Binding Promises: The Late 20th-Century Reformation of Contract Law

Binding Promises

Binding Promises

The Late 20th-Century Reformation

of Contract Law

W. David Slawson

Princeton University Press Princeton, New Jersey

Copyright © 1996 by Princeton University Press

Published by Princeton University Press, 41 William Street,

Princeton, New Jersey 08540

In the United Kingdom: Princeton University Press, Chichester, West Sussex

All Rights Reserved

Library of Congress Cataloging-in-Publication Data

Slawson, W. David 1931-

Binding promises : the late 20th-century reformation

of contract law / W. David Slawson.

p. cm.

Includes bibliographical references and index.

eISBN 1-4008-0744-1

1. Contracts—United States. I. Title.

KF801.S525 1996

346.73'02—dc20

[347.3062] 95-25448

CIP

This book has been composed in Times Roman

I dedicate this book to the

American common law judge.

Contents ______________________________________________

Acknowledgments

Introduction

1.Classical Contract

Freedom of Contract and the Common Callings

Freedom of Contract at Its Zenith

The American Rule

Troubles with the Will Theory

The Objective Theory and the Failure to Require Evidence of Real Consent

2.Product Dependence and Unequal Bargaining Power

Product Dependence

Unequal Bargaining Power

The Effects of Classical Contract on the Law’s Ability to Serve Public Purposes or to Prevent Abuses of Bargaining Power

Different Conceptions of Bargaining Power

Arguments in Opposition to the Reforms

Conclusion

3.Reasonable Expectations

Origins in Insurance

Justifications in Insurance

Acceptance in Insurance

Estoppel in Insurance

Employment Contracts

Origins and Justifications in General Contract Law

The Restatement (Second) of Contracts

Contracts of Adhesion

Unconscionability

Article 2 of the Uniform Commercial Code

The Covenant of Good Faith and Fair Dealing

Unknowing Uses

Acceptance

Public Lawmaking and Contracting Power

Concerns

Division of Labor between Jury and Judge

The Effect of Special Knowledge

The Role of Reasonable Expectations in the Reform of Contract Law

The Future of Reasonable Expectations

4.Relational Torts

Limitations of Freedom of Contract in Classical Contract Law

Products Liability

The Birth of Relational Torts in California

Insurance

Wrongful Discharge from Employment

Sales of New Dwellings and Construction Services

Landlord and Tenant

Services Generally

Warranty Disclaimers under the Code

Brokers’ Commissions

Fiduciary Relationships

Discretionary Powers

The Covenant of Good Faith and Fair Dealing Not Sounding in Tort

Consumer Protection Legislation

Analysis

Confusion with Contract

Criticisms

Acceptance

5.Bad Faith Breach and Remedies Reform

The Birth of Bad Faith Breach in California

Bad Faith Breach Nationally

Justifications

Bad Faith beyond Contract

Recovery of Litigation Costs: The American Rule

Damages for Emotional Distress

Punitive Damages

The Roles of Bad Faith Breach and Remedies Reform in the Reform of Contract Law

6.Article 2 of the Uniform Commercial Code

The Reasons for Creating Article 2

The Efforts to Make Amending Article 2 Unnecessary

The Process for Drafting and Enacting the Code

Unconscionability

Contract Formation in a Battle of the Forms

Warranties and Remedies

7.Choices and Prohibitions

The Choice between Reasonable Expectations and Relational Torts

Reasonable Expectations under the Uniform Commercial Code

Relational Torts under the Uniform Commercial Code

Bad Faith Breach under the Uniform Commercial Code

The Choice between Legislation and Judicial Lawmaking for Article 2

Constitutional Considerations

Preventing Abuses

Making Promises Binding Again

Notes

Index

Acknowledgments ________________________________________

The University of Southern California Law Center provides its faculty with a magnificent atmosphere for scholarship and helpful financial support, from which I have benefited immeasurably. I would especially like to thank Dean Scott H. Bice, whose interest in scholarship and whose labors on behalf of the Law Center have been instrumental in creating and maintaining this atmosphere and support.

I would like to thank the library staff of the Law Center for the excellent and goodhearted service it invariably provides. I would like to thank in particular the director, Albert O. Brecht, reference librarian Brian Raphael, and a former reference librarian here, now director of the Law Library at Vanderbilt University, Pauline M. Aranas. I would also like to thank my secretary, Madeline Paige, for her very competent work, her loyalty, and her enthusiasm.

