Oman on Contract Theory

Posted by Jeff Lipshaw

Nate Oman (William & Mary, left) has an interesting new article (The Failure of Economic Interpretations of the Law of Contract Damages) out on the reconciliation of efficiency (i.e. law and economics) and autonomy (i.e. the moral consequence of promising) as a basis for a coherent internal interpretive theory of contract law – why does the doctrine say what it says?

Nate demonstrates that the bilateral nature of private contract remedies (i.e. the parties sue each other, rather than having some state apparatus remedy the situation) creates an unresolvable paradox for economic justifications.  The problem is that the expectation remedy is thought to create inefficient over-reliance by the promisor, but the remedy best suited to making sure the promisee does not over-rely – restitution – creates inefficient incentives for the promisor to breach.  If the state were an intermediary, “fining” the promisor to the extent of expectation damages, but rewarding the promisee only to the extent of restitution, there would be (in the perfect world of economists) the optimum efficient.  But the bilateral nature of the remedy means that the system – which only rewards and punishes in a single amount between the parties – cannot be wholly efficient.

I think Nate is a wonderful communicator of contract theory (not to mention Anglo-American legal history), and this is a nice read.  I also admire his doggedness in pursuing the internal reconciliation of the justification of contract law as it exists.  Understand what that means:  by Nate’s own analogy (chess), he is going to stay inside the game to provide a coherent explanation for why the game’s rules are what they are. 

Patrick O’Donnell, commenting over at Concurring Opinions, asked Nate to juxtapose my recent take on the futility of the effort to justify contract law with Nate’s piece.  I can’t resist offering up my own take.  To some extent, Nate and I are ships passing in the night.  I am less concerned about trying to create a coherent internal explanation.  Indeed, my point is that a wholly complete and consistent model is not possible under any system of axioms and logical rules (which, as a mathematical model, economics is).  So it is hardly surprising to me that Nate’s conclusion is hybrid (as was Jody Kraus’s).  Both moral theory and efficiency seem to play a role in different aspects of contract law.  My piece is expressly “meta” in trying to come to terms with why.  Or to put it more cynically (or hopefully, depending on your perspective), I am going to try to explain the relationship of the internal view to the external perspective – the one taken by law and society types, legal realists, critical theorists, and moral philosophers.  Not surprising I get all twisted up (in a fun sort of way) in the question whether the participants in a contract dispute are on inside looking out (as involved first parties), or on the outside looking in (as objective third parties), or if at some point they move from one to the other.

For the last couple weeks, I have been teaching UCC Article 2 remedies, and the dominant theme (in some respects a revelation to me) is the conflict we often find between a literal or mechanical application of the remedy formulas and our intuitive notion of the correct result.  Within the Code, the problem shows up as a conflict between a remedy in the 2-700 series of statutes and Revised 1-305 that says the purpose of the remedy is to put the aggrieved party in as good a position as he or she would have been had the breaching party performed.  But I’m willing to posit, as a metaphor or analogy (here, not in my class, or the students’ eyes would be spinning like pinwheels), that it’s not just a matter of reconciliation within the system, but the problem that the system (here, legal axioms and rules of inference) will contain true but unprovable propositions – like “the literal application of Section 2-708(1) in X circumstance will overcompensate the aggrieved party.”

Nate’s abstract is below the fold. Highly recommended! Download it while it’s hot!  (Sue me, Solum.)

Here is the abstract:

The law of contracts is complex butremarkably stable. What we lack is a widely accepted interpretation ofthat law as embodying a coherent set of normative choices. Somescholars have suggested that either economic efficiency or personalautonomy provide unifying principles of contract law. These twoapproaches, however, seem incommensurable, which suggests that we mustreject at least one of them in order to have a coherent theory. Thisarticle dissents from this view and has a simple thesis: Economicaccounts of the current doctrine governing contract damages havefailed, but efficiency arguments remain key to any adequate theory ofcontract law. Contractual liability – like virtually all civilliability – is structured around the concept of bilateralism, meaningthat damages are always paid by defeated defendants to victoriousplaintiffs. Ultimately, economic accounts of this basic feature areunpersuasive. This criticism, however, leaves untouched many of the keyeconomic insights into the doctrine of contract damages. The limitedfailure of economic interpretations points toward a principledaccommodation of both autonomy and efficiency in a single vision ofcontract law where notions of autonomy provide the basic structure andeconomics fills in most of the doctrinal detail.