Binding Promises

BINDING PROMISES

BINDING PROMISES

T H E L AT E 2 0 T H-C E N T U R Y R E F O R M AT I O N O F C O N T R AC T L AW

W. David Slawson

PRINCETON UNIVERSITY PRESS

P R I N C E T O N, N E W J E R S E Y

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 1931Binding promises : the late 20th-century reformation of contract law / W. David Slawson. p. cm. Includes bibliographical references and index. ISBN 0-691-04415-5 (alk. paper) 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 Princeton University Press books are printed on acid-free paper and meet the guidelines for permanence and durability of the Committee on Production Guidelines for Book Longevity of the Council on Library Resources Printed in the United States of America by Princeton Academic Press 10

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I dedicate this book to the American common law judge.

Contents

Acknowledgments

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Introduction

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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

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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

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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

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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

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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

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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

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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

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Unconscionability Contract Formation in a “Battle of the Forms” Warranties and Remedies

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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

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Notes

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Index

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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.

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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 reason-

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ably 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.

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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

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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

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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. A lawmaker’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 produc-

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ers 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.

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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 Englishspeaking 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.

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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 the case had agreed to sell at a lower price. By such reasoning the courts were able to reduce most of the duties of the common callings to the status of customs and practices, which buyers and sellers could legitimately agree to change. Economic competition and liberalism contributed to both aspects of freedom of contract. Economic competition required that buyers and sellers be free from the duties of the common calling and free to set prices and other terms of their choosing. Liberalism advocated that government confine itself to the three tasks of maintaining domestic order, providing for the national defense, and protecting property. Tort laws, the duties of the common callings, and other laws that would displace those which people could make by contract did not serve any of these tasks. Government therefore should protect people from such laws by abolishing or limiting them. The contribution of liberalism to the “freedom to” aspect was to enlist the power of government to protect the making and enforcing of contracts. Contracts were property, and one of the tasks of government was to protect property. Two more ideas current in the nineteenth century bore similarities to freedom of contract, but whether they contributed more to freedom of contract than it contributed to them is problematic. One was the economic doctrine of laissez-faire, or “let be.” Government was to leave business

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affairs entirely in private hands. The other was social Darwinism, which took the findings of Charles Darwin’s The Origins of Species about plant and animal evolution and used them as recommendations for contemporary social policy. Government should refrain from helping the losers in the “race of life,” because to help them would diminish the quality of the “breed of man” by promoting the survival of the least fit. The similarities of these ideas to certain aspects of freedom of contract are obvious. Philosophies of the “will,” which were influential in the nineteenth century, probably also contributed to freedom of contract and certainly influenced the form that classical contract took in its beginnings. These philosophies made the “will” the ground of all existence. “Will” in this sense was not just the wills of individual human beings; rather, human beings were of unique metaphysical importance because they possessed wills to a greater degree than did other species. Idealism, a version current towards the end of the century, went so far as to see the will of each person as constituting all being. Nothing existed except as each person him or herself willed it. (Idealism had some difficulty in explaining why people commonly willed the same things, including other people, into existence.) The will as these philosophies conceived of it was free by definition, because if anything controlled it, that thing would be the ground of the will’s existence, rather than vice versa as the theory maintained. The leading theory of contract until the close of the nineteenth century was the “will theory.” A contract was said to be a combination of wills: a consensus ad idem, or more plainly, a “meeting of the minds.”

Freedom of Contract at Its Zenith The American common law of contract was practically indistinguishable from the English common law of contract until late in the nineteenth century. An early English case that increased freedom of contract in both countries was Winterbottom v. Wright,3 which the Court of Exchequer handed down in 1842. The court held that the maker of a carriage wheel was not liable to anyone who was injured as a result of a defect except the person to whom the maker had sold it. All others lacked “privity of contract.” The court expressed concern that liability would otherwise extend too far: “even passersby” might be entitled to compensation for their injuries. Although the court did not explicitly state a connection with freedom of contract, the decision implicitly held that a manufacturer owed no duties to anyone except the persons with whom he contracted. The reaction to a similar situation today would likely be precisely the opposite. One would think that passersby especially should be entitled to compensation for their injuries, because unlike purchasers, they had no

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opportunity to protect themselves by contract. What other than blind adherence to the dictates of freedom of contract made the Court of Exchequer so concerned to limit the manufacturer’s liability is difficult even to guess, but it may have been the thought that the purchaser of a product should be liable for any injuries it inflicted instead. For he could discover any defects in it by inspection. For the relatively simple products of the time, this may have been a reasonable assumption. Purchasers who failed to inspect the product or chose to use it anyway ought to be exclusively responsible for any adverse consequences to passersby or others, just as they would be if they themselves had made the product. In any event, American courts universally followed Winterbottom. Lack of privity of contract remained a defense against a seller’s liability for product defects in the United States until the New York Court of Appeals abolished the defense in 1916, in MacPherson v. Buick Motor Company.4 Other American jurisdictions soon followed MacPherson.5 In 1861, the English historian Henry Maine described the change “from status to contract” as the direction of progress characteristic of societies throughout history, noting the change in English law from the duties of the common callings to freedom of contract in particular.6 In 1875, Sir George Jessel, Master of the Rolls, declared in Printing Company v. Sampson:7 [I]f there is one thing which more than another public policy requires it is that men of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts when entered into freely and voluntarily shall be held sacred and shall be enforced by Courts of justice.8

American judges frequently quoted Jessel in their own opinions.9 The twentieth-century American legal historian Patrick S. Atiyah places the zenith of freedom of contract in England at 1871. That was when Parliament first limited the freedom of contract of employers by enacting legislation to govern the employment relationship. Until then, freedom of contract in England and the United States were essentially the same. However, instead of beginning a decline in 1871, freedom of contract in the United States continued to increase. It eventually reached heights never even approached in England. American courts did not decisively repudiate freedom of contract until they began making the new laws that are the subject of this book late in the present century. Freedom of contract reached its zenith in the United States in the socalled Lochner era, when courts constitutionalized it. The era lasted from about 1890 to 1920. It takes its name from a 1905 decision of the U.S. Supreme Court, Lochner v. New York,10 that invalidated a New York State statute limiting the hours bakery employees could work to ten hours a day and sixty hours a week. The first words of the Court’s opinion on the subject were:

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The [New York] statute necessarily interferes with the right of contract between the employer and employés, concerning the number of hours in which the latter may labor in the bakery of the employer. The general right to make a contract in relation to his business is part of the liberty of the individual protected by the Fourteenth Amendment of the Federal Constitution.11

However, the Supreme Court addressed the freedom of contract issues at greater length in Coppage v. Kansas,12 a decision it handed down in 1915. A Kansas statute made it a misdemeanor punishable by a fine or up to thirty days in jail for an employer or its agent to condition employment on an employee’s signing a contract not to be a member of a labor union. Such contracts were popularly known as yellow dog contracts. During the summer of 1911, Coppage, a supervisor for the St. Louis & San Francisco Railway Company, fired an employee for refusing to resign his union membership and enter into a yellow dog contract. The State of Kansas convicted Coppage under the statute, and the Kansas Supreme Court affirmed the conviction. The U.S. Supreme Court reversed the conviction on the precedent of Lochner, among others. The Kansas Supreme Court said it was “a fact of general knowledge, that employés, as a rule, are not financially able to be as independent in making contracts for the sale of their labor as are employers in making a contract of purchase thereof.”13 These words were presumably a reference to an argument first put forward by Adam Smith, who wrote that employees lack bargaining power relative to employers because of the advantages that owners of capital inherently possess over those who might want to sell their services to them. An owner of capital does not have to keep his capital fully employed on a short-term basis. He does not lose much if he keeps it in a bank, drawing interest, or even just keeps it in a safe for a few weeks. Workers, on the other hand, generally must remain gainfully employed, because they need steady incomes in order to support themselves and their families. An owner of capital is therefore generally able to outlast a worker in bargaining over terms of employment. The only limit on the employer’s power in this respect is full employment, which requires him to offer higher wages in order to attract workers away from other employers.14 The U.S. Supreme Court’s answer to the argument of the Kansas Supreme Court (and Adam Smith) was as follows: No doubt, wherever the right of private property exists, there must and will be inequalities of fortune; and thus it naturally happens that parties negotiating about a contract are not equally un-hampered by circumstances. This applies to all contracts, and not merely to that between employer and employé. Indeed a little reflection will show that wherever the right of private property and the right of free contract co-exist, each party when contracting is inevitably more or less influenced by the question whether he has much property, or little, or none;

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for the contract is made to the very end that each may gain something that he needs or desires more urgently than that which he proposes to give in exchange. And, since it is self-evident that, unless all things are held in common, some persons must have more property than others, it is from the nature of things impossible to uphold freedom of contract and the right of private property without at the same time recognizing as legitimate those inequalities of fortune that are the necessary result of the exercise of those rights. But the Fourteenth Amendment, in declaring that a State shall not “deprive any person of life, liberty or property without due process of law,” gives to each of these an equal sanction; it recognizes “liberty” and “property” as co-existent human rights, and debars the States from any unwarranted interference with either.15

Although the Supreme Court’s logic was murky at best, its meaning was clear: freedom of contract was a fundamental principle of constitutional economics, with which legislatures were not to interfere. This remained the general tenor of American constitutional law until the Great Depression of the 1930s, when the Court repudiated its Lochner-era decisions by handing down a number of decisions upholding regulatory legislation. Courts continued to apply freedom of contract in their common law decisions until late in the twentieth century. They used it primarily as a rationale for preventing either party from impeaching a written contract by introducing evidence of additional or conflicting oral agreements, practices, or understandings. Thus, freedom of contract contributed to the evolution of the parol evidence rule, which lasted in its stricter forms until the 1960s in most jurisdictions and as of 1995 still exists in every jurisdiction in one form or another.16 Written contracts of employment received especially strong protection. A rule evolved that oral contracts for permanent employment, employment for life, or the like were terminable at the will of either party as a matter of law. In effect, an employee could not enforce an employer’s promise of tenure unless he got the promise in writing. Although the rule was neutral on its face, it favored employers in practice. No reported decision used the rule to allow an employee to quit early despite an oral contract binding him for an extended period. The employment rule existed in some states in a stronger version, which permitted an employee to enforce even a written contract of permanent employment only if he could prove that he had given a separate consideration for the promise of permanent employment. For example, the employee could enforce the promise by showing that he had accepted a lower wage in exchange for it or had left another job at the employer’s request, in which he had rights of tenure. The employment rule still exists in most jurisdictions in one form or another, although it is doubtful that the highest courts of many states would hesitate to overrule it if an employee were to challenge it.17

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Economic theory also lends some support to the employment rule, holding that competition could not work effectively in the labor market if employers were not free to fire their employees as current business conditions required. Another justification offered, which also shows a connection with freedom of contract, is that the rule reflects reality. In this view, employment for life is too good to be true; an employee who claims an employer promised it is engaged in wishful thinking or trying to defraud the employer.18 Given the generally depressed economic conditions of the late nineteenth and early twentieth centuries, this may well have been a sincere justification.

The American Rule The chief heritage of freedom of contract is an attitude, which has lasted to this day: a court should enforce a contract as it stands, absent a compelling reason not to do so. The attitude is largely one of freedom to contract. It was generally only the freedom from aspect of freedom of contract that disappeared when the Supreme Court repudiated the Lochner line of decisions. However, these generalities are subject to a very important exception: the American Rule. The American Rule is unique to the United States. The rule is that the winning party in a civil action does not recover his costs of litigation from the loser. The origins of the rule go back to the seventeenth century, when attorneys in England and North America worked for the court, at least in principle, no matter whom they represented. The court paid them at the end of a case out of the costs it taxed against one or both of the parties. It was the losing party that normally bore the burden of the costs. In England, the court set the amounts, whereas in the American colonies the colonial legislatures set them. Possibly out of a dislike for lawyers, who were seen as representatives of the royal government, the legislatures generally set low amounts and rarely reviewed them for adequacy, despite currency depreciations and other changed circumstances. As a result, the amounts had become nominal by the end of the eighteenth century. Clients resorted to giving their lawyers “gifts” in order to get good representation. Lawyers in the United States eventually won the right to obtain their fees by contract, but this meant they obtained them only from their clients. However, a winning party could still reasonably expect to recover what he had contracted to pay his lawyer as part of the damages from the losing party until the latter part of the nineteenth century. That ended when courts decided that a losing party was not liable for the lawyers’ fees of the win-

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ner.19 Typical of the law on lawyers’ fees that resulted from this development is Section 1021 of the California Code of Civil Procedure, which has survived without relevant change since its 1872 enactment: Except as attorney’s fees are specifically provided for by statute, the measure and mode of compensation of attorneys and counselors at law is left to the agreement, express or implied, of the parties; but parties to actions or proceedings are entitled to their costs, as hereinafter provided.20

In most states, however, the American Rule is common law rather than a statute. Section 1021 was enacted shortly after California became a state as part of a code intended to incorporate the common law as it then existed. Only some of the decisions granting lawyers the right to obtain their fees by contract21 or eliminating lawyers’ fees from damages awards22 expressly invoke notions of freedom of contract, but the influence of freedom of contract is implicit anyway. The decisions granting lawyers the right to obtain their fees by contract manifest the “freedom to” aspect. The decisions eliminating lawyers’ fees from damages awards manifest the “freedom from” aspect. The dates of the decisions are also indicative. They were all in the mid to late nineteenth century, when freedom of contract was most influential. The only exception to the American Rule that courts have always recognized also shows the influence of freedom of contract: the winner can recover his attorneys’ fees from the loser if the litigation arose out of a contract that so provided.23 The American Rule bears a remarkable similarity to the rule of Winterbottom, the most extreme expression of freedom of contract in this country except for the Lochner-era constitutional decisions. Both deny any liability except that which rests on contract, despite the fact that both deal with situations in which most of the people who would benefit from the liability have no opportunity to provide for it by contract. Courts carried freedom of contract beyond its legitimate boundaries in both instances.

Troubles with the Will Theory The will may have been an attractive basis for a metaphysics of being, but it proved to be an unsatisfactory basis for contract. It undermined the binding character of a contract, which is a contract’s most salient characteristic. If a contract consists of the concurrence of the parties’ wills, how can it continue to exist if one of the parties withdraws his will from it? Another difficulty is determining if the wills of two people indeed had met. If one of them later claims he did not have the requisite will, on what basis can a judge or jury conclude he is lying? Only the person himself knows what he

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thinks. One can observe both difficulties in two nineteenth-century decisions that are still famous. One is Adams v. Lindsell,24 an 1818 King’s Bench decision. The defendants mailed an offer to sell some wool to the plaintiffs, asking for an acceptance “in course of post.” The defendants misaddressed their offer, and it arrived late. Not realizing this, the plaintiffs mailed back their acceptance in what they thought was the course of post. Not having received an acceptance in what they thought was the course of post, the defendants sold the wool to someone else. The plaintiffs brought suit, claiming their acceptance was timely. The trial court found for the defendants on the ground that the wills of the parties had never met. By the time the plaintiffs’ wills had been communicated to the defendants, the defendants’ wills had changed to contracting with someone else. The King’s Bench reversed. It said that the trial court’s reasoning would lead to an infinite regress. According to the trial court, the parties’ wills cannot meet unless the offeror receives the offeree’s acceptance while the offeror is still inclined to make the contract. If this were true, the parties’ wills also could not meet unless the offeree received the offeror’s notice that it had received the offeree’s acceptance while the offeror was still inclined to make the contract, while the offeree was still inclined to make the contract—and so on, ad infinitum. In order to avoid the infinite regress, the King’s Bench held: The defendants must be considered in law as making, during every instant of the time their letter was traveling, the same identical offer to the plaintiffs, and then the contract is completed by the acceptance of it by the latter. Then as to the delay in notifying the acceptance, that arises entirely from the mistake of the defendants, and it therefore must be taken as against them that the plaintiffs’ answer was received in course of post.25

One might call this the radio satellite theory of making a contract. The King’s Bench was a century and a half ahead of its time in understanding how traveling objects can send and receive communication signals. Adams is still the law, although few now accept the rationalization the court offered for it. An offeree accepts an offer sent by mail (or by other means of communication requiring time) as soon as he dispatches his acceptance, assuming that the dispatch is timely, properly addressed, and so on. Some sixty years after Adams, Lord Justice Theisger, sitting in the Court of Exchequer, suggested that the rule could be more logically rested on an assumption that the post office was the agent of the offeror, because the offeror was the first of the parties to chose to use it. When the offeree delivered his acceptance to the post, therefore, it was as if he had delivered it “into the hands of a messenger sent by the offeror himself as his agent to deliver the offer and receive the acceptance.”26

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Lord Theisger’s suggestion does not work, however. An agent is a person to whom a principal has given authority to affect the principal’s legal relationships. The usual authority of an agent is to make the principal’s contracts. A person has to consent to another person’s making his contracts for him just as he has to consent to the contracts he makes himself. The law can no more declare an agency relationship to exist without the consents of the parties to it than it could declare a contract to exist without the consents of the parties to it. The fact is that no workable rule can reconcile the will theory with contracts by correspondence, because nothing one person does without the other’s knowledge can make a contract if a contract must have both their simultaneous consents. The other decision is Dickenson v. Dodds,27 handed down in 1876. The Court of Chancery had to decide whether an offer had terminated before the offeree could accept it. Dodds gave Dickenson a written offer stating the terms on which he would sell some real property, the offer reciting that it would remain open until 9 A.M. the following Friday. While still in the course of deciding whether to accept, Dickenson learned from a Mr. Berry “that Dodds had been offering or agreeing to sell the property to Thomas Allan.” Apparently in the mistaken belief that he lacked the power to revoke his offer, Dodds never tried to do so. Instead, he tried to avoid Dickenson until after the offer had expired by its terms. He was unsuccessful, however. Dickenson caught up with him Friday morning shortly before 9 A.M., just as Dodds was boarding a train to take him out of town. Dodds then told Dickenson that it was too late, for he had already sold the property to someone else, a fact of which Dickenson, of course, was already aware. The court held for Dodds. It reasoned that the offer terminated with Dickenson’s receipt of Berry’s information. Once having received the information, [Dickenson] . . . was perfectly well aware that Dodds had changed his mind, and that he had in fact agreed to sell the property to Allan. It is impossible, therefore, to say there was ever that existence of the same mind between the two parties which is essential in point of law to the making of an agreement.28

Whatever the merits of the decision, the will theory only confused the reaching of it. The parties would never have been “of the same mind” to make the contract even if Dickenson had not received Berry’s information. In order to prevent the making of a contract under the will theory, all Dodds logically had to do was to think that he no longer wanted to sell to Dickenson, which he necessarily must have the moment he decided to sell to Allan instead. If the law logically followed the will theory, offerors would never have to bother to revoke. Just changing their minds would be enough. Like the rule of Adams, the rule of Dickenson has survived despite the demise of the will theory and the deficiencies in the court’s rationalization.

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The rule of Dickenson has not survived as fully, however. The Restatement (First) of Contracts limited what it called “the rule of indirect revocation” to situations in which the offer was for the sale of property and the information the offeree received was that the offeror had actually sold, or contracted to sell, the property to someone else. Information merely to the effect that the offeror had changed his intentions was insufficient.29 The Restatement (Second) of Contracts altered the rule again, although this time in the opposite direction. Information an offeree receives now revokes the offer if the information is reliable and to the effect that the offeror has taken “definite action inconsistent with” an intention to enter into the proposed contract with the offeree. The official comment explains that the quoted words mean “unequivocally inconsistent with.”30

The Objective Theory and the Failure to Require Evidence of Real Consent American courts had replaced the will theory with the so-called objective theory by 1900 or 1910. The parties’ objective manifestations of mutual assent now compose the contract, and the law interprets their manifestations as a reasonable person under the circumstances would interpret them. How either of the parties actually intended or interpreted them is of no consequence. Although Oliver Wendell Holmes, Jr., reported courts already following the objective theory by 1881,31 Grant Gilmore showed in 1974 that this was not so.32 All Holmes actually demonstrated was that the objective theory could support some of the major contract holdings of the time. By 1911, however, Judge Learned Hand was able to say that even if “twenty bishops” were to testify that the parties had intended something different, the contract would still mean what it would to a reasonable person viewing the situation objectively.33 Not only did freedom of contract survive the death of the will theory, it was strengthened by it. The objective theory provides a sturdier foundation by avoiding the logical entanglements into which the will theory led. A contract is a law for the parties to it. The legitimacy of that law derives from their consent, which each of them manifested by making the contract or at least manifesting his assent to it. The will theory requires that this consent have been actual, and it seems to require that it be continuing, too. If the parties’ wills should cease to coincide, the contract, which consists of that coinciding, should logically disappear. The objective theory, on the other hand, requires only that the parties have manifested their consents, so it lends itself to the idea that a contract exists by itself once the parties have made it. A manifestation of consent by its nature is limited in time, that is, the time it takes the person to speak, write, or otherwise signify it. Once

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made, therefore, a contract is a fact that does not depend on anything else to continue in existence. A contract that exists independently of the parties’ actual consents can also logically have a meaning of its own, independent of either party’s actual intentions. This is exactly what the objective theory dictates. Finally, by directing us to look only at the outward manifestations of consent, the objective theory makes it easier to demonstrate consent by something entirely formal, such as a signature or a handshake. Indeed, the objective theory positively forbids any inquiry into what a person actually thought he was consenting to when he made the contract. The practical result was to allow people to make contracts without any meaningful consent. In principle, two people could make the Encyclopedia Britannica their contract just by signifying it was. Judges and commentators later sometimes referred to this aspect of contract law as “the duty to read.” A person who signifies that a writing is his contract does so at his own risk. He cannot renounce it later by saying that he did not read it, was not given an opportunity to read it, or did not understand its terms.34 No one in the nineteenth century seems to have questioned this aspect of the law. If someone had, someone else might have defended it on the ground that a person who signifies consent to a contract does so voluntarily: he could have chosen not to. This might have been a valid argument in the nineteenth century, but it has not been thereafter. Two developments have largely eliminated the alternatives to contracting blindly. People have become dependent on numerous kinds of commercial services and manufactured products, and the producers of these services and products offer them only with standard contracts. A person today who refused to contract unless he understood what he was committing himself to would deny himself most of the means of living in society.

2 Product Dependence and Unequal Bargaining Power

PRODUCT DEPENDENCE and unequal bargaining power are the two conditions that chiefly motivated courts to make the reforms that are the subject of this book.

Product Dependence There is little to be said about the greater dependence upon products that exists in a modern society, because it is so obvious. The chief source is greater specialization. Each member of society produces only a narrow range of things but consumes or otherwise uses an enormous variety of them. The result is that all are dependent on others for almost everything they need or desire. Lawyers, for example, produce only legal services and in most cases only those that fall within a particular specialty, so they are dependent upon others for everything they eat, wear, or use or consume in any other manner. Of course specialization has long existed, but it did not exist to anything like its current extent when technology was less advanced. Another source of greater dependence on products is the greater potential harmfulness of modern products if they are not designed, made, or used properly. For example, whereas about the only harm a badly made plow could do in the nineteenth century was to increase farmers’ labor unnecessarily, a badly made grain combine today can maim or kill people, and whereas farmers in the nineteenth century used only natural fertilizers and had no insecticides at all, the chemical fertilizers and insecticides farmers use today can pollute the environment for decades and poison millions of people. Economic markets manage and control much of this dependence more or less automatically, and to the extent they do, the problem of dependence merges into the problem of unequal bargaining power. If people are dependent on producers only in the capacity of consumers, they will generally have all the protection they need if they and the producers have equal bargaining power. However, people are also dependent on producers in other capacities. We are all at risk if the brakes on someone else’s auto-

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mobile are defective, for example, or if his financial assets or liability insurance would not be enough to compensate us if he injured us. Dependence that is divorced from bargaining power creates a need for laws that serve public purposes: for example, laws that encourage or require automobile manufacturers to make reliable brakes or encourage or require drivers to carry adequate liability insurance. Although the courts that invalidated the liability limitations in the standard contract in use in the American automobile industry until 1960 (see the introduction) were motivated in part by a desire to protect consumers from the manufacturers’ superior bargaining power, they also hoped to protect everyone from the risks of defective automobiles. The hope was that if the manufacturers were unable to use their contractual defenses to shield themselves from consumers’ claims, the safer automobiles they would be encouraged to produce would protect everyone.

Unequal Bargaining Power Bargaining power is the power to set the terms of a contract. Bargaining power is a social power, and like other social powers, it implies more than just an ability to cause consequences. It also implies an ability to choose the consequences intelligently. Power without this ability is blind, and blind power is not power in the social sense because it confers no advantages. “Bargaining power,” therefore, as I use the term, includes the ability to choose intelligently the results one seeks to achieve by making a contract. Contracts are bargains. People make bargains in order to further their interests as they perceive them. I will therefore take the results people seek to achieve by contracting to be the furthering of their interests as they perceive them. This is neither a very precise definition nor a completely accurate one. It fails to include the use of contracts for the purpose of making gifts, for example, or situations in which the law will create a contract even against a person’s expressed wishes.1 However, it is precise enough for our purposes and sufficiently accurate to include the vast majority of contracts in our society. Contract law should take bargaining power into account for the simple reason that if people lack it there is no assurance their contracts will take their interests intelligently into account. A lack of bargaining power in one or both parties is a reason for limiting their freedom of contract, their contracting power, or both. It is not a conclusive reason, because other considerations may point the other way; however, it always at least poses the question of whether the law should limit the freedom or the power. Twentieth-century lawmakers have been mostly concerned with inequalities of

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bargaining power, but bargaining power is also necessary in an absolute sense. Two people making a contract with each other can injure their own interests even if they have equal bargaining power, if neither has a reasonable understanding of the probable results. Before proceeding any further, I will define a few terms. Although of only instrumental importance, they will help to clarify the matters to come. “Product” shall mean anything manmade in whole or in part, whether it is tangible or intangible. Foods and services as well as manufactured things are products under this definition. Insurance, professional sports, and telephone service are products, for example. “Producer” shall mean a person who produces products for sale. “Consumer” shall mean a person who buys a product in order to consume it. This is not the sense in which the term is commonly used, which includes just individuals who consume for personal purposes. In the sense in which I will use the term, even large business organizations can be consumers. For example, a manufacturer typically purchases hundreds of different kinds of products that it uses in its manufacturing processes, as office equipment, as office supplies, or for the comfort and convenience of its employees. To take a specific example, an automobile-manufacturing company would normally purchase steel for use in manufacturing processes. It might buy automobile tires from a tire manufacturer for installation on its vehicles. It would buy electricity, telephone service, and water for a variety of uses. It would buy word processors and paper for office use and coffeemaking equipment, paper cups, and napkins for the comfort and convenience of its employees. Thus, it would be a “consumer” of all these products. “Person” shall mean either a natural person (a man or a woman) or an artificial person (a corporation, for example). I will ordinarily say “persons” if I mean to include both natural and artificial persons, but “people” if I mean to include only natural persons. I will also state here my practice on gender-neutral terminology. I will use it unless it would be inaccurate, ungrammatical, unclear, awkward, or excessively lengthy. That I have defined “person” the way I have means I would have to say “he, she, or it” in order to be both gender neutral and accurate when referring to a person. The usually sufficient gender-neutral phrase “he or she” would inaccurately imply that I meant only a natural person, whereas “it” alone would inaccurately imply that I meant only an artificial person. Therefore I will often use a masculine singular pronoun to refer to a person. The relevance of the distinction between producer and consumer for my purposes is threefold. First, in a modern society with a market economy, a very large proportion of all contracts made are between producers and consumers. Contracts between consumers of the product concerned are rare. (A person selling his used car to someone other than a used-car dealer

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would be an example.) Contracts between producers of the product concerned are even rarer. (One car manufacturer selling cars to another would be an example.) Second, this distinction indicates the balance of bargaining power better than anything else. The party possessing the greater bargaining power is almost invariably the producer. Third, a producer almost invariably possesses substantial bargaining power over its own products in an absolute sense. It would not stay in business long if it did not. Although I believe I am the first to attach such importance to this distinction, others have drawn similar distinctions for similar purposes. Section 2-104 of the Uniform Commercial Code defines “merchant” as a person who deals in goods of the kind involved in the contract at hand or who otherwise holds himself out as having knowledge or skill relative to such goods. Businesses as well as individual consumers may not be merchants under this definition. Article 2 of the Code holds “merchants” to higher standards of behavior and affords them less protection than it does persons who are not “merchants.” The “merchant/nonmerchant” distinction is similar to the producer/consumer distinction I draw, and Article 2 employs the distinction for purposes similar to mine. When the Code introduced the doctrine of unconscionability, legal scholars generally thought that courts would limit its application to protecting individual consumers (i.e., not businesses). There was even speculation that courts might deny its protections to businesses as a matter of law.2 In fact, however, the protected parties in at least 40 percent of the reported cases involving unconscionability have been businesses in recent years.3 The courts have effectively adopted the same distinction I have. By using unconscionability when they see its protections are needed, they have used it even when the consumers are businesses. It is not literally the case that nearly all contracts in a modern society are between a consumer and a producer. The consumer sometimes only contracts with a retailer or some other intermediary in the distribution train. We are interested in bargaining power, however, and it is the producer that almost invariably determines what the contract with the consumer will be, whether the producer “makes” it in the legal sense or not. If there is an intermediary, the producer still generally provides the standard contract that sets the terms of the transaction for all concerned. The intermediary merely delivers the contract to the consumer on the producer’s behalf. For example, the insurer almost invariably provides the insurance contract even if an independent agent sells the insurance. Retailers of tangible products typically pass along the producer’s warranty or other standard contract together with the product when it is sold; contract and product are often in the same box. In many instances, the consumer’s contractual expectations about a product are at least partly formed from advertising or from the producer’s reputation. The producer almost always controls

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this kind of advertising, and of course the producer is responsible for its own reputation. Bargaining power, as I have defined it, is not the same as what economists call market power and has little to do with economic power of any kind. There are two chief sources of the producer’s generally superior bargaining power in a modern economy. One is that he understands the products he produces better than the consumer does. The other is that he can make the contract more efficiently, by making a standard contract and using it for every sale. Neither source depends on the producer’s having market power. The arguments and descriptions I provided in Chapter 1 were largely uncontroversial. This will no longer be the case. In order to make the presentations as understandable as possible, I will generally make my own arguments first and treat the arguments others have made in opposition toward the end. I hope the reader will keep this in mind if he or she thinks I have overlooked a counterargument or weak point in my own arguments.

Technology Technology has increased the producer’s bargaining power through product proliferation. Products today exist in virtually infinite kinds and varieties, and consumers buy thousands of kinds and varieties over the course of their lives. Therefore, consumers cannot hope to have more than a minimal understanding of all the different kinds and varieties of products they will buy. On the other hand, a producer only needs to understand the products he produces. Product proliferation does not reduce his ability to do this at all. The producer also possesses much greater resources for gaining an understanding and has a much more powerful motive for using them. He must understand his products very well if he is to be competitive. He can afford to gain a deep understanding of them, because relative to the resources required to produce a product, the additional resources required to understand it are typically small. On the other hand, the consumer lacks the resources the producer has for gaining a deep understanding, and he is not subject to competitive pressures to gain as much understanding as he can. The only pressure on the consumer is to gain a sufficient understanding to use the product for his own purposes. Technology has also increased the producer’s bargaining power by making products more difficult to understand. For example, although the typical purchaser of an automobile can appreciate design, color, comfort, and how the car handles on the road, he has no understanding of the underlying mechanical, chemical, and electronic properties the car possesses. Most

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consumers know next to nothing about a car’s safety and durability, because they cannot assess either of these qualities without understanding the engineering that went into the car’s manufacture and design. Of course consumers can learn about a producer’s reputation for product safety or durability, but this information still leaves them in a position much inferior to that of the producer in at least two respects. First, whatever the producer’s reputation, the particular product the consumer buys may fall short of it. In order adequately to protect themselves against this eventuality, consumers would have to understand the probabilities of each respect in which the product might fall short, how great a loss or injury such a defect probably would cause, and what rights, if any, the contract of sale provides for their protection if such a defect should occur. Second, consumers have no way of quantifying a producer’s reputation; that is, no effective way of estimating how much higher a price it is worth. Technology also enables producers to engage in continual product testing. A typical automobile manufacturer, for example, tests its automobiles’ resistance to collision, their ability to hold the road under slippery conditions, their stability when turning at high speeds, how long their finishes can be expected to last in different climates and under different driving conditions, and so on, practically ad infinitum. A producer today also knows the effectiveness of its quality-control procedures. This knowledge enables it to predict the frequency with which defects will manifest themselves after the product has been sold. Magazines such as Consumer Reports and those catering to special interests, in computers or sports cars, for example, reduce some of the producer’s advantages, but only to a small extent. The consumer’s ability to understand sharply limits the usefulness of the information these magazines can convey, and the consumer’s attention span limits it still further. Moreover, few consumers read the magazines for more than just the one or two kinds of products in which they have a special interest, and only a few could read those for all the different kinds of products sold. Finally, the understanding that such magazines can provide is subject to the same inherent deficiencies as is the understanding a consumer can gain from a producer’s reputation. It is impossible to quantify, and it does nothing to help the consumer deal with the possibility that the particular product he buys may not conform to what the magazines report. We do not ordinarily think of laws as technology, but they can have the same effect on consumers’ ability to understand the consequences of what they are buying. The number of laws that affect products and the sales of products has multiplied many times over since the nineteenth century, and these laws have also become individually more important. Implied warranties now attach to many more kinds of things than they used to4 and cover many more kinds of losses.5 Product liability6 and expanded notions of

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negligence7 have become a part of the law, although they did not exist fifty years ago. The legal implications arising from credit8 and insurance transactions9 alone have probably multiplied several times since the nineteenth century. A producer can efficiently inform itself of the laws that affect its products and their sale and change its practices accordingly, because it can spread the costs over all of its affected products. A consumer typically has no such cost-spreading opportunities. Some states have enacted “plain-language laws” requiring certain kinds of contracts to be in easily understandable language. However, plain language in the contract does nothing to reduce the advantage the producer gains from its superior understanding of the product; understanding the contract is not the same as understanding the product. Any legal advice the consumer might obtain is generally unhelpful for the same reason. A lawyer may be able to explain the contract, but he will understand the product no better than the consumer does. For example, on a multimillion-dollar financing arrangement that was brought to my attention recently, the contract devoted slightly more than a thousand words merely to describe the formula the lender would use to set the interest rate. One small part of the formula read as follows: the rate obtained by dividing the latest three-week moving average of secondary market morning offering rates in the United States for three-month certificates of deposit of major United States money market banks, such three-week moving average (adjusted to the basis of a year of 365 or 366 days, as the case may be) being determined weekly by . . . [the lender] on the basis of such rates reported by certificate of deposit dealers to, and published by, the Federal Reserve Bank of New York or, if such publication shall be suspended or terminated, on the basis of quotations for such rates received by . . . [the lender] from three New York certificate of deposit dealers of recognized standing selected by . . . [the lender], by a percentage equal to one hundred percent (100%) minus the “Reserve Percentage” (as defined below) for such three-week period, . . .