I thank my former colleague at the Law Center, Robert M. Thompson, for the many interesting and helpful discussions we had on the subjects of remedies and bad faith breach. Bob taught remedies, I taught contracts, and we shared interests in litigation and insurance law. Bob also gave me many valuable insights from his years of experience as a litigator and trial and appellate court judge. I also wish to thank my former colleague and fellow contracts teacher, Richard Craswell, with whom I had many helpful discussions and who read and commented on early drafts of some chapters. Dick was especially helpful with economic theory and the Uniform Commercial Code. I presented early versions of parts of this book as papers at our faculty workshops. I would like to thank all my colleagues who attended for their trenchant, lively, and helpful comments. As is usual, however, I have to exonerate all of the above-mentioned people from blame for any mistakes I may have made. Of course, the responsibility for accuracy is entirely mine.

I have always found the critical analyses of my student assistants to be very helpful, as well as their research. I would like to thank the following for their long labors and insights: Daniel H. Baren, Richard Slane Davis, Thomas Ian Dupuis, Mark Andrew Finkelstein, Edward Alexander Hoffman, Timothy S. Lykowski, Patrick Casey McGannon, Elizabeth Marie Otter, and Daniel Scott Schecter. Ed Hoffman, Casey McGannon, and Dan Schecter also contributed through their work in a seminar on new developments in contract law that I taught, as did the fourth member of that seminar, who was not one of my student assistants, Patricia Byars Cisneros.

I will not try to name here the scholars and judges from whose published works I have benefited; I have named those from whose works I especially benefited in the text. I will make one exception, however, because textual references alone cannot explain my indebtedness. James J. White’s and Robert S. Summers’ treatise on the Uniform Commercial Code was an especially valuable resource because of the manner in which it treats legal issues. It presents all the reasonable arguments others have made before presenting the authors’, and if the authors disagree with each other, it explains their disagreements. The result is to provide the reader with a succinct, comprehensive, and fairly balanced view of every significant current issue on the subject of the treatise.

It has been a pleasure working with Princeton University Press. I am very grateful for the confidence,the help, and the patience it has shown me. I would especially like to thank its former editor, Malcolm DeBevoise, his assistant, Heidi Sheehan, and the promotions editor, Harriet Hitch.

Finally, I want to thank my wife, Kaaren Tofft Slawson, for her many comments, suggestions, and criticisms and for her love and emotional support through the years of our marriage and especially during the several years of illness that came between my beginning and completing this book. Kaaren reads widely and eclectically. She is not a lawyer. Both facts increased the value of her help.

Binding Promises

Introduction ____________________________________________

The courts of England began the making of modern contract law in the late eighteenth century. It was then that commerce and industry, stimulated by new forms of long-distance transportation, began the expansion that brought England into the industrial age. The courts of England and the United States had completed the law of what we now call classical contract by the beginning of the twentieth century. Contract law remained in its classical state until late in the twentieth century, when the courts of the United States began the reforms that are the subject of this book.

Classical contract had three distinguishing characteristics: nearly unlimited freedom of contract, nearly unlimited contracting power, and a clear separation from tort. Freedom of contract is the freedom to choose the contents of a contract. For example, a law that requires employers to maintain safe working conditions limits freedom of contract by preventing employers from contracting with their employees to accept unsafe working conditions. Contracting power is the power to make contracts. For example, the Statute of Frauds limits contracting power by preventing people from making contracts without writing and signing them. Tort is the category of laws that hold people liable for their harmful conduct. For example, tort laws require careless drivers to compensate their victims. These characteristics enabled people to make the contracts they chose, practically without limitation as to kind or extent.

Classical contract rested on two premises: that people can serve their private interests by contracts, and that contracts can serve the public interest well enough to enable governments to limit their functions to law enforcement and national defense. Although these premises were unrealistic even under the relatively simple societal conditions of the nineteenth century, they had some plausibility then, but certain social and economic developments eventually made their unrealisticness obvious. The developments decreased consumers’ bargaining powers and made people more dependent on products produced by others. The courts responded by making laws that increased consumers’ bargaining powers and placed public responsibilities on producers. These are the reforms that are the subject of this book.

