Center for Contract and Economic Organization
Program in the Law and Economics of Capital Markets
The relationship between legal rules and the strategies that commercial parties use to deal with risk is among the most important and least understood topics in law and economics. Organizational theorists have generally confined their analyses to the nature of the firm and other permanent relationships. Academic commercial lawyers, in turn, have been far less venturesome than their corporate colleagues in applying fundamental economic insights. Not surprisingly, therefore, we know very little about the inner workings of most commercial relationships. For these reasons (and more) I applaud efforts to integrate economic insights and legal structures, exemplified by Clay Gillette's imaginative essay on the nature of commercial relationships.
Gillette makes two independent claims in his article. The first concerns how commercial parties deal with risk. The second concerns how we, as independent observers, can ferret out the strategies that these parties have pursued toward risk in individual cases. His second claim is potentially the more important. Although Gillette is cautious to note the limits of his project, he argues that the structural relationship between the parties provides a rich source of information that enhances our ability to predict the type of contractual terms that the parties would have chosen to govern their affairs when certain remote or unanticipated contingencies occur. This perspective, which Gillette develops in some detail, provides additional support for resorting to hypothetical bargain analysis to supply the relevant default terms by rendering it more plausible that these particular parties would have chosen this default rule if required to bargain explicitly in advance.
Gillette's method of analysis would constitute a genuine theoretical advance if it allowed legal academics and policymakers to make more refined predictions about the outcome of hypothetical bargains among commercial actors. Yet while his transaction approach yields important insights about particular contracting strategies, paradoxically, Gillette is ultimately unable to generalize about risk-allocation strategies or about the choice of default rules that best implements his desired goals. Unhappily, Gillette is disabled from making any generalizations (at least with any degree of confidence) by the internal logic of his very complex model of how parties deal with risk. Moreover, Gillette's dilemma is not an isolated phenomenon. Other commentators, most notably Jules Coleman, Douglas Heckathorn, and Steven Maser and Ian Ayres and Robert Gertner, have recently advanced additional normative arguments in support of more complex and particularized default rules for commercial contracts. Taken together, these arguments challenge both the wisdom and the efficiency of the existing stock of generalized default rules used by courts and legislatures to fill gaps in incomplete contracts.
Robert E. Scott,
A Relational Theory of Default Rules for Commercial Contracts,
J. Legal Stud.
Available at: https://scholarship.law.columbia.edu/faculty_scholarship/341