This is not simple prose, but a reasonably intelligent person can understand it. The difficulty is appreciating its significance. Why is the rate thus computed deemed to be appropriate for this transaction? What relationship is it likely to have with the rates borrowers similarly situated can obtain from other lenders? Why is the Federal Reserve Bank of New York being used rather than the Federal Reserve Bank of San Francisco, which would seem more appropriate for a financing in California? What is a “secondary market morning offering rate,” and how does it relevantly differ from other rates for three-month certificates of deposit? Why use three-month certificates of deposit rather than certificates of deposit for some other time period? Why use certificates of deposit instead of, say, residential mort-

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gages? The only advice that would be truly helpful for the consumer in this kind of situation would be the advice of someone who knew the producer’s product as well as the producer did. The lawyer’s merely legal expertise means very little. Examples closer to home are also common. Suppose a health insurance policy provides coverage of up to $250 a day for thirty days for a hospital room. That in itself would be perfectly understandable, but consumers could not gauge its significance unless they knew what the hospitals they were likely to stay in charged for the use of a room, and how long various illnesses or injuries would likely require them to stay in a hospital. If the hospitals were charging over $700 a day in large metropolitan areas, a daily rate limit of $250 would be grossly inadequate for a city dweller. On the other hand, it might still be sufficient in some rural areas. A consumer would encounter similar difficulties in gauging the adequacy of the thirtyday limit. The point is that understanding the language is only a small part of the problem. The much more difficult part is understanding the product. The warranties on new automobiles provide an even more common example. Many now cover just the “power train” and are limited to 36,000 miles or three years, whichever comes sooner. What does the “power train” include, and what doesn’t it include? What are the likely consequences of a defect appearing in some part of the car not in the “power train”? Is 36,000 miles or three years long enough to cover most of the kinds of defects that might appear, or did the manufacturer choose these limits precisely because most defects would not appear until the warranties had expired? Again, the consumer cannot hope to answer such questions without expert knowledge of the product. One might think that competition would make any differences in knowledge or understanding between producers and consumers unimportant. For example, a consumer might not need a detailed understanding of the significance or value of a new car warranty in order to compare warranties being offered by different manufacturers. The thought is incorrect, however. The warranties may be different in ways that make it impossible for the consumer to judge their relative worth without a deeper understanding of the warranties, the law, and the products involved. Even identical warranties will have markedly different worth if the products they cover have substantially different maintenance requirements or repair prospects. Competition works to eliminate the producer’s bargaining advantage only if the products in competition with one another are substantially identical. All consumers then need to know are the prices, because none of their other interests will be affected by their choices. Consumers today are rarely confronted with choices among substantially identical products, however.

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Standard Contracts When businesses become large enough to engage in numerous transactions of a kind, they can reduce their transaction costs by making their contracts in standard form. Businesses incur the costs of drafting a standard contract only once and spread them over as many transactions as they use the contracts. Standard contracts also make a business’s legal risks more manageable by making them more uniform, also effecting a cost saving. These savings ultimately benefit consumers, because producers’ cost savings are largely passed on in the form of lower prices in a competitive economy. In fact, the savings effected by standardizing contracts are so great that when for some reason a business cannot realize them, the business is likely not to use contracts at all. The costs of composing a contract tailored to the particular aspects of each sale are usually prohibitive. Before contracts became standard, goods were generally sold without contracts, and sales of services were generally accompanied with just brief notations of the most basic elements of what the parties had agreed. For example, a contract to install a new roof might state just the price, the kind of shingles, the building to be roofed, and the expected completion date. Retailers still generally sell inexpensive goods without contracts. Food and clothing are examples. An overwhelming proportion of all contracts made today are standard whether or not they appear to be. The “secretly” standard are those that appear to be individually crafted to the transaction at hand, but which the producers composed from standard parts taken from a form book (the old way) or from the memory bank of a word processor (the new way). For example, the lender had apparently composed the contract used in the financing transaction I mentioned earlier entirely from parts stored in the memory of a word processor—a standard contract for a financing of $20 million. Although everyone ultimately benefits from the producer’s ability to reduce its costs by standardization, the consumer does not benefit from the producer’s enhanced bargaining power. The standard contract enables the producer to take maximum advantage of his superior understanding of the product and the law. Neither length, lack of understandability, nor onesidedness reduces sales, because consumers rarely read the contracts. They know there is no reason to do so. There is no reason to read them if they cannot change them, if they probably would not understand them, or if they are unlikely to discover anything in them that would persuade them to buy the product from another producer. If there were anything in a standard contract to the consumer’s benefit that other producers were not also

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offering, the producer concerned would surely have drawn the consumer’s attention to the benefit as an inducement to making the sale. If there were anything in a standard contract to the consumer’s detriment that other producers did not also require, the other producers would have drawn it to consumers’ attention as an inducement to making their sales. Salespeople also rarely read the standard contracts for the products they sell. For example, I have never met an insurance or mortgage salesperson who read the insurance policies or the mortgages. Both learn what they need to know about the contracts they sell from instruction booklets their employers give them. Consumers so regularly fail to read standard contracts that in industries with especially long and complicated contracts, producers often dispense even with the formality of showing the contract to the consumer and having him or her sign it. They ask the consumer instead to sign a short and simple “order” or “agreement” that incorporates the contract by reference. The practice in the insurance industry for years has been to send a person the insurance policy some weeks after he has purchased the insurance. Before purchasing their insurance, buyers typically see only a one-page form on which they check the blanks to indicate the coverage amounts, exemptions, and additional coverages they want. Prepaid health plans, such as Blue Cross and Kaiser-Permanente, generally do not show subscribers their contracts at all. Those who inquire are told they can come down to a certain office, where the health plan keeps a copy. Mortgage and real estate companies typically do the same.

The Disappearance of the “Level Playing Field” One can describe the condition of equal bargaining power presupposed by freedom of contract as a level playing field. Most contracting did not really occur on a level playing field even in the nineteenth century, but at least the description then would have been approximately accurate. It no longer is, however. We now contract on a field of hills, so to speak. The producer-consumer relationship is vertical. The producer of a product is always higher than the consumer of the product in the production and distribution chain. Almost all contracts now made are between persons related in this way. Horizontally related persons rarely contract. Two corporations in the same industry will contract if one acquires the other’s assets. Two lawyers will contract to settle a dispute. Two individuals or two couples will contract if one is buying the other’s house. As these examples illustrate, however, these occasions are exceptional. None is a routine occurrence for the persons concerned. Not even lawyers who specialize in litigation devote a large portion of their time to making settlement con-

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tracts. On the other hand, vertical contracts are now an essential and regular part of the business of life for virtually everyone. No one has a fixed place in this hierarchy. All of us occupy different levels depending on whether we are the producer or the consumer of the product concerned. The university that employs me is a producer in its capacity of contracting with its students, who are consumers of its services. However, the university is a consumer in virtually every other contract it makes, for example, when it purchases computers, office supplies, books and periodicals, and so on. This is the case no matter how wealthy or powerful a person is. It is true for IBM as well as for people who make their living mowing lawns. Vertical contracts inherently give the party on the higher level the superior bargaining power that derives from the level’s technology. If the party uses standard forms to contract, he also gains the bargaining advantages they offer. Unequal bargaining power is now characteristic of contracting generally. The long-held assumption that “sophisticated businesspeople” do not need the law’s protection when they contract with each other10 is no longer correct. We all need the law’s protection except when we contract about what we produce.

Consequences As one would expect, the chief and most evident consequence of these systematic inequalities of bargaining power was to make contracts very unfavorable to consumers. Producers everywhere took advantage of the opportunities their superior bargaining powers opened to them. Thanks to the developments treated in the coming chapters, however, the worst is past. Although many one-sided consumer contracts are still in use, and virtually all consumer contracts are still one-sided in certain respects, the truly egregious cases are by now over two decades old. I will describe a few of the egregious cases, however, in order to give the reader an idea of how much advantage some producers took of their superior bargaining power before the law began to change. The standard contract that American automobile manufacturers used until the courts began invalidating it in 1960 disclaimed the manufacturer’s liability for any personal injuries, property damage, or other loss a purchaser might incur as a result of a defect. It limited the manufacturer’s liability on the car itself to defects that surfaced within thirty days or 3,000 miles, whichever came first. Even then, the manufacturer’s only liability was to repair or replace the part. The purchaser had to ship the part to the manufacturer’s place of business (normally Detroit) at the purchaser’s expense, and the manufacturer had to agree after its own inspection that the

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part was defective. A purchaser had no right to return the car to the dealer from whom he bought it for repairs even within the thirty days or 3,000 miles. The only promise to which this contract effectively bound the manufacturer was to deliver something that looked like an automobile. Manufacturers did not always hide behind their contractual defenses; they usually made minor repairs voluntarily. However, they were ruthless in avoiding large liabilities. The facts of the first judicial decision to overturn the standard American automobile industry contract provide an example. A defect in the steering mechanism swerved the car into a brick wall near the highway and destroyed the car only ten days after the owner had purchased it. The owner’s wife, who was driving the car, was seriously injured. The Chrysler Motor Company denied liability for all the losses and injuries on the basis of the contract provisions I described in the preceding paragraph, although in this case, the Supreme Court of New Jersey overrode them. The case was Henningsen v. Bloomfield Motors, Inc.11 Individual consumers were not the only victims. Businesses were also denied significant contractual rights when they were consumers. Typical of the remedies limitations on business consumers were those invalidated in Wilson Trading Corp. v. David Ferguson, Ltd.12 in 1968. The contract was for the sale of yarn. The producer was the manufacturer of the yarn; the consumer, a manufacturer of sweaters. The consumer cut and knitted the yarn into sweaters, and then washed the sweaters. The color “shaded” during the washing, making the sweaters unmarketable. The producer defended on the basis of the following language in the contract: 2. No claims relating to excessive moisture content, short weight, . . . or shade shall be allowed if made after weaving, knitting or processing, or more than 10 days after receipt of the shipment. . . .

The consumer had not made the claim until after the knitting and also more than ten days after receipt of the shipment. The trial court gave summary judgment for the producer, and the first two levels of appellate courts affirmed. However, the New York Court of Appeals reversed and remanded for trial on the factual issues of whether the shading defects were discoverable before the knitting and, if not, whether the consumer had reported them to the seller within a reasonable time after he should have discovered them. The fact that the consumer had not reported the damage until more than ten days after receipt of shipment was not conclusive against him. It is not relevant to our purposes to go into the grounds of reversal in detail, except to say that the Uniform Commercial Code makes remedies limitations like this unenforceable. The yarn producer had evidently artfully designed the remedies to give only the appearance of protection. Be-

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cause the consumer could not discover the yarn’s tendency to “shade” during washing until he had washed it, he would never discover the defect until after the warranty had expired. The producer apparently designed the ten-day limitation to have the same effect. Any defects that might appear in its yarns would likely not appear until after ten days. Wilson illustrates how deeply entrenched freedom of contract was before the new developments began to challenge it. The New York Court of Appeals’s application of the Code to the facts of the case was simple and straightforward. The same facts today would present too easy a case even for a good law school examination. New York enacted the Code in 1962. The New York State bar and legislature held hearings and deliberated on it for three years before the legislature enacted it. Members of the bench and bar could hardly have failed to notice. Yet it was not until three courts had heard the case and it had reached the highest court in the state that the lawyers for the garment manufacturer could persuade a majority of the court that the Code set limits on a seller’s ability to limit a buyer’s remedies for breach. Egregious examples of unfair insurance contracts are still legion, despite the efforts of courts to combat them. For example, disability insurance policies promise monthly payments for life only if the insured is “permanently disabled from engaging in gainful employment” and “subject to continuous house confinement.”13 Think for a moment about the chances that all the conditions thus expressed will simultaneously exist. Disabled from engaging in any gainful employment? If one can still talk, presumably one can still solicit orders for magazine subscriptions over the telephone. If one still has the use of one hand, presumably one can still write with a pen and so still hold a desk job. Permanently disabled? Almost any condition other than the loss of a limb or organ could get better. Even if an insured could meet both conditions, the chances that he could continue to meet both of them for more than a few months are practically nil. An individual who was truly unable to engage in any gainful employment and continuously confined to the house would not long remain confined there. His family or doctors would soon remove him to a hospital or nursing home, and the insurer presumably could stop paying the benefit when they did, because the claimant would no longer be in “continuous house confinement.” It seems doubtful that the insurers who sell these policies would ever pay a dollar in claims if the courts did not order them to. Even producers who might want to treat consumers fairly have difficulty doing so in a competitive economy when the law sets no limits on the elimination of a party’s contractual rights. The money a producer can save by eliminating consumers’ rights is pure profit. It costs no more to make an

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unfair contract than a fair one, and an unfair one will not noticeably reduce sales because so few consumers will read it. Competitive pressure therefore works to compel every producer to make its contracts at least as unfair as the contracts of the other members of its industry. It will make fewer profits than its competitors if it does not. The logical end result is for all the contracts in the industry to be the same and all to be as unfavorable to the consumer as a lawyer’s skills can make them. There have been no studies to test the extent to which our economy actually reached this state before contract law began to change, but the pre-1960 standard contract for the American automobile industry shows that at least the American automobile industry had reached this state by 1960. I know from my experience as a practicing lawyer that the finance industry had also reached it by the 1960s. A law of contract that fails to prevent producers from exploiting their superior bargaining powers also ultimately reduces the value of the products themselves. Producers have less to fear from making or performing them inadequately. The general quality of American products had in fact fallen to a low level by the 1960s, which was one reason foreign manufacturers began entering American markets so successfully. That American products (as well as foreign products sold in the United States) are now generally much safer than they were in the 1960s is due in no small part to the new tort and contract laws that were made then and thereafter, especially the laws that overrode contractual disclaimers of liability for personal injuries. However, the law still has a way to go before consumer’s will be adequately protected against the purely economic losses they can suffer from defective or poor-quality products.

The Effects of Classical Contract on the Law’s Ability to Serve Public Purposes or to Prevent Abuses of Bargaining Power Although the U.S. Supreme Court implicitly overruled the constitutional decisions of the Lochner era in the 1930s, the common law characteristics of classical contract continued to aggravate the harmful effects of inequalities of bargaining power until the advent of the reforms that are the subject of this book. The principle of freedom of contract prohibited a court from either invalidating provisions in a contract that it concluded were unfair or from overriding unfair contract terms with laws it created itself. The first option would violate the parties’ “freedom to” include anything in their contracts they chose. The second would violate their “freedom from” laws that would limit this freedom. The clear distinction between contract and

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tort reinforced the “freedom from” prohibition by clearly separating contract laws from laws limiting contractual freedom. Classical contract’s failure to limit contracting power was the most harmful of all. The objective theory of contract interpretation seemingly compelled the conclusion that people could bind themselves to contracts without giving consent in any meaningful sense. Something purely formal, such as a signature or a handshake, was enough, even if the person had only the vaguest notion of what he was accepting. Thus, classical contract gave producers the power to make contracts without the consumers’ meaningful consent. This aspect of classical contract gave producers considerable advantages even under the relatively primitive economic conditions of the nineteenth century. The advances in technology and increases in the use of standard contracts in the present century made the producer’s advantages overwhelming. Classical contract also increased the producer’s superiority of bargaining power in certain other respects. The only real discussion of rights and duties that occurs in most standard contract situations occurs after the parties have made the contract, and then only if something goes wrong. They will then generally have to settle at least two questions: who, if anyone, breached the contract, and what the contract obligates the breacher to do. It is reasonable to characterize the settlement of these questions as bargaining for our purposes, because the same bargaining strengths and weaknesses that affected the parties’ making of the contract are likely to affect their settlement of these questions, too. A producer can ensure that he will also have the superior bargaining power in such settlements if something goes wrong by using the standard contract to eliminate as many of the rights the consumer will have as the law will allow. Then, even if the producer breaches the contract, there will still be little or nothing the law will require him to do about it. Freedom of contract ensured that a court would enforce whatever the producer’s contract provided in this respect. The standard contract that was universal in the American automobile industry until 1960 was typical. It gave the manufacturer the exclusive right to decide whether he was at fault if the automobile failed to function as it should, and it left the purchaser with virtually no rights against the manufacturer even if the manufacturer admitted he was at fault. On the other hand, in situations in which the consumer rather than the producer was the more likely to breach the contract, the producer could include provisions in the contract to increase his remedies. The law still generally permits these kinds of contractual remedies provisions. For example, a credit institution can require large amounts of security, provide for quick methods of foreclosure, and require the borrower to pay all expenses of collection, including attorneys’ fees. Freedom

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of contract allows producers to increase their own remedies for breach for the same reason it allows them to reduce the consumer’s remedies. A producer can also use the American Rule to enhance his “secondround” bargaining power. If he structures the transaction to require the consumer to sue him for any redress if anything goes wrong, the consumer’s inability to recover his litigation costs will usually be sufficient to prevent him from suing the producer, even if the contract provides for remedies otherwise sufficient to make suing worthwhile. The American Rule has such a powerfully discouraging effect on contract litigation because the amounts involved are characteristically too small to cover the litigation costs. For this reason, it is currently rarely worth suing for less than about $25,000 in a large metropolitan area even in a simple case, or for less than about $100,000 if the case is complicated. The simplest way a producer can require the consumer to sue him for redress is to make the consumer pay for the product up front. This prevents the consumer from subtracting what he thinks the producer owes him from the purchase price. The producer can achieve the same result even in a credit transaction by keeping the credit period shorter than the period of time after which any defects in the product are likely to appear. There are also more complicated ways of achieving the same result in a credit transaction. The producer can require the consumer to borrow the purchase money from someone else (typically a bank) or to sign a negotiable note, which the producer assigns to someone else (again, typically a bank). Defects in the product will not entitle the consumer to cease making payments in either case. If the consumer ceases paying nevertheless, the only result will be to get him in trouble with the person to whom he owes the money, because the producer will already have been paid. The effects of the American Rule go beyond merely discouraging suits. The rule also leaves a plaintiff undercompensated if he sues and wins. Moreover, because both producers and consumers understand this fact, the rule reduces the amount a consumer is likely to get in settlement. The consumer will accept less in order to avoid incurring unrecoverable litigation costs, and the producer will offer less because he knows the consumer will accept it.

Different Conceptions of Bargaining Power Duncan Kennedy has argued against using superior bargaining power as a justification for laws that protect or otherwise benefit the weaker parties. However, he conceives of bargaining power differently than I do. He offers three conceptions of superior bargaining power: one party is wealthier

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or in some other sense financially stronger than the other; one party possesses more market power (in the economic sense) than the other; or one party (in this case, the weaker party) needs to make the contract more than the other does. He concludes that none of these conceptions provides a satisfactory justification for a law or judicial decision intended to protect or otherwise benefit the weaker party. He suggests instead that we frankly accept the paternalistic justification, which he defines as a belief that we know what is better for others, whether or not they realize it.14 I think I agree with the first part of Kennedy’s argument, although whether I do or not does not matter for present purposes, because none of the conceptions of superior bargaining power he offers is the one I am using. Bargaining power, to me, is simply the power to set the terms of a contract. Its principal sources, in my view, are the producer’s superior understanding of his products and his ability to make the contract more efficiently by standardizing it. Neither my conception of the power nor the sources I think it derives from bear any necessary connection to financial strength, market power, or relative need. However, the second part of Kennedy’s argument does matter for present purposes, and I do not agree with it. There is indeed a large area of lawmaking for which the paternalistic justification is sufficient. Certain laws can serve their purposes only if everyone is subject to them. The Social Security system is an example. It could not provide the nearly universal protection it does if we did not require nearly everyone to contribute to it. Because a majority of the American electorate decided it wanted a Social Security system, it had the right to impose it on the minority that did not want it, in the belief that the minority would benefit even if it did not realize it would. But the whole area of lawmaking is not like this. In particular, there is generally no need to impose something on people who do not want it if economic markets can provide it to the people who want it. Properly operating economic markets allow people to choose whether they want something and generally also offer them varieties to choose from. Therefore, the courts have been right sometimes to condition their reforms of contract law on a perception of inequalities of bargaining power and to justify the new laws on this basis. People generally express their choices in economic markets through contracts, and inequalities of bargaining power can prevent them from effectively expressing their choices or from enforcing them after they make them. Of course, the courts would have been wrong never to override a contract unless they perceived inequalities of bargaining power, but they have not done this. The second principal motivation for the reforms was to place public responsibilities on producers, and this motivation was enough in many cases.

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Arguments in Opposition to the Reforms Not everyone welcomed the reforms when they came, but the only arguments I will treat here are those that opposed any changes at all in classical contract. I will treat the arguments that opposed only certain reforms in connection with the reforms they opposed. One could call the principal argument in opposition to any change at all the basic economic argument, because it rests on some of the most basic suppositions of economic theory. Any elementary economics text will explain why consumers in a competitive economy get what they want at the lowest prices consistent with the costs of producing it, if the “market” in which they are buying is working properly. One can even expand this basic theory to include the information consumers need in order to decide what they want, by characterizing information itself as a commodity. Then, if consumers are not getting what they would want if they knew enough to ask for it, the reason must be that they prefer choosing in ignorance to paying the costs of obtaining the information they would need to choose intelligently—so even when they seem not to be getting what they want, deeper analysis will disclose that they really are. What they really want is whatever mixture of ignorance and intelligent choice the market is providing them. Thus, it seems to follow that if the law intervenes to require producers to give consumers anything other than what they are already getting, the law will only harm consumers, at least in terms of their own preferences, because they are always already getting what they want the most, consistent with the costs of producing it. The law should leave freedom of contract and contracting power unconstrained. People should be free to make whatever contracts they like, and there should be no limits on what or how much they can include in them. For example, if consumers really wanted stronger remedies for breach of contract, they would demand them, and some producers, at least, would include them in their contracts. These producers would increase their prices, but if the consumers really wanted the stronger remedies badly enough, they would be willing to pay the higher prices for them. The absence of contracts with strong consumer remedies in them in actual markets thus demonstrates that consumers do not want such contracts badly enough to pay what it would cost producers to provide them. If the law were to require producers to provide stronger consumer remedies, consumers would be less happy with the result than they are currently. One study showed that consumers rarely sued producers for breaches of contract before courts and legislatures changed the law to strengthen consumers’ remedies.15 This fact might seem to support the argument that consumers really preferred things as they were, at least for remedies. If consumers had

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wanted stronger remedies, would they not have made more use of the remedies they already had? It is rare to find this argument made as baldly and sweepingly as I have made it here, but it underlies practically innumerable more modestly expressed arguments and opinions. I will mention just one, Judge Richard A. Posner’s well-known opinion in Lake River Corp. v. Carborundum Co.16 Posner is an economist as well as a lawyer and was a law professor before becoming a judge on the U.S. Court of Appeals for the Seventh Circuit. At issue was the validity of a liquidated-damages provision that provided damages greatly in excess of those that the plaintiff actually suffered or could reasonably have expected to suffer from a breach of the kind the provision covered. Traditional contract law invalidates such a liquidateddamages provision on the ground, among others, that it coerces a party into performing the contract even if everyone concerned would be better off if the party breached and compensated the other party for the actual damages. Illinois followed the traditional law, and the court was obligated to follow Illinois law. Posner recognized all this and consequently joined the other members of the court in invalidating the provision, but he nevertheless took the occasion to lecture the courts of Illinois on how they ought to treat liquidated-damages provisions. He told them they should not interfere with what the parties had chosen to include in their contract, at least if, as here, the parties were “fully competent”: [The traditional rule] . . . overlooks the . . . important point that the parties (always assuming they are fully competent) will, in deciding whether to include a penalty clause in their contract, weigh the gains against the costs—costs that include the possibility of discouraging an efficient breach somewhere down the road—and will include the clause only if the benefits exceed those costs as well as all other costs.17

The basic economic argument suffers from the characteristic weakness of any argument that reasons from fact to preference. That consumers must be content with the way things are because it is the way things are constitutes a valid argument only if consumers have the power to change things. However, the chief point of this chapter has been to explain why consumers lack this power. They lack it because they lack bargaining power, which is, by definition, the power to set the terms of a contract. Moreover, the principal source of the consumer’s lack of bargaining power is not lack of information; it is lack of understanding, which is not nearly so easily rectified. Even with all the information they wanted, people could not understand most products today sufficiently well to choose intelligently among them if the law did not require producers to conform their products to the relatively simple expectations that consumers have about them. Therefore, to take the example first mentioned, the more plausible explanation for the

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rarity of consumer suits against producers before the law gave consumers stronger remedies is that consumers generally realized it was not worth suing with only the weak remedies they had. I am aware of only one argument that goes deeper into the problem than does the basic economic argument. Alan Schwartz and Louis L. Wilde are the authors of one article that makes it,18 and Douglas G. Baird and Robert Weisberg, of another.19 The argument concerns contract formation, that is, offers and acceptances. Schwartz and Wilde treat contract formation under the common law, and Baird and Weisberg treat it under the Code. The differences between contract formation under the two laws are only technical, and the technicalities are irrelevant to the argument both articles make. In this view, the economic market in which the parties make their contracts should be examined to determine whether it satisfies three conditions. It must be of substantial size, competitive, and such that the sellers cannot “price discriminate” between large-volume and small-volume buyers. “Price” is used as a term of art to mean anything about a product, including its quality and the contracts the sellers use to sell it. Therefore, “price discrimination” includes differences between the contracts of sale for some buyers and those for other buyers. Any market of substantial size, the argument goes, is likely to have a significant number of largevolume buyers, for whom it will be worthwhile to ascertain the sellers’ standard terms and understand their factual and legal implications. These large-volume buyers will bargain to get the best deals they can. Because the market is by hypothesis competitive, the terms that result will be economically “efficient,” which means that these buyers will get the terms they like the most at the price they are willing to pay. Finally, because the sellers must give everyone the same terms as they give these largevolume buyers (they cannot “price discriminate”), every buyer will obtain the same advantages as the large-volume buyers, no matter how weak the bargaining power of the particular buyer may be. Where the three stated conditions exist, therefore, every buyer gets the best deal possible regardless of any weakness in any buyer’s own bargaining position. Any attempt by a court or legislature to make the contracts more favorable to buyers would backfire. It would only make things worse for most buyers even if it made things better for a few of them. Therefore, freedom of contract ought to be maintained.20 The argument sounds too good to be true, and it is. It has at least two flaws. First, the assumed community of interest between large- and smallvolume buyers rarely exists. As a result, the advantages that large-volume buyers obtain for themselves with their superior bargaining power do not necessarily work to the benefit of small-volume buyers, or at least not as much. Second, and more important, sellers generally can and do discrimi-

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nate between large- and small-volume buyers in contract terms. Producers generally do not give to small-volume buyers the advantages that the largevolume buyers have obtained by their greater bargaining power. For example, the large-volume buyers in the automobile market are the national car rental companies—Hertz, Avis, and so on. Each of them buys tens of thousands of new cars each year. The companies’ executives do not ride in the cars, however; only their customers do. Their executives therefore have no concern for their own personal safety. At most, the companies have only a concern that they not be liable for any personal injuries their customers may suffer, and the least expensive way of avoiding this is to include disclaimers in their rental contracts. They can also require the car manufacturers to indemnify them. Many of the car rental companies’ other interests are also significantly different from the interests of the ordinary car buyer. They either have their own maintenance and repair facilities or contract this work out on a large scale, which makes it relatively inexpensive. The inconvenience and expense that individual car owners incur if they have to take a car in for repairs is not a problem for these companies, because they can avoid it by buying a few more cars than they need to be in operation at any one time. Thus, the national car rental companies are far less interested in getting favorable warranty terms than an individual car buyer would be and more interested in getting their cars at a lower price instead. They also have less interest than does an ordinary buyer in the physical durability of the cars, and no interest at all in the possible early obsolescence of its style. The national car rental companies routinely replace their cars with new ones in one or two years. The second flaw in the argument is that contrary to what it assumes, sellers can and do discriminate between large- and small-volume buyers in terms of sale. In fact, such discrimination is routine. A large-volume buyer takes for granted that it will get better terms than those given to the ordinary buyer. The only questions are how much and in what respects. Ordinarily, a seller will not even offer a large-volume buyer the standard contract nor deal with it through the same channels as it would use for ordinary buyers. For example, Hertz would not send its purchasing officer to a car dealer. It would send him to the car manufacturer’s national headquarters, or a car manufacturer would send a high-level sales executive to see Hertz. Even if a seller and a large-volume buyer do set the terms of their specially negotiated deal by one of the seller’s standard consumer forms, a simple way of expressing the special terms is to cross out or write over the conflicting terms in the form.21 Thus, no matter how the producers and the large-volume buyers negotiate their contracts, the terms the producers give to the large-volume buyers are not also given to low-volume buyers.

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Conclusion Technology and standard contracts combined with certain aspects of classical contract early in the present century to produce wide, systematic inequalities of bargaining power between producers and consumers. The result was to make contracts generally very unfavorable to consumers and in many instances to lower the quality of the products themselves. Judges and legislatures began to take these facts into account beginning about 1960. The new laws they made are the subject of the following chapters.

3 Reasonable Expectations

ROBERT E. KEETON discovered that courts in insurance cases were using an approach he called reasonable expectations in the 1960s. I derived the same approach on theoretical grounds for all contracts. Keeton and I worked independently but by coincidence published our results within a year of each other in 1970–1971. The highest courts of most jurisdictions have since adopted the approach, although some adopted it only for insurance. This chapter gives a history of “reasonable expectations” and tries to bring together its many manifestations under a common set of principles.

Origins in Insurance The traditional judicial approach to the insurance contract is a vigorous use of the doctrine of contra proferentem; that is, ambiguities in a legal instrument are construed against the drafter. Contra proferentem has serious drawbacks, however. An insurer can avoid it by using clear language, and the clear language does not warn the purchaser, because people rarely read their policies before purchasing them. The doctrine can work unfairly, because resolving an ambiguity against the insurer can result in the insured’s getting more than he bargained for. Precedents do not settle anything, because insurers can redraft their policies. The doctrine frequently produces unprincipled decisions, because the uncertainties of language allow courts to create ambiguities in order to rationalize conclusions they want to reach for other reasons. Many people were aware of these drawbacks, but no one came forward with a better solution until some courts began using one in the 1960s. Keeton, then a professor at Harvard Law School, discovered these decisions and reported them in a two-part article titled “Insurance Law Rights at Variance with Policy Provisions,”1 which he published in 1970. In the decisions he discovered, the court did not stop at construing the policy against the insurer, but declared rights that might be at variance with or in addition to those the insurer provided in the policy. Keeton’s analysis of the cases led him to conclude that he had discovered a new principle, which he formulated as follows:

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The objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.2

For example, in one of the cases Keeton reported, Gerhardt v. Continental Insurance Co.,3 the court gave the insured coverage under her comprehensive homeowner’s policy for her liability to a domestic employee who was injured while working at the insured’s home, despite an exclusion in the policy for domestic employees who were covered by workers’ compensation law. The face sheet of the policy contained language stating there was coverage for liability because of bodily injury and a declaration by the insured that she employed not more than two full-time residence employees. The policy did not mention the exclusion except in its back pages. Quoting itself in an earlier case, the court said: [I]nsureds are entitled to the measure of protection necessary to fulfill their “reasonable expectations” and . . . they should not be subject to “technical encumbrances or to hidden pitfalls.”4

Justifications in Insurance Principles and policies are more fundamental than rules and doctrines. We justify rules and doctrines by reference to principles or policies. Although Keeton initially characterized the decisions he discovered as embodying a new principle, he must have changed his mind later, because he eventually began suggesting principles and policies to justify it. Other commentators always regarded it as a rule or doctrine. Kenneth S. Abraham suggested three justifications in 1981: efficiency, equity, and risk distribution. By “efficiency,” he meant allocative efficiency, which is an economist’s term for a particular kind of beneficial distribution of wealth, or “utility.” Put simply, Abraham’s “efficiency” justification was that the doctrine of reasonable expectations gives people the insurance they expected, by requiring insurers to give it to them regardless of the contents of the policies. By “equity,” Abraham meant such equitable doctrines as estoppel, reliance, and fairness. He defined risk distribution as the courts’ holding that the insurance covered the risks they thought it should cover regardless of whether the insurers had written the policies to cover those risks.5 Keeton offered some slightly different justifications in the treatise he coauthored with Alan I. Widiss in 1988.6 First, insurance contracts are typically long and complicated, and few insureds read them with care, if they read them at all. Second, people who buy insurance typically could not read the policy before agreeing to it even if they wanted to, because insurers

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typically do not deliver the policy until weeks or months after they have sold the insurance. Third, the provisions in insurance policies are sometimes unconscionable or unfair. Fourth, it is appropriate to protect an insured’s expectations that derive from the marketing practices of the insurer or from the conduct of the industry as a whole. Fifth, sometimes the insurer’s conduct in the particular instance leads the insured to expect something the policy does not provide.7

Acceptance in Insurance Despite the justifications that Abraham and Keeton had offered for it, Mark C. Rahdert found reasonable expectations to be in trouble in 1986. Rahdert reported a number of jurisdictions announcing limits to it or “retreating” from “advances” made previously.8 In 1990, however, Roger C. Henderson concluded that the doctrine was solidly established and predicted that additional jurisdictions would continue to adopt it until it was the law everywhere.9 Henderson identified two versions of the doctrine. The stronger is the one Keeton stated in 1970: the reasonable expectations of the insured prevail even if they are at variance with the policy. The weaker version allows clear policy language to override the reasonable expectations, at least if the language is conspicuous. Henderson describes the weaker version as not really an advance beyond contra proferentem. The observation is not quite correct. Contra proferentem resolves ambiguous language against the insurer, but it does nothing for inconspicuous language. Therefore, requiring that policy language be conspicuous in order not to be ignored in favor of the insured goes some distance in the direction of reasonable expectations, although it still falls short of it. Conspicuous language still cannot affect the insureds’ expectations about what they are getting if they do not have an opportunity to read the policy before purchasing it. Henderson found ten jurisdictions in which the highest court has clearly stated the stronger version and six more in which he concluded that the stronger version is probably in force, although the highest courts’ decisions do not clearly say so. He found one jurisdiction (Idaho) in which the highest court had rejected the stronger form of the doctrine and eight in which a court at a lower level had declared that its highest court had not yet adopted the doctrine. Of the remaining twenty-five jurisdictions, he found twelve with decisions that use the language of reasonable expectations but do not use it clearly enough to allow one to know whether they are applying the stronger or the weaker version and thirteen with decisions that either say nothing about the doctrine or say something that leaves their position on it unclear.

