Default v. Mandatory rules

Source: https://www.coursera.org/learn/law-student/lecture/4tlub/2-4-lecture

[MUSIC] The effect of many of the rules that you will learn in law school can be altered by agreement of the parties. Rules that the parties can contract around are often called default or gap filling rules. Just as word processing software establishes default margins that a user can alter by changing the settings, many rules are merely legal presumptions that only govern when the parties have remained silent in the absence of agreements to the contrary. Default rules can be established by
common law courts or by legislatures. When a court decision says,
as Judge Cardozo wrote in Jacob & Youngs versus Kent, that future parties are, quote, free by apt and certain words, unquote, to contract for an alternative result. The decision is announcing
the default rule. When a statute prescribes a rule that will
apply, quote, unless otherwise indicated, unquote, in a private contract,
it is announcing a default rule. But many times, statutes and decisions
will not expressly address whether particular rule can be altered
by private agreement, or what words would be sufficient
to accomplish such altering. When a rule is merely a default, it’s
important to understand the necessary and sufficient requirements for
opting out of it. Or what are known as altering rules. The UCC, the Uniform Commercial Code, section 22061A, for example, establishes the default that an offer invites acceptance, quote in any manner and by any medium reasonable in the circumstances, unquote. The same section provides the default will obtain, quote, unless otherwise unambiguously indicated, unquote, by the offer or war. The reasonable medium rule is the default, and the unambiguously indicated requirement provides the altering rule.

Not every contract rule can be contracted around. Those that cannot be changed are termed mandatory or immutable rules. Mandatory rules are established by both courts and legislators. The common law has also established immutable limits, for example, on the maximum amount of damages that parties can contract for. These are restrictions on so
called liquidated damages and limits on the maximum length of covenants not to compete. The duty of good faith is a mandatory part of every agreement, although standards of good faith can, within reason, be altered by agreement. In the last 60 years, legislative and administrative bodies have promulgated a host of immutable rules that restrict freedom of contract. Some types of transactions, such as those concerning insurance and employment, have to large extents been removed from the general law of contract and are now subject instead to a host of specific mandatory, statutory rules. Since 1964, for example, employers have had an immutable duty not to discriminate on the basis of race or gender when making employment decisions. Many other commercial activities are subject to more limited mandatory rules covering issues such as anti-trust, consumer protection and anti-terrorism. Even the relatively simple construction of a private home is awash with immutable duties. Default rules are not just
about contract law though. Every realm of law can be characterized
as a mixture of default and mandatory provisions. Every area of law has this mixture. The law of intestacy is the default legal treatment of people who die without a will. Corporate law is awash with default rules,
and again, a mixture of mandatory rules as well. Cumulative voting used to be the default rule of corporate demography, but now straight or non cumulative voting is the legal default. Even constitutional law is a mixture of default and mandatory laws. For example, article four of our
constitution includes the mandate that full faith and credit shall be
given in each state to the public acts, records and judicial proceedings of every other state. That’s the full faith and credit clause. But then it immediately goes on to say that quote, Congress may by general laws prescribe the effect thereof, unquote. Thus suggesting that the effects
of the state’s full faith and credit duty can be altered by Congress. For the rest of your legal education, indeed for the rest of your life in the law,
it’s useful whenever you learn a new rule to identify whether the rule
can be contracted around. And, if so, how indeed a worthwhile exercise after reading each case is to consider what contractual provisions would be sufficient to reverse the courses decision? If there is no language that could reverse the decision, make the losing party win, no altering rules for displacing this default result, then the court is applying a mandatory rule. It’s also import to think about the policy considerations that are relevant to setting legal defaults and altering rules. As an initial normative matter, you should always question whether it’s reasonable to limit freedom of contract by making a legal rule immutable. I’ll be talking about this in the next lecture.

If a particular rule is not going to be immutable, how should the lawmakers set the default? The traditional answer is giving the parties what they would have hypothetically contracted for, if they had expressly contracted. But this hypothetical contracting rule is often devilishly difficult to apply in practice. It’s hard to know what terms two parties would have arrived at given their individual interests, relative bargaining power, other opportunities and so forth.

Often, the best a court can do is adopt, instead, a majoritarian approach. And seek out which terms most parties in similar circumstances would prefer. For example, in the sale of goods contracts, covered by the uniform commercial code, if the parties fail to name a price, the UCC fills the gap with a reasonable price default. These kinds of parties probably contract for a reasonable price. Who wants an unreasonable price? Which is normally going to be cashed out as closely related to the market price. Indeed, anytime you see the word reasonable included in the description of a default, there’s a good chance that hypothetical or majoritarian gap-filling is at work. But the law sometimes chooses to
fill gaps with terms that do not accord with the hypothetical
contracting approach. Whereas the UCC will fill in a missing
price with a reasonable price, it does not fill in quantity gaps
by trying to divine what would have been a reasonable quantity. Instead, the impact of the UCC Statute
of Fraud is often to create, de facto, a quantity default of zero. The Contra Proferentum rule, which is
Latin to say to resolve a contractual ambiguity by interpreting the contract
against the drafting party. This Contra Proferentum rule seems
to aim to penalize sloppy drafting, rather than attempting to divine what the
parties would have expressly contracted for if they had been asked to
resolve the ambiguity themselves. These departures might,
at times, make good sense. Sometimes it might be useful to
establish defaults that penalize one or both parties in ways that encourages
the parties to provide information by contracting around the default. Penalty defaults, or
information forcing defaults, that intentionally penalize
a contractor failing to fill a gap can further both equity and efficiency
by giving a contractor the incentive to expressly say, to the other party and
to the world, what they want. A penalty default rule is a rule that
the contractors would not have wanted. It’s presence in the right case will
provide contractors an incentive to contract around the default rule and therefore to choose affirmatively
the contract provision they prefer. In contrast to the received wisdom,
penalty defaults are purposely set at what the parties would not want in
order to encourage the parties to reveal information to each other or
to third parties, especially courts. When strategic consideration cause a more
knowledgeable party not to raise issues that could improve contractual efficiency,
a penalty default that penalizes the more informed party may
encourage the revelation of information. The Hadley rule, which limits
consequential damages to those that are foreseeable by the breaching party, is arguably an information forcing
default of just this kind. It gives the party with hidden information
about its unforeseeable losses. In this case, in the case of breach, it gives them a new reason to share
that information with the other side. Only by revealing that you, as a buyer, are likely to suffer unusual losses in
the case of seller breach will you be able to recover extra damages
from a breaching seller. In fact, there are a host of reasons,
besides information forcing, that can cause a minoritarian default. That it is a default that only
a minority of contracting parties would actually prefer. Minoritarian rules might be
justified by differences in private cost of contracting, differences in
private costs of failing to contract, differences in the public
costs of filling gaps, differences in private
information about the law. At the end of the day, the choice
of an efficient default does not boil down merely to a choice
between the majoritarian rule, for which most contractors
would have contracted. And a penalty default designed to induce a contractor to reveal
information about her type. Instead, efficiency minded lawmakers will often need to consider a host of
factors to decide whether it is more efficient to choose a default
than only a minority values. Finally, once lawmakers have decided
that a rule should be contractible, and decided whether to
adopt majoritarian or minoritarian default, they must still
establish separate rules governing how private parties can contract
around the default legal treatment. Altering rules establish the necessary and sufficient conditions for
displacing a default. Usually law makers try to
facilitate contractual freedom and efficiency will allow
multiple altering means so as to minimize the cost of
contracting around a default. But as with the default setting,
the setting of altering rules should take into account the cost of altering,
the cost of various kinds of error, and the possibility that altering can impose
negative externalities on others. There are two broad reasons for structuring altering rules that deviate
from merely minimizing transaction costs. First, at times it’ll be more important
to minimize the cost of party error, especially non-drafter error and
third party error, especially judicial error, than it
is to minimize the cost of altering. Second, when externality concern or paternalistic concerns protect
the contractors themselves are insufficient to justify a full
blown mandatory rules, lawmakers might, at times, impose impeding altering rules,
which intentionally deters subsets of contractors from contracting
for legally disfavored provisions. Impeding altering rules produce
an intermediate category of quasi-mandatory, or sticky,
defaults which manage but do not eliminate externalities and
paternalism concerns. What is the last legal
rule that you learn? Is it a mandatory or a default rule? Identify a mandatory rule on
your word processing system. Identify a default rule of your
word processing system and describe in detail the altering
rules associated with that default. Would it be better for
contract law to set the reasonable quantity as the default quantity for
contracts? [MUSIC]