The Economics of Form and Substance in Contract Interpretation

Avery W. Katz, Columbia Law School


For the past 100 years or so the historical trend in the law of contracts has been to water down formal interpretive doctrines in favor of a more all-things-considered analysis of what the parties may have meant or what justice might require in the individual case. This trend away from formal and toward substantive interpretation of contracts has been alternately celebrated and criticized for over a century; and in recent years, a number of economically influenced scholars, in translating some of the classic arguments into economic language, have helped to clarify some of the traditional commentators' concerns. While this new economic analysis of formalism has been relatively successful in relating the traditional debates over formalism to specific transactional and institutional problems such as imperfect information and rent-seeking, however, it has fallen short along the dimension of advancing toward practical legal or policy recommendations. This essay, accordingly, proposes a different approach: one that focuses on private rather than public legal decisionmakers as a primary audience. In general, private lawmakers are likelier to be in a better position to make practical use of the economic analysis of contracts, in part because the detailed information that is necessary to implement such analysis intelligently is much likelier to be available at the individual level. Furthermore, there are many opportunities for contracting parties to choose between relatively formal and relatively substantive interpretive regimes. What is needed is a basic taxonomy of economic considerations that can serve as an organizing framework for parties choosing between form and substance when designing contracts; and the later part of the essay attempts to establish such a taxonomy.