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The scholarly reaction to Keeton’s articles and to the development of reasonable expectations itself has been enormous. There have been criticisms, but the favorable opinions are much more numerous. Henderson’s article is a good source of references to the scholarly literature.

Estoppel in Insurance If an insurer leads a potential insured to expect something that the policy does not provide, and the potential insured relies on the expectation to his substantial detriment, the law almost everywhere is that the insurer is estopped from denying that the policy fulfills the insured’s expectations. As Robert H. Jerry II points out in his treatise, this estoppel is the same as the law of reasonable expectations (or nearly so) except for the requirement of detrimental reliance. In most cases the insureds satisfy this requirement by showing that they could, and presumably would, have obtained other insurance that would have provided what they expected, if they had not expected that the insurance they purchased would provide it.10 I estimate on the basis of my familiarity with the reasonable expectations decisions that the insured could have satisfied this requirement in nearly all of the cases in which he won on the ground of reasonable expectations. Thus, the two doctrines overlap. However, the overlap is not quite as great as this indicates. The estoppel decisions rest on the insurer’s having created actual expectations in the potential insured, whereas the reasonable expectations decisions rest only on there having been circumstances under which a hypothetical “reasonable person” would have had the expectations. The estoppel doctrine is also more limited in being subject to what is now commonly called the Hunter limitation, that an estoppel “not be used to create coverage that does not exist according to the terms of the policy.” The idea is that an estoppel can only waive a condition or exclusion; it cannot create coverage greater than that which the policy would provide without the condition or exclusion. Although the limitation now takes its name from the 1955 decision of the North Carolina Supreme Court in Hunter v. Jefferson Standard Insurance Co.,11 it was already well established in 1955. The Hunter court cited the leading legal digests and numerous cases as authority for the limitation. The basis of the limitation is evidently an attempt to conform the estoppel to the principles of classical contract. Classical contract regarded the policy as the contract no matter how unrealistic it was to think that the insured actually contracted on the basis of its content. Therefore, the policy overrode anything to the contrary that the insurer may have had led the insured to expect. Moreover, the parol evidence rule for-

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bade the insured to even introduce evidence of any oral or written statements the insurer may have made prior to the sale of the insurance. As Jerry points out, however, the limitation is illogical. It would eliminate the estoppel entirely if it were taken literally; any estoppel creates coverage where otherwise there was none in the sense that it allows the insured to recover on the insurance where otherwise he would not have been able to do so. Moreover, short of taking the limitation literally, there is no principled stopping point, so the result has been a steady erosion of the limitation. Jerry concludes that although the Hunter limitation is still the majority rule, the broad allowance of estoppel seems destined to displace it in the near future.12 It was the unrealistic assumptions underlying classical contract that must have driven judges to create this limitation. Presumably they did not want to prohibit all estoppels, as classical contract logically would require, so they went as far as they felt they could by allowing estoppels subject to the limitation. Moreover, even the requirement that the insured show some detrimental reliance is illogical. A promisee’s detrimental reliance on a promisor’s promise constitutes a substitute for consideration when consideration is lacking and thus makes the promise enforceable despite the absence of consideration. However, in the situations in which this estoppel operates, consideration is not lacking. The insured has paid the premiums, or at least promised to pay them. Thus, the estoppel doctrine in insurance logically reduces to the doctrine of reasonable expectations. The doctrine serves to prevent injustice despite its illogical foundations. Many judges seem more comfortable with it than with the newer doctrine of reasonable expectations. It does not so directly challenge their received notions, and it possesses the evident fairness of protecting the insured’s justified reliance. The older treatises on insurance law that are still in print give it a lengthier treatment than they give reasonable expectations,13 while the newer treatises emphasize reasonable expectations.14 However, the estoppel doctrine is surely destined to disappear into the doctrine of reasonable expectations, because the newer doctrine makes the older one unnecessary.

Employment Contracts The employment relationship was a primary target of the freedom of contract principle. Courts often interpreted employment contracts to be terminable at the will of either party even when they expressly promised employment for life or other tenure rights. The U.S. Supreme Court forbade legislatures from improving wages or working conditions on constitutional grounds during the Lochner era. Consequently, it should not be

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surprising that employees were among the chief beneficiaries when classical contract began to change. Lawrence E. Blades was the first to discover the new employment cases. In 1967, he reported that courts were taking two new approaches.15 In one, they counted it a tort for an employer to violate a well-established public policy in taking adverse action against an employee. I will treat these cases in Chapter 4. The other approach Blades reported was similar to that which Keeton had discovered courts taking in insurance cases. Courts were inferring employment contracts from the employer’s conduct and informal expressions of intent even if the implied contracts contradicted explicit provisions in the formal written contracts and even if the employer accompanied its conduct or informal expressions of intent with explicit disavowals of contractual intent. In one case, for example, the court enforced seniority rights which it found in the employer’s personnel manual although the manual expressly stated its provisions were without legal effect. The court said the employer ought reasonably to have expected the employees to rely on them anyway.16 Many more jurisdictions have taken a reasonable expectations approach to employment contracts since Blades first reported the trend.17

Origins and Justifications in General Contract Law Although Keeton’s analysis and support greatly accelerated the development, courts originated the reasonable expectations doctrine in insurance law and have continued to lead its development there. Scholars, on the other hand, originated the development in general contract law. But of course scholars cannot literally originate a law; they can only propose that courts or legislatures make it. Another difference between scholars and courts is that when scholars originate proposals, they usually work out the justifications before the proposals become law; they have to, as a practical matter, in order to convince the courts or legislatures to make them into law. Therefore, whereas I treated the origins and justifications of reasonable expectations separately for insurance, I will treat them together for general contract law. Karl N. Llewellyn and Friedrich Kessler made the first contributions. Llewellyn first characterized the problem with the standard contract as the consumer’s lack of consent in 193918 and elaborated on the point in 1960,19 but he made no proposals for changing the law in either writing. Llewellyn’s great achievement was the creation and enactment of the Uniform Commercial Code. He put his proposals for changing the law of contract into the Code insofar as he could. I will explain later how the Code and reasonable expectations each influenced, and was influenced by, the other.

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Kessler’s contribution was a long and masterful socioeconomic analysis of how and why businesses use standard contracts, published in 1943.20 He included a proposal for changing the law, which he phrased in the deferential manner that was then characteristic of legal scholarly writing: In dealing with standardized contracts courts have to determine what the weaker contracting party could legitimately expect by way of services according to the enterpriser’s “calling,” and to what extent the stronger party disappointed reasonable expectations based on the typical life situation.21

A reader in 1943 presumably would have realized that Kessler was proposing that courts ignore the terms of standard contracts and give effect instead to the consumer’s reasonable expectations based on the “typical life situation” and the producer’s “calling.” However, although legal scholars have come to regard the article as a classic, the proposal never generated the kind of discussion and support it needed to become law. Apparently the only court decision to cite it is one by the California Supreme Court in 1966, using it to support an application of contra proferentem.22 Arthur Allen Leff made the next contribution in 1970 in “Contract as Thing.”23 Leff showed that in many of the situations in which people used standard contracts, the consumers thought of them not as contracts but as the things they had purchased. According to Leff, for example, purchasers of insurance typically thought of the insurance policy as representing the insurance itself rather than as the contract by which they purchased the insurance. One result of this attitude was consumers’ acceptance of their inability to change the contractual terms. According to Leff, a purchaser of insurance would no more try to change the terms of the policy than a purchaser of an automobile would try to change the automobile’s engine design or body shape. Thus, Leff thought, the problem with standard form contracts was the consumers’ failure to engage in term-by-term bargaining; they accepted the contracts as they were, as though they were “things.”24 Leff’s observation was accurate, but he attached the wrong significance to it. Standard contracts do indeed discourage term-by-term bargaining, but contract law does not make the validity of a contract depend on the parties’ negotiating it term by term. People often make even nonstandard contracts without bargaining term by term, such as the contracts they make by accepting offers that were made by mail, in catalogues, or in media advertisements. The only necessary element of a contract that standard contracts characteristically lack is the consent of both parties, as Llewellyn realized. People can consent to a contract without having bargained term by term. Leff’s proposed solution was for law teachers and others to start calling standard contracts “things.” He hoped this would eventually persuade legislators to create administrative agencies for regulating the terms of standard contracts, just as they had already created administrative agencies

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for regulating the content and qualities of other “things.” Administrative agencies already regulated the content and qualities of foods, drugs, and various services, for example.25 The weaknesses in this solution are apparent. The law is not importantly changed just by renaming things; at least it never has been. It would require a huge and consequently very expensive bureaucracy to provide meaningful oversight of all the standard contracts in common use, and there is no assurance that it would be effective. Administrative agencies have been regulating the terms of insurance contracts for more than fifty years now. Yet it has been the courts, not the agencies, that have made progress toward solving the standard form problem for insurance. I published articles on standard contracts in 1971 and 1974. The first and more important was “Standard Form Contracts and the Democratic Control of Lawmaking Power.”26 The second carried my analysis further and made some applications specific to California law.27 I began with what I believed was the first principle of democracy, that a person not be governed without his or her consent. A contract is a form of private governance. It governs the parties after they have made it. Therefore, a contract is not a democratic government unless both parties consented to it. The classical definition of a contract is to the same effect, that a contract is the parties’ manifestations of mutual assent.28 However, this does not mean that a contract must receive the parties’ actual consents. It is enough if each party has given the other reasonable grounds for thinking he has given his consent. Contract law refers to this as the parties’ “objective manifestations” of consent.29 The law grounds all consensual processes on manifested rather than actual consent. Voting is an example. A person who drops a ballot in a ballot box or raises a hand during a floor vote cannot retract the vote later on the ground that he thought the ballot box was a wastebasket or that he was only reaching for his hat. One has to determine consent objectively for any situation in which the consent of one person affects another person’s rights. First, I asked whether it was reasonable to conclude that the typical standard contract receives both parties’ objectively manifested consents. I concluded it did not, for the reasons I set out in Chapter 2. Producers and others who provide standard contracts generally cannot reasonably expect the consumers to read them, understand them, or appreciate the significance of their terms. Many societal conditions have contributed to this situation, but the chief one is technology. Consumers are no longer capable of understanding the products they buy well enough to protect their interests in the contracts by which they buy the products. If the consumer does not objectively consent to the standard form, is there anything to which he does give his objective consent when he buys or contracts for something? This is a factual question, the answer to which

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depends on the facts of the case; however, the word I chose to describe that to which the consumer gives his consent was the same word that Keeton had chosen: the consumer’s “reasonable expectations.” I went on to say that the consumer’s reasonable expectations are also the producer’s, because a reasonable producer knows what the consumers who buy its products will expect. Therefore, one can properly speak of the parties’ reasonable expectations without distinguishing between consumer and producer, at least as a rule. Thus my reasoning and Keeton’s analysis of insurance decisions led to the same result. Although I began with the consent principle, the consent principle led me to the principle of reasonable expectations, which was where Keeton began. In addition, I went one step further than Keeton had. I concluded that the reasonable expectations are the contract, because it is to them, rather than to the standard form, that the parties give their manifested consent. Under my analysis, there is no need to search for justifications for the doctrine, as Abraham, Keeton and others had thought there was. The doctrine is not really a doctrine after all; it is a conclusion one should reach by logical application of the principles of contract law. There is no more need to justify enforcing the parties’ reasonable expectations than there is to justify enforcing any contract. Nonetheless, I added some economic justifications. Reasonable expectations or something like it is necessary if the product qualities that the consumer could not otherwise understand are to receive the benefits of competition. If producers are able to enforce contract terms even if consumers do not reasonably expect them, the producers whose contract terms provide consumers with less are not penalized by selling less, and the producers whose contract terms provide consumers with more are not rewarded by selling more. The tendency, as I explained in Chapter 2, is to reduce all the producers’ contract terms to the level of those that are least favorable to the consumer, because the producers that use the less favorable terms obtain a costless benefit. Their terms do not cost them any sales, and they save the costs of providing whatever the more favorable terms would provide the consumer. Reasonable expectations, on the other hand, holds a producer liable for delivering an inferior product unless consumers expect the product to be inferior, and if consumers expect that, the producer will sell fewer products—unless it offers what the consumers consider to be sufficient compensating advantages, such as lower prices. The necessity of choosing between losing sales because one’s products are inferior and incurring the costs of making one’s products equal or superior is, of course, competition. The members of the law and economics school of legal scholarship should become supporters of reasonable expectations when they come to understand this.

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The insurance industry has used standardization of contract provisions to increase competition. Congress has exempted insurance from the federal antitrust laws to the extent the states regulate it. All states regulate insurance, but the regulation generally allows insurers to compete if they choose to, and competition is often vigorous. However, insurers have agreed on standard formulations for many policy provisions, and state regulators and legislatures have mandated many others. One of the rationales of the standardization is that it increases competition by making it easier for the consumer to tell which brand of insurance is the better bargain. Of course, it is the one that has the lowest price if all the provisions are standard.30 Standardization does indeed facilitate price competition, but at the cost of eliminating competition in the standardized provisions. Standardization is also inferior to reasonable expectations in that it does nothing to inform consumers about what they are buying. Although Keeton’s articles, Leff’s article, and my first article all came out within a year of one another, we all wrote in ignorance of the others’ contributions. Keeton’s articles appeared first. Leff and I did not read them because we thought of Keeton only in connection with torts and insurance. Leff’s articles and mine were each submitted before the other’s appeared. The similarities among our three contributions and the proximity of their appearances must be attributable to the zeitgeist. The time had come for scholars to reassess the principles of contract law in the light of the widespread use of standard forms. The only systematic analysis of standard contracts after 1974 was a 1983 article by Todd D. Rakoff.31 Rakoff concluded that standard contracts should be presumptively unenforceable, but he reached no clear conclusions about how the producer might rebut the presumption. He did say, however, that solutions to the standard contract problem would not be found in contract law but would require “a new legal structure.”32 He rested this conclusion on his analysis of the solutions others had offered, all of which he found inadequate, plus his confessed inability to come up with any good solutions of his own. However, he overlooked or misinterpreted the solutions almost everyone else had offered. He misinterpreted my first article, overlooked my second, overlooked Keeton’s, Abraham’s, and everyone else’s writings on reasonable expectations in insurance, and overlooked Blades’s article on the new approaches to employment contracts. He misinterpreted my article by assigning my proposals for dealing with the consumer’s lack of understanding to the conclusions I had reached about the quite different problem of the legitimacy of contracts that one party had no choice but to accept. It is not surprising that he thought my solutions would not work. Although the scholars I have named were the chief sources of reasonable expectations in general contract, they were not the only sources. The insur-

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ance decisions have been another source. Many courts adopted reasonable expectations for general contract after or as soon as they adopted it for insurance simply because they realized that there is no principled ground for limiting it to insurance. In still other cases, courts have construed a contract exactly as they would have done by using reasonable expectations without evidencing an awareness that this was what they were doing. I count these cases as additional sources of reasonable expectations because all it should take to make them literally reasonable expectations is my pointing out that this is what they amount to. The first of these other sources I will describe is one that, ironically, originated as an attempt to prohibit courts from denying contractual effect to standard forms in order to construe the contract on the basis of the parties’ reasonable expectations.

The Restatement (Second) of Contracts The Restatement (Second) of Contracts, which was published in 1981, includes just one section, Section 211, dealing with contracts by standard form. Section 211 has favorably influenced the development of reasonable expectations despite the fact that courts have generally misinterpreted it. The section was drafted in early 197033 by people who were not—and given that Keeton and I first published in late 1970 and 1971, could not— have been aware of the scholarly literature on reasonable expectations. Robert Braucher, the first Reporter for the Restatement, drafted the section. He resigned his position as Reporter the following year in order to become a member of the Massachusetts Supreme Judicial Court, and apparently no one looked at the section again before the Restatement was published in 1981. Unfortunately, however, people since have generally assumed that the section takes reasonable expectations into account, presumably because the development of reasonable expectations was well under way when the Restatement was published. Section 211 appears in Topic 3 of the Restatement’s Chapter 9. Topic 3 deals with the parol evidence rule. The parol evidence rule operates if, and only if, the written contract is an “integrated agreement,” which is an agreement the parties intended to be their final and complete expression of agreement on the subject. Section 211 reads as follows: § 211. Standardized Agreements (1) Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing.

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(2) Such a writing is interpreted wherever reasonable as treating alike all those similarly situated, without regard to their knowledge or understanding of the standard terms of the writing. (3) Where the other party has reason to believe that the party manifesting such assent would not do so if he knew that the writing contained a particular term, the term is not part of the agreement.

Subsection 1 states the rule for determining whether a standard contract is an integrated agreement. Subsection 3 states an exception to the rule of Subsection 1. Subsection 2 has nothing to do with the parol evidence rule. The record of the proceedings shows that Braucher included it for other reasons and that the members of the American Law Institute who were present when Braucher presented the section paid no attention to it.34 In effect, Subsection 1 makes a standard contract an integrated agreement if the recipient has reason to believe it is a standard contract. Because a recipient would have reason to believe this in virtually every case, the subsection makes standard contracts subject to the parol evidence rule virtually per se, a dubious honor the Restatement confers on no other kind of contract. Thus, Subsection 1 makes the recipient’s reasonable expectations less capable of overriding standard contracts than contracts that are not standard. Braucher twice explained why he had drafted subsection (1) as he did: When I came to put [the section] . . . together, . . . I stated first a rather reactionary proposition . . . that when you agree to a standard agreement, you agree to it, and that means everything that’s in it, subject, of course, to qualifying terms.35 Primarily I have talked about standardized agreements, and I think I regarded this as a good opportunity and a good place to write something in favor of these contracts, which seem to me to be essential to human life. I mean, one of the things we need is freedom from choice and freedom from information. (Laughter) We’re all absolutely swamped with things we would rather not know about, and it seemed to me a chance to say that was something worth having this in for.36

Braucher did not explain why he thought his proposition was “rather reactionary,” but in fact it was, even in 1970. Llewellyn had opined that the recipient gives a standard contract only “a blanket assent (not a specific assent) to any not unreasonable or indecent terms . . . , which do not alter or eviscerate the reasonable meaning of the dickered terms.”37 Moreover, there was also the doctrine of unconscionability, which the Code had recently introduced. Neither Llewellyn’s opinion nor the Code’s new doctrine gave the recipient’s agreement the sweeping effect that Braucher’s “rather reactionary proposition” gave to it. Moreover, Subsection 3 provides only a narrow exception. Braucher explained that he had originally drafted the subsection to refer to “bizarre or

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oppressive terms” but had omitted the reference at the suggestion of Charles Hastings Willard;38 however, the purpose was still to provide a defense against the inclusion of bizarre or unusual terms to which the recipient’s objections were known, although these terms would not have to be unconscionable. Some of the other participants at the session pointed out that the subsection does not require that the terms be bizarre or unusual, but Braucher never revised or retracted his statement about the subsection’s purpose,39 and even repeated it later in the session.40 Ironically, the little effect the section has had on contract law has largely supported reasonable expectations. The highest courts of Arizona,41 Iowa42 and Massachusetts43 cited the section as support for adopting the doctrine. The Iowa court virtually equated the section with the doctrine in an early decision,44 although it went on later to give the doctrine its usual definition without trying to square it with the section.45 All the other highest-court decisions adopting the doctrine ignored the section. The only scholarly comment of which I am aware that deals with the effect of the section on reasonable expectations is Henderson’s, and he comes to the conclusion that although the section presents major difficulties, on the whole it has helped by demonstrating the American Law Institute’s support!46 The effect has not all been supportive, however. A federal district court47 and the U.S. Court of Claims48 have cited Section 211 as authority for refusing to follow the doctrine, although each decision also rests on the particular facts of the case.

Contracts of Adhesion Edwin W. Patterson characterized standard contracts as “contracts of adhesion” in 1919.49 Only continental lawyers had used the name before Patterson imported it.50 Kessler’s classic 1943 article on standard contracts also used this name.51 We saw that Rakoff also used the term with this meaning in 1983. Of course this meaning of “contract of adhesion” makes it nothing more than a marker for using the doctrine of reasonable expectations, which is how the courts of California52 and Nevada53 use it. The Supreme Court of Hawaii used the term in this sense in a 1990 decision,54 but on all other occasions it seems to have said simply “standard contract.” There are lower-court decisions using “contract of adhesion” to mean simply a standard contract in Kansas,55 Missouri,56 and Pennsylvania.57 On the other hand, other writers have given the term a different meaning. They have used it to mean a contract prepared in advance by one party and offered to the other on a take-it-or-leave-it basis, which the other party has no reasonable alternative but to accept. For example, a contract prepared by an electric public utility and offered to its subscribers on a take-it-or-leave-

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it basis would be a contract of adhesion in this sense, if the utility were the only provider of electricity in the area.58 Terms in a contract that a person accepts because he had no alternative do not receive the person’s consent, because consent must be voluntary. A contract of adhesion in this sense is not enforceable as such even if the party with no choice reasonably expected it. Whether the contract is enforceable in this case depends upon whether there are some noncontractual grounds for enforcing it. Approval by the relevant public utility regulatory commission would constitute such a ground, for example. There are decisions using “contract of adhesion” in this sense in Alaska, Colorado, Illinois, Michigan, Minnesota, New Jersey, New Mexico, South Dakota, and Texas.59

Unconscionability Almost every state had enacted the Uniform Commercial Code by the end of the 1970s, and most had done so by the end of the 1960s. The most important change in contract law that Article 2 of the Code introduced was the doctrine of unconscionability. Courts generally adopted unconscionability into the common law of contract almost as soon as their state legislatures enacted the Code. Generally speaking, unconscionability denies enforcement to a contract term that is very unfair to one party if that party did not have a reasonable opportunity to read and understand the term before committing to the contract. The similarity of the second part of the doctrine to reasonable expectations is apparent. If a person had a reasonable opportunity to read and understand the term, he would reasonably expect it, and if he did not have such a reasonable opportunity, he might not reasonably expect it (although he would still reasonably expect it if it stated something widely understood or ordinary). But the first part of the doctrine distinguishes it from reasonable expectations and makes it much less effective against abuses of bargaining power. Whereas reasonable expectations gives the consumer his reasonable expectations in every case, unconscionability requires the court to conclude that the contract or contract term will operate very unfairly against the consumer in the particular case, and the consumer has the burden of persuading the court to reach this conclusion. The result is that unconscionability decisions are too particularized to the facts of the case to constitute precedents, and the doctrine fails to generate any sizable body of law to protect consumers. Nevertheless, their similarities made unconscionability and reasonable expectations each into a support for the other. Many of the early reasonable expectations decisions also rested on unconscionability, for example.60

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Article 2 of the Uniform Commercial Code The courts have also taken approaches similar to reasonable expectations under sections of Article 2 that they did not adopt into the common law of contract. One of these is Section 2-207, which Llewellyn intended to determine the contract the law would deem the parties to have made if each of them sent his own standard forms to the other. The first two subsections of 2-207 provide for composing the contract out of parts of each party’s forms, although the forms do not match, if the parties are deemed to have reached an agreement on the basis of them. Subsection 3 provides for making the contract if the parties did not reach an agreement on the basis of their forms but proceeded as though they had a contract anyway. In essence, Subsection 3 provides that the contract is composed of the parties’ forms insofar as they match and of “supplementary terms incorporated under any other provisions of [the Code]” insofar as the forms do not match. Courts have interpreted the quoted phrase as referring to what are commonly called the Code’s “gap-filler provisions.” These provide for parts of the contract upon which the parties have not agreed. Some of them are quite specific, such as the provision setting the place of delivery if the contract does not specify one, but even the specific provisions are invariably qualified by a statement such as “unless circumstances indicate otherwise.” Most of the gap-filler provisions are very vague, doing no more than referring the court to the facts of the case it is deciding. For example, the gap-filler for the price says the price shall be a “reasonable price at the time of delivery.” In either case, the court proceeds as if it were following the reasonable expectations doctrine: it fills the “gaps” with the parties’ reasonable expectations. Courts have been increasingly deciding cases under Subsection 3 rather than under the other subsections, because the results under the other subsections are arbitrary. Courts are also deciding cases under Section 2-207 even if only one party uses a standard form.61 If all these trends continue to their logical conclusions, the result will be that reasonable expectations will apply to all contract formations under the Code, in effect if not in name, so long as at least one party uses a standard form. Courts have also used reasonable expectations, in effect, under Section 2-316, the warranty disclaimer section, and Section 2-719, the section dealing with limitations of remedies. Section 2-316 generally invalidates warranty disclaimers unless they are clear and conspicuous;62 if they are clear and conspicuous, the buyers will ordinarily have reasonably expected them. Section 2-719 does not include a clear-and-conspicuous requirement, but courts have nevertheless read it into this section.63

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The Covenant of Good Faith and Fair Dealing The so-called covenant of good faith and fair dealing will be treated in Chapters 4 and 5, because it played a major role in the evolution of the relational torts and the tort of bad faith breach. I will also briefly mention it here, because it played a minor role in the evolution of reasonable expectations. Contract law has traditionally required a person to perform a contract in good faith. The courts sometimes express this requirement by saying that every contract implies a covenant of good faith and fair dealing. The covenant was traditionally limited to prohibiting people from taking unfair advantage of literal readings of their contracts. In Patterson v. Meyerhofer,64 for example, the contract provided that Patterson would purchase certain properties being auctioned as inexpensively as he could and that Meyerhofer would repurchase them from him for a total price of $23,000. Patterson was betting he could purchase the properties for less than $23,000, and Meyerhofer was willing to pay $23,000 for getting the properties at that price with no risk of having to pay more. The contract did not say that Meyerhofer would refrain from bidding at the auction herself, but she did bid, and she succeeded in getting the properties for less than $23,000. Presumably if she had seen that she could not get the properties for less than $23,000, she would have let Patterson buy them. Thus, if one read it literally, Meyerhofer had trapped Patterson in a contract from which she could only profit and he could only lose. Patterson sued her for the profits she prevented him from making and won, on the ground that Meyerhofer violated the covenant of good faith and fair dealing.65 The courts in recent decades have expanded the covenant to include situations in which even a fair reading of the contract would permit a party to act unfairly. All these decisions, to my knowledge, involve standard forms, in which the party supplying the standard form did not bring the attention of the other to the provisions concerned or in which the party supplying the form could not reasonably have expected the other to understand the provisions. Thus, the courts used the covenant to give recipients of standard forms what they reasonably expected although the provisions in the forms would have defeated those expectations. For example, in Silberg v. California Life Insurance Co.,66 a 1974 decision, the disability insurance policy allowed the insurer to withhold payments until the insured and the appropriate authorities had resolved the question of the insured’s entitlement to workers’ compensation benefits. The plaintiff and the authorities were unable to resolve this question for almost two years, during which the plaintiff was compelled to lie and use

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other subterfuges to obtain medical treatment, because he could not pay for it. He suffered two nervous breakdowns and was eventually financially ruined. The Supreme Court of California held that the insurer had violated the covenant of good faith and fair dealing as a matter of law. The policy application form declared in large, heavy type, “Protect Yourself Against the Medical Bills That Can Ruin You.” This was the protection the plaintiff reasonably expected to get. The provisions in the policy allowing the insurer to withhold payments until the question of workers’ compensation benefits had been resolved were not enforceable because under the circumstances they conflicted with this expectation.67

Unknowing Uses Courts have also occasionally used reasonable expectations without knowing it.68 Judge Richard A. Posner’s opinion for the U.S. Court of Appeals for the Seventh Circuit in Morin Building Products Co. v. Baystone Construction, Inc.69 is an example. Baystone was the general contractor to build an addition to the General Motors Chevrolet plant in Muncie, Indiana. Morin was a subcontractor, engaged to supply and erect the aluminum walls. The contract required that the exterior siding of the walls be of “aluminum type 3003, not less than 18 B & S gauge, with a mill finish and stucco embossed surface texture to match finish and texture of existing metal siding.” The contract also provided: [A]ll work shall be done subject to the final approval of the Architect or Owner’s [General Motors’] authorized agent, and his decision in matters relating to artistic effect shall be final, if within the terms of the Contract Documents. . . . [S]hould any dispute arise as to the quality or fitness of materials or workmanship, the decision as to acceptability shall rest strictly with the Owner, based on the requirement that all work done or materials furnished shall be first class in every respect. What is usual or customary in erecting other buildings shall in no wise enter into any consideration or decision.70

When viewed from an acute angle in bright sunlight, the exterior siding that Morin erected did not give the impression of having a uniform finish. General Motors rejected it after Morin had erected it, required Morin to tear it down and remove it, and obtained another contractor to build another. Morin argued that there were no objectively reasonable grounds for the rejection: there was nothing to show that the walls were to serve anything other than a strictly utilitarian purpose, and the trade usage of “mill finish steel” meant “‘sheet having a nonuniform finish which may vary from sheet to sheet and within a sheet, and may not be entirely free from stains or oil.’”

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Indiana law enforces a subjective standard of satisfaction if the contract provides for it, even if the subject matter is susceptible to an objective evaluation. A subjective standard requires only that the expression of dissatisfaction be honest. Morin presented no evidence that the General Motors representative’s expression of dissatisfaction was not honest. The district court nevertheless held for Morin, and the court of appeals affirmed. The court of appeals reasoned that although the language quoted above may have been sufficient to express an intention to have a subjective standard of satisfaction, the district court judge was right to ignore it. It appeared only as item 17 in a list of conditions in a general purpose form contract. This in turn was incorporated by reference into the form contract the parties used, in which it appeared as Paragraph 35. Under these circumstances, the court of appeals concluded: We do not disparage form contracts, without which the commercial life of the nation would grind to a halt. But we are left with more than a suspicion that the artistic-effect and quality-fitness clauses in the form contract used here were not intended to cover the aesthetics of a mill-finish aluminum factory wall.71

Judge Walter E. Hoffman’s opinion for the U.S. Court of Appeals for the Ninth Circuit in Nanakuli Paving and Rock Co. v. Shell Oil Co.72 is another example. Nanakuli signed a long-term requirements contract with Shell for the asphalt Nanakuli would use for its paving contracts for the public roads and highways of the island of Oahu. The contract provided that the price of the asphalt would be Shell’s posted price at the time of delivery. However, Nanakuli showed at trial that it was the practice in the paving trade on Oahu for suppliers of asphalt, aggregate, and other paving materials to provide “price protection” to their customers. A paving contractor could take as much as two years to perform a paving contract, but the government agencies that let the contracts required that the contractor perform for the price at which it was awarded the job despite any increases that might occur in the prices of paving materials before the job was finished. Under price protection, a supplier would provide a contractor’s requirements for a paving job at the posted price in effect when the contractor bid for the job, regardless of what the posted price might be at the time of delivery. Nanakuli also showed at trial that Shell had given it price protection on the only two prior occasions when it needed such protection under its requirements contract. The district court gave judgment for Shell despite a jury verdict in Nanakuli’s favor. The court of appeals reversed and reinstated the verdict on the ground, among others, that “agreement” as the Code defines it73 “is broader than the written paper” of the contract and includes all the circumstances under which the contract was made, including any relevant trade practice or usage.74 The court’s argument is illogical if one accepts the principles of

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classical contract, and the Code sections the court cited do not support the argument. The only intent those sections evidence is to reject the old “four corners rule,” under which a court would interpret a written contract without regard to the circumstances under which the parties made it. On the other hand, the court’s argument makes good sense if one accepts the principle of reasonable expectations, and a reading of the whole opinion suggests that this is the spirit in which the court made the argument. The evidence showed that neither party paid attention to the written provisions about price at the time of delivery, but that until a new man took charge of Shell operations on Oahu, both parties assumed Shell would give price protection to Nanakuli.