Most of the reforms still do not have generally accepted definitions or names. I have gathered them into four groups, which I call reasonable expectations, relational torts, bad faith breach, and remedies reform. Reasonable expectations is a restriction on contracting power. It limits the power to make a contract to agreements the maker can reasonably expect the other party to understand. Relational torts are the new laws that impose duties sounding in tort in certain kinds of contractual relationships, for example, duties that insurers owe to insureds or that residential real estate developers owe to purchasers of new homes. (That a law sounds in a certain legal category means simply that it falls into that category.) Lawyers and judges have been using the term bad faith breach to describe a variety of loosely defined wrongs committed in contractual situations since the 1960s. I will try to discover the principles that are common to the condemnations of these wrongs and to give the concept of bad faith breach a definition that expresses the substance of this reform. The emergence of the bad faith breach doctrine brought with it some damages entitlements seldom seen before in contracts cases. By now they have taken on a life of their own and so warrant separate treatment. These new damages entitlements constitute the remedies reform.

Reasonable expectations increases the consumer’s bargaining power, relational torts impose public responsibilities on producers, and bad faith breach and the remedies reform do both. The new laws have also eliminated the three distinctive characteristics of classical contract. Reasonable expectations limits contracting power. Relational torts and bad faith breach, which most courts define as a tort, limit freedom of contract and blur the distinction between contract and tort. The remedies reforms also limit freedom of contract, because the laws that provide the new remedies generally prohibit producers from contractually eliminating them.

By 1995 a majority of jurisdictions recognized reasonable expectations in some form, thirty-seven jurisdictions recognized some form of bad faith breach, and all jurisdictions recognized some relational torts and had adopted some of the remedies reforms. A Rand Corporation survey showed that a majority of the contract cases litigated to judgment in California in 1986 involved a relational tort and about a third involved a bad faith breach.¹ Despite this widespread acceptance in practice, scholars have largely ignored the new laws. The Restatement (Second) of Contracts, published in 1981, mentions none of them. The Restatement (Second) of Torts, published in 1965, says nothing about the relational torts or bad faith breach. Contracts and torts casebooks give the new laws almost equally short shrift.

Some scholars have underestimated the new laws’ importance because they think of them not as affecting the body of contract law but as consumer laws. Consumer laws apply only to individuals and give them some additional protection when the amount at stake would not warrant hiring a lawyer and engaging in litigation. In fact, however, the new laws extend their protections to businesses and individuals without distinction, and they are not limited to situations where the amounts at stake are small. These scholars also fail to realize that businesses need the protections of the new laws just as much as do individuals.

The other reasons for the lack of scholarly attention are specific to particular reforms. Relational torts fall into a crack between scholarly disciplines. Contract scholars ignore them because they are torts. Torts scholars ignore them because they arise only in contractual situations. Commercial legal digests categorize them neither as contracts nor as torts, but according to the industries to which they relate: insurance or construction law, for example. The widespread ignorance of the new restrictions on contracting power results mostly from intellectual conservatism. The concept of contracting power is itself new, and the idea of limiting it is foreign to the traditional notions of how people make contracts. Consequently, it almost seems that the more learned contract scholars are, the more resistant they are to understanding the new laws that limit contracting power. On the other hand, when I introduce these laws to my students, their usual reaction is to wonder why contract law did not include something so sensible long ago.

In an effort to overcome this widespread ignorance, I have included a good deal of description and explanation in this book, but my purposes are nevertheless primarily analytical and normative. Chapter 1 describes the characteristics of classical contract that when combined with certain social and economic developments of the present century increased producers’ bargaining power relative to that of consumers. Chapter 2 describes these social and economic developments. Both these chapters are as much analytical as descriptive, however. I believe I am the first to claim that nearly unlimited contracting power was a characteristic of classical contract, so of course I must support this claim by analysis. I must also demonstrate that the characteristics of classical contract did indeed combine with the social and economic developments I identify to increase producers’ bargaining power relative to that of consumers. Chapters 3 through 5 describe the new laws that seek to protect consumers against abuses of bargaining power and to give producers public responsibilities. Again, I must analyze the new laws in order to determine whether they succeed in providing these protections and responsibilities and how we might improve them if they fall short. Chapter 6 takes up Article 2 of the Uniform Commercial Code. Finally, Chapter 7 presents an overview of the reforms and their relationships to one another and analyzes two recent lines of decision by the U.S. Supreme Court that place certain constitutional constraints on contract law.

Pennsylvania became the first state to enact the Uniform Commercial Code (U.C.C.) in 1953; as of 1995, every state and the District of Columbia had enacted it. Each of its nine articles except the first codifies an area of commercial law. (The first consists of general provisions for the other eight.) Article 2 codifies the law of sales of goods and certain parts of the law of contracts if the contracts concern sales of goods. Goods are tangible, movable things. For example, automobiles are goods, but telephone service is not, because it is not tangible, and real estate is not, because it is not movable. The law of sales of goods differed widely among the states, scholars and lawyers considered much of it to be bad law, and it was not well integrated with the law of contract, before legislatures enacted the U.C.C. Article 2 was designed to correct these deficiencies, and it generally did. However, for reasons they never disclosed, the drafters also included numerous provisions in the article that have nothing to do with sales of goods but just state laws of contract. Some of these provisions restate contract law as it existed when the article was drafted in the 1940s and 1950s, some were apparently attempts to restate the old law but do so incorrectly, and some overtly change the old law, but the result in all cases is that we now have two laws of contract and only occasionally any justification for the differences.

Moreover, the differences are sure to widen, because different institutions make the laws. Only the state legislatures that enacted it can change Article 2, whereas the courts can, and almost exclusively do, change the common law of contract. The difficulty of amending the article greatly aggravates the problem. We do not want to amend it if the amendment would destroy its uniformity among the states, because this would defeat one of the purposes for which it was enacted. Therefore, no state should amend it unless all states will enact the same amendment, but it is nearly impossible to obtain such universal agreement if the amendment is controversial, and almost any important amendment will be controversial. State legislatures have not enacted a single important amendment to Article 2, although most of them enacted it more than twenty-five years ago. We also need to amend Article 2 for reasons other than its differences from the common law. Many of its provisions are simply bad laws. Either they were bad to begin with, or conditions or perceptions have changed since they were drafted. In particular, some of its provisions prevent the new laws the courts have created from applying to contracts the article covers, because if a statute conflicts with a common law (i.e., a law made by a court), the statute triumphs. (This rule expresses the constitutional superiority of the legislature over the judiciary as a lawmaker in a democracy.)

Karl N. Llewellyn, the principal architect of Article 2, foresaw the difficulty of amending it and tried to compensate by making it especially amenable to judicial construction, but his efforts proved to be only partly successful. Llewellyn also once proposed to provide the authority in Article 2 for the courts to treat it as though it were a body of their own past decisions; they could overrule it and make new law if they believed that changed conditions or perceptions justified it. I will propose that state legislatures now enact a version of this old proposal. The only way we can hope to eliminate the many arbitrary and positively harmful differences between the U.C.C. law and the common laws of contract is to place the responsibility for making them in a single institution. That institution should be the courts, as it was before Article 2 was enacted. I make two comparisons to support this proposal, both of which, I think, demonstrate the superiority of judicial lawmaking to legislation for contract law. I compare the reforms the courts have made with Article 2, and I compare the process by which courts make common law with the process by which scholars drafted and legislatures enacted Article 2. I give a brief history of the latter process in order to make the second comparison.

Finally, I use the comparisons to support my argument that judges should begin taking a more active role in reforming the reforms. Many judges seem to believe that if there are problems with the new laws, it is up to the legislatures to solve them. The judges who believe this must have forgotten, or perhaps never knew, that it was they or their predecessors who made the new laws in the first place. The comparisons should also help to convince these judges that they would do a much better job of reforming the new laws than state legislatures would. I make these comparisons and the arguments based on them in Chapters 6 and 7.

In addition to describing, analyzing, and critiquing the new laws, I sometimes do the same for the judicial decisions that created them. The reader who is not a lawyer or legal scholar may wonder why I believed this to be necessary. A judicial decision that makes a law is the law it makes; any statement of such a law that I or anyone else may offer can never be more than an interpretation of the decision or decisions that made it. There will usually be a consensus on an interpretation when a common law has become established, but some of the laws I will treat have not yet reached this point in their development. For such laws, therefore, I have no choice but to state some representative decisions and give my interpretations of them and my reasons for coming to those interpretations.

Moreover, interpreting the decisions often discloses the purposes the courts intended the new laws to serve, and it is always necessary for determining why the courts made the laws they did rather than others which could have served the same purposes. Alawmaker’s purposes are generally greatly underdeterminative. There are countless ways a court might design a law to prevent producers from abusing their bargaining powers, for example. Therefore, one has not given a complete explanation of why the courts made the laws they did if all one says is that they wanted to prevent producers from abusing their bargaining powers. Descriptions and analyses of the decisions that made the laws often help to complete the explanations. The courts made these particular new laws rather than others that might also have prevented producers from abusing their bargaining power because, at least in the judges’ opinions, these laws were the most consistent with the principles and precedents to which they believed the laws should or must conform.

1 ______________________________________________

Classical Contract

The reforms that are the subject of this book are reforms of the contract law we inherited, which has come to be called classical contract. Classical contract is largely a product of the industrial revolution. The courts of England began creating it almost as soon as the industrial revolution began, which was late in the eighteenth century. One needs to understand classical contract and the forces that shaped it in order to understand the reforms of it and the forces that shaped them. The courts of the United States began the reforms late in the present century.

Freedom of Contract and the Common Callings

People in modern times use contracts chiefly to set the terms of trade, but trade was not common in the Western world until the late eighteenth century. Before that, the law set the terms of what trade existed. A court would even set the price if a person objected to what a tradesman tried to charge him. The terms the law set were known as the duties of the common callings. A calling was a trade. Common meant the trade served the public.

No special skill was required for a service to be calling. Laborer , for example, which meant someone who provided service of no particular skill, was a calling. The only requirement was that the services be offered to the public. Domestic servants and others employed for long periods by a single employer, or people still bound by the old feudal obligations, were practically the only ones whose callings were not regarded as common.¹

The duties of the common callings were inconsistent with economic competition, which became important in England and North America in the latter part of the eighteenth century. Two economic developments encouraged it. New labor-saving machinery and methods of dividing labor into small, repetitive steps greatly reduced the costs of manufacturing, and new means of transportation (canals and railroads) greatly reduced the costs of shipping things over long distances. Manufacturers of similar goods then came into competition with one another, because they could make their goods inexpensively in large volumes and sell them at low prices over long distances.

Competition requires that buyers and sellers be free to set prices and other terms of sale by agreement. However, it does not require that buyers and sellers make contracts. Contracts are promises, but if goods are sold as is, for cash, neither buyers nor sellers make any promises. Nevertheless, contracts became useful when sellers shipped their goods over long distances, because buyers wanted assurances that the goods would be as promised, and sellers wanted assurances that they would be paid what the buyers had promised them when the goods were delivered. Contracts are always useful for buying and selling services, because sellers of services require time to perform them. Sales of services therefore put both buyers and sellers in the same need of assurances as do sales of goods that are shipped over long distances.

A law of contract already existed in the eighteenth century, but it was rudimentary. Contracting was time-consuming, and legal technicalities made the outcome of contract litigation uncertain. Moreover, the duties of the common callings made it illegal for buyers and sellers to set prices or other terms of sale any different from those the duties already set for the goods or services. Courts therefore had to both create a simpler and more reliable law of contract and abolish or at least limit the duties of the common callings. The courts of England and the United States accomplished both tasks remarkably quickly. They had substantially abolished the duties of the common callings and constructed a largely new law of contract by the end of the century. That law of contract, now often called classical contract, still comprises the basis of contract law in the English-speaking world.

The Anglo-American law of contract has always been largely common law, which, of course, means that courts rather than legislatures make it. The general conception of the common law in the nineteenth century was that judges found it rather than made it. They found it in customs, practices, and principles of morality and proper conduct. The chief sources of the new law of contract were the theory of economic competition and liberalism. Adam Smith set forth the theory of economic competition in An Inquiry into the Nature and Causes of the Wealth of Nations, first published in 1776. Liberalism was a political philosophy that emerged in the late seventeenth and early eighteenth centuries from the writings of many authors in Europe and the United States. Both the economic theory and liberalism emphasized the value of freedom. The Wealth of Nations explained that people had to be free to set prices and other terms of sale in order for economic competition to provide its benefits. Liberalism conceived of freedom as freedom from laws and other forms of state coercion, and it offered reasons for believing that increasing such freedom would increase the well-being of humanity and promote moral and political progress.

The chief principle the courts distilled from these sources was freedom of contract. Freedom of contract had two aspects: freedom from and freedom to. People were to be free from the duties of the common callings and other duties imposed by law and free to make contracts of whatever kind they chose. Freedom of contract required a sharp distinction between the laws of tort and contract. Generally speaking, tort law consists of the duties people owe one another simply by virtue of being members of the same society. Tort law obligates a person not to injure another or to damage the other’s property, for example. Freedom of contract, on the other hand, dictates that people be free from obligations except as they agree to assume them. Moreover, if people contract, they can disclaim obligations the law would otherwise impose and create new or different ones. Freedom of contract not only substantially eliminated the duties of the common callings; it also limited or reversed the development of tort law, especially in the United States.²

There were fewer avowed changes in the law than one might suppose. Many of the old decisions were simply ignored. That was possible because the only people with legal standing to complain were the sellers who continued to make their goods or provide their services by hand, and they eventually died out. The new methods of manufacture and transportation benefited everyone else. When a court did have to confront one of the old decisions, it could distinguish it on the ground that the seller in