Publication Date

2009

Publication Title

Berkeley Business Law Journal

Abstract

A recent movement in contracts scholarship-the so-called New Formalism-seeks to justify limitations on the introduction of extrinsic evidence to interpret contracts on the instrumental grounds of efficiency and empirical observation. Less attention has been directed at the development of a similar instrumental argument for the more contextual types of interpretation observed in the Uniform Commercial Code and the Restatement (Second) of Contracts. This Article engages this question by arguing that the relative ability of transactors to draft complete contracts is likely to be an important determinant of their preferred interpretive regime. Where low contracting costs allow commercial parties to draft relatively complete contracts, it is understandable that these parties would have a strong preference for formal contract rules. This approach may best ensure the interpretation of these contracts in accordance with their express terms. But when contracts are more difficult to write-and hence contain more gaps--transactors may prefer interpretive rules that allow courts to fill in contractual gaps based on extrinsic evidence such as industry custom, unexecuted drafts, and other indications of the parties' understanding of their obligations under the contract. At least in some instances, the use of this ex post evidence may be more cost effective relative to the ex ante investments that would be necessary to draft more complete contracts. To explore this problem, this Article adapts the framework used to predict vertical integration in the New Institutional Economics literature to identify the variables that are likely to affect the ability to draft complete contracts. This adapted model argues that the frequency and uncertainty of a transaction are the key variables that will determine the amount that parties are likely to invest in filling contractual gaps. The predictions generated by this model help to explain why some transactors, such as the grain, cotton, and diamond merchants studied by Lisa Bernstein, have strong preferences for formal interpretation. The model also suggests why industries that involve infrequent and uncertain transactions-such as construction, tailored software, and the market for mergers and acquisitions-do not share the preference for formal interpretation advocated and observed by the New Formalists.

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