Acceptance The principle of reasonable expectations has been a part of American contract law at least since the adoption of the objective theory of contract around the turn of the century. The principle has grown in importance since to become probably the most important principle in contract law. Section 1 of Arthur L. Corbin’s great treatise on contract, first published in 1950, is titled “The Main Purpose of Contract Law Is the Realization of Reasonable Expectations Induced by Promises.”75 Corbin’s assertion was allinclusive. He was not just saying that contracts should be interpreted to give effect to the parties’ reasonable expectations. He meant to include the whole law of contract: the grounds of enforceability, the excuses of performance, the damages measures, the allowances for assignment and delegation, the recognition of the rights of third parties—everything. The principle manifests itself in the damages measures by making the expectation measure the norm, for example. Although Keeton and I did not discover or devise the principle of reasonable expectations in 1970, we did discover or devise some radically new applications of it. No one had thought before that the parties’ reasonable expectations should override the standard contract, as Keeton discovered the courts using them in some insurance cases, nor had anyone thought before that the parties’ reasonable expectations were the contract, as I concluded they should be. Although a few of the decisions Keeton discovered were as far back as the late 1950s, no court accepted my suggested application of the principle until the Iowa Supreme Court accepted it in C & J Fertilizer, Inc. v. Allied Mutual Insurance Co.,76 a decision it handed down in 1975. In this instance, there was no gap between the court’s accepting the principle for insurance and its accepting it for general application. Although the Iowa Supreme Court had once used the weak version of the principle in an insurance case,77 C & J was the first time it used the

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strong version, and the court accepted it in its general application. More precisely, although the court’s opinion accepted the general application, only three of the five justices who joined in the opinion agreed to go so far. The other two only accepted the principle for insurance. The three justices who agreed to the general application were W. W. Reynoldson, who wrote the opinion, David Harris, and Mark McCormick. A majority of the Iowa Supreme Court accepted the principle for general application in 1981.78 C & J involved burglary insurance. The plaintiff’s store was burglarized over the weekend when it was not open for business. The evidence of burglary included marks of forceful entry on some interior doors. No such marks appeared on the exterior doors despite unrefuted evidence that they had been locked before the weekend closing. However, there was also evidence that the burglars could have forced open the exterior doors without leaving marks. The insurance policy was entitled, “BROAD FORM STOREKEEPERS POLICY” and “MERCANTILE BURGLARY AND ROBBERY POLICY,” but it contained provisions defining burglary as only a felonious entry that left “visible marks” on the exterior of the premises. The agent who sold the insurance to the plaintiff had told him there would have to be some visible evidence to distinguish a true burglary from an “inside job,” but when the insurer denied coverage for this burglary, the agent expressed “complete . . . surprise” and testified at trial for the plaintiff. Justice Reynoldson’s opinion held for the plaintiff on three grounds: breach of warranty, reasonable expectations, and unconscionability. The policy definition contradicted the common meaning of “burglary,” and because the defendant had not informed the plaintiff beforehand of its intention of literally enforcing the definition, the plaintiff could reasonably have expected that the insurance he was buying would cover burglaries in the common meaning of the term. The insurer therefore implicitly warranted that the policy covered burglaries as they are commonly understood (the breach of warranty grounds). Likewise, the plaintiff could reasonably expect the policy to cover burglaries as they are commonly understood (the reasonable expectations grounds), and the policy definition of “burglary” was unconscionable. Justice Reynoldson took the breach of warranty ground from my 1971 article. I did not limit it to insurance in the article, and he did not limit it to insurance in the opinion. The unconscionability grounds was also not limited to insurance, because the unconscionability doctrine applies to all contracts. Justice Reynoldson did not even limit the reasonable expectations ground to insurance, although he only cited insurance cases (from other states) as precedents for it. Rather, he rested this part of the decision primarily on Section 211 of the Restatement (Second), which applies to all standard contracts. Henderson’s 1990 article regards C & J as one of the most important decisions in the principle’s development in insurance up to

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that time.79 I would say that it is the most important decision in the principle’s development for all contracts to date, because it so clearly explains and justifies the grounds on which it rests. Its only rivals on the present subject are two opinions by Justice Stanley G. Feldman of the Supreme Court of Arizona,80 which Henderson also admires.81 Eleven of the sixteen jurisdictions Henderson counted in 1990 as adopting what he called the strong version of reasonable expectations for insurance also recognized the principle’s general applicability. Iowa and Arizona have already been noted. The others were California, Colorado,82 Hawaii,83 Montana,84 New Jersey,85 Nevada, North Carolina,86 Pennsylvania,87 and Rhode Island.88 (The California and Nevada decisions demonstrating the recognition are those that use the reasonable expectations principle under the name of “contract of adhesion,” noted earlier.) In addition, two Missouri Court of Appeals decisions apply the principle to insurance contracts but cite my article and make arguments that recognize its general applicability.89 All the implicit recognitions of the principle, for example, in decisions concerning employment contracts and in Section 2207 of the Code, were outside insurance and thus also support the general application. Simple logic also favors it. The principle protects consumers from contracts the producers could not reasonably expect them to read or understand. There is no more reason to limit the principle to insurance contracts than there is to limit it to contracts made on a Tuesday. There can be little doubt that the courts of every jurisdiction will eventually accept the principle for all contracts. Why did the courts create reasonable expectations for insurance contracts almost twenty years before they began accepting it for contracts generally? The typically greater bargaining power that insurers have relative to producers in other industries must be at least part of the answer. Many aspects of insurance are very difficult for consumers to understand, and insurance contracts are notoriously complicated. However, the greater importance of the insurance contract to the consumer relative to the importance of the contract to the consumer in other industries must also have contributed. The insurance contract is almost the whole product in itself, because the purchaser of insurance obtains almost nothing other than what the contract gives him. (One has to say “almost,” because the honesty, competency and financial soundness of the insurer are also important.) The product and the contract are separate and distinct in almost every other industry, and the consumer generally regards the product as much more important. For example, purchasers of automobiles get the automobile itself, which they presumably regard as much more important than the contract effecting the sale. The nature of insurance also makes the insurance contract of relatively greater importance. People generally buy insurance to protect themselves or others against what would other-

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wise be very large financial losses. The insurance contract is likely to be the only thing that stands between the insured person and financial ruin if such a loss eventuates. The relatively great importance of the insurance contract to the insured makes it more likely that the insured will litigate if he and the insurer cannot settle their differences, and it makes it more likely that the court will be alert to protect the insured if it suspects that the insurer may not have treated him fairly. Insurance litigation is also probably more likely to reach the appellate courts than other kinds of contract litigation, because the greater complexity of insurance contracts makes it more likely that the litigation will involve appealable issues. An informal computer sampling showed that about a fifth of the reported decisions on contracts are on insurance contracts.90 One can see that all these factors probably contributed to bringing reasonable expectations to insurance before it came to other industries by comparing insurance with industries in which some but not all of the same factors are present. For example, contracts for residential mortgages are typically much longer and more complicated than even insurance contracts, but residential mortgages are not difficult to understand (they are essentially just secured loans), and home buyers presumably regard the money the bank lent and the interest rate it charges as much more important than anything in the mortgage contract. Membership contracts of health maintenance organizations are another example. They, too, are generally longer and more complicated than insurance contracts, but HMO members presumably regard the quality and extent of the medical care they receive as more important than the written description of their rights to it in the membership contract.

Public Lawmaking and Contracting Power Reasonable expectations does not limit freedom of contract, but it limits contracting power. People remain free to set whatever terms they like in offers to contract, but the terms will become a part of any contracts they make only to the extent they could reasonably expect the offeree to understand them. For obvious reasons, this limitation has its major impact on contracting by standard form. Consumers will have accumulated a large pool of actual expectations about the products of any industry that has been in existence for more than a few years. A court can draw upon this pool of actual expectations to determine the reasonable expectations. Large areas of ignorance and only partial understanding are bound to exist, however, for the reasons stated in Chapter 2. Products in the modern world are technologically complex.

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They come in too many varieties for anyone to have anything except a superficial understanding of more than a small fraction of them. The same limitations apply to the standard contracts themselves. They, too, are frequently complex, and they, too, come in too many varieties for anyone to have anything except a superficial understanding of more than a small fraction of them. The question arises, therefore, of how to treat aspects of a contract that we cannot reasonably expect the consumer to understand. I suggested one answer in my 1971 article: we should regard the reasonable expectations as pertaining to ends rather than means.91 This is the way we regard warranties for tangible products. If a new automobile fails to start when you turn the ignition key, this is generally all you need to know to conclude that the manufacturer breached the warranty of merchantability. The end is that the car should start when you turn the key. There is no need to know the technological means by which the automobile manufacturer sought to achieve this end. Similarly, the contractual formula for varying the interest rate quoted in Chapter 2 is a good illustration of how one could take the same approach for services. Presumably, the purpose of the formula was to protect the lender against losses from rising market interest rates and to provide the borrower with the gains from falling market interest rates, but not to provide either a windfall at the other’s expense. The reasonable expectations were therefore that the formula would in fact achieve these results. If the particular interest rate measures the formula used failed to do this, to the borrower’s disadvantage, one should regard the failure as a breach of the borrower’s reasonable expectations. One can logically reach this result without supposing that the consumer (i.e., the borrower) knows anything about how the formula works. It is enough that he would reasonably expect it to achieve the results described. Viewing reasonable expectations as relating to ends rather than means greatly increases contracting power, but contracting power is still not unlimited. Questions will still arise that one cannot answer even by regarding reasonable expectations as ends rather than means. At this point, contract law should cease. A court can no longer rest its decision on the parties’ manifested consents. Some public lawmaking institution will have to make the law for governing transactions beyond this point. We should frankly acknowledge this fact, not hide it under a cloak of contrived “reasonable expectations.” In fact, public institutions have been making much of the law that is ostensibly contract on certain subjects for over a century. For example, public law governs many aspects of the relationships of debtor and creditor92 and of insurer and insured.93 The standard insurance policy in current use for business liability shows why this supplementation by public law is necessary.94 The Insurance Services Office drafted the policy to com-

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ply with the plain language laws many states have enacted. We can therefore fairly attribute any difficulties of understanding that remain to the inherent difficulties of the subject, which clear language alone cannot overcome. The policy is divided into five sections, titled “Coverages,” “Who is an Insured,” “Limits of Insurance,” “Commercial General Liability Conditions,” and “Definitions.” Each section is written in outline form, and there are forty-three paragraphs, subparagraphs or sub-subparagraphs in all. Courts have interpreted many of the phrases the policy uses, in some instances hundreds of times. An insurer could not possibly convey all this information to a purchaser of insurance in an understandable form. No single individual fully understands it. It is a body of knowledge available only in parts, after research and study, like the knowledge in an encyclopedia. Although legislatures and administrative agencies can make some of this law, courts will have to make most of it. Most of it lies beneath the notice of a legislature, and there are too many industries for there to be a regulatory agency for each of them. One can get an idea of how courts could make this law for other industries by observing how they have made it for insurance. The insurance policy (i.e., the standard form) is the usual starting point. It presumably states the law as the insurer would like it. The lawyers for the insurer and the insured make arguments about the insured’s reasonable expectations, the parties’ and the industry’s needs, and public policies of a more general nature. The court makes the law, taking all of this into account. Precedents accumulate, treatises and reporting services extract rules and principles from the precedents, and the result is what we call “insurance law.” Weber v. IMT Insurance Co.,95 which the Iowa Supreme Court decided some years after C & J, illustrates the process. The Weber brothers raised crops and hogs. They used the hog manure to fertilize the crops and used the same machines both to transport the manure from the hog pens and to spread it on the crops. One route from the hog pens to the crops went past a farm owned by Newman. Manure dropped from the machines onto the road by Newman’s farm, and the tires also tracked the manure. The odor eventually contaminated Newman’s sweet corn, making it unmarketable. The Webers kept doing this for several years despite Newman’s protests. Newman sued them and won a judgment, and the Webers subsequently sued their insurer under their Farmer’s Comprehensive Personal Liability Policy, which covered liability resulting from “accidents.” The trial court held for the insurer, and the Iowa Supreme Court affirmed on several grounds. It was not reasonable for the Webers to expect such repeated conduct to be classified as an accident. Requiring liability insurers to pay for people’s intentionally harmful conduct would be contrary to public policy.

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The courts’ authority for making this kind of law is their constitutional authority to make common law. It does not really matter what particular category of common law (property, tort, etc.) we regard this law as falling into, except that we cannot reasonably call it contract law because courts do not derive it from the parties’ manifested consents. Most courts making or applying this kind of law in insurance cases do not bother to categorize it, except occasionally as the law of insurance, thus making insurance itself a legal category. However, courts in some of the more recent decisions in insurance cases have categorized it as tort law. These, plus decisions concerning other industries, are the “relational torts” I treat in Chapter 4. Thus, reasonable expectations and relational torts complement each other. Relational torts are the largely judge-made public laws that govern producerconsumer relationships in the respects that we cannot reasonably expect the consumer to understand. Relational torts are only “largely” judge made, because legislatures have also made some of them.

Concerns Like any major new development, reasonable expectations has given rise to concerns. One that people frequently express to me, although I have only occasionally seen it in print,96 is that the principle gives a court too much discretion. Reasonable expectations will not resolve many of the questions that will arise, because the questions will involve matters that consumers do not understand. The court will therefore have to resolve them, without legislation or anything else to guide it. But a person who believes that reasonable expectations gives a court too much discretion must logically believe that insurance law, the law of debtor-creditor relationships, and every other part of the common law give courts too much discretion—and have been doing so for some ten centuries. People have also expressed concerns to me about the effect reasonable expectations may have on the use of standard forms. If consumers will get their reasonable expectations regardless of the terms in the forms they sign, won’t forms become useless? If forms become useless, won’t producers stop using them? And if producers stop using them, won’t everyone suffer from the loss of the efficiencies they make possible? Standard forms reduce transaction costs and increase the predictability of legal obligations. Granted that producers have abused the bargaining power the forms give them, still, won’t reasonable expectations, by rendering the forms useless. throw the baby out with the bathwater? If reasonable expectations will result in less use of standard forms, it has not yet discernibly done so, and as of the mid-1990s, it has been in effect for insurance contracts for over twenty years. The insurance experience

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may not be a fair test, however, for despite the spread of the principle, there are still many jurisdictions it has not reached. An insurer can still expect to benefit in many jurisdictions from policy provisions that insureds will not read. If one is to fairly address the concern, one must assume that the principle has become so universally established that a producer cannot expect to benefit from contractual provisions that conflict with reasonable expectations almost anywhere. Will producers then still use standard forms? If not, will the reductions in transaction costs and increased predictability of legal obligations that standard forms provide be lost? Producers are likely to continue to use standard forms. First of all, they need them in order to inform consumers about their products. For example, insurers need to provide insureds with statements of their insurance coverage, the coverage limits, and what they should do if a covered loss occurs. Automobile manufacturers need to inform purchasers of automobiles of what they must do to maintain their warranty rights throughout the warranty period. Producers need forms in order to provide such information whether or not the information constitutes a legally enforceable obligation. If reasonable expectations are to attach to ends rather than means, producers will continue to need forms to state the means. The example I used to illustrate the ends-means distinction in the use of reasonable expectations also illustrates this necessity. The lender needed a form in order to state the formula for determining the variable interest rate. Otherwise, the lender and the borrower would have to negotiate the variation every time market rates materially changed, and if they could not agree, a court presumably would have to determine it for them. Stating a formula in the form is obviously much more efficient. The lender only has to prove that the formula serves the end of providing an interest rate fair to both parties if the borrower challenges it, which he will do only rarely. I noted earlier that to the extent the consumer’s reasonable expectations do not determine the outcome of the case, the court will have to decide it on the basis of the parties’ and the industry’s needs and public policy. Producers will presumably continue to use forms for provisions that reflect their and their industries’ needs and their views on the relevant public policy considerations. For example, the insurance policy in Weber included provisions limiting the insurer’s liability to “accidents” and denying its liability for an insured’s intentionally harmful conduct. These provisions reflected both the needs of the insurer and the insurance industry and the public policy considerations upon which the court relied in deciding the case. Producers will also presumably continue to use standard forms to give specific content to the consumer’s reasonable expectations. For example, even if reasonable purchasers of fire insurance would expect a requirement of prompt notification of fire damage, they might not have a clear idea of what period of time is deemed to be prompt. The policy could resolve

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the uncertainty by specifying a certain number of days. The same would be the case for the times for making warranty claims under contracts for the sale of goods. Finally, producers will continue to need forms to fix the consumer’s reasonable expectations, either to fix them with greater certainty or to fix them differently from what they otherwise would have been. Of course if a producer is to use forms for this purpose, it must bring them to the consumer’s attention before the consumer purchases the product, and they must be understandable. Insurers commonly use application forms in this manner, for example. The forms state the kind or kinds of insurance being offered in simple terms and provide boxes for the consumer to check to indicate his choices. However, although producers will undoubtedly continue to use forms, forms will be less effective for determining the producer’s legal obligations. So it might seem that the producer’s legal obligations will be less predictable. Such a result is unlikely, however. The predictability of legal obligations that forms supposedly provided before the development of reasonable expectations is largely a myth. The doctrine of contra proferentem always undercut it, and since the 1960s producers have also had to contend with the doctrine of unconscionability. Further, if goods are involved, Sections 2-207, 2-316, and 2-719 of the Code are relevant, and their effects can be unpredictable. Reasonable expectations should ultimately achieve greater predictability by largely replacing these less comprehensive and often unpredictable laws with a single, clear principle.

Division of Labor between Jury and Judge The rule has long been that the court determines the meaning of a written instrument as a matter of law, despite the more general rule that juries determine questions of fact, and the fact that meaning is largely a factual question.97 (The meaning of a contract is not entirely a factual question, because laws, such as the objective theory of contracts and the parol evidence rule, can also influence it.) There is an equally well established exception to this rule, however. If the meaning of the written instrument depends on extrinsic evidence, and credibility is an issue with respect to that evidence, the jury decides at least the credibility issue and often also the meaning of the instrument. The Restatement (Second) of Contracts proposes to expand this exception to allow juries to decide the meaning of written instruments whenever the meaning depends upon a choice of reasonable inferences to be drawn from extrinsic evidence, even if credibility is not an issue.98 Even without the Restatement’s proposed liberalization, one could argue that juries ought to determine reasonable expectations

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when they are derived entirely from extrinsic evidence. In C & J, for example, the court derived the reasonable expectations from the common meaning of “burglary.” The common meaning of a word depends exclusively on extrinsic evidence. Nevertheless, the practice, apparently without exception, is to treat reasonable expectations as a question of law for the court’s determination. Four of my research assistants examined all the decisions involving reasonable expectations they could find in a single jurisdiction. None of them found a decision in which the jury determined the reasonable expectations. The practice is a wise one. Determinations of reasonable expectations will not constitute precedents unless courts make the determinations, and unless there are precedents, people will have to litigate the same questions over and over again. Jury determinations are not precedents, and even if they were, appellate courts, which create most precedents, do not use juries. Moreover, the kinds of facts required for determining reasonable expectations are generally just as accessible to an appellate court as they would be to a jury. They rarely depend on credibility, and they rarely relate just to the case at hand. C & J again makes a good illustration. Nothing made the common meaning of “burglary” any different for the parties to the case than it would have been for any reasonable person in any situation. The traditional credibility exception should apply for reasonable expectations, however, just as it applies for determining the meanings of written instruments. For example, if the consumer claimed that the person who sold him the product said something about it that influenced his reasonable expectations, the jury should decide whether the salesperson really said it, and if so, whether it really influenced the consumer’s reasonable expectations as he claimed. Juries are as justified in deciding credibility issues in reasonable expectations cases, as they are in cases involving the meaning of written instruments. Such decisions rarely require any technical or special knowledge of the product or industry. Such decisions do not become precedents. Appellate courts are not generally competent to redetermine them on a written record. Under the U.S. Constitution and most state constitutions, a party is entitled to have a jury make such a decision if the case is otherwise one in which a party is entitled to a jury trial.

The Effect of Special Knowledge Keeton and Widiss ask in their treatise whether insurance purchasers who know something to their disadvantage that a purchaser generally would not know, ought to be required to accept the disadvantage because they reasonably expected it. They answer in the negative, presenting several arguments. Consumers should never be disadvantaged by their special knowl-

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edge. The insurer presumably set the insurance premiums high enough to cover the costs of the ordinary purchaser, so the purchaser with the special knowledge has paid for the coverage. The insurer will be unjustly enriched if it does not have to pay according to the ordinarily expected coverage. Not to give the knowledgeable insured the benefit of the ordinary expectations would penalize him for being informed, and the law ought not to discourage the acquisition of information.99 Thus, for example, the insurer would have had to pay the owner of the feed store in C & J for his burglary losses even if the owner had read and understood the narrow definition of burglary in his policy before he purchased it, at least if the insurer had set the premiums high enough to cover such losses. My conclusion in the preceding section that courts rather than juries ought to continue to determine reasonable expectations except when credibility is an issue also supports this position. If courts determine reasonable expectations, their decisions are precedents, and precedents are laws. Every purchaser of a product should be equally entitled to the benefits of the laws regardless of his or her possession of information that might have led the courts to make different laws if purchasers generally had the information.

The Role of Reasonable Expectations in the Reform of Contract Law Reasonable expectations evens bargaining power. The two sources of the producer’s generally superior bargaining power are its superior knowledge of its products and its ability to draft the standard form. Reasonable expectations requires the producer to communicate its superior knowledge to consumers in ways they can understand, and it denies legal effect to the standard form except to the extent it conforms to the consumer’s reasonable expectations. Reasonable expectations is especially effective against the abuses of bargaining power that classical contract permitted by the “duty to read,” which I explained in Chapter 1. The new approach abolishes this “duty”; it denies legal effect to the standard contract except to the extent one could reasonably expect the consumer actually to read and understand it. There are limits, however. One I have already mentioned is that many products in a modern economy have aspects that one cannot reasonably expect the consumer to understand. Another, which I have not mentioned, is that reasonable expectations does not materially increase the consumer’s power in the bargaining that generally occurs over who is responsible and what that party will do about it if the product proves to be defective. The bargaining power in this case is chiefly a function of the effectiveness of the parties’ legal remedies. The developments I will treat in later chapters

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strengthen the consumer’s bargaining powers in these situations, which reasonable expectations does not reach. Reasonable expectations does not serve the second of the major purposes the reforms generally serve: it does not impose public responsibilities on producers, because it does not require them to do or not do anything they cannot avoid by contract. It is only the other reforms that impose duties producers cannot avoid by contract.

The Future of Reasonable Expectations Reasonable expectations will eventually become an integral part of contract law everywhere. Future law students will wonder how lawyers and scholars could have persisted so long in treating as contracts writings that both parties knew one of them did not read or understand. One can confidently make these predictions because the principle of reasonable expectations is basic to the law of contract. The new approach to standard form situations really amounts to no more than a recognition that the old approach violated this principle. Reasonable expectations will eventually disappear as a doctrine for the same reason. Scholars and practitioners will eventually regard it simply as a part of the objective theory of contract interpretation. A contract will always be what a reasonable person under the circumstances would think it was. It will include a writing only to the extent that this reasonable person would expect both parties to read or understand the writing.

4 Relational Torts

COURTS HAVE CREATED duties for parties to certain relationships since time immemorial, but they did not generally create them for contractual relationships until about 1960. I call these new duties relational torts. They are torts because they are imposed by law rather than by contract, and they are relational because they apply only to parties to certain relationships.1 Relational torts are similar to the duties of the common callings that courts abolished early in the nineteenth century. The duties of the common callings were also imposed by law rather than by contract, and they also applied only to parties to certain relationships. The courts abolished those duties because they were obstacles to freedom of contract. That the courts are now creating new duties so similar to them obviously evidences a new attitude towards freedom of contract. Relational torts and reasonable expectations complement each other. Relational torts are the largely judge-made public laws that govern producerconsumer relationships in the respects we cannot reasonably expect the consumer to understand. Relational torts limit freedom of contract, but always in at least an attempt to serve a public purpose or to make the contract more effective or fairer to the weaker party.

Limitations of Freedom of Contract in Classical Contract Law Classical contract did not include any relational torts, because it did not impose duties on contracting parties that could override those in the contract. It did limit freedom of contract, however, apparently in an attempt to make contracts more effective, and sometimes even in an apparent attempt to make them fairer to the weaker party. These limitations took the form of refusals to enforce certain kinds of contractual provisions. The Uniform Commercial Code also includes some such restrictions. The parties to a contract can set the amounts for which one of them will be liable if he should breach. Damages so set are “liquidated.” However, a court will not enforce liquidated damages that exceed what would have been a reasonable estimate of the loss a breach of the kind would cause, based on the facts known to the parties at the time they made the contract.

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We commonly call such an excessive liquidated-damages clause a “penalty.”2 Section 2-718 of the Uniform Commercial Code places essentially the same constraint on liquidated damages for the kinds of contracts the Code covers. The law places a similar constraint on the parties’ freedom to condition the receipt of contractual benefits. A court will not enforce a condition if it would forfeit a benefit unfairly or if the benefit lost would be out of proportion to the harm that the failure to meet the condition inflicted upon the other party. We commonly call such conditions “forfeitures.”3 For example, the contract of purchase on my automobile made my warranty rights conditional on my strict compliance with every detail of the maintenance program. I would have lost all the warranty rights if, among other things, I delayed getting a scheduled oil change by so much as a day. A court presumably would not have enforced this condition, at least not literally. If a breach is “material” (i.e., serious), the common law entitles the injured party to rescind the contract. The injured party can stop performance, take back any benefits his performance has already conferred upon the breacher, and receive damages in addition.4 Although the Code does not use the word “rescission,” it achieves the same effect through what it calls “rejection” (Section 2-601) and “revocation of acceptance” (Section 2608). Section 2-601 entitles a buyer to reject goods that do not conform to the contract. Section 2-608 entitles a buyer to revoke his acceptance if he could not reasonably have detected the goods’ defects when he accepted them.5 Although I was unable to find any decisions addressing the question, the general assumption is that a court would not enforce a contractual provision significantly reducing the protections that the remedies of rescission or of Sections 2-601 and 2-608 provide. Courts have also allowed parties to exercise their rights of rescission when other remedies for breach of contract have failed, even if the breach was not serious enough in itself to entitle the party to rescind. In Hibschman Pontiac, Inc. v. Batchelor,6 for example, the contract of purchase limited the automobile owner’s remedies for breaches of warranty to returning the automobile to a dealer for repairs. The owner returned it to the dealer repeatedly for the same repairs, because the dealer never satisfactorily performed. The Indiana Supreme Court held that the owner could return the car and get his money back in addition to recovering damages for his wasted time. But despite cases like Batchelor, the right of rescission does not provide as much protection as it might seem. Only a small portion of breaches are serious enough to entitle a person to rescind, and people often are reluctant to rescind even if the law would allow it. Rescinding can be inconvenient and expensive, and it generally requires that the person go through the same kind of transaction over again. For example, if a buyer of an automo-

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bile rescinds, he generally has to buy another automobile. Rescinding can also be risky. If a party mistakenly believes that the conduct of the other entitles him to rescind, the attempted rescission will itself be a breach, and presumably a material one that entitles the other party to rescind. “Pulling the trigger” of rescission can thus result in a “backfire.” The party who thought he was entitled to rescind has to keep the faulty product and pay damages to the other party.7 Finally, a consumer who has already paid the purchase price may find the right of rescission to be of little value because he cannot exercise it without litigating to get his money back. I explained in Chapter 2 why litigation is seldom practical for a consumer.

Products Liability Products liability is the law that holds manufacturers and intermediate sellers liable for personal injuries or property damage resulting from defects in their tangible products (i.e., products liability does not cover services). Technically, products liability is not a relational tort, because the duties it imposes are not limited to persons who were in a contractual or other preexisting relationship with the manufacturer. Rather, it entitles anyone who is injured as a result of a product defect to compensation from the manufacturer. Products liability limits freedom of contract, however, because, except under special circumstances, a manufacturer cannot contract out of the liabilities it imposes, so it is relevant to relational torts. The leading case holding that a manufacturer cannot contract out of its products liabilities was the 1960 decision of the New Jersey Supreme Court, Henningsen v. Bloomfield Motors, Inc.8 By now, products liability is the law everywhere. Products liability is a relational tort even in the technical sense if it is expanded to include so-called economic losses. An economic loss is one that is only economic; that is to say, it includes no tangible aspects. For example, if the brakes on a new automobile are defective, the owner suffers an economic loss because he will have to repair or replace the brakes or continue to drive a defective (and therefore less valuable) automobile. The only person who can suffer an economic loss is the owner of the product. Because products liability applies only to new products, the owner and the manufacturer are in a contractual relationship with each other, if not directly, at least through the agency of one or more intermediate sellers. Most courts already allow the owner of a product to recover for economic losses if the defect caused an accident that also resulted in tangible losses.9 Reported decisions in eleven jurisdictions have allowed an owner to recover for economic losses even if there were no tangible losses, but reported decisions in twenty-seven jurisdictions have denied such recover-

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ies. However, many of the decisions denying the recoveries limited the denials to special circumstances. The grounds of denial in five decisions were that the plaintiff was a commercial organization, implying that an individual consumer could recover. The courts in eleven of the decisions said or indicated that they would allow recovery if the losses were a result of a “sudden calamity” rather than a gradual decline in the value or workability of the product. The courts in eight of the decisions said or indicated that they would allow a recovery if the defects posed a material risk of personal injury or property damage even if there was no such injury or damage. These categories are not mutually exclusive; some decisions fall into two or more of them.10

The Birth of Relational Torts in California One can find decisions creating tort duties for the parties to liability insurance relationships as far back as the early twentieth century, but the duties these decisions created were generally owed to the liability claimant, who is not in a contractual relationship with the other two parties.11 The late twentieth-century decisions, on the other hand, although some of them also concerned liability insurance relationships, created tort duties even for the parties who were also in contractual relationships with each other. The Supreme Court of California handed down its first such decision, Comunale v. Traders and General Insurance Co.,12 in 1958. While on a personal errand one day in 1948, Percy Sloan drove his brother’s truck into Anthony and Carmela Comunale, injuring Carmela slightly and Anthony seriously. There was no doubt that Sloan was liable, because the Comunales were in a marked crosswalk. Sloan’s insurer, Traders and General Insurance Co., told him his insurance did not cover him because he did not own the vehicle. The statement was false. Like virtually all automobile liability policies, Sloan’s policy covered his driving even if he did not own the vehicle. Sloan hired a lawyer when the Comunales sued him. The lawyer formally demanded that Traders undertake the defense. Traders refused, saying that Sloan had forfeited his coverage by not reporting the accident until the second day after it happened. This statement was also false. The policy did not require insureds to report accidents more promptly, and the delay had not prejudiced Traders. The policy limits were $10,000 per injured person and $20,000 per accident. The Comunales offered to settle for $4,000. Sloan’s attorney advised him to accept, but Sloan did not have the money, and the case went to trial. The court awarded Anthony $25,000 and Carmela $1,250, but Sloan could no more pay the judgments than he could have paid the settle-

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ment. California law made Traders liable to the Comunales under these circumstances, but the policy limits left the payment to Anthony $15,000 short of satisfying his judgment. Anthony thereafter made a contract with Sloan: in exchange for Sloan’s assigning his, Sloan’s, rights against Traders to Anthony, Anthony agreed not to seek satisfaction of his judgment against Sloan. Anthony then sued Traders as Sloan’s assignee. He demanded $800 for the attorneys’ fees and other costs of litigation Sloan had incurred and $15,000 for the excess judgment for which Sloan was liable. Traders paid the $800 but denied liability for the $15,000 on the ground that although the policy allowed it to settle claims, the policy did not require it to settle them. The jury found for Comunale, but the judge gave judgment for Traders notwithstanding the verdict because he agreed with Traders’ interpretation of the policy.13 Comunale appealed all the way to the California Supreme Court, where he finally won. The court began by saying: There is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement. . . . This principle is applicable to policies of insurance.14

Citing a Wisconsin decision for the proposition that the rights of the insured “go deeper than the mere surface of the contract written for him by the [insurer]” and that there are implied obligations “based upon those principles of fair dealing which enter into every contract,”15 the court continued: Under these circumstances the implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty.16

The decision was unanimous. Chief Justice Phil S. Gibson wrote the opinion, which was very brief. One had to be well acquainted with the law to realize how much the decision changed it. The assertion that there is an implied covenant of good faith and fair dealing implicit in every contract was uncontroversial. This “covenant” is more commonly called the duty of good faith performance. As its more common name indicates, the duty is to perform in good faith the duties the contract imposes. In this case, however, the contract did not impose a duty on Traders to accept a reasonable settlement offer. The policy only allowed Traders to accept a settlement offer, and it limited Traders’ liability to $10,000 per person or $20,000 per accident no matter what happened. Therefore, when the court declared that a liability insurer owes its insured a duty to accept a reasonable settlement offer, it was imposing the duty regardless of the insurance contract and even in contradiction with it.

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The first edition of Robert E. Keeton’s insurance law treatise, published in 1971, cited Comunale as one of the earliest decisions expressing the “new principle” that required insurers to fulfill their insureds’ reasonable expectations even if a close reading of the insurance contract would defeat them.17 However, one can now see that Comunale did not begin the development of reasonable expectations, at least not in California. It began the quite different development of relational torts. The court did not impose the duty to accept a reasonable settlement offer on Traders because Sloan had reasonably expected it; rather, it imposed this duty on every liability insurer as a matter of law. The court’s decision to limit freedom of contract was appropriate, because the settlement of liability insurance disputes can be very complicated. The interests of three parties—the insurer, the insured, and the liability claimant—are involved, and they are often conflicting. Casebooks on insurance law typically devote about a week’s worth of material to such settlements, and their goal is simply to introduce the student to the subject. Even if insurers were to explain the process as clearly as possible, consumers would not be able to decide intelligently which policies provided the better protection of their interests in the settlement of liability claims. The California statute of limitations was four years for contracts and two years for torts. Sloan’s cause of action against Traders arose when the judgment against Sloan on Anthony Comunale’s personal injury claim became final. Comunale sued Traders as Sloan’s assignee more than two years but less than four years after this had occurred. Comunale’s attorney tried to avoid the shorter limitations period on tort claims by characterizing the claim as sounding in contract, but Traders was able to point to some precedent for the proposition that actions for a wrongful refusal to settle sound in tort. Rather than deciding the point, the court held that actions for breach of the covenant of good faith and fair dealing sound “both in contract and tort” and added that the plaintiff in such an action “will ordinarily have freedom of election between an action of tort and one of contract.”18 Thus, ironically, it was an insurer who first forced the California court into recognizing that a liability insurer’s duty to settle sounds in tort as well as contract. The conclusion is logically implied anyway, because the duty exists regardless of the terms of the contract. The court’s explicit recognition was nevertheless important, because it facilitated the development of new relational torts by putting them on a clear and logical basis. The development generally proceeded less rapidly in jurisdictions where the courts were not so quick to recognize the grounding in tort. For example, the development proceeded less rapidly in Oregon, where the Supreme Court did not recognize the grounding in tort until 1992.19

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Insurance Insurers now have relational tort duties in every state. Allan D. Windt’s insurance law treatise lists more than three dozen. I have selected the following to give an idea of the kinds of things with which they deal: promptly responding to the insured’s notice of claim, making a reasonable investigation of a claim before denying coverage, promptly notifying the insured if coverage is denied, promptly paying an undisputed claim or undisputed portion thereof, and if the insurance is liability insurance, defending the insured even if coverage is uncertain, and (as in Comunale) promptly accepting the injured person’s settlement offer if it is reasonable.20 In addition, insurance law includes a number of rules resting on public policy that operate to constrain both insurers and insureds. Courts and commentators generally call them rules of interpretation, but they are effectively rules of law. The difficulties of rewriting insurance policies discourage insurers from rewriting them until all attempts at obtaining favorable judicial interpretations have failed, and failure may not become apparent until after a decade or more of litigation. For example, the meanings of “occurrence” (an event that triggers an insurer’s liability), “accident” (as opposed to intentional conduct), and “arising out of the use of” have been subjects of litigation for several decades. An example of a rule that does not go under the guise of an interpretation is the insurable interest requirement. An insurance purchaser must have a real economic stake in the insured property or person, and the amount of coverage cannot exceed a reasonable estimate of that amount.21

Wrongful Discharge from Employment The employment relationship was one of the chief targets of freedom of contract. In the absence of an express contract to the contrary, either the employer or the employee could terminate their relationship at will. Basically, employers owed no duties to their employees, not even to provide a safe work environment. The U.S. Supreme Court protected this “freedom” against even legislative attempts to limit it during the Lochner era. However, courts began using the principle of reasonable expectations in employment situations in the 1960s, and they have also created relational torts for the employment relationship. Although called wrongful discharge from employment, the tort covers any kind of adverse action an employer takes against an employee. Such an adverse action is tortious if the employer uses it or the threat of it to

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coerce the employee into acting contrary to public policy or to punish the employee for acting in conformity with public policy. For example, in Palmateer v. International Harvester Co.,22 the employee informed the law enforcement authorities that a fellow employee might be committing crimes and agreed to assist the authorities in investigating the matter. The employer discharged the employee when it found out what he had done. The court awarded the employee damages on the ground that it was wrongful to punish an employee for helping the authorities to enforce the laws against criminal conduct. Likewise, in Vermillion v. AAA Moving and Storage,23 a moving-company employee alleged his employer had fired him because he told a customer his employer had stolen the customer’s property after the employer had salvaged it from the wreck of one of its moving vans. The court held the employee had stated a cause of action.24 In a few of these cases, the courts have grounded their decisions in contract rather than tort, on the theory that the employment contract implicitly incorporated the applicable public policy.25 I count these decisions as relational torts anyway, because the contract ground is so flimsy; an employer who violated a public policy would hardly have contracted with its employees not to. Moreover, it is illogical to ground such a decision in contract, because if the contract had required the employee to violate public policy, traditional law would require the court to refuse to enforce it. There has also been a fairly widespread development of applying the traditional tort of intentional infliction of emotional distress to employment situations. The elements of the tort are that the defendant acted intentionally, the conduct was “outrageous” or “extreme,” it caused the plaintiff’s emotional distress, and the emotional distress was “severe.”26 In some cases, employees have succeeded in using the tort even if their employment contract was terminable at will, on the ground that the employer is still obligated not to discharge or otherwise treat them unfairly and unfair conduct in an employment situation meets the “outrageous” or “extreme” requirement of the tort. In other cases, however, the courts have declined to count even unfair dismissals as “outrageous” or “extreme” and have reserved the use of the tort for conduct by the employer that goes beyond the dismissal in itself.27 For example, one court upheld use of the tort when the employer placed his blank checks in the employee’s purse in order to “set her up” for a threat of criminal prosecution,28 and another when the employer reduced the employee, a vice president of the company with twenty years’ seniority, to sweeping floors and cleaning up the employees’ cafeteria for no apparent reason other than that he was “too old.”29 Practicing attorneys have told me that use of the intentional infliction tort is widespread in California, although there are no published appellate decisions specifically upholding it.

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Sales of New Dwellings and Construction Services The rule of caveat emptor governed the sale of new buildings and the provision of building construction services until the 1950s. The seller’s obligations were over when he delivered the deed to the land. The only warranties he made were those in the deed covering clear title.30 This traditional law was in contrast with the law for the sale of “goods” (tangible, movable property), which had had implied warranties of quality and freedom from defect since the nineteenth century.31 The traditional practices of the building industry are presumably the explanation. Until after the Second World War, builders did not construct residences on land they owned. Rather, they constructed buildings on land that was owned by the person who intended to live in the building or use it for business purposes. The only thing the landowner purchased were the construction services, and the law did not traditionally imply warranties in the sale of services unless they were professional (a lawyer’s or doctor’s services, for example). After the Second World War, land developers began purchasing large tracts of land, subdividing them into lots, and building residences on the lots, which they sold “door-key ready.” The courts of a few jurisdictions changed the rule of caveat emptor in the 1950s, but the flood of cases that changed the rule nationally did not come until after the 1968 decision of the Texas Supreme Court in Humber v. Morton.32 The new rule, by now in force almost everywhere, is that the sale or construction of a new dwelling carries with it a warranty of habitability. There is no settled rule yet for buildings that are not dwellings.33 There was initially some doubt as to whether a seller could contractually disclaim the warranty of habitability. The Texas Supreme Court held he could not in 1987, in Melody Home Manufacturing Co. v. Barnes, and held at the same time that the warranty sounds in tort as well as contract.34 I have found only three decisions allowing a seller to disclaim the warranty, and they all support the proposition that a seller generally cannot disclaim it by resting their allowance of a disclaimer on the presence of special circumstances. In Frickel v. Sunnyside Enterprises, Inc.,35 the Supreme Court of Washington held that implied warranties of habitability do not apply to the sale of a used apartment building. The court also noted that the buyer was just as experienced as the seller in the business of owning and managing apartment buildings. In Lenawee County Board of Health v. Messerly,36 the Supreme Court of Michigan also held that there is no implied warranty of habitability when the building being sold is not new. In Schepps v. Howe,37 the Supreme Court of Oregon held that the buyer waived the implied warranties of habitability when the contract provided the sale was “as is” and

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the sellers were amateur builders who were not intending to engage in a commercial venture when they constructed the dwelling. Frona M. Powell has concluded from an analysis of cases across the country that all the highest state courts will decide that sellers of new dwellings cannot disclaim the warranty of habitability as quickly as home buyers bring their cases to the courts for decision.38

Landlord and Tenant The law characterizes a lease both as a conveyance of an interest in property and as a contract. Courts began creating duties that landlords owe to their tenants regardless of the terms of the leases in the late 1960s. Residential tenants especially have been the beneficiaries of these duties, although commercial tenants have also benefited. The courts have usually characterized the new duties as property laws rather than tort laws, for understandable reasons. Many of the decisions expressly rest on the tenant’s relative lack of bargaining power. The principal such relational tort is the warranty of habitability. The law imposes a warranty that the premises shall be habitable at the beginning of the lease and that the landlord shall maintain them in a habitable condition throughout the lease term. Generally speaking, the applicable building codes define the minimum requirements of habitability, but only the minimum, especially if the court considers the building codes to be inadequate. The other such relational torts limit the landlord’s rights to terminate the tenancy. Whereas prior to the late 1960s these rights were unlimited except as the lease limited them, landlords now generally cannot evict tenants in retaliation for exercising any right they have under the lease, and in some jurisdictions not unless the landlord has a good cause for evicting the tenant.39

Services Generally When the Texas Supreme Court held in Melody Home that a seller of construction services could not waive the warranty of habitability the court had created in Humber, the court based its holding on the broad ground that the seller of any services to a consumer gives an unwaivable warranty that the services shall be done “in a good and workmanlike manner.”40 The court used “consumer” in the narrow sense of individual consumer rather than in the broad sense in which I have been using the term, which also includes businesses.

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Texas is the only state yet in which all services now come with undisclaimable warranties, but many states seem to be heading in the same direction. Courts and legislatures everywhere have been characterizing more and more occupations as professions for the purpose of applying traditional professional malpractice duties, which have always been undisclaimable.41 For example, California’s Business and Professional Code now includes building contractors, barbers, hearing aid dispensers, motor vehicle mechanics, private investigators, and pest controllers. The code makes these persons legally responsible for maintaining professional standards of competence and care.42 William L. Prosser and W. Page Keeton’s torts treatise takes a view of the matter that would effectively duplicate that of the Melody Home decision. The treatise treats professional malpractice as just a particular application of the reasonable person standard of behavior applicable to all conduct. The treatise concludes that everyone must . . . use care which is reasonable in light of their superior learning and experience, and any special skills, knowledge or training they may personally have over and above what is normally possessed by persons in the field. . . . Professional persons in general, and those who undertake any work calling for special skill, are required not only to exercise reasonable care in what they do, but also to possess a standard minimum of special knowledge and ability.43

The treatise cites cases that apply these standards to experienced milk haulers, hockey coaches, skiers, construction inspectors, dentists, pharmacists, architects, engineers, accountants, lawyers, doctors, “and many other professions and skilled trades.”44 In other words, if you hold yourself out as possessing a skill, you must exercise the care and competence that is commonly associated with it. It does not matter that people generally or the practitioners themselves do not regard the skill as a professional one. The latest edition of the Prosser and Keeton treatise was published in 1984. An Indiana court took essentially the same approach as the treatise in 1986 when it held a computer consultant liable in tort for his incompetent advice. The court did not find that computer consultancy was a profession; rather, it held that being a trade is enough: Those who hold themselves out to the world as possessing skill and qualifications in their respective trades or professions impliedly represent they possess the skill and will exhibit the diligence ordinarily possessed by well-informed members of the trade or profession. . . . We hold these principles apply with equal force to those who contract to develop computer programming.45

Additionally, a U.S. court of appeals held computer consultancy to be a profession for malpractice purposes in 1989, although it recognized that it

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was departing from the traditional criteria for identifying a profession in doing so. There are no certification requirements, professional examinations, or codes of ethics for computer consultants. The court held it enough that the ordinary person does not understand computers and their associated software well enough to protect his or her interests in the contract.46 The same reasoning would support inferring unwaivable warranties of competence and care in almost any service offered to the public.

Warranty Disclaimers under the Uniform Commercial Code In both the cases just noted concerning computer services, the computer consultant advised his client what to buy, but did not sell the product to him. Should it have mattered if he had sold the product he recommended? Not in principle, but at this point principle has to accommodate legislation. Article 2 of the Code covers sales of goods. A situation in which the seller offered special advice on the product (if the product were “goods”) would fall under Section 2-315, which reads: Sec. 2-315. Implied Warranty: Fitness for Particular Purpose. Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.

The Code thus imposes essentially the same duty of competence and care on a seller of goods who offers advice as Prosser and Keeton and the two cases mentioned imposed on persons who offer services or just advice. Indeed, the duty the Code imposes is stronger. It makes the seller liable if the goods are not fit for the particular purpose even if the seller exercised competence and care that they would be. The Code also provides warranties that apply in any case, whether or not the seller offers special advice. The most important of these are the so-called warranties of merchantability in Section 2-314. However, Code Section 2-316 allows a seller to disclaim any of the warranties it imposes so long as the disclaimers are conspicuous and clear, and sellers who use standard forms routinely disclaim all the Code warranties and substitute much more limited warranties of their own. Thus, except to the extent that courts have used liberal constructions to overcome its provisions, the Code blocks the extension of relational torts to contracts for the sale or lease of goods. I will treat the effects of the Code on each of the four major developments in contract law in more depth in Chapter 6.

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Brokers’ Commissions Although a property owner ordinarily expects to pay a commission to a real estate broker only if the broker sells the property, the standard contracts used to provide that the broker earned the commission if he produced a person wanting to buy, whom the property owner accepted, even if the sale never went through. The courts always found for the broker if there was a dispute in such cases until 1967, when the New Jersey Supreme Court held differently in Ellsworth Dobbs, Inc. v. Johnson.47 Justice John J. Francis wrote the opinion. Justice Francis had also written the opinion in Henningsen v. Bloomfield Motors, Inc., the pathbreaking 1960 decision overriding warranty disclaimers and remedies limitations in consumer contracts. In Dobbs, the Johnsons listed their farm for sale for $250,000 with Ellsworth Dobbs, Inc., a real estate broker. The commission was to be $15,000, payable in parts as the Johnsons received portions of the purchase price from the buyer. Dobbs found Iarussi, who appeared to be financially able. Iarussi signed a contract to buy the property and made a $2,500 deposit. However, after several delays, including a court action in which the Johnsons won a decree of specific performance, Iarussi convinced all concerned that he lacked the financial resources to continue. The Johnsons settled with him on the basis of their keeping the deposit and his indemnifying them for anything they owed Dobbs. Dobbs sued both the Johnsons and Iarussi for his commission. The trial court gave judgment for Dobbs on the ground that the contractual provisions making the commission payable in parts went only to the time of payment.48 The New Jersey Supreme Court reversed.49 If there is “substantial inequality of bargaining power, position or advantage” between broker and seller, the broker does not earn his commission until the seller sells the property unless the seller was at fault in failing to consummate the sale.50 The court found the requisite substantial inequality of bargaining power in the broker’s experience and expertise in the brokerage business, the seller’s lack of both, and the broker’s use of a standard form contract with which only he was familiar.51 The decision effectively makes the rule for when a real estate broker earns his commission a rule of law and thus a relational tort, because the elements the court deemed sufficient to demonstrate substantial inequality of bargaining power are present in virtually every case. Although the highest courts of most states still have not decided the point,52 all those that have have followed Dobbs.53 Ordinarily the seller of real estate receives the purchase price as soon as the property is sold; the buyer obtains any credit he needs from a lending institution. Three recent cases deal with the application of the Dobbs rule

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if this is not the case, but the seller extends credit to the buyer. In each case, the court decided that the seller takes the risk of the buyer’s nonpayment and so must pay the broker even if the buyer does not pay the seller. The rationale is that the seller chose to take this risk when he accepted the buyer’s credit instead of demanding cash.54

Fiduciary Relationships A “fiduciary,” generally speaking, is a person whom the law requires to be loyal to the interests of some other person, who is usually called the “beneficiary.” The classical instance of a fiduciary is a “trustee,” who is a person who holds title to property for the benefit of someone else, again, the “beneficiary,” but the law has long since expanded the category of fiduciary beyond just those who are trustees. Now, for example, agents are fiduciaries for their principals.55 Each partner in a partnership is a fiduciary for every other partner and for the partnership as a separate entity.56 Professionals are fiduciaries for their clients or patients.57 Courts have held virtually all the relationships that exist in a corporate context to be fiduciary either per se or at least under certain circumstances. These include the relationships among the corporation, its officers, directors, shareholders as a group, and shareholders of different classes or kinds.58 As a result, fiduciary duties govern the making and the performing of any contracts these people make with one another on the subjects concerned. The law imposes certain duties on fiduciaries that they cannot disclaim. Fiduciary duties require that the fiduciary put the interests of the beneficiary before his own. If two people in a fiduciary relationship make a contract that concerns the object of the trust, the fiduciary duties apply to the making and the performance of the contract. Fiduciary relationships are sometimes called “confidential” rather than “fiduciary” in contract law, especially if the relationship is informal.59 Courts in the 1960s began characterizing certain contractual relationships as fiduciary and imposing fiduciary duties on the dominant party even if the fiduciary relationship did not exist prior to the contract. Although sometimes the reason they gave was that the fiduciary character of the relationship was implicit in the position that the dominant party occupied in the community—for example, the position of banker or insurer—more often, the reason or reasons given were more specific to the facts of the case. The court found either that one party had placed trust and confidence in the other or that the relationship made one party dependent on the other’s good faith, honest intentions, or judgment. Deborah A. DeMott has found decisions imposing fiduciary duties on one or more of these grounds between franchisor and franchisee, manufacturer and distributor, bank and bor-

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rower, bank and depositor, and among the holders of different kinds of interests in oil and gas estates.60 Austin W. Scott, the late eminent authority on the law of trusts,61 defined a fiduciary as “a person who undertakes to act in the interest of another person.”62 This definition rests the determination on the fiduciary’s intent. John C. Shephard would characterize a relationship as fiduciary if one person entrusted another with something.63 Shephard’s determination would rest on the beneficiary’s intent. However, as DeMott points out, neither of these determinations captures the full range of situations in which the law imposes fiduciary duties, because the law sometimes imposes them although neither party has manifested the appropriate intent.64 DeMott suggests what she calls an “instrumental” definition: a fiduciary obligation is one the law imposes when a “person’s discretion ought to be controlled because of characteristics of that person’s relationship with another” (emphasis added).65 Her formulation would make the determination a normative one. Although the normative judgment would take the manifested intentions of either party into account, presumably neither the presence nor the absence of appropriate manifestations would be determinative. Her suggestion is descriptive; she believes it captures the essence of current case law. DeMott’s definition shows how broad the fiduciary principle has become. Unless sufficient standards for controlling it are set out in the contract, any contractual discretionary power “ought to be controlled because of characteristics of . . . [the parties’] relationship.” A unlimited discretionary power inherently places one party at the mercy of the other. Therefore, the law should control a discretionary power if the contract itself does not, in every case. The only real question is the standard of control the law should impose. Good faith is the minimum, because even classical contract imposes a duty to perform a contract in good faith. In fact, courts have already reached the conclusion that the law should control the exercise of any contractual discretionary power by a more direct route, as the next section demonstrates.

Discretionary Powers Even classical contract requires that a party exercise a discretionary contract power in good faith. This requirement is simply a part of the broader requirement that a party perform all his contractual duties in good faith.66 Many decisions have gone further and held that a party must also exercise a discretionary power reasonably. Some of these decisions have justified the additional requirement by saying it presumably was the parties’ intentions.67 When the party with the discretion could exercise it over every

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contractual duty he owed, the court decisions have often justified the reasonableness requirement by saying that the contract would otherwise be illusory.68 Still other decisions offer no justification but simply hold that a party must exercise a contractual discretionary power reasonably as a matter of law.69 The laws reflected in all these decisions are relational torts except possibly for the decisions that rest on the parties’ presumed intentions, and these are probably also relational torts in effect, because if the parties made clear their intentions that a discretionary power could be exercised arbitrarily, presumably a court would invalidate the declarations of intention as unconscionable. So-called satisfaction clauses are a kind of discretionary power. They condition a contractual duty on the party’s being satisfied with something. For example, the buyer’s duty to take and pay for real property may be conditional on his ability to find satisfactory mortgage financing within a certain period of time. The law for satisfaction clauses is the same as the law for discretionary powers of other kinds. Courts always require that the party not be satisfied in good faith. In many cases they also require that he prove that his dissatisfaction had reasonable grounds.70

The Covenant of Good Faith and Fair Dealing Not Sounding in Tort We saw earlier that in California and elsewhere, courts developed the concept of the relational tort out of the covenant of good faith and fair dealing. The covenant originally required only that a party to a contract perform a duty the contract imposed in good faith. However, courts developed the covenant to impose duties on parties to certain kinds of relationships regardless of the contract, and when they used it this way, they generally at least eventually recognized that it sounded in tort. On the other hand, some courts have not recognized that the covenant sounds in tort when they use it in this manner. Thus, for example, in K.M.C. Co. v. Irving Trust Co.,71 the U.S. Court of Appeals for the Sixth Circuit held that the defendant breached the contract by terminating the plaintiff’s line of credit without giving reasonable notice, even though the contract did not require notice. Among other things, the defendant argued that the contract implicitly permitted termination without notice, because it expressly permitted the defendant to obtain repayment of all outstanding amounts on demand. The court answered the argument by saying that the covenant would also override these provisions and require reasonable notice for a repayment demand. The court mistakenly assumed that Article 2 of the Uniform Commercial Code (which governs “transactions in goods”) covered the case and consequently applied

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the definition of good faith set forth in Code Section 1-208, but it also cited decisions under the common law. A large portion of the decisions of this kind involve lending institutions. Charles L. Knapp and Nathan M. Crystal have collected the citations to the recent literature on the relatively recent law of lender liability.72

Consumer Protection Legislation Congress enacted the Federal Trade Commission Act in 1914.73 It authorizes the Federal Trade Commission to issue cease and desist orders against persons who engage in unfair or deceptive practices affecting interstate commerce and to impose fines (subject to court approval) in certain instances. The courts and the Commission have used the act in a variety of ways to protect consumers. Many states enacted similar statutes in the 1960s and 1970s, and by the mid-1990s every state and the District of Columbia had some form of statute prohibiting what are commonly called “unfair or deceptive acts or practices.” Unlike the federal act, state acts generally authorize private actions as well as administrative enforcement. The private actions provide damages in addition to those that a plaintiff could obtain under classical contract law.74 In addition, virtually all states have statutes requiring sellers of certain services to disclose certain facts before they sell the services. For example, automobile repair garages must give itemized estimates of what they will do and how much they will charge,75 and providers of home repair services must disclose their hourly rates before they begin their work if the customer asks them.76 Penalties for violations range from small fines to excusing the consumer from paying for anything the seller failed to disclose. In 1975, Congress enacted the Magnusen-Moss Federal Trade Commission Improvement Act.77 It allows a seller to label his warranties “full” only if he disclaims none of the warranties implied by law. Otherwise, he must label his warranties “limited.” The idea was that competition would compel most sellers not to disclaim the warranties implied by law, but the result has been that sellers simply label their warranties “limited.” Consequently, the act accomplishes nothing of substance.

Analysis Relational torts limit freedom of contract because they impose duties on parties to relationships that they cannot contractually avoid. One justification for a relational tort is that it prevents abuses of bargaining power. If the law did not impose the duties, the party with the superior bargaining power

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could use its contractual freedom to oppress the party with the inferior bargaining power. A relational tort also at least implicitly gives the party to which the duty is owed certain remedies if the party with the duty should fail to perform the duty. Therefore, a relational tort also prevents abuses of bargaining power in any dealings the parties have with each other if the party owing the duty violates it. If the party on which the relational tort imposes a duty is a producer, which he almost invariably is, there is also the possibility of justifying the duty as serving a public purpose. In that case, the parties should not be able to avoid the duty by contract even if the consumer party possesses sufficient bargaining power to protect his interests. The courts that have created relational torts have justified them on both these grounds, although the prevention of abuses of bargaining power seems to predominate. The California Supreme Court held in Seaman’s Direct Buying Service, Inc. v. Standard Oil Co.78 that the “covenant of good faith and fair dealing” sounds in tort (and therefore justifies the creation of a relational tort) only if the parties’ relationship possesses “elements of public interest, adhesion and fiduciary responsibility.”79 The New Jersey Supreme Court referred to the same three elements, along with unequal bargaining power, to justify the relational tort it created for real estate brokers in Ellsworth Dobbs.80 The Texas Supreme Court referred to the same three elements, among others, as justifications for an unwaivable warranty that services offered to consumers shall be performed “in a good and workmanlike manner” in Melody Home.81 The Indiana Supreme Court referred in F.D. Borkholder Co. v. Sandock82 to the public interest, to the necessity for trust (which is tantamount to fiduciary responsibility), and to the producer’s superior expertise in finding that the breach of contract concerned was also a tort and could therefore support an award of punitive damages. The public interest requirement is obviously the public purpose justification, and the adhesion requirement is the justification of preventing abuses of bargaining power, although perhaps not so obviously. I related the derivation of “contract of adhesion” in Chapter 3. Its literal meaning is a contract one party prepares to which the other must adhere if he chooses to make the contract, because the first party will not bargain over its terms. Thus, a contract of adhesion is simply a standard contract. Although the use of a standard contract is only evidence of unequal bargaining power, the evidence becomes conclusive for all practical purposes if we add the fact that the party providing the standard contract is a producer and the other party a consumer, which was invariably the case in these decisions. We dealt with the concept of fiduciary responsibility a few pages back. I concluded that, generally speaking, a finding that a relationship is fiduciary merely expresses a conclusion that the law ought to control the dominant party’s exercise of some contractual power. Although the cases in

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which the courts expressly mentioned fiduciary responsibility comprise only a fraction of the cases in which the courts have created relational torts, this conclusion seems equally correct for the broader range of cases. Thus, generally at least, the fiduciary responsibility requirement collapses into the other two. It merely expresses the court’s conclusion that there ought to be a relational tort duty in order to serve a public purpose and/or to protect against abuses of bargaining power. However, both justifications miss the point if the court applies them to the parties’ relationship as a whole. The focus should be just on the aspect for which the court is considering whether to create a relational tort. It is irrelevant whether the public has an interest in the other aspects of the relationship or whether the consumer lacks bargaining power with respect to them. For example, when the California Supreme Court created the duty of a liability insurer to accept a reasonable settlement offer in Comunale, it presumably believed that the public has an interest in the prompt and fair settlement of insurance liability claims and/or that the settlement of such claims is generally too complicated for the consumer of liability insurance to understand. There was no need to inquire into other aspects of the relationships among liability insurers, insureds, and third-party claimants, and the court did not do so. Focusing on the relationship as a whole instead of just the aspect in question can result in relational torts’ being over- or underinclusive. A court may not create a relational tort when it should, if it concludes that neither justification applies to the relationship as a whole, and it may create a relational tort when it should not, if it concludes that one or both of the justifications apply to the relationship as a whole, although they might not apply to the aspect concerned. Although the presence of a public interest or unequal bargaining power may demonstrate a need for a relational tort duty, neither justification tells us what the duty should be. Fortunately, courts and commentators have already developed principles for determining certain traditional torts, and these principles would also be appropriate for determining many relational torts. Most contract disputes arise from events the parties did not anticipate when they made the contract. Generally, something goes wrong with the tangible product or the service because the producer improperly designed or made the product or performed the service improperly. Such unanticipated events are accidents. The same principles that guide the courts in allocating the costs of accidents in traditional tort law can guide them in allocating the costs through relational torts. These principles are “better cost-avoider” and “better cost-spreader.” The lawmaker asks two questions. First, to the extent either party might be able to reduce the risk of the kind of accident concerned, which one could reduce it less expensively? Second, to the extent that neither could reduce the risk of the kind of accident concerned, which one could better spread the costs of the accidents among the persons who should bear them? Both

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questions address the parties as members of classes rather than as individuals: the class of producers and the class of consumers of the product concerned. Thus, the questions expand the lawmaking considerations to take account of the public interest in two ways. They consider classes of persons rather than the parties to the case, and they consider the incentives for future conduct rather than the fault for the accident which occurred.83 The producer is both the better cost-avoider and the better cost-spreader in almost every case. It is in the superior position to avoid defects in its own products if they are tangible, because it designs and produces them. It is in the superior position to avoid defects in its products if they are services, because it performs them. It is generally in the better position to spread the costs of the accidents among those who should bear them, because it can pass them on to all the buyers of the product by raising the product’s price. However, the consumer may be the better cost-avoider for certain kinds of losses. For example, consumers are generally in the better position to take precautions in the use of the product and to mitigate any injuries to their person or property. They may even be in the better position to mitigate injuries to the product itself, because if an accident resulting from a defect occurs, the accident will usually occur while the consumer is using the product. It is obvious how one could apply these principles to relational torts involving tangible products, because the application would be no different from the application to traditional torts. It is less obvious, however, how one could apply these principles to relational torts involving services, so I will give an illustration of how one could apply them there. Take again the California Supreme Court’s decision in Comunale. The accident was the liability claimants’ winning their case against the insured and obtaining a judgment in excess of the policy limits. As between the insured and his insurer, obviously the insurer was in the better position to have reduced the risk of such an accident. The liability insurer handles the claim from start to finish, and it is both expert and experienced in handling claims of the kind. To the extent that allocating this risk to the insurer will increase its costs, it can spread them among all purchasers of insurance of the kind by raising the price of the insurance. Most jurisdictions apply a negligence standard to liability insurers in this kind of case, although a few require only that a refusal to settle be in good faith. No jurisdiction applies a standard of strict liability, although some commentators have suggested it.84 I will not stop to explore the standards question here, but I point it out in order to demonstrate the extent to which the issues for relational torts are the same as the issues for the traditional torts. Courts and commentators have been wrestling with the same issue of standards in traditional tort law for decades. One can also apply the better cost-avoider principle to questions of notice, although the question of who is the better cost-avoider in these situa-

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tions is usually so simply answered as to make it unnecessary to resort to such an elaborate conceptual apparatus. The purpose of notice is to give a person time to deal with the subject before it is too late. The risk is therefore that the notice will be too late. The costs to be avoided are the losses the person will incur if the notice is too late. The costs of reducing the risk are the costs incurred in giving the notice promptly. Many relational tort duties for insurers consist simply of giving timely notice of something. The better cost-avoider and better cost-spreader principles should work even better for many relational torts than for most traditional torts, because relational torts rarely involve noneconomic losses. A court in a traditional tort situation is often required to balance incommensurables: how many dollars it is worth to reduce a risk to human life or a risk of personal injury. The court in a relational tort situation rarely has to make such a balance, because the losses involved in relational torts are generally measurable in dollars. However, the principles are not relevant to every relational tort. For example, they are not relevant in analyzing a penalty damages or forfeiture situation or in deciding what duties the law should impose on a party with a discretionary contractual power. Considerations of public policy are helpful in some such cases, but beyond that there is not much to say. In the last analysis, designing a relational tort is not much different from designing a traditional tort. Besides the differences in commensurability mentioned earlier, the only differences are factual. Whereas the designer of a relational tort needs to take into account only the needs and expectations of the parties to a certain kind of relationship, the designer of a traditional tort must take into account the interests of everyone the conduct might affect. William K. Jones has concluded that products liability law should not allow recoveries for economic losses unless bargaining power was unequal. However, he assumes that bargaining power is unequal only if the consumer of the product is an individual.85 All that is required to make his conclusion the same as mine is to eliminate his assumption that business consumers and producers generally have equal bargaining power. I gave my reasons for concluding that this assumption is incorrect, because business consumers generally have no more bargaining power than individual consumers, in Chapter 2.

Confusion with Contract The new duties logically sound in tort and not in contract because they are not consensual. They do not derive from the contract; they may even conflict with the contract; the parties are not free to contract out of them. As we have seen, however, many courts have held that they sound in both tort and

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contract, and although I have not previously pointed it out, some scholars believe that we ought to regard them as sounding only in contract. Spencer L. Kimball in particular has been an outspoken advocate of this position. His writings on the subject deal only with the new duties in insurance law, which is his specialty. Kimball makes several arguments. First, the courts originally derived the new duties from the duty to perform a contract in good faith, and many decisions still refer to a breach of one of the duties as a bad faith breach. Second, the reason the courts held that the duties sounded in tort as well as contract was to provide the additional damages that a plaintiff could obtain only in tort, and this reason was inadequate, because the courts could have provided essentially the same damages in contract simply by following certain contract principles to their logical conclusions. Third, holding that the duties sound in tort opens the door to punitive damages, which are inherently difficult to control. Fourth, the new damages entitlements, in total, overly deter the conduct at which they are aimed, so that insurers are forced into defensive measures that are expensive and conflict with sound insurance principles.86 I share Kimball’s concern with punitive damages, which I will treat in the next chapter, but I find his other arguments unpersuasive. We should not allow the legal categories from which laws are derived to determine their categories forever; if we did, we would still be referring to “trespass on the case” and “indebitatus assumpsit,” for example. Kimball’s belief that the courts originally held that the duties sounded in tort as well as contract chiefly in order to provide additional damages is a misreading of the decisions in my opinion. The courts’ chief reason was to establish a basis for overriding the contract, which did not impose the new duty or even contradicted it. The reader can judge for him or herself on this issue for the decision of the California Supreme Court in Comunale, which I described earlier; the court did not even award any tort damages in this case. More important, it does not matter for present purposes what the courts’ reasons were for creating the new duties. The whole thirty years or more of judicial development would be in vain if producers could avoid the duties simply by contracting out of them, which they logically could if we were to characterize them as sounding only in contract. Allowing producers to contract out of the new duties would also undermine the public purposes the courts intended the new duties to serve. That many courts and commentators in the insurance area continue to refer to the new torts as bad faith breaches is true but confusing. A person can violate virtually any of the new duties without being in bad faith. Simple negligence is sufficient for most of them, and some of them make a person strictly liable, which is to say, a person violates them if he fails to perform them even if he was without fault in failing to perform them. Kim-

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ball recognizes this problem with his position.87 The name “bad faith breach” is also confusing because it fails to differentiate among the duties, of which there are already dozens just in the insurance area. We will never make sense of the new duties if we continue to have only a single name for them. Finally, there is no reason to think that the new damages entitlements, in total, overly deter the conduct at which they are aimed—except for punitive damages, about which I share Kimball’s concern, as I have already noted. Although it is chiefly scholars who have disputed the sounding in tort, the unspoken assumption that the new duties are essentially contractual has also led to some bad judicial lawmaking. In particular, it has led the courts of almost every jurisdiction to refuse to extend liability insurers’ relational tort duties to liability claimants, because there is no contract between them.88 Of course the only parties to the insurance contract are the insurer and the person who has the liability insurance. As a result of the courts’ refusals, it is only the insured person who has a right to sue the insurer for a breach of a relational tort duty. If the breach also harms the liability claimant, the claimant’s only recourse is to sue the insured, who can sue the insurer later to try to collect anything it had to pay the claimant, or to obtain an assignment of the insured’s rights against the insurer and sue as an assignee. Both alternatives produce serious injustices. If the liability claimant sues the insured to obtain compensation for the insurer’s breach of duty, the result is to make the insured pay for the insurer’s wrong. The insured can then sue the insurer to recover whatever he had to pay the liability claimant, but even if he is fully successful, the American Rule will ordinarily deny him any recovery for his litigation costs in the second suit, and he will not be entitled to recover anything for the ordinarily very substantial efforts he invested in both suits. Knowing this, an insured is likely to agree to assign his rights against his insurer to the liability claimant in exchange for the liability claimant’s agreement not to levy the judgment he obtained against the insured. However, such assignments can produce other injustices. The facts of Comunale demonstrate some of them. Sloan, the insured, never received any compensation for the $800 he had to pay a lawyer when Traders, the insurer, refused to defend him, or for the years of worry and irritation that Traders’ callously wrongful behavior caused him. Traders paid the $800 to Comunale instead, as Sloan’s assignee, and Traders never paid anyone anything for the suffering it caused Sloan through its wrongful behavior. Another California case, Crisci v. Security Insurance Co.,89 decided in 1968, produced even worse injustices. Rosina Crisci owned and managed a small apartment building, which she also used as her residence. A tenant, June DiMare, fell through an outdoor stairway when a step

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broke, suffering physical injuries and allegedly a “psychotic break” as a result. Crisci’s liability insurance coverage was $10,000. Security refused the DiMares’ offer to settle for $3,000. The jury awarded June DiMare $100,000 and awarded her husband $1,000 for loss of consortium. Security paid the policy limits of $10,000. The DiMares’ settled the excess judgment against Crisci for $22,000 cash, a 40 percent interest in the apartment house, and an assignment of Crisci’s claim against Security for its failure to accept the DiMares’ $3,000 settlement offer. The California Supreme Court described the effect of Crisci’s settlement with the DiMares as follows: Mrs. Crisci, an immigrant widow of 70, became indigent. She worked as a babysitter, and her grandchildren paid her rent. The change in her financial condition was accompanied by a decline in physical health, hysteria, and suicide attempts.90

Then, the Court used Crisci’s mental suffering as the basis for awarding the DiMares $25,000, as Crisci’s assignees, in addition to the $91,000 it awarded them as compensation for the judgment in excess of the policy limits of $10,000 that Crisci had borne. The DiMares were able to keep all of the $91,000 as well as the $25,000, although Crisci had already given them $22,000 in cash and a 40 percent interest in her apartment house as part payment of the excess judgment. Crisci herself apparently never received a cent for the cash and property the DiMares took from her or for the mental distress she suffered from Security’s conduct. The laws governing assignments of claims also produce injustices because they are unclear and uncertain. So-called personal torts—those involving wrongs to a person’s body, reputation, or feelings—are not assignable in most states, at least in theory. For example, Crisci, in theory, should not have been able to assign her right against Security for damages for emotional distress to the DiMares. The laws of most jurisdictions are unclear as to what is a personal tort for this purpose and in particular whether a right to punitive damages is a personal tort. Although attorneys for liability claimants have been ingenious in getting around the prohibitions on assignments, the devices they use can be costly and always run the risk that a court will hold them to be improper.91 Relational tort duties that ran directly from insurers to liability claimants would not only avoid these injustices, they would also serve the public purpose of providing funds for compensating liability claimants. State governments have expressed public policies to this effect already in a variety of ways, especially with respect to automobile accidents. For example, virtually every state has some sort of automobile driver compulsory liability insurance or financial responsibility law.92

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Criticisms The critics of relational torts have dealt almost exclusively with the relational torts that apply to manufactured products, probably because these torts are of such great economic importance. Moreover, most of the critics have been economists, probably because relational torts violate the principles of free markets. They violate them for the same reasons they limit freedom of contract, which I explained in Chapter 1. However, the criticisms are still pertinent to all relational torts, because they rest on grounds of wide generality. One of the chief benefits of a competitive market is what economists call allocative efficiency. In lay terms, this means simply that consumers can buy what they want at prices they consider appropriate. It seems to follow from this that if a market is functioning properly, the law should not require producers to change their products in any manner. Any changes, in this view, would make things worse, because consumers are already getting what they want at prices they consider appropriate. For example, if the law were to require that automobiles be durable enough to last at least 100,000 miles under normal use, some automobile manufacturers presumably would have to charge higher prices for their cars than if the law had not required that they improve them. As a result, some consumers would have to buy better cars, at higher prices, than they would have liked, and some would have to forgo buying any new cars at all, because they could not afford to pay the lowest prices at which the manufacturers could afford to make them. Economists have applied this reasoning to the laws that constrain producers from limiting their liability for defective products by characterizing the risk that a product will turn out to be defective as an aspect of the product’s quality. The less risk, the better the product; the more risk, the worse the product. Once one makes this characterization, the allocative efficiency argument leads to the conclusion that these laws have only made things worse. Consumers presumably were taking the amount of risk they wanted (in exchange for lower prices, of course) before these laws came into effect. Therefore, some consumers are now buying better (because less risky) products, at higher prices, than they would like, and others are forgoing buying any products of the kind, because they cannot afford to pay the lowest prices at which producers can afford to sell them.93 One does not need a deep understanding of economics to make this argument. All it amounts to is the observation that if the law prohibits inferior products, some people will have to buy better products than they would like, and some people will not buy any of the kinds they would like to have. The observation is as true as it is obvious, but it is incorrect to apply it to

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laws expanding producers’ liabilities, because the risk of a defect is not an aspect of a product’s quality. At least, consumers do not ordinarily so view it. Consumers do not ordinarily expect any product they buy to be defective, whatever else they expect of it. Defects almost invariably come as unpleasant surprises. A reasonable person would not be surprised to find that the Hyundai he purchased did not perform as well as a Mercedes Benz or that a three-dollar wine he purchased did not taste as good as a fortydollar one. However, he would be unpleasantly surprised if the wine gave him a case of food poisoning or the car uncontrollably swerved into a brick wall, as happened in Henningsen v. Bloomfield Motors, Inc.94 Thus laws that protect consumers from loss or injury resulting from defective products by expanding producers’ liabilities protect consumers from these unpleasant surprises or their consequences. They do not require consumers to buy higher-quality products. These laws have done nothing to narrow the gap between the performances of a Hyundai and a Mercedes Benz or between the tastes of wines of different quality. However, they have done a great deal to make products safer, to ensure that products conform with consumers’ expectations, and to compensate consumers to whom products cause loss or injury. Moreover, the economists’ argument falls even if one accepts their characterization of risk of defect as an aspect of a product’s quality. Even if consumers did regard this risk as something to consider in choosing which product to buy at the price, the typical consumer would have virtually no bargaining power on the subject. The reasons why consumers typically lack bargaining power relative to producers apply with especially great force to risk of defect: with very few exceptions, consumers cannot assess the risk merely by examining the product, and even if they had all the technical information they would need to make the assessment, they would lack the expert knowledge and understanding to utilize the information. Economists have also criticized the laws expanding producers’ liabilities on the ground of “cross-subsidization.” Cross-subsidization occurs if some buyers pay more for a product because it is worth more to other buyers. As a result, the first group of buyers subsidizes the second group by helping pay for something from which only the second group benefits. Cross-subsidization is supposedly an inevitable result when the law does not allow producers to disclaim warranties, limit remedies, or otherwise avoid liability for product defects.95 The facts of Wilson Trading Corp. v. David Ferguson, Ltd.,96 treated in Chapter 2, provide an illustration. Suppose garment manufacturers could test the yarn they purchased for a defect such as “shading” before using it, but the testing was expensive. The garment manufacturers who tested would incur the costs of testing, and they would thereby avoid the losses of garments’ shading. The manufacturers who did not test would not incur the

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costs of testing, but they would occasionally incur the losses from shading, as the plaintiff did in Wilson. Therefore, when the law holds yarn manufacturers liable for losses caused by shading, only the garment manufacturers who do not test their yarns for shading before using them receive a benefit. However, the yarn manufacturers have to charge all purchasers the same higher prices in order to cover their increased liabilities. They cannot continue to charge lower prices to purchasers who agree to disclaimers of liability for shading, because the law prohibits the disclaimers. The garment manufacturers who test for shading thus cross-subsidize the garment manufacturers who do not. This line of criticism also predicts a wealth redistribution from poor to rich in some cases. Suppose a certain kind of product defect can cause the product to catch fire. If it does, the fire may damage the surroundings. If the law holds the producer liable for the fire damage to the surroundings, the liabilities will tend to be higher for buyers who use the product among expensive surroundings and lower for buyers who use the product among inexpensive surroundings. In effect, both kinds of buyers receive fire insurance in exchange for the higher prices they pay for the product, but the wealthier buyers receive more fire insurance for their money than the poorer buyers do. Cross-subsidization in this case goes from poor to rich.97 According to this line of criticism, the only way to avoid either of these kinds of cross-subsidization is to restore freedom of contract. The law should allow producers to disclaim warranties, limit remedies, or otherwise avoid liabilities by contract, so that they can price-discriminate. They should be free to sell their products at lower prices to consumers who agree to accept such contractual reductions of their remedial rights and at higher prices to consumers who do not agree to accept the reductions. The criticism is invalid because it overlooks important countervailing considerations. First of all, cross-subsidization is not an evil so bad that the law should avoid it at any cost. It may be worth incurring in order to obtain certain benefits. Most criminal laws and tort laws result in some cross-subsidization, for example, but we accept this because we believe that these laws provide benefits that make it worthwhile to accept the crosssubsidization. Rich people have more to lose to robbers and burglars than poor people do. Some people install security systems in their homes or hire private police to watch for burglars and apprehend them. How much people pay in taxes to support the police does not necessarily depend on how rich or poor they are or on whether they install security systems in their homes or hire private police to protect them. The same is true of the taxes that support criminal courts and prisons. A similar situation exists for the losses people risk from accidents, assaults, libels, fraud, and the other things from which tort law protects us. Some people benefit more than others, and some take more costly precautions to protect themselves than

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do others. Yet, it would be foolish to abolish our criminal laws and tort laws and the institutions that support them merely because they result in some cross-subsidization. Like any criticism that ends with a proposal to restore unlimited freedom of contract, this criticism overlooks the problems posed by unequal bargaining power. The technological character of products today makes it generally impossible for consumers to assess either the products’ probable useful lives or the probability they are defective. Consumers generally could not make effective use of the freedom to choose between better warranties and lower prices if the law were to give it to them. Nor is there any reason to think that many producers would offer consumers the choice if the law allowed them to. History is to the contrary. Before the law changed, producers routinely removed virtually all the consumer’s rights in virtually every industry. The contracts in Henningsen and Wilson were typical in this respect. This criticism also misunderstands the common law, which includes numerous doctrines that serve to avoid cross-subsidization. The doctrines of proximate cause, intervening cause, contributory or comparative fault, contributory or comparative negligence, assumption of the risk, foreseeability, and mitigation all serve this purpose, as does the concept of “defect,” which I explained earlier. So do the concepts of “better cost-avoider” and “better cost-bearer” or “better cost-spreader,” which I explained earlier. Consequently, it is not true that there will be cross-subsidization unless producers can limit or disclaim liability for defects. The law generally avoids it anyway. I will explain using two illustrations. Suppose the following: A dye manufacturer makes a dye that produces an uneven color just on certain kinds of fabrics. The large number of fabrics makes it impractical to determine beforehand all those on which the dye will have this undesirable effect. The manufacturer therefore sells the dye with a warning that the garment manufacturer should pretest it on a small sample of the fabric on which he proposes to use it. Common sense dictates that if a garment manufacturer used the dye without pretesting, he could not hold the dye manufacturer liable for any resulting damage. A court could use any one of the abovementioned common law doctrines or concepts to reach this conclusion. It could say that the dye was not the proximate cause of the loss, because the failure to test was more proximate, or “intervening.” It could say that the dye manufacturer was not negligent, because he gave fair warning. It could say that the garment manufacturer was contributorily negligent, which would be a defense for the dye manufacturer even if the court had deemed him negligent. The court could say that the loss was not reasonably foreseeable, because a reasonable garment manufacturer would not have ignored the warning. Even if the applicable law was one of strict liability for product defects, the court could say that

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the dye was not defective. The dye manufacturer could not have eliminated the propensity to produce an uneven color at a reasonable cost, and it had given the garment manufacturer fair warning. For example, one would not consider a can of gasoline defective if it exploded when the buyer doused a cigarette in it, despite a warning that it was flammable. Thus, a court could avoid making careful garment manufacturers cross-subsidize careless ones by any of these concepts or doctrines. My second illustration is the foreseeability rule, which is especially pertinent in contractual situations. It dates from an 1854 English decision, Hadley v. Baxendale.98 The defendant was a carrier that failed to deliver the plaintiff’s mill shaft to a repair shop and back as promptly as it should have. The plaintiff’s mill was shut down for several days as a result. The court held the carrier not liable, even though the delay was a breach of contract, because it was not reasonably foreseeable that a mill owner would fail to have extra shafts on hand to replace those it had to remove for repairing. Thus, farsighted millers who kept extra shafts on hand did not have to cross-subsidize shortsighted millers who did not. One of the commentators who makes the cross-subsidization argument illustrates it with a hypothetical example indistinguishable from Hadley. Daniel S. Schecter posits two widget manufacturers, Speedy Widget Supply and Long-Term Widget Manufacturing Company. Speedy sells its widgets to a Japanese firm that needs them exactly on time, because it operates with “zero inventory.” Long-Term sells its widgets to an American firm, which is content to have only quarterly deliveries because it carries a large inventory. Neither Speedy nor Long-Term keeps extra widgetmaking machines on hand in case some break down. Acme Widget Machine Company makes the widgetmaking machines that both Speedy and Long-Term use. Both widget manufacturers have one of their widgetmaking machines break down, and both send the broken machines back to Acme for repair. Acme takes too long to repair and return both of them, but only Speedy incurs large consequential damages, because only Speedy incurs a large breach of contract liability to its customer (the Japanese firm) for delivery delays. Schecter concludes that the law should have allowed Acme to exclude liability for consequential damages, because otherwise firms such as LongTerm will cross-subsidize firms such as Speedy. He is forgetting the foreseeability rule, however. A court presumably would deny Speedy’s claim on the authority of Hadley. Under the circumstances (i.e., Speedy’s having a “zero inventory” customer) Acme could not reasonably foresee that Speedy would not have kept some spare widgetmaking machines in its machinery inventory.99 None of this is to say that a lawmaker should ignore cross-subsidization because it is never a problem. Of course it can be a problem under some

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circumstances. In particular, a court should ordinarily allow a buyer and seller to contract for weaker warranties in exchange for lower prices if the seller can prove that the buyer had about equal bargaining power on the matter, that is, if the seller can prove that the buyer sufficiently understood what he was risking to have made an informed and intelligent choice to give up his protection in exchange for lower prices. Courts often allow parties to contract out of traditional tort liabilities one of them would normally have to the other upon a showing that the party who gave up his tort-law protections understood the risk he was taking.100 They could grant the same allowance to buyers and sellers with respect to warranties and other relational-tort duties.

Acceptance With but one exception, there is a relational tort in at least one jurisdiction for every kind of product, and there are numerous and comprehensive relational torts for insurance and manufactured products in every jurisdiction. Courts have created relational torts for dwellings and services both as laws applicable to these things generally and as laws that apply only to certain products or in certain situations. Examples of the latter are the relational torts for employment, construction services, brokers, fiduciary relationships, and discretionary contract powers. The one exception is for buildings that are not dwellings, and even this exception is probably only apparent. A person who wants such a building ordinarily hires a general contractor and possibly an architect to build it instead of buying it from a developer already made. The laws of professional malpractice already cover architects, the relational torts for construction services already cover the services of general contractors, and the courts will probably hold that the laws of professional malpractice cover general contractors as soon as the cases come to them. Relational torts cover many of the same situations as does the law of reasonable expectations. I will treat the connections between relational torts and reasonable expectations in Chapter 7.

5 Bad Faith Breach and Remedies Reform

ALTHOUGH NOT EVERY court would define bad faith breach quite the same way, the consensus is that a breach of contract is in bad faith if the breacher knows he has no defense but still tries to avoid liability. A bad faith breach is a tort. In addition to the usual damages for breach of contract, the injured party can recover damages for emotional distress and punitive damages. In a growing number of jurisdictions, he can also recover his litigation costs. Courts now also award some of these additional damages in contract actions not involving a bad faith breach; this is the remedies reform to which I refer in the chapter title.

The Birth of Bad Faith Breach in California The tort of bad faith breach was “born” in many states in the 1970s and 1980s. I will describe its development just in California, because I am most familiar with its development there and because the California courts took a leading role in its development, although by no means an exclusive one. I described the California Supreme Court’s 1958 decision in Comunale v. Traders and General Insurance Co.1 in Chapter 4. The court there held that a liability insurer must accept a reasonable settlement offer from a liability claimant. The court also held that the covenant of good faith and fair dealing sounded in both contract and tort. This part of the holding was almost offhand, the court’s purpose being to avoid having to decide which statute of limitations applied to the plaintiff’s claim, but it proved to be of crucial importance for the development of bad faith breach. California law, like that of virtually every state in the 1960s, forbade recovery of damages for emotional distress in contract cases unless the contract was “for the protection of personal interests”2 and forbade recovery of punitive damages in any contracts case.3 The category of “for the protection of personal interests,” with rare exceptions, was limited to contracts of just three kinds: contracts for funeral arrangements, contracts for plastic surgery, and contracts for food or lodging where the breach consisted of an insulting, or at least unwarranted, ejection from the premises.4 Still more limitations were imposed in practice. A plaintiff could not recover unless he could show that the defendant’s conduct was outrageous

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and his emotional distress severe. The requirement of severity probably derived from the rule that the plaintiff in a contracts case prove his damages to a reasonable degree of certainty.5 A person could recover punitive damages only for a tort, and even then, only if the tort was of a certain kind or if the conduct of the wrongdoer was especially bad.6 Comunale opened up the possibility of avoiding these traditional limitations and recovering damages for emotional distress and punitive damages in a contracts case, because the state supreme court had held there that the covenant of good faith and fair dealing is implied in every contract. No one thought the court had meant to say that every breach of contract is also a tort, but there was nothing to do but to try to reason how far the court would go until the court spoke again on the matter. In the meantime, all that was clear was that the covenant sounded in both contract and tort in a liability insurance case, because Comunale was a liability insurance case. Nine years after Comunale, in 1967, the court held again that the covenant sounded in both contract and tort in another liability insurance case but gave no hint of where else it might do so.7 This was the situation when two intermediate appellate courts decided cases involving disability insurance. Fletcher v. Western National Life Insurance Co.8 was decided in 1970. Wetherbee v. United Insurance Co.9 was decided in 1971. Judge Marcus M. Kaufman wrote the court’s opinion in Fletcher, and Judge Daniel R. Shoemaker wrote the court’s opinion in Wetherbee. Both decisions have been influential in and outside of California to this day, but for the sake of brevity I will only treat Fletcher. The insured, U. L. Fletcher, had left school after the fourth grade. He supported a family of ten by working seventy to eighty hours a week as a scrap operator for a rubber company. He owned his home and some real estate in Arizona. His disability insurance promised him $150 a month for up to thirty years if he became “totally disabled” as a result of an accident. While working, he suffered a back injury from lifting a 360-pound bale of rubber. The physicians who examined him concluded he was totally and permanently disabled. Nevertheless, his insurer, Western National Life, wrote to him that it had concluded his ailment was a “mild form of glanders . . . contracted from horses” rather than a result of an accident. They accused him of failing to disclose this “congenital back ailment” when he purchased his insurance and demanded he pay back the slightly less than $2,000 they had already paid him, less the premiums he had paid before he became disabled. Left without either wages or insurance benefits, Fletcher used up his savings, sold his property in Arizona, and put himself and his family on a nearly all-starch diet. Mrs. Fletcher found a job, he cared for the children, and some of their friends gave them money, but they still could not make ends meet. Their utilities were eventually cut off for nonpayment.

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Fletcher sued and won a verdict of $60,000 compensatory damages and $640,000 punitive damages against Western and $10,000 punitive damages against the Western supervisor who had handled the case. The court reduced the punitive damages against Western to $180,000 and struck those against the supervisor upon Fletcher’s agreement to accept the reductions in lieu of a new trial. The court of appeals affirmed on two grounds. It held that the covenant of good faith and fair dealing sounded in both contract and tort in a disability insurance case, and it held that Western had committed an included tort. A defendant in a contracts case commits an “included tort” if his conduct in connection with the breach constitutes an ordinary tort. The court of appeals held that Western had committed the ordinary tort of intentional infliction of severe mental distress. This tort has three elements. The defendant must have intended to cause the mental distress, his conduct must have been “outrageous,” and the mental distress must have been severe.10 Western did not appeal, so the California Supreme Court did not have an opportunity to affirm or reverse on either ground. However, in 1973 the California Supreme Court affirmed a decision resting on the same two grounds by holding that either one was sufficient to support an award of damages for emotional distress and punitive damages.11 The principal unanswered question after 1973 was whether the covenant ever sounded in tort as well as in contract in relationships other than insurance relationships. The California Supreme Court did not give an answer until Seaman’s Direct Buying Service, Inc. v. Standard Oil Co.,12 in 1984. Seaman’s was a retailer of supplies for ships and boats. The city of Eureka, California, planned to build a new marina in which there would be space for a fuel station for boats. Seaman’s and Eureka negotiated a contract under which Eureka would lease space in the new marina to Seaman’s for selling boat fuel, but the contract was conditional on Seaman’s providing proof that it had obtained a fuel dealership from a reputable wholesale fuel supplier. Seaman’s signed a dealership contract with Standard and presented a copy to Eureka as proof, on the basis of which Eureka gave Seaman’s the lease. However, before Eureka completed the construction of the marina, the worldwide oil shortage of 1973–1974 started. The federal government limited oil companies to supplying the customers they already had unless they obtained individualized exceptions, called supply orders. With Standard’s assistance, Seaman’s applied for and was granted a supply order, but Standard then changed its mind and appealed to the next higher level in the federal agency to revoke the order, taking the position that it did not have a binding contract with Seaman’s. Standard won the appeal, but Seaman’s took an appeal to a still higher level and got the agency to reinstate the order. However, the agency conditioned the reinstatement on Seaman’s obtaining a court decree that its contract with

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Standard was binding. Seaman’s asked Standard to stipulate to the fact, because Seaman’s could not stay in business without fuel supplies for the time it would take for a trial. The Standard officer involved reportedly laughed and said, “See you in court.”13 Seaman’s went out of business and lost its lease with the city of Eureka. Seaman’s sued Standard, claiming breach of contract, violation of the covenant of good faith and fair dealing sounding in tort, and tortious interference with its business relationship with Eureka. It won on all counts in the trial court. The jury awarded Seaman’s $397,050 compensatory damages for breach of contract, $1,588,200 in compensatory damages for intentional interference with advantageous business relations, and $11 million in punitive damages on both the bad faith and the interference counts, for a total of $23,985,250. The court ordered a new trial unless Seaman’s would agree to reductions of the punitive damages on the bad faith count to $1 million and on the interference count to $6 million. Seaman’s agreed to the reductions. Standard appealed all the way to the California Supreme Court. The court affirmed the breach of contract count but reversed and ordered a retrial on the other two. The retrials, however, were solely for findings of fact. The court held that the plaintiff’s allegations on the last two counts were sufficient as a matter of law.14 Standard settled with Seaman’s for $4.5 million rather than relitigate the case.15 I will say no more about the count of tortious interference, because it lies outside our concerns. The court’s decision on the violation of covenant count was unanimous except for a concurrence by Chief Justice Rose Bird, who construed the tort even more expansively than the rest of the court did. Marcus M. Kaufman, the author of the opinion in Fletcher, was now a justice of the California Supreme Court. However, neither he nor any of the other justices signed the court’s opinion, which was simply labeled, “By the Court.” The court held that a breach of the covenant is also a tort, generally at least, if it occurs within the “‘special relationship’ between insurer and insured” or within “other relationships with similar characteristics.” The characteristics that make the relationship of insurer and insured “special” are its possession of “elements of public interest, adhesion, and fiduciary responsibility.”16 The relationship between Seaman’s and Standard was not “special” because it lacked these elements. Their contract was only an “ordinary commercial contract.” Nevertheless, the court held that the covenant would still sound in tort in this case if Standard’s breach of the contract possessed certain characteristics. The only authority the court cited for these characteristics was a 1976 decision by the Supreme Court of Oregon, Adams v. Crater Well Drilling, Incorporated.17 One needs to understand Adams in order to understand the California Supreme Court’s decision on this point.

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Crater drilled a well for Adams under a contract that provided for a price of $4 a foot unless Crater encountered hard rock, in which case the price was to be $8 a foot. Crater found water at 500 feet and billed Adams at the rate of $8 a foot for all but 63 feet of the depth, claiming that the other 437 feet were hard rock. Adams disbelieved Crater and gave him a check for $2,000, saying that was all he owed. Knowing that Adams’s wife was critically ill at the time and that she was fearful of litigation, Crater threatened to take Adams to court for the balance. Adams gave Crater a second check for the balance but sued him for restitution after his wife had recovered. The jury returned a verdict for Adams, agreeing with him that none of Crater’s drilling had been through hard rock, but the trial court set the verdict aside. The Oregon Supreme Court reinstated the verdict for Adams on the ground that he paid Crater the extra amount under duress. A person performs an act under duress if he had no reasonable alternative to performing it, and the absence of reasonable alternatives was a result of the other person’s wrongful threat or act. Adams’s wife’s illness and her fear of litigation left him no reasonable alternative to making the payment. Crater’s threat of suit was wrongful because he made it “‘without probable cause and with no belief in the existence of the cause of action.’ ”18 Several years after Seaman’s was decided, I asked one of the California Supreme Court justices why no one had signed the opinion. He replied that it was because none of them knew what to make of the “odd little Oregon case,” which was the only precedent they had for their holding. Odd or not, the California Supreme Court put the case to effective use. The court said: There is little difference, in principle, between a contracting party obtaining excess payment in such manner, and a contracting party seeking to avoid all liability on a meritorious contract claim by adopting a “stonewall” position (“see you in court”) without probable cause and with no belief in the existence of a defense. Such conduct goes beyond the mere breach of contract. It offends accepted notions of business ethics. [citing Adams]. Acceptance of tort remedies in such a situation is not likely to intrude upon the bargaining relationship or upset reasonable expectations of the contracting parties.19

Although the court here phrased the test of bad faith as whether the breach was without probable cause and with no belief in the existence of a defense, there are other indications in the opinion that an absence of a belief in a defense is enough. The court at several points seems to say this, using such terms as “belief” or “good faith,” standing alone.20 More important, Standard pleaded in defense that the contract was not binding because it was not definite enough to satisfy the Statute of Frauds. Although the court found that the contract was definite enough,21 such a finding does not mean that the alleged lack of definiteness did not constitute a probable cause, and

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the court never said it did not. Among the reasons the court gave for ordering a retrial on the count of bad faith was that if the jury were to conclude that Standard had the Statute of Frauds ground in mind when it denied to the federal agency that it and Seaman’s had a binding contract, Standard would not have acted in bad faith.22 It logically follows that if Standard did not have this defense in mind when it denied the existence of a binding contract, it was acting in bad faith—even though the defense was a probable cause. In other words, a lack of a belief in a defense is enough; a defense that actually constitutes a probable cause is irrelevant unless the breacher is aware of it. The court characterized Standard’s conduct as an attempt to escape all liability on the contract. However, any doubts that the tort of bad faith breach might not include attempts to escape only some liability were removed in future years, when the court affirmed decisions involving only such partial attempts.23 Thus bad faith breach was eventually established in California to be simply an attempt to avoid liability on a contract without an honest belief in a defense. The bad faith decisions up to and including Seaman’s allowed recoveries of damages for emotional distress and punitive damages in addition to the traditional damages for breach of contract. The California Supreme court added the winning plaintiff’s litigation costs in Brandt v. Superior Court24 in 1985. It supported the addition on two grounds. The first was an analogy to an automobile accident victim’s recovery of his medical costs. The court said that the victim of a bad faith breach is just as much required to pay a lawyer to rectify the effects of the breach as the victim of an automobile accident is required to pay a physician to mend his or her injuries. This makes a sound argument in principle, but the compensation principle was not the problem. The problem was the American Rule, which prohibits the recovery of litigation costs even though they are a proximate cause of the defendant’s wrongful conduct. The second ground was an analogy to the tort of malicious prosecution. This tort is committed if one person induces a public prosecutor to bring criminal charges against another person or himself brings a civil action against another person, in either case without a probable cause or a belief in the basis of the charges or civil action. A victim of this tort can recover the costs of defending himself against the criminal charges or the civil action, and, of course, these costs ordinarily include attorneys’ fees.25 This is a valid analogy. Indeed, malicious prosecution and bad faith breach as the court defined it in Seaman’s are almost opposite sides of the same coin. A person commits the tort of malicious prosecution if he brings a civil action without probable cause or a belief in the basis of the action and commits the tort of bad faith breach if he defends against a contract action without probable cause or a belief in the basis of the defense. Malicious

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prosecution consists of dishonestly bringing a claim. Bad faith breach consists of dishonestly defending against one. However, the victim of a malicious prosecution must bring a separate action to recover the litigation costs he incurred in the criminal or civil actions he had to defend against. It is this fact that avoids the operation of the American Rule, which only prohibits a defendant from recovering his litigation costs in the same action. The plaintiff in a bad faith action, on the other hand, would be recovering litigation costs incurred in the same action. The defendant in Brandt pointed out this difference, but the court rejected it as merely procedural and noted that it would be wasteful to require a plaintiff to bring a second action to recover his litigation costs. However, the court stayed as close to the analogy to malicious prosecution as it could by limiting the recovery to just the litigation costs the plaintiff incurred in the contract part of the action. A plaintiff could not recover the litigation costs he incurred in proving that the defendant had committed the tort of bad faith breach.26 The court confused the matter just a year later, however, in White v. Western Life Insurance Co.,27 by affirming a plaintiff’s recovery of all his litigation expenses in a bad faith action without comment. This was in 1986. Surprisingly, as of the mid-1990s, there has been no other reported state court decision on the point. Attorneys have told me that there are trial court decisions going both ways, with perhaps those allowing full recovery in the majority. In 1993, the U.S. Court of Appeals for the Ninth Circuit, applying California law, enforced the limitation, citing only Brandt, and denied the plaintiff’s request for leave to amend on the ground that the law on the point was too clear to excuse overlooking it.28 The denial of the request for leave to amend seems a bit harsh under the circumstances. The court did not elaborate in Brandt on the analogy between bad faith breach and malicious prosecution. Judge H. Walter Crosskey of the California Court of Appeal articulated the analogy in a carefully reasoned manner in 1990, in Careau & Co. v. Security Pacific Business Credit, Inc.29 The analogy to malicious prosecution has the advantage over the analogy to duress that the California Supreme Court offered in Seaman’s of including a justification for allowing the plaintiff to recover litigation costs, but apart from this, the analogies seem equally persuasive. However, recoveries of litigation costs ought not to require special justification. The winning party ought to recover his litigation costs from the loser in any case, as we will see presently. Seaman’s and its progeny were unpopular among defense lawyers, especially those who represented insurance companies.30 Some published comments went so far as to find in Seaman’s a license to award damages for emotional distress and punitive damages in any contracts case.31 There was a nationwide insurance crisis in the early 1980s, in which prices for

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liability insurance skyrocketed and some kinds of liability insurance were unavailable at any price. Many people blamed the changes in the law that permitted higher damages awards. In California, these concerns coincided with concerns about the apparent reluctance of the courts to enforce the death penalty, which the state had recently reinstituted. Judges in California have to stand for election only once, a number of years after the governor has appointed them. By coincidence, four of the seven members of the California Supreme Court had to stand for election in November of 1986. Only one of them was elected. Another member of the court resigned shortly thereafter. These losses, plus two other resignations that had occurred earlier, left only one justice on the court in 1987 who had been there since 1981.32 The new court dealt with bad faith breach in 1988 in Foley v. Interactive Data Corp..33 Foley’s employment contract with Interactive was terminable at the will of either party. Foley nevertheless claimed that Interactive’s termination of him was wrongful because it was tortious. He alleged that Interactive acted for reasons that violated public policy and that the covenant of good faith and fair dealing made any termination from employment without good cause tortious. The court recognized the validity of the public policy claim but ruled that Interactive had not violated public policy, and it declined to recognize the claim resting on the covenant of good faith and fair dealing. Although Foley characterized Interactive’s actions as being in bad faith, nothing in the situation presented a question of bad faith breach as the court had developed that tort in its previous decisions. The justices nevertheless quarreled about the elements of bad faith breach. The quarrel was not even on the merits. It was on what the court had meant in its opinion in Seaman’s. A four-to-three majority in Foley said the Seaman’s court had meant that a person can commit a bad faith breach of an ordinary commercial contract only by denying in bad faith the contract’s existence. A bad faith assertion of a defense is not enough.34 This interpretation is absurd. It rests on a single statement in the opinion, in which the court referred to Standard’s denial of the existence of a contract with Seaman’s, although there are seven other references on the same page to a person’s denial of the existence of a “binding,” “meritorious” or “valid” contract, his liability under a contract, or the existence of a defense.35 The interpretation also contradicts the court’s instructions to the trial court on remand about the effect it was to give to Standard’s belief, or lack of belief, in a Statute of Frauds defense.36 Needless to say, Foley caused a great deal of confusion. Despite Foley, however, all California courts continued to recognize some form of bad faith breach, and some continued to recognize it as the California Supreme Court actually held in Seaman’s,37 until the court overruled Seaman’s in Freeman & Mills, Inc. v. Belcher Oil Co.38 in 1995. The

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court gave as reasons for the overruling the widespread confusion that had arisen over Seaman’s, compelling policy reasons for precluding tort remedies in contractual situations, and the fact that no other state except Montana had recognized the tort of bad faith breach in commercial contracts. None of the reasons is persuasive. It was Foley that created most of the confusion about Seaman’s, and in any event, the logical remedy for confusion over a decision is to dispel the confusion, not to overrule the decision if it is otherwise a wise one. The so-called compelling policy reasons were either restatements of the old notion of classical contract that tort and contract law should be rigidly separated or more claims that Seaman’s was confusing. Finally, it is not true that no other state except Montana recognizes the tort of bad faith in commercial contracts. The fact is that sixteen other states recognize it for all contracts or at least a broad range of them, as I will show in the next section. In any event, the decision is unlikely to greatly reduce the volume of punitive damages claims in contract cases, as the court presumably intended, because many bad faith cases can be grounded on fraud instead, which also entitles a plaintiff to punitive damages. For example, the defendant in Seaman’s committed a fraud when it knowingly falsely denied having a binding contract with the plaintiff.

Bad Faith Breach Nationally Despite many questions of interpretation, it is fair to say that thirty-six jurisdictions now recognize a tort of bad faith breach substantially as the California Supreme Court defined it in Seaman’s. I count a law to be substantially like California’s was before Freeman & Mills changed it if the law imposes a nonwaivable duty not to breach in bad faith and if the offending party is liable for punitive in addition to compensatory damages under aggravated circumstances, whether or not the jurisdiction uses the name “bad faith” or characterizes the law as a tort. However, most of these jurisdictions still do not allow the tort the full scope of application California did. Sixteen recognize it for all contracts or at least a broad range of them.39 Nine, counting California, narrowly confine it, usually just to insurance contracts.40 Thirteen have not yet ruled on the scope question.41 Only the supreme courts of Pennsylvania42 and Utah43 have declined to recognize the tort of bad faith breach or anything like it for any contracts, thus leaving eleven jurisdictions in which the question is still open.44 It is practically impossible to determine the number of states that currently allow recoveries of litigation costs in bad faith actions, because the commercial legal digests do not categorize reported decisions in a manner that enables one to identify these decisions. However, the West Corporation recently created a category for recoveries of litigation costs by insureds

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whose insurers delayed or refused payment of claims, from which one can determine that at least thirty-three jurisdictions now allow such recoveries in these cases.45 A few states define the tort even more broadly than the California Court did in Seaman’s. For example, in a series of decisions dating back to 1976 the Indiana Supreme Court has allowed punitive damages in a contract case if the breach was “tortious in nature” or if “ ‘elements of fraud, malice, gross negligence or oppression mingle in the controversy’” (emphasis in original). It is enough if the defendant’s behavior was deceptive or fraudulent “in nature,” even if the requirements of common law fraud are not met. This is especially so if the defendant was in an occupation or otherwise in a position in which the public must necessarily place a high degree of trust. The court found such a degree of public trust in members of the insurance industry and of the construction industry. However, in one case the losing defendant was an automobile dealer, and the court did not say that automobile dealers are recipients of the public trust.46 But verbal variations do not seem to matter. If one applies the Seaman’s definition to the facts, the results generally are the same as those the court reached, no matter what verbal formulation it was using. An Indiana case, Hibschman Pontiac, Inc. v. Batchelor,47 makes a good illustration. Batchelor took his new car back to Hibschman, the dealer from whom he had bought it, for warranty work five times within the first month after it was delivered to him and eventually twelve times for overnight work and twenty times in all. Much of the work supposedly done was for work the dealer’s service manager claimed already to have done on previous occasions. Yet each time Batchelor came to pick up his car, the service manager told him it was “‘ready to go.’” When at last Batchelor went over the head of the service manager to complain to the next in command, he was told, in effect, to stop bothering them. The Indiana Supreme Court affirmed an award of punitive damages on the ground that there was “cogent proof to establish . . . fraud . . . and oppressive conduct,” among other things.48 The elements of a bad faith breach as Seaman’s defined it are easy to see. The car dealer had a contractual obligation to deliver a car in good working order or to do the warranty work in a workmanlike manner if the car was not in good working order when it was delivered. It failed on both counts but sought to avoid liability for its failures without an honest belief in a defense. John A. Sebert, Jr., published a pioneering work on the new contract damages entitlements in 1986.49 He surveyed contract cases in which the courts had awarded “nonpecuniary” damages, by which he meant damages that were compensatory but not for an objectively measurable economic loss. Damages for emotional distress are an example. This criterion included the bad faith breach cases and also cases in which the courts had

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awarded nonpecuniary damages for included torts. Sebert found decisions awarding nonpecuniary damages in twenty-one states.50 Michelle A. Harrington published a similar survey in 1989 in which she added eight more states to the twenty-one Sebert had found.51 Harrington also found lower court decisions awarding punitive damages or at least saying they were available in contract cases in six states.52 Although Sebert’s and Harrington’s criteria included more decisions than just those recognizing bad faith breach, the difference between 1995 and 1986 is remarkable even without taking this fact into account. The number of jurisdictions recognizing the tort of bad faith breach (in substance if not in name) went from twenty-one or less to thirty-seven in only nine years.

Justifications Why is a bad faith breach worse than an ordinary breach? The California Supreme Court said in Seaman’s that it is because a bad faith breach “offends accepted notions of business ethics.”53 This is probably true, but it does not get us very far, because it does not tell us why bad faith breaches offend these notions. The additional wrongfulness that is not present in every breach is the breacher’s dishonesty. The breacher does not just violate a contractual duty—he knowingly violates the duty. He knows he has no defense or, as courts sometimes put it, he “lacks an honest belief in a defense.” Such conduct is not necessarily dishonest in the sense of lying, although the bad faith breacher lies if he claims to have a defense. It is dishonest in the broader sense of knowingly violating a legal or moral norm to obtain an advantage at the expense of another. It is dishonest as robbery or extortion is dishonest, for example. A robber or extortionist may be quite honest in what he says to his victim, but he takes or extorts something that rightly belongs to the victim, and he knows that what he is doing is wrong. What the bad faith breacher knowingly wrongfully takes is his victim’s contract rights. One must understand contractual duty in this context to be the duty to perform a contract or compensate the other party for not performing it. Not even in a perfect world would people always perform their contracts, because under some circumstances all concerned are better off if the parties to a contract do not perform it. However, ordinarily at least, the other party will be worse off unless the breacher compensates him. The bad faith breacher’s attempt to avoid liability for his breach distinguishes a bad faith breach from what economists call an “efficient breach” of contract, in which although the breacher breaches knowingly, he voluntarily compensates the other party.54

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The law traditionally punishes knowing violations of duties more severely than unknowing or accidental ones. Presumably the reason is that knowing violations generally inflict public injuries in addition to the injuries they inflict on their victims. They undermine the mutual trust that people need to compose a civilized society. In addition, as Judge Crosskey noted, bad faith breaches inflict a public injury similar to that inflicted by malicious prosecutions.55 The public maintains judicial systems at substantial expense. Jurors and others contribute long periods of time to them for little or no money. For civil laws, the principal purpose of a judicial system is to resolve disputes. People abuse them when they use them to obligate others dishonestly (malicious prosecutions) or to avoid their own obligations by dishonest means (bad faith breaches). The reasons why bad faith breaches are worse than ordinary breaches have nothing to do with the kind of contract concerned or the industry of which the producer party to the contract is a member. Therefore, as lawyers and judges come to understand the tort more fully, one can expect that the courts will eliminate the limitations that currently exist in some jurisdictions on when the tort is recognized. In the late 1980s and early 1990s, courts in some of the jurisdictions where the tort was still limited, or largely limited, to insurers took a step toward eliminating these limitations by recognizing that an insured can also commit the tort.56 The justifications for limiting bad faith breach to insurers are the same as the justifications for limiting relational torts to insurers, which were treated in Chapter 4, but these justifications do not support extending the tort to insureds. Some have criticized bad faith breach as too vaguely defined and as leaving juries too free to make large damages awards.57 Judge Alex Kozinski once called it “a cause of action so nebulous in outline and so unpredictable in application that it more resembles a brick thrown from a third story window than a rule of law.”58 The charges of vagueness were premature. Many of the courts that used the phrase “bad faith breach” a decade or more ago used it without clearly defining it, but in recent years courts have given it just as precise a meaning as they give traditional doctrines. However, there is still some confusion in allocating functions between judge and jury. Whether the defendant had an honest belief in a defense is a question of fact, which most judges have therefore left to the jury. The jury will not be capable of rendering a competent decision, however, if the answer depends on whether a defense the defendant offered had a reasonable basis in law and fact, and the answer does depend on such a determination in many cases. Although it is possible that a person who offers a defense that has a reasonable basis in law and fact does not have an honest belief in it, under ordinary circumstances the possibility is so remote that the judge ought not to let the jury speculate on it. Moreover,

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the judge rather than the jury should decide whether a defense had a reasonable basis in law and fact, if that is an issue, in every case, because the decision requires a legal judgment. It is settled law, for example, that the judge rather than the jury makes these determinations in a malicious prosecution case.59 Tan Jay International, Ltd. v. Canadian Indemnity Co.60 is a case in which the trial judge seems to have done everything wrong in this respect. He left it to the jury to decide whether the insurer’s defense of no coverage had a reasonable basis in law and fact, and he allowed the jury to find that the insurer did not have an honest belief in the defense even if the defense had a reasonable basis in law and fact. In Seaman’s, on the other hand, the California Supreme Court did everything right in this respect. When the Court remanded the case for a jury determination of whether the defendant had been aware of its statute of limitations defense when it denied it had a binding contract with the plaintiff, the court limited the jury to this determination. It did not order the trial judge to allow the jury to decide whether the defense had a reasonable basis in law and fact, and it did not order the trial judge to allow the jury to decide whether the defendant lacked an honest belief in the defense even if he was aware of it. If juries make damages awards too large in bad faith cases, the fault lies with the substantive or procedural controls over the damages awards, not with the tort of bad faith breach. A jury has no more discretion over how much to award for emotional distress or as punitive damages in a bad faith case than it does in any other case where the law allows these kinds of damages.

Bad Faith beyond Contract A person can commit the same kind of wrong he would commit with a bad faith breach although the duty he fails to perform is not a contractual duty. All that is required is that he knows he has no defense and nevertheless seeks to avoid liability. For example, a manufacturer would violate the law of product liability in bad faith if it knowingly marketed a defective product and sought to avoid liability for the resulting personal injuries and property damage. Courts have already used the concept of bad faith in connection with violations of relational torts, although they have generally clouded the fact by calling the violation a breach, either of the contract or of the covenant of good faith and fair dealing.61 We should recognize the tort wherever a person commits it. It would help if we reserved “breach” for commissions of the tort in connection with breaches of contract and said simply “bad faith” in other cases.

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Recovery of Litigation Costs: The American Rule Litigation cost recoveries are necessary to make the winning plaintiff’s compensation complete. A person who was wrongfully injured is not fully compensated unless his compensation includes his costs of litigation, if he had to litigate in order to recover compensation for his initial injuries. The inclusion of litigation costs among the damages for bad faith breach needs no more justification than this. What needs justification is the American Rule. Why can’t the winner recover his litigation costs in every case? The rule in the rest of the world is that he can. I will treat this rule first, because it is the alternative to the American Rule that most commentators suggest. I will treat thereafter the rule that would allow only winning plaintiffs to recover their litigation costs. When litigation costs are recoverable, the recoveries are subject to all the legal requirements for recoveries of other kinds of losses: causation, certainty, foreseeability, and mitigation, for example. Two important rules follow from this fact. One is that the winner can recover his litigation costs only to the extent they were reasonable, because the loser did not cause them to the extent they were more than reasonable. This limitation applies both to the lawyer’s hourly rates and to the time he or she spent on the case.62 This rule has the salutary effect of maintaining the costs of litigation at reasonable levels, from which both the parties and the public benefit. The public benefits because unnecessarily lengthy litigation imposes unnecessary costs on the judicial system. Another rule that follows from these legal requirements is that a plaintiff can recover his litigation costs only to the extent they were necessary to recover his other damages. For example, a plaintiff who wins no more in court than the defendant offered to settle for before the plaintiff’s lawyer began preparations for trial cannot recover for the costs incurred after the lawyer began preparations for trial.63 This rule encourages defendants to make fair settlement offers and plaintiffs to accept them. It increases the amount each will lose if he fails to act fairly. For obvious reasons, this rule also discourages either party from using tactics intended to increase the other’s costs of litigation. Countries that generally allow litigation cost recoveries also generally prohibit contingent fee arrangements, but this fact does not reflect any logical necessity. We could continue to allow contingent fee arrangements in cases for which we had abolished the American Rule if we chose to. However, we would have to make certain adjustments. The amount of litigation costs a winning plaintiff would recover would be the same whether or not he and his lawyer had a contingent fee arrangement. The plaintiff would

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recover only the reasonable litigation costs in either case. If it were otherwise, there would be nothing to discourage plaintiffs’ lawyers from charging exorbitant percentages. The percentages would cost the plaintiffs nothing because the defendants would pay them. We would avoid this problem if we allowed the court to set the percentage after the case was over, but this would not avoid other problems. Plaintiffs who made contingent fee arrangements would still have an advantage over plaintiffs who paid their lawyers; defendants would be more willing to settle with the former, because they would have more to lose if they lost to them. This would be unfair, and it would also encourage all plaintiffs to use contingent fee arrangements, even those who could afford to pay their lawyers and would otherwise prefer to pay them. A plaintiff with a contingent fee arrangement should have to pay his lawyer the agreed percentage if he wins and receive only the reasonable value of the lawyer’s services on a prepayment basis as damages from the defendant. Such a recovery would leave the plaintiff something short of full compensation and give his lawyer something more than the reasonable value of his or her services on a prepayment basis, but these results would be fair because the lawyer took all the risks of losing, and the plaintiff took none of them. Lawyers on contingent fees should also be jointly liable with their clients for the other parties’ litigation costs if they lose. This, too, would be fair, because the lawyers’ contingent fees give them a joint economic interest in the case. How the lawyer and client might agree to split the potential liability between them could be left to their discretion, but it seems safe to predict that competition would quickly force most lawyers to agree to shoulder the whole burden. This is also as it should be, because the lawyer is both the better cost-avoider and the better cost-spreader. She or he is the expert, has the experience, and can spread the risk over a number of cases. Law firms that engage in contingent fee litigation typically carry caseloads of dozens and often hundreds of such cases. In personal injury cases, at least, the large majority of contingent fee clients are already impoverished by the event that sent them to the lawyer, so the lawyer would know that as a practical matter he or she had sole financial responsibility anyway. The lawyer’s joint liability on contingent fee arrangements would also answer the only valid objection I have ever heard against holding losing plaintiffs liable, which is that it would discourage poor or risk-averse people from bringing meritorious cases.64 Because poor people cannot afford to bring a case except on a contingent fee basis, the potential liability to the defendant would have no effect on them. Risk-averse people who were not poor could do the same, and in addition could choose a lawyer

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who would agree to take all the risk him or herself. If a poor or risk-averse person could not find a lawyer who would agree to take all the risk, it is right that he not bring his case, because he would have demonstrated by his own choices that he did not believe in his case or care enough about it to take a risk. Legal actions are expensive and disruptive of other people’s lives. The law ought not to encourage people to bring them at no risk to themselves. The lawyer’s joint liability would also help the client by giving the lawyer an incentive to investigate the merits of a case before agreeing to represent the victim. If the lawyer turned down the case, the victim would be free to try to find another lawyer. Some lawyers regard potential contingent fee clients simply as exploitable resources. They will agree to represent them without first investigating the merits of the case; they may even advertise their services on television and elsewhere, practically promising to represent anyone with the appropriate kind of injury. However, they provide effective representation only to the few whose cases will give them a substantial return on their investment. They give the others little or nothing, even if a serious investigation of their cases would have disclosed they had merit. Another common argument against litigation cost recoveries is the nearly opposite one that they would increase the volume of litigation, because people who were confident of winning would be even more willing than they now are to bring cases.65 The short answer to this argument is that it is irrelevant. More people should bring cases, if suing is the only way they can enforce their rights. If reducing the volume of litigation were our goal, we could equally well achieve it by reducing or eliminating other kinds of damages. We could limit victims of automobile accidents to recovering only 50 percent of their medical expenses, for example. However, such empirical research as there has been indicates that litigation cost recoveries would not have much effect either way on the volume of litigation, although they might well (as they should) have some effect on the contents of the volume. For example, we presumably would want to reduce the volume of so-called strike suits, suits without merit brought solely to extort defendants into settling. George L. Priest has done a study of the effects on litigation volume of a change in the law that sharply increased the damages a plaintiff could recover for a certain kind of tortious injury. The immediate impact was to increase the number of claims filed, but the number eventually fell back to what it had been. Presumably the reason is that a potential plaintiff and defendant are likely to litigate rather than settle only when their perceptions of the likely outcome of litigation are far apart. They are likely to settle if their perceptions are not far apart, because settling both increases the plaintiff’s net recovery and reduces

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the defendant’s net loss by eliminating the costs of litigation for both of them.66 Thus, when the law changed, plaintiffs’ and defendants’ perceptions presumably changed with it, but they eventually came back into rough agreement again. John J. Donohue III reached the same conclusions Priest did, and for similar reasons.67 The Priest and Donohue studies may not be fully applicable to recoveries of litigation costs, however. At least in principle, no other kind of recovery has the same effects on litigation as do litigation cost recoveries, because no other kind so directly affects the decisions whether to bring a suit and whether to settle one rather than go to trial on it. Some have suggested lifting the American Rule just for plaintiffs. The rationale is that whereas a plaintiff’s litigation costs are included in the compensation principle because the defendant’s wrongdoing required the plaintiff to incur them, the same cannot be said of the defendant’s litigation costs.68 However, making the plaintiff’s recovery fully compensatory is not the only reason for abolishing the American Rule, and even if it were, abolishing the rule only for plaintiffs would go to the opposite extreme and create a situation generally unfair to defendants. Moreover, abolishing the rule only for plaintiffs surely would increase the volume of litigation. It would increase the amounts plaintiffs stood to win, make defendants more willing to settle, do nothing to increase the risks of plaintiffs’ losing, and do nothing to discourage strike suits. The Florida Medical Association persuaded the Florida Legislature to abolish the American Rule for medical malpractice cases in 1980. The statute made indigent plaintiffs an exception. The Florida Supreme Court ruled that lawyers for indigent plaintiffs should also be exempt, although they (of course) represented their indigent clients on contingency fee arrangements. The court’s ruling had a large impact, because many plaintiffs in medical malpractice cases can reasonably claim indigence. The statute did not specify whether a winning plaintiff with a contingent fee agreement should recover the contingent fee or a reasonable amount on a prepayment basis from the defendant, and some courts held that he could recover the contingent fee. These holdings created a bonanza for plaintiffs’ lawyers. They profited much more from winning and lost no more from losing than before the legislature enacted the statute. The legislature repealed the statute in 1985. The experience proved nothing except the dangers of enacting poorly thought out legislation.69 The argument to this point has been to abolish the American Rule for all civil cases. The argument for abolishing it in contract cases is even more compelling, because there it operates so unfairly. As a practical matter, it operates only against consumers, because producers can waive its operation against them in the standard contract. For this reason, the courts would be justified in exempting consumers in contract cases from the operation of

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the American Rule unless the producer could prove that the consumer had about equal bargaining power, even if the courts did not abolish the rule for all civil cases. Legislatures have created another reason for comprehensive judicial action in this area. A 1984 study found nearly 2,000 fee-shifting state statutes,70 and legislatures are still enacting them.71 A reporting service, “Attorney Fee Shifting Statutes,” helped lawyers keep track of such statutes from 1977 to 1990.72 The statutes vary widely in the kinds of cases they cover and the conditions and qualifications they set for fee-shifting. Their existence evidences both the popular distaste for the American Rule and the incompetence of legislatures to deal with it. Broad, principled limitations on the American Rule would make these statutes unnecessary. The U.S. Supreme Court and the U.S. Court of Appeals for the Ninth Circuit have recognized that depriving people of their ability to pay lawyers reasonable compensation can unconstitutionally deprive them of the property rights that lawyers would help them to enforce. In my opinion, these decisions make the American Rule unconstitutional in situations where it effectively deprives people of lawyers by making it uneconomical to pay them. I will treat these decisions in the last chapter.

Damages for Emotional Distress A plaintiff can now recover damages for emotional distress in almost any jurisdiction if the defendant committed a bad faith breach or a relational tort. Traditional law already entitles a plaintiff to recover such damages for ordinary breach of contract if the contract is “of a personal nature” or if the conduct that breached the contract “included” the commission of a traditional tort. Since the 1970s courts have also increasingly allowed plaintiffs to recover damages for emotional distress even if the defendant committed only an ordinary breach, on condition that the party’s emotional distress was a reasonably foreseeable result of a breach when the parties made the contract. As of the mid-1990s, there were decisions in nineteen jurisdictions so holding.73 This condition is simply the foreseeability rule, which limits a contract plaintiff’s entitlement to any kind of damages. Thus, the trend has been to eliminate the special limitations that have traditionally applied to emotional distress damages and treat them like damages of any other kind.74 However, a plaintiff who can ground a claim in tort still gains certain advantages. The tort foreseeability rule is considerably broader. A plaintiff who was unusually susceptible to emotional distress might recover in tort although he could not have recovered in contract, for example. The time at

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which the defendant must have been reasonably able to foresee the distress is moved forward. For contracts, it is when the parties made the contract, whereas for torts it is when the defendant took the wrongful action.75 Perhaps most important, the right to recover in tort cannot be contractually abrogated unless the parties have equal bargaining power. It is not inconceivable that employers and insurers, for example, could begin to include provisions in their contracts expressly precluding emotional distress damages. Courts would then have to decide whether such provisions were contrary to public policy or to reasonable expectations, unconscionable, or unenforceable for some other reason.

Punitive Damages People ought not to be liable for punitive damages merely for breaching a contract. They have done nothing wrong if they pay full compensation. Indeed, society loses if people do not breach contracts that would cost them more to perform than to pay compensation for breaching.76 Nothing in the law of bad faith breach conflicts with these conclusions. Bad faith breach is a tort, not a mere breach of contract, and one of its elements is that the perpetrator tried to avoid paying compensation. The following analysis assumes the defendant has committed a tort and asks under what circumstances he should be liable for punitive damages and how the law should measure them.

Purposes Another name for punitive damages is “exemplary damages.” The two names connote the two purposes of retribution and deterrence. They give the defendant his just deserts and set an example to discourage others from engaging in similar conduct.77 The retribution is both public and private. Punitive damages vindicate the public values against which the wrongdoer offended. They can also assuage the suffering of the injured party by demonstrating that those who injured him have been punished. They may be especially effective for this purpose because the injured party knows that he was instrumental in compelling the wrongdoer to pay them. However, the deterrence purpose is exclusively public. If the damages succeed in deterring people from engaging in similar conduct, the victim will benefit no more than will any other member of the class protected by that deterrence. The fact that punitive damages punish the defendant does not distinguish them from compensatory damages. A defendant pays any damages under

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court order, and doing anything one would not do voluntarily is a punishment. The distinction between punitive and compensatory damages is that the former are more than is necessary to compensate the plaintiff and thus serve only to punish the defendant. I will therefore sometimes refer to their purpose as providing “additional” punishment. Although I have not seen it identified before, punitive damages also serve the purpose of rewarding plaintiffs and their lawyers for “convicting” the defendant. Public authorities often offer rewards for information leading to the conviction of criminals. The laws entitling plaintiffs to punitive damages serve a similar purpose of encouraging people to identify and punish those who are guilty of civil wrongdoing. This purpose is even more important for the enforcement of laws against civil wrongdoing than it is for criminal wrongdoing, because without the reward that punitive damages provide for plaintiffs, those who engage in civil wrongdoing would not be punished frequently enough to serve the deterrence and retribution purposes. Public enforcement authorities are generally too busy with serious criminal matters to bother with civil wrongdoing. Our laws also provide other rewards for those who identify and punish civil wrongdoers. For example, courts generally reward the lawyers who succeed in winning a class action by allowing them to recover generously large attorneys’ fees.78 Federal antitrust laws entitle winning plaintiffs to three times their actual damages plus attorneys’ fees.79 State usury laws often entitle the debtors who expose their lenders as usurers to treble damages or other substantial benefits.80 The private law enforcement that such rewards encourage can be more efficient and more effective than public enforcement would be. The public authorities do not need to search for the victims, because the victims identify themselves. Victims cooperate in the prosecutions because they bring them. Victims have an incentive to keep the costs of prosecution reasonable because they will have to bear them if they lose. Even if a victim wins, the court can refuse to reimburse him for more than it considers to have been reasonable. Finally, punitive damages save time and money by combining the compensatory and punitive purposes in a single case. Even the defendants benefit from this efficiency, because they need to defend themselves only once. Insurance regulation is an instance where private enforcement has been demonstrably superior to the public kind. Public authorities with the power to prosecute insurance fraud and other civil wrongdoing by insurers have existed in the United States for more than a century, but it was not until courts began to award punitive damages in insurance cases that insurers who engaged in serious civil wrongdoing began to run a material risk of being punished. Punishments of insurers in private actions vastly outweigh punishments imposed by public authorities.

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Amounts There are currently no rules for determining the amount of punitive damages. Rather, the law permits the court or jury to weigh certain factors. The chief factors are the culpability of the defendant’s conduct,81 the defendant’s net worth or total profitability,82 and the amount of compensatory damages awarded. Higher compensatory damages justify higher punitive damages.83 Of course the culpability of the conduct is relevant, but culpability is not an objective standard. Moreover, the second and third factors are inappropriate. The second punishes a defendant for being legitimately wealthy or profitable. Only a small portion of a defendant’s net worth or profitability is likely to have been attributable to the wrongdoing for which he is being held liable.84 The third arbitrarily compounds the punishment, because compensatory damages also punish a defendant. However, the second factor (the defendant’s net worth or total profitability) is so widely employed85 that a few more words about it are appropriate. The underlying assumption is that it takes a larger liability to punish a wealthier defendant. This is presumably true if the defendant is a natural person, but the overwhelming majority of defendants in punitive damages cases are corporations or other legal entities. Whether it even makes sense to think of punishing a legal entity is problematic, but in any event the only persons who are directly punished when a court awards punitive damages against a legal entity are the entity’s owners (the corporation’s shareholders, for example), the value of whose shares in the entity are reduced. The owners may or may not respond by taking some action to punish the individuals within the legal entity who were responsible for the bad conduct, but even if they do, there is no assurance that the punishment they inflict will bear any reasonable relationship to the size of the punitive damages award. Moreover, the likelihood that the shareholders of a corporation will inflict any such punishment on the responsible corporate officers is generally inversely proportional to the wealth or total profitability of the corporation. This is because the wealthier or more profitable the corporation, the more likely it is to be “publicly held,” which is to say, to have so many shareholders, so widely scattered, that even as a group they are unable to exercise any effective control over the corporation’s executive officers. Thus we would do better to leave the punishment of shareholders or executive officers of wealthy corporations to criminal law enforcement agencies and concentrate instead on deterring the bad corporate conduct. The wealth or total profitability of any defendant, whether a legal entity or a natural person, is irrelevant to the deterrent effect of a given amount of damages liability, at least if the defendant thinks and acts rationally. A

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rational person weighs the probable gains against the probable losses and chooses to engage in conduct only if the former outweigh the latter. The only difference between an honest and a dishonest person in this respect is that the former includes moral considerations in his calculations whereas the latter looks only to the monetary measures. Therefore, in order to deter even dishonest persons from engaging in bad conduct, we must make the probable losses great enough to outweigh the probable gains, and if we succeed, the deterrence will work equally well against everyone, whatever his total profitability or wealth. If the conduct we seek to deter was part of an ongoing policy, the profits the defendant must have expected to make are those he did make or would have made from pursuing the policy. If we require the defendant to disgorge just the profits he made or would have made from the single instance, he will still find the pursuit of the policy to be profitable. The minimum amount for which a defendant should be held liable in a punitive damages action, therefore, is the amount he made or would have made from pursuing the wrongful policy. One can also justify this conclusion on the ground that people who pursue a wrongful policy deserve more punishment than those who engage in only a single instance of wrongful conduct. This is the assumption underlying the laws punishing criminal conspiracies86 and organized crimes87 more severely than individual acts of criminality. It is also the assumption underlying the common practice of giving repeat criminal offenders more severe punishments. Moreover, the award should be no more than this amount, at least as a rule. An award should provide sufficient deterrence and retribution, and once these purposes are served, any additional punishment is gratuitous. Because virtually all the defendants in bad faith cases are business organizations, I will assume that is the case here. I will refer to the organization as “the company.” The question then is whether the wrongful conduct was part of a “company policy.” The law should consider the acts of an employee to be company policy if the employee possessed the authority to act as he or she did, if the employee acted within the scope of a policy made by his or her superiors at a policymaking level, or if these superiors were aware of the employee’s actions and tolerated them. In substance, these conditions are restatements of the law for holding a principal criminally responsible for the acts of one of his agents.88 An outsider will generally find it very difficult to prove the existence of a company policy. Companies rarely keep public records of their wrongful policies, for obvious reasons, and the employees who could testify to their existence are typically under great pressure not to do so. The law ought therefore to place the burdens of proof and persuasion on a company to prove that the wrongful conduct of its employees was not pursuant to a company policy. Generally, only the company will have access to the evi-

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dence needed to prove or disprove such an allegation. The law should presume that the defendant engaged in the same kind of wrong conduct in all its transactions of the kind unless it proved to the contrary. The pressure such a presumption would put on a company would be proportionate to the amount of business of the kind it was engaged in, which is appropriate. The more business of the kind a company is engaged in, the more harm its wrongful policies inflict, and the more damages liability it takes to deter its engaging in them. A company could rebut the presumption in a number of ways. It could show that it fired or otherwise severely punished the employees promptly after learning of their behavior. It could prove that the conduct was merely accidental—the result of a misplaced file, for example. It could show that it had in place an effective program for preventing such conduct, which for plausible reasons failed to work in this instance. A less direct but still sufficient way would be to show that the company did not profit from the kind of conduct that such a policy would have produced. No rational business has legally wrongful policies unless it expects to profit from them. For example, if the insurer in Fletcher could have shown that its ratio of claims paid to coverage outstanding was no less than that of the reputable insurers in the disability insurance industry, that ought to have been enough to prove that its claims adjuster’s denial of the plaintiff’s claim on specious grounds was not pursuant to a company policy. If a plaintiff were to recover all the defendant’s profits from its pursuit of a policy, a subsequent plaintiff who obtained a judgment against the defendant for injuries resulting from pursuit of the same policy would logically not get any punitive damages, although he would still recover compensatory damages. Although I am not aware of this ever happening, it could, and it might be unfair. The judges in the two or more actions ought to be able to work out a fair division of the punitive damages among the several plaintiffs if such a coincidence were to occur. Almost all the reported bad faith breach cases seem to have involved company policies. One of the exceptions is Seaman’s, in which the defendant oil company’s bad faith denial of a binding contract was apparently opportunistic. The worldwide oil shortage unexpectedly required it to reduce its deliveries substantially, and it decided to favor its old customers by refusing to deliver any oil to the plaintiff. The defendant presumably could have carried the burdens of proof and persuasion that its bad faith breach against the plaintiff was not pursuant to a company policy. On the assumption that it carried these burdens, should the court still have awarded some punitive damages? No rule should control the answer. We should regard the approach I have suggested of gauging punitive damages by the profits the defendant made from pursuing a wrongful policy as a guideline, not a rule a court should follow under all circumstances.

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The Roles of Judge and Jury Setting the right amount of punitive damages is a matter of making the punishment fit the offense. The judge performs this function in criminal cases; all the jury does is decide whether the defendant was guilty. We should do the same for punitive damages. The judge should determine the amount of punitive damages if the jury decides that the defendant should pay them. Unlike the fines or sentences judges give in criminal cases, however, the amounts of punitive damages judges award should be appealable, and appellate courts should review them as matters of law. As of 1991, three states had statutes providing that judges set the amounts of punitive damages awards.89 There is no need for a state supreme court to await legislation, however. Courts traditionally determine the allocations of functions between judge and jury themselves (subject to constitutional constraints, of course). These changes would only conform the theory with what the practice has already been for years in some places. Judges subsequently reduced nine out of the ten punitive damages awards juries made in excess of $500,000 from 1979 to 1984 in San Francisco County, California, and Cook County, Illinois.90 Thus, all the juries in the nine cases really decided was that the defendant had committed an offense warranting a punitive damages award; the judge in the trial court or some judges on an appellate court decided the amount. The same thing must have happened in effect even in the tenth case, because the trial judge had to approve the amount the jury awarded before he could rest his judgment on it. However, judges only decide the amount of punitive damages that will be awarded if the jury tries to award too much, and in many places juries are not generally trying to award too much, at least not yet. The Seventh Amendment to the Constitution of the United States would not prohibit this change. Whether a state constitution prohibits it would, of course, have to be determined for each state. The Seventh Amendment requires that the right to trial by jury be preserved as “at common law.” The U.S. Supreme Court has been lenient in allowing changes in jury functions under this standard. The rule is that a change does not violate this Amendment unless the change contradicts a practice that existed when the states ratified the Bill of Rights in 1789.91 There was no practice on the points at issue here in 1789, because jury verdicts did not distinguish between compensatory and punitive damages at the time.92 The 1988 California case of Tan Jay International, Ltd. v. Canadian Indemnity Co. is not typical, but it illustrates how far the punishment can exceed what appears to have been the seriousness of the offense under the current system. The sole shareholder of a California manufacturing com-

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pany was a citizen and resident of Canada. He docked his yacht in a California port after returning from a race in the Indian Ocean and asked his company manager to move it into storage for him. The manager got the help of some of the company’s employees on a Saturday after they finished a softball game in a nearby public park. The employees had no experience with yachts or with moving a large object on a truck on a road. The mast of the yacht hit a power line while the employees were moving it, seriously injuring one of them. The company’s liability insurer denied coverage on the ground that the employees were not engaged in company business in moving the yacht. The jury found the denial to have been in bad faith and awarded $35 million in punitive damages in addition to $1 million in compensatory damages. The trial judge reduced the punitive damages to $4,273,257 and the compensatory damages to $500,000. The net worth of the insurer was less than $10 million.93 There was not even any evidence of bad faith in the case. The judge should have held the insurer’s denial of coverage to have been reasonable as a matter of law. Even if the denial was in bad faith, the jury award was grotesque, and the judge’s reduction of it was inadequate by far. The judge could not have justified the punitive damages he allowed on principled grounds, and if the defendant had appealed, the appellate court surely would have reduced the punitive damages again, if it did not eliminate them entirely. The current law is unfair to both defendants and jurors. The days or weeks jurors spend listening and deliberating are wasted when the trial judge disregards their decision and substitutes his or her own. Such jurors must also be humiliated. The judge has treated them as though their opinions were worth nothing. The defendant is deprived of the benefits it might have obtained from an informed verdict or from a compromise verdict. Jurors who are not informed of the upper limits the judge will allow lack information they need in order to deliberate in a reasonable manner. For example, jurors who did not believe the defendant should be additionally punished at all might have compromised by voting for what they thought was a low amount, only to learn later that even that was more than the judge would allow. Had they known what the judge would allow, they could have demanded and presumably obtained an amount even lower as a compromise measure.

The Plaintiff’s Reward Under the present system, the defendant’s added punishment and the plaintiff’s reward are necessarily the same, because the plaintiff is entitled to the punitive damages. We should break this connection. The amount by which

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the defendant ought to be punished and the amount of reward the plaintiff ought to receive are not necessarily the same, and in fact bear no necessary relationship to one another. The reward could never be more than the added punishment, because the punitive damages are the only source from which the reward can be paid, but the reward could be less. The court should have the authority to make it less, by requiring that the defendant pay the difference to the state, just as a criminal defendant pays the state a fine. The current system makes the rewards much too high. The excess is not just a waste of what could otherwise be public funds. It also encourages plaintiffs and their lawyers to engage in gross exaggeration or fraud, so that defendants are sometimes punished undeservedly. There are no objective measures of how often this happens but no one who has observed many of these proceedings or read the relevant depositions or reports can fail to believe that fraud and exaggeration are serious problems. These abuses of punitive damages are a tax on the honest consumer from whom the dishonest profit is ultimately taken, and they bring the system of civil justice into disrepute. Eight states by 1991 had statutes requiring that some portion of a punitive damages award in a product liability case be paid to the state,94 but I am not aware of any such statute for bad faith breach cases. The judge would have to decide the size of the reward even if she or he did not decide the amount of the punitive damages. The decision on the size of the reward would have to take into account the difficulty, expense, and public importance of the case and the risk the plaintiff and plaintiff’s lawyer took of losing. These considerations require knowledge and experience in the law and in litigation in particular. A judge has this knowledge and experience, but jury members do not.

Necessary Procedural Controls If Juries Are to Continue to Set the Amounts If we are going to continue to allow juries to set the amounts of punitive damages, we should at least give them the information they need to set them reasonably and to prevent the trial judge’s rendering their efforts nugatory. The law should require the trial judge to tell the jurors the maximum amount she or he will approve before they retire. At the same time the judge should make clear that this amount is only a maximum and that the jurors are free to award less or nothing at all. A three-judge panel of the U.S. Court of Appeals for the First Circuit ordered the circuit’s district judges to proceed in this manner in 1987,95 although it withdrew this part of its decision before the decision appeared in the Federal Reporter.96 The judges composing the panel must have belatedly realized that they lacked the authority to issue an order to all the district judges in the circuit.

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Charges and Concerns Justices William P. Clark and Frank K. Richardson of the California Supreme Court reflected the concerns of many people when they charged some years ago that consumers ultimately bear the burden of punitive damages because the businesses that pay the damages pass them on in the form of higher prices.97 However, the charge is correct only if the system is not working properly. In a properly working system, the businesses that pay punitive damages can no more pass them on by increasing their prices than convicted thieves can pass on the fines they pay by increasing their stealing. A business in a competitive industry can pass on its additional costs to consumers by raising its prices only under one of two conditions. One is that consumers will willingly pay the higher prices because they consider the higher quality of the products to be worth them. A business could not pass on the costs of paying punitive damages for this reason, because paying punitive damages does not improve the quality of its products. The other condition is that all the businesses in the industry incur about the same additional costs per product. Consumers then have no choice but to pay the higher prices, because every business charges them. This condition also does not exist for punitive damages unless the system for identifying the businesses that ought to pay punitive damages is so inaccurate that innocent businesses are about as likely to have to pay them as are guilty ones. All the businesses will then be able to pass on the added costs of the punitive damages because those costs will be about the same per product for every business in the industry. A related charge is that consumers ultimately pay at least the costs the businesses incur in avoiding having to pay punitive damages, because at least these “avoidance costs” are passed on in the form of higher prices.98 This charge possesses the same logical faults as the previous charge to the extent the avoidance costs are themselves avoidable. If the system for identifying the businesses that ought to pay punitive damages is so inaccurate that innocent businesses are about as likely as guilty businesses to have to pay them, every business will have to incur about the same avoidance costs, and these costs will indeed be passed on to consumers in the form of higher prices. Of course the reasonable response to both charges is to maintain the accuracy of the system or improve it if it has fallen to such a low level. The reforms I have suggested should do this. However, because no system can distinguish between the guilty and the innocent with perfect accuracy,

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some minimum avoidance costs will inevitably have to be incurred by every business in an affected industry. Consumers and society as a whole will still be better off than if punitive damages were abolished if these minimum avoidance costs are less than the costs of allowing the bad behavior of the guilty businesses to go unpunished.99 We have to decide which way this balance goes for the kinds of bad conduct we choose to punish with punitive damages, but there is no doubt that the balance comes out positive at least for bad faith breach. The costs of avoiding committing a bad faith breach are practically nothing if the legal system is working properly, because they are only the “costs” of behaving honestly and with a decent regard for the feelings of others. No honest and decent business would have behaved as the defendants did in Fletcher and Seaman’s, for example.

The Roles of Bad Faith Breach and Remedies Reform in the Reform of Contract Law Both these developments grew out of a desire to punish producers for engaging in socially harmful conduct. The concept of the bad faith breach defines the conduct. Punitive damages provide the principal punishment, and fee-shifting and damages for emotional distress add more. The damages entitlements also make the punishment more certain by providing a powerful incentive for the victims of the wrongdoing to prosecute the perpetrators. Fee-shifting and damages for emotional distress also serve to compensate the victim. Even punitive damages can serve a compensatory purpose by providing victims with the satisfaction of punishing those who wronged them. But though both developments grew out of a desire to punish producers, except for damages for emotional distress, which the courts presumably will not award to business organizations, both are available to punish wrongdoers of any kind. Indeed, an important potential application of fee-shifting and punitive damages is to punish plaintiffs and lawyers who press dishonest claims. The law of bad faith breach imposes public responsibility: the responsibility to act in good faith in the performance of one’s contracts, which means honestly and with a decent regard for the rights and sensibilities of the other parties. Bad faith breach and the new damages entitlements also serve to enforce the public responsibilities that the courts have placed upon producers through the relational torts. The classical damages entitlements are insufficient to enforce these responsibilities under most circumstances. Both developments also increase consumers’ bargaining power, in particu-

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lar, their power in the “second round” of bargaining that generally occurs if something goes wrong with a product after it has been sold. Secondround bargaining power is important in itself, and it provides an essential support for consumers’ first-round bargaining power. Consumers cannot benefit from the better contracts their increased first-round bargaining power gets them unless they have enough second-round bargaining power to enforce their contracts if the producers breach them.

6 Article 2 of the Uniform Commercial Code

I EXPLAINED the relevance of Article 2 of the Uniform Commercial Code in the introduction. Some of the article’s provisions anticipated the reforms and thus created an attitude that facilitated their acceptance; and, courts interpreted certain provisions in a way that made them part of the reforms. On the other hand, other provisions require courts to act contrary to the reforms, many provisions are bad law, and many unnecessarily complicate contract law by arbitrarily differing from the common law of contract. The genesis of Article 2 is also relevant, because it demonstrates the strengths and weaknesses of legislating in comparison to judicial lawmaking as a means of making contract law.

The Reasons for Creating Article 2 Article 2 grew out of a movement to revise the law of sales. The movement began in 1922 with a presentation to the American Bar Association of a proposed draft of some modifications and additions to the Uniform Sales Act, a law then in effect in about half the states.1 By the mid-1930s the aim had changed to enacting a Federal Sales Act. The act would apply only to interstate sales but would serve as a model for state legislation. Karl N. Llewellyn, then a professor of law at Columbia University, became the leader of the movement during the 1930s and remained so until his death in 1962. In 1940 he changed the aim again, this time to creating a new uniform state law, which is how the article (together with the rest of the Code) was finally brought into existence.2 The law of sales prior to Article 2 was largely just a law of the transfer of ownership of personal property. As Llewellyn expressed it, the central concept was the present sale of present goods, about which the seller made no promises.3 Llewellyn’s goals for the Code were to improve the law of sales, to integrate it with contract law so that it could take effective account of promises,4 and to make it uniform across the states.5 As time went on, however, the project came to include more purposes. By the time the Conference of Commissioners on Uniform State Laws offered the Code for enactment, it included nine articles, only the second of

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which dealt with sales. It is largely this article that will concern us, because with only unimportant exceptions, just this article affects contract law. Like all the other UCC articles, however, Article 2 is affected by Article 1, which is the repository of provisions that apply throughout the Code. I therefore will occasionally refer to Article 1. For the sake of simplicity, however, I will often refer just to “the Code,” without bothering to specify which article. Although Llewellyn did not state it as one of his goals, he also hoped to improve the law of contract. This is the only reasonable explanation for the inclusion in Articles 1 and 2 of so many laws that have no more to do with contracts concerning goods than with any other contract. To name just a few, there are provisions for contract amendments, the parol evidence rule, waiver (three kinds!), offer and acceptance, expectation damages, liquidated damages, and the defense of impracticability of performance. However, with few exceptions, the Official Comments to the Code do not explain why its provisions differ from the common law of contract when they do. As a result, we do not know why the drafters thought the differences were improvements, or even if they intended them rather than their being mistakes. The Code can change the common law of contract in three ways. First and most directly, it displaces the common law to the extent it states the law if the situation concerns a “transaction in goods.” Second, it can influence the common law as a model for judges to follow if they think the common law is unclear or that they ought to change it. Third, it can serve as a model for future editions of the Restatement of Contracts, and these, in turn, can influence the common law as a model for judges to follow. As it turned out, the Code exerted a direct and personal influence on the Restatement (Second) of Contracts, which the American Law Institute published in 1981. The American Law Institute appointed Robert Braucher, then a professor at Harvard Law School, to be the Reporter for this Restatement in 1960. Braucher had been one of the two editorial coordinators who helped Llewellyn put together the Code. Prior to taking the job as Reporter, he had not taught contracts since 1950. His lifetime publication record includes nothing on contract law. The only reason the American Law Institute could have appointed him Reporter was to bring the influence of the Code to bear on the Restatement. Braucher served as Reporter until 1971, when he resigned to become a justice of the Massachusetts Supreme Judicial Court. E. Allan Farnsworth, a professor at Columbia Law School, succeeded him as Reporter. The Restatement (Second) of Contracts allocates credit between Braucher and Farnsworth for the sections they produced.6 Several of Braucher’s sections are almost verbatim repetitions of Code provisions,7 and the entire Restatement uses “modification” for “amendment”8 and various circumlocutions instead of “unilateral

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contract” or “bilateral contract.”9 Llewellyn used these same terms and circumlocutions in the Code in the hope they would contribute to certain substantive changes he hoped to make in the law of contract. Although Article 2 achieved Llewellyn’s stated purposes, it failed to change contract law. Ultimately, the only way it could have changed contract law would have been by persuading judges that its provisions were superior to the common law, but judges were not persuaded. With the exception of the provisions on unconscionability, not a single provision of Article 2 has been adopted into the common law of contract of a single state, let alone a sufficient number of states to justify our saying that the provision has become a part of our general law of contract.10 Even the unconscionability exception is only apparent. Although the Code introduced the concept, it did not define it. Section 2-302 says no more than that a court can refuse to enforce a contract or contract term if it finds it to be unconscionable. Courts themselves had to make the law of unconscionability even as they used it under the Code. Therefore, when they adopted it into the common law, they were not changing the common law to be like Article 2—they were making the common law and the law of the article simultaneously.

The Efforts to Make Amending Article 2 Unnecessary Article 2 has never been importantly amended although it has been in existence in most states for more than twenty-five years. Llewellyn anticipated this and called it “the problem of a semi-permanent code.”11 He realized that unless every state legislature enacted the same amendment, amending the article would destroy its uniformity among the states,12 which was one of his chief reasons for creating the article, and that it would be difficult to obtain the agreement of every state legislature to the same amendment. Llewellyn’s solution to the problem was to use the Code itself, Articles 1 and 2 in particular, to revive what he called “grand-style judging,” which he hoped would make amendment unnecessary, or at least necessary much less frequently. Llewellyn defined grand-style judging as that which creates a new rule to serve the underlying purposes for which a rule is needed, rather than follows an existing rule past the point where it ceases to serve its purposes. He contrasted grand-style judging with “formalism,” which follows the existing rule regardless of the consequences, at least ostensibly. Formalist judges were not necessarily blind to the needs of justice, but their principles required them to serve those needs surreptitiously. They fudged the law or the facts or twisted logic in order to come to a just result while pretending to follow the existing rules. This fudging and twisting had two

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negative consequences. Justice was done less often, because it was only in egregious cases that formalist judges felt justified in compromising their principles. The fudging and twisting produced confusing and contradictory laws, which provided no predictability for future cases. Although Llewellyn thought life was too complex for laws ever to provide anything close to perfect predictability, he believed that grand-style judging could make the outcomes of future cases at least “reckonable.” However, he thought that with a few exceptions (he admired Benjamin Cardozo and Learned Hand) grand-style judging had ended at about the time of the Civil War.13 Ordinarily at least, judges cannot engage in grand-style judging except when making common or constitutional law. They cannot engage in this style of judging under statutes, not at least as lawyers tried to draft statutes in Llewellyn’s time. Unless an administrative agency was to administer the statute, the goal then was to draft it to provide clear and comprehensive directions that left the courts with as few unanswered questions as possible.14 Llewellyn decided to construct the Code differently, so that it would encourage, or even require, judges to engage in grand-style judging. He used four tactics to try to achieve this goal. One was to draft the Code in such vague terms that the courts would have no choice but to use their creative powers in deciding cases falling under it. Subsection 2-718(1) is an instance of this tactic. It reads: Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty.

Anyone not already familiar with the common law of liquidated damages would be at a loss for the meaning of this subsection. Its evident purpose is not so much to state the law of liquidated damages as to invoke it. In effect, the reader is being told to treat liquidated-damages provisions in contracts governed by the Code as he or she would treat such provisions under common law, as the common law changes and develops. A second tactic was to make frequent reference to trade practice. This would allow each trade (today we would be more likely to say “each industry”) to make its own rules by choosing its practices without legislative or judicial intervention. This tactic is closely related to the first, because when the Code uses broad language, a court will often look to trade practice to decide a case even if the Code does not expressly refer to trade practice. A third tactic was to provide specific answers but condition them on the court’s not having a reason for concluding differently. For example, some Code provisions set forth the result that is to follow unless the contract or circumstances indicate a different one.15 Others instruct the court in very

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general terms how to go about determining the meaning of the contract if the contract is not clear on the question.16 Still others state a rule the court is to follow unless the court decides that a different rule would be better.17 A court can generally reach the same conclusions it could properly reach under the common law under any of these kinds of provisions, because the provisions allow the court to rest its conclusions on the same considerations as it would a common law decision. None of these tactics raised eyebrows even among the most conservative people with whom Llewellyn dealt, but his fourth tactic did. Evidently in an effort to be as clear as possible about this last tactic, he stated it in three separate places in both the 1940 and the 1941 drafts: in the report accompanying the proposed legislation, in the legislation itself, and in the official comments he intended to be part of the legislation. (The quotations that follow are from the 1941 draft.) First, the Code would include a statement of its general underlying principles and policies. Second, the Code’s provisions would make their more particular underlying principles and policies manifest. Third, the Code would include a statement that its provisions were subject to all these underlying principles and policies. Fourth and most radically, the Code would be “hedge[d] . . . against its own errors. . . . [W]hen circumstances unmistakably and persistently show the obsolescence of a [principle or] policy declared in the Act, the Courts are free to move in the common-law manner toward cure.”18 In other words, the Code would direct the courts to treat it as though it were common law. A court could “overrule” a part of the Code if it became obsolete, just as though the Code were a body of judicial decisions rather than a statute. Authorizing courts to treat the Code as a body of judicial decisions was a brilliant idea in my opinion, but it was more radical than the Commissioners on Uniform State Laws would accept. Llewellyn never proposed it again. He also eventually dropped the proposal that the official comments be part of the legislation. However, the Commissioners on Uniform State Laws published the official comments, every legislatively authorized publication of the Code includes them, and the courts frequently refer to them. Moreover, the Code as the Commissioners finally proposed it includes a section urging and authorizing the courts to interpret its other provisions broadly to effect its underlying purposes and policies and stating these purposes and policies so broadly as to leave the courts a practically unlimited discretion in interpreting them.19 Although Llewellyn presumably dropped the proposal because he thought he had to, his dropping it caused all his other tactics for keeping the Code current to fail. Grand-style judging without this authority will not keep the Code current for several reasons. First and most important is the inherent conflict between grand-style judging and the reasons the Code was made. The Code was made in order to improve sales law, to integrate it

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with contract law, and to make the integrated law uniform among the states. One cannot achieve these goals without giving clear statutory commands about how the courts shall decide cases, but clear statutory commands preclude grand-style judging, which requires that courts be free to decide cases according to the laws they make. Moreover, the courts generally have not engaged in grand-style judging even when the statutory commands are not clear, but have tried to interpret the Code, instead. Interpretation is not grand-style judging, because grandstyle judging is lawmaking. The courts have also generally failed to engage in grand-style judging out of deference to their state legislatures, although the deference is misplaced in this situation. The practice with an ordinary statute is that if the highest court of a jurisdiction interprets it, no court thereafter will reconsider the interpretation. The legislature presumably will amend the statute if it disagrees with the interpretation. Therefore, if the legislature has not amended the statute, it presumably agrees with the interpretation, and the courts will be obeying the legislature only if they allow the interpretation to stand. Courts ought not to follow this practice with the Code, because state legislatures enacted the Code only in the technical sense; their members did not draft it and rarely understood or even cared what it contained. Nor is a state legislature likely to amend the Code in order to change a judicial interpretation of it. On the contrary, a legislature is not supposed to amend the Code for any reason without the advice and consent of the Conference of Commissioners on Uniform State Laws, in order to preserve the Code’s uniformity across the states. Nevertheless, courts have generally tried to interpret the Code rather than make law for it when it is unclear, and the highest courts of a jurisdiction have generally refused to reconsider their interpretations of the Code. I will describe just one example out of many where both these obstacles to grand-style judging have been present. Debtors or alleged debtors who dispute the amount they owe (or whether they owe anything at all) sometimes try to settle the dispute by delivering a “full-payment check” to the creditor. This is a check upon which the debtor has written words to the effect that he is offering it in full payment and if the creditor cashes it, the creditor accepts it as full payment and thus loses any right to anything more. Creditors sometimes try to avoid losing their rights if they cash these checks by writing on them that they reserve their rights or by notifying the debtor to the same effect before they cash them. The common law rule is that the debtor wins; creditors lose their rights to more if they cash such checks whether or not they try to reserve their rights in some manner.20 However, Code Section 1–207 provides that a person can reserve his rights by saying that he does, in which case if he then proceeds to exercise his rights or perform his duties under the contract, he will not have lost the rights reserved. Therefore, the question was

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whether Section 1–207 changed the common law rule. A large majority of the state highest courts that have answered the question have answered it in the negative. In none of the decisions, did the courts engage in grand-style judging; they merely tried to discern what the Code drafters or their state legislature intended or what the language of the section means. And in no case yet has a highest court even asked itself whether it should overrule its first interpretation.21

The Process for Drafting and Enacting the Code Although the Code is legislation, it possesses none of the attributes of legislation that ordinarily determine the attitude an interpreter should take toward it. The legislatures that enacted it did so for none of the reasons ordinarily associated with legislating. The politically organized interest groups that normally take sides on legislation ignored it. Even the state bar associations usually had to be persuaded by Llewellyn or one of his associates to take an interest in it. Soia Mentschikoff, Llewellyn’s principal associate, addressed the first state bar convention I ever attended. She urged us to commend the Code to our state legislature, and we did. The Colorado State Legislature enacted it a year or so later, if my memory serves me correctly, with even less thought than we gave it. The Code received close scrutiny before being enacted in only one state, New York, but even there the scrutinizers were largely members of the bar rather than legislators. Their interests were largely just those of lawyers who wanted a law that would clarify uncertainties and overcome various technical problems.22 The real authors of the Code were Karl N. Llewellyn, a general advisory group of six people, and additional advisory groups of six people each for each of the Code’s nine articles. These people were academics, practitioners, judges and members of the staff of the Conference of Commissioners on Uniform State Laws. None was a legislator.23 Another result of this process is that the Code lacks a legislative history that might be useful for interpreting its provisions. There is no legislative history for the most part, because there was no meaningful legislative process. Most legislators simply said “Aye” to some thick packets of bill paper. The fact that every legislature enacted virtually the same Code also makes its legislative history meaningless. No matter what a legislator may have thought, his or her thoughts can rarely have influenced the language of the Code, because the Code was rarely changed in the process of enactment.24 Even if the six-person group that drafted an article intended a provision to have a particular meaning, there would be no reason to give the intention any weight. The group exhausted its authority when it presented the pro-

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posed legislation, Official Comments, and any further reports or comments to the state legislatures. Any intentions it might have had that were not expressed in these documents should have no more effect on us today than they could have had on the enacting legislatures. Of course any intentions that were not expressed in these documents could not have had any influence on these legislatures. The Official Comments that accompany every section are sometimes helpful, especially when the subject of the section is a law of sales, but it is difficult to determine what weight one should give them, because they lack all the usual sources of authority. They are not part of the legislation, because the state legislatures did not enact them. They are not legislative history for the reasons already given. Although they presumably express the intentions of the six-person group that drafted the article, the only authority the group’s intentions could have had ended when the legislatures enacted the legislation without enacting the Official Comments. The Official Comments to the sections on contract law are rarely helpful if the section does not purport to change the common law, because anyone who is familiar with contract law already understands the purposes of particular parts of it. Although the Official Comments to the sections that purport to change the common law might be helpful if they gave the reasons for the changes, they rarely do this. For example, the Official Comment to Subsection 2-209(1), which states, “An agreement modifying a contract within this Article needs no consideration to be binding,” states, “Subsection (1) provides that an agreement modifying a sales contract needs no consideration to be binding.” Although the comment goes on to say more, it adds nothing that is not also true of the common law.

Unconscionability The unconscionability section is a striking demonstration of how effective Llewellyn’s tactic of encouraging grand-style judging by deliberate statutory vagueness could be when he was willing to use it. Section 2-302 does not define the doctrine.25 Official Comment 1 adds only, “The principle is one of the prevention of oppression and unfair surprise . . . and not of disturbance of allocation of risks because of superior bargaining power.” Scholars initially reacted with shock and derision at such vagueness, predicting that it would render the doctrine ineffectual,26 but the courts soon vindicated Llewellyn. The U.S. Court of Appeals for the District of Columbia Circuit, in a decision written by Judge J. Skelly Wright, gave the doctrine a formulation in 1965 that has largely survived to this day. This was also the first decision to explicitly declare unconscionability to be a part of

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the common law of contract, and virtually every jurisdiction has also followed it in this respect.27 The case was Williams v. Walker-Thomas Furniture Co.28 Williams had purchased a stereo set from Walker-Thomas Furniture Company in April 1962 and various other items at other times dating back to December 1957. All of the purchases were on credit. The security clause in WalkerThomas’s standard credit contract subjected to repossession all items a customer had ever purchased on credit if the customer failed to make a scheduled payment on any of them. Williams missed a payment, and Walker-Thomas began repossession. Williams resisted on the ground that the repossession clause was unconscionable. The lower courts held for Walker-Thomas without considering the Code, because the Code was not in effect in the District of Columbia when these events occurred. The court of appeals reversed and remanded for trial on the ground that the doctrine of unconscionability was a part of the District of Columbia’s common law. The court stated, “Unconscionability . . . [is] an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.” An “absence of meaningful choice” exists if the weaker party accepted the terms because he had no reasonable alternative, had no notice of the terms, or was unable to understand the terms or their significance for him.29 Although this formulation has hardly changed in substance to this day, courts and scholars subsequently made some verbal alterations in it. Instead of “absence of meaningful choice,” one now says, “procedural unconscionability,” and instead of “unreasonably favorable to the other party,” one now says, “substantive unconscionability.” Scholars and judges chose the new terms because they conceived of the elements of lack of meaningful choice as attributes of the procedures by which the parties made the contract, and they conceived of the one-sidedness of a contract as a matter of its substance. Thus, using the new names, Walker-Thomas held that a contract or contract term is unconscionable if it is both procedurally and substantively unconscionable. Judge Wright followed the Official Comment to some extent. Substantive unconscionability seems to derive from “oppression,” and procedural unconscionability from “unfair surprise.” However, he ignored the Comment’s disclaimer of an intent to disturb the allocation of risks because of superior bargaining power. As Williams alleged them, the facts of WalkerThomas itself demonstrated both a disparity of bargaining power and a resulting one-sided allocation of the risks of nonpayment onto the purchaser. If the court had not allowed the unconscionability doctrine to “disturb” this allocation, the court could not have protected Williams against the operation of the repossession provision. The court must have realized that the doctrine could hardly provide any protection at all without “dis-

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turbing” the allocations of risk resulting from disparities of bargaining power. The court thus used the vagueness that Llewellyn left in the concept of unconscionability in the way that Llewellyn intended a court to use it, to give effect to what the court perceived to be the principles and policies underlying the section. Despite the Official Comment, the court perceived these to include protection against abuses of superior bargaining power. Unconscionability was Llewellyn’s solution to the problem of the recipient’s lack of consent to a standard form. Although nothing in Section 2302, the Official Comments, or Judge Wright’s formulation specifically restricts the doctrine’s application to standard forms, the element of procedural unconscionability is almost sure to be lacking in any other case. In the thousands of decisions concerning unconscionability the courts have handed down since the Code was enacted, there is not one in which the terms held to be unconscionable were not standard. Llewellyn first addressed the problem of the standard form in 1939.30 The Common Law Tradition: Deciding Appeals, published in 1960, expressed his final thoughts. There, after concluding that the problem was that the recipient did not give the form his full assent, Llewellyn said: The answer, I suggest, is this: Instead of thinking about “assent” to boilerplate clauses, we can recognize that so far as concerns the specific, there is no assent at all. What has in fact been assented to, specifically, are the few dickered terms, and the broad type of the transaction, and but one thing more. That one thing more is a blanket assent (not a specific assent) to any not unreasonable or indecent terms the seller may have on his form, which do not alter or eviscerate the reasonable meaning of the dickered terms.31

What Llewellyn here called “a blanket assent (not a specific assent),” courts now call “procedural unconscionability.” Terms Llewellyn here described as “unreasonable or indecent” or as “alter[ing] or eviscerat[ing] the reasonable meaning of the dickered terms,” courts now describe as “substantively unconscionable.” The substantive changes courts have made in the doctrine since WalkerThomas have only strengthened it. Whereas Walker-Thomas required that a contractual provision be both procedurally and substantively unconscionable in order to be stricken, courts now use a so-called sliding scale. A term is now stricken if the two kinds of unconscionability, considered together, “weigh enough.” In principle, therefore, either procedural or substantive unconscionability is now sufficient, if it alone “weighs” enough.32 Judge Wright may have anticipated even this one change in his formulation. He suggested in a footnote in Walker-Thomas that highly substantive unconscionable terms might be evidence of procedural unconscionability. The consumer presumably would not have agreed to a very unfair term if he had been aware of it, understood it, and had a free choice in accepting

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it.33 The logical result of following this suggestion would be to strike terms if they were highly substantively unconscionable without independent proof that they were also procedurally unconscionable, because their procedural unconscionability would be presumed. Judge Wright did not make it, but there is also an argument that a high degree of procedural unconscionability ought to be sufficient reason to strike a term, because a high degree of procedural unconscionability is tantamount to fraud. Fraud is a defense to enforcement of a contract without regard to the seriousness of the harm. Courts now apply the unconscionability defense to business consumers and individual consumers without distinction. The first step away from the initial assumption that the doctrine protected only individual consumers was to hold that although a business claiming to be a victim of unconscionability confronted a higher burden of persuasion, it could raise the defense. By now, hardly any reported decisions even note the character of the party pleading the defense, and there are no evident differences in the results. At least 40 percent of the parties seeking the protections of unconscionability in the reported cases have been business consumers since 1990.34 Unconscionability has been a valuable defense against egregious unfairness, judging from the frequency with which it has been used, but it has had no discernible effect on business conduct. There is no evidence that producers against whom unconscionability defenses have been successful have removed the offending provisions from their contracts as a result. The reason, presumably, is that including possibly unconscionable provisions in a contract is a no-lose gamble. The producer gains the advantages the provisions provide if the consumer does not contest them or if the consumer does contest them but the court disagrees, and the producer is no worse off than it would have been if it had not included the provisions if the consumer contests them and the court agrees. The burden is on the consumer to recognize the unconscionability and to convince the court that it is the case, and the producer loses nothing for having tried to enforce the provisions in the first place. Unconscionability resembles reasonable expectations. The first two elements of procedural unconscionability—that the consumer not have had a reasonable opportunity to read the terms or could not reasonably have been expected to understand them—are essentially the same as a finding that the terms do not conform to the consumer’s reasonable expectations. However, unconscionability differs from reasonable expectations in three respects. First, reasonable expectations does not include any parallel to the third element of procedural unconscionability, which is that the consumer had no reasonable alternative to accepting the terms. Second, reasonable expectations overrides standard terms that conflict with it even if they are not substantively unconscionable. Third, whereas reasonable expectations re-

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places any terms it overrides with the parties’ reasonable expectations, it has never been clear how a court should determine what should replace the terms if unconscionability renders them unenforceable. Most courts have allowed the reasonable expectations to replace them, however, presumably because this is the rule for filling any “gaps” in an express contract, even under classical contract law. The condition that the first difference addresses is rare, and the third difference will presumably disappear as courts realize that the parties’ reasonable expectations should “fill in” any “gaps” that an application of unconscionability creates. Therefore, the only important difference is the second one noted, that the parties’ reasonable expectations override conflicting standard terms even if the terms are not substantively unconscionable. One might conclude from this that unconscionability will eventually disappear, because reasonable expectations will render it unnecessary. Any time that unconscionability would override the terms, reasonable expectations also would do so, and reasonable expectations would override terms in some cases in which unconscionability would not. The differences between the two laws’ conceptual schemes point to the same conclusion. The theoretical underpinnings of reasonable expectations are simple and straightforward. They ground the law in the most basic principle of contract. The theoretical underpinnings of unconscionability, on the other hand, are not simple, and to some extent they are self-contradictory. They require one to accept the legitimacy of contracts to which one party did not give meaningful consent but to deny their legitimacy to the extent they operate unfairly. Consequently, one would expect that although judges might have more difficulty in accepting reasonable expectations, because it constitutes a greater change from prior law, once they became familiar with it, they would use it in preference to unconscionability if a case permitted them to do so. The reported decisions support this prediction. Whereas the first or first few decisions in a jurisdiction resting on reasonable expectations may also rest on unconscionability, the subsequent decisions resting on reasonable expectations are likely to rest on reasonable expectations alone.35 Nevertheless, I doubt that unconscionability will disappear. We are more likely to see it change so as to do just those things that reasonable expectations cannot. Decisions on unconscionability will increasingly emphasize substantive unconscionability, so that the doctrine will eventually be concerned with this element alone. Contracts will always consist of the parties’ reasonable expectations, but unconscionability will authorize a court to invalidate any aspects of the reasonable expectations that unexpectedly operate unfairly. Appellate courts will continue to make most of the law of reasonable expectations, whereas trial courts will make most of the unconscionability decisions on the basis of the particular facts of the case.

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Contract Formation in a “Battle of the Forms” Section 2-207 governs contract formation in a “battle of the forms.” One could describe Sections 2-207 and 2-302, on unconscionability, as the two extremes of Article 2. Whereas Section 2-302 is probably the article’s best and most successful section, Section 2-207 is certainly the worst. What contracts teachers have dubbed a “battle of the forms” can occur if both parties use standard forms. Some businesses regularly buy enough to make it worth their while to compose their own standard buying forms. Buying forms are not product specific; rather, the businesses that use them draft them as best they can to cover the whole range of things they buy. The “battle” consists of the buying and selling businesses sending each other their standard forms, each trying to make its forms compose any contract they eventually make. The winner of the “battle” is the one that succeeds in this attempt. Classical contract law decided the winner by the “last-shot rule,” which in turn derived from the “mirror image rule.” By the logic of classical contract, a purported acceptance that is not the “mirror image” of the offer does not make a contract, because the parties have evidently not agreed on the different terms.36 Consequently, a purported acceptance that is not the mirror image of the offer is a counteroffer, which terminates the earlier offer and becomes a contract only if the other party accepts it by a mirror image acceptance before it expires.37 Therefore, when two businesses engage in a battle of the forms, their exchanges of forms only create more offers. Each form either one sends operates to reject the offer consisting of the previous form the other sent and becomes itself the only offer outstanding. The “battle” ends when one of two things happens. Either the buyer accepts the goods while the seller’s form is the offer outstanding, or the seller delivers the goods while the buyer’s form is the offer outstanding. The law deems the acceptance or delivery of the goods to be an acceptance of the offer that was then outstanding. So the terms of the last offer made become the terms of the contract; the “last shot” wins. The result is arbitrary, because the parties’ contractual intentions bear no necessary connection with who fired the “last shot.” Section 2-207 displaced the “last-shot rule” for contracts covered by Article 2.38 The reader who is not familiar with the section should read it just enough to appreciate the difficulty of understanding what it requires. Experience has demonstrated not only that the section is difficult to understand but that even understanding it does not solve its problems, because it provides for only some of the alternatives it leaves open.39 For example, although Subsection (2) says what should happen if the parties are both merchants and the acceptance or confirmation includes terms additional to

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those in the offer, it says nothing about what should happen if one of the parties is not a merchant or if the acceptance or confirmation includes terms different from those in the offer. Worst of all is that the section is no improvement over the common law even if one could overcome all its difficulties of interpretation. The results to which it leads are no less arbitrary than the results of the “last-shot rule,” because they bear no more connection to the parties’ contractual intentions than it does. The section’s existence is a mystery, because its complications violate the precepts Llewellyn set for himself for encouraging grand-style judging, but there is a line of decisions on the section that managed to engage in grand-style judging anyway. The leading case is Daitom, Inc. v. Pennwalt Corp., which the U.S. Court of Appeals for the Tenth Circuit handed down in 1984.40 Judge William E. Doyle wrote the opinion. Pennwalt, the seller, sent a form containing terms limiting the warranties to one year. Daitom accepted Pennwalt’s offer with a form containing terms creating a warranty by description, not subject to a one-year limitation. Daitom did not make its claim of breach of warranty until more than one year after purchase. The court held for Daitom on the ground that terms that are in one party’s forms but not the other’s are “knocked out,” thereby creating a “gap,” which the court is to “fill in” as provided by the last sentence in Subsection (3). With few exceptions, the “supplementary terms incorporated under . . . