithic view of economists and economics-minded lawyers. It is true that economists such as Kaplow and Shavell, and economically-minded non-economists like Judges Posner and Easterbrook, have argued that contract law ought to serve the lone goal of economic efficiency. However, there have been important contributions to this debate made from within the Law and Economics tradition, arguing that the law ought to deviate from strict efficiency goals in the presence of any social preference for equity, rather than try to accomplish redistribution solely through taxes and transfers (e.g., Sanchirico 2000; 2001). Economists Ulrike Malmendier and Stefano Della Vigna explore the efficiency characteristics of contracts made between profit-maximizing firms and human persons who exhibit realistic psychological biases (see e.g., Malmendier and Della Vigna 2006; 2004). Although their models of the contracting environment include agents who have “behavioral traits” (quasi-hyperbolic discount rates, implying impatience) and thus Prentice would probably locate them in the BDT camp, they are, in fact, simply economists who believe that economic models may improved by taking seriously human psychology.

The criticisms recited by Prentice about BDT’s application to law are virtually the same as some of the objections that were raised against behavioral economics in its early stages: that it serves to undermine the foundations of traditional economic analysis without offering something to replace it with, that its insights are context specific and, in Prentice’s words, “unable to be melded into an overarching theory” (p.49). These and other objections were once a hot topic within economics but are no longer much discussed. What is interesting about these questions is that they were initially raised by economists primarily concerned about methodology and the status of economics as science. Even if these questions had remained unanswered, which I do not believe to be the case, it is not clear that they apply equally to whether behavioral economics can be usefully applied to contract law as to whether the research program weakens economics’ claim to be scientific. In particular, the fact that BDT may not provide an “overarching” [*787] or “unified” theory of contract law should hardly be seen as a weakness in light of the authors’ thesis at the outset that many theories may provide insight into contract law and rejecting the notion that one theory can explain it all. What matters is that BDT may assist in some way the positive and normative theorizing about contracts. That is the threshold for each of the other approaches to contract theory discussed in VISIONS OF CONTRACT THEORY, and it is the appropriate standard for behavioral decision theory.

REFERENCES:

Della Vigna, Stefano, and Ulrike Malmendier. 2006. “Paying Not to Go to the Gym.” 96 AMERICAN ECONOMIC REVIEW 694-719.

Della Vigna, Stefano, and Ulrike Malmendier. 2004. “Contract Design and Self-Control: Theory and Evidence.” 119 QUARTERLY JOURNAL OF ECONOMICS 353-402.

Sanchirico, Chris William. 2000. “Taxes versus Legal Rules as Instruments for Equity: A More Equitable View.” 29 JOURNAL OF LEGAL STUDIES 797-820.

Sanchirico, Chris William. 2001. “Inequity and Distortion: The Continuing Debate on Equity and Efficiency in the Law (A Counter-Response to Professors Kaplow and Shavell).” 2001. UVA Law School, Law-Economics Research Paper No. 00-19. Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=241573.

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