Document Type

Working Paper

Publication Date

1999

Center/Program

Center for Contract and Economic Organization

Center/Program

Program in the Law and Economics of Capital Markets

Abstract

This paper begins with the claim that the state's primary role in uniformly enforcing commercial contracts is to regulate incomplete contracts efficiently. This role requires the state to perform two interdependent but conceptually distinct functions. The first is an interpretive function -- the task of correctly (and uniformly) interpreting the meaning of the contract terms chosen by parties to allocate contract risk. The second is a standardizing function -- the task of creating broadly suitable default rules or assigning standard meanings to widely used contract terms. Correct interpretation argues for a "textualist" or plain meaning interpretation of the express terms used in incomplete contracts. The task of generating useful defaults argues, on the other hand, for contextualizing incomplete contracts so that courts can find out about commercial practice. Thus, the first goal seems to require keeping context out whenever possible, and the second goal seems to require incorporating context as often as possible. As a consequence, the law is apparently forced to trade off one goal against the other. The UCC has quite clearly chosen the strategy of incorporation; it adopts a pervasive standard of commercial reasonableness that requires context to supply meaning to many of its generic default rules. But curiously, the Code fails even at the one task it was explicitly designed to do. Under the Code there has been very little production of standardized defaults. Moreover, the Code, intent on incorporation, fails at the first enterprise -- reliable and predictable interpretation of contractual text. Surprisingly, the development of standardized defaults has been much more successful under the common law, in those areas of contract law such as commercial services to which the Code does not extend. And these courts have also retained more traditional plain meaning and parol evidence rules and thus have reinforced their textualist interpretive strategy. The result is that both kinds of efficiency gains -- the creation of a fairly uniform menu of standardized defaults, with regular additions of new terms to the menu and stable (i.e., uniform) interpretation of express terms, are seen much more in the common law than under the Code. I argue that the inefficiencies of the Code are a product of the codification enterprise itself -- of trying to introduce a civil-law approach into a largely successful common law system. Because gaps are filled with reference to the internal norms of the Code rather than the external contractual context, interpretation is both contextual and self-referential--the worst of both worlds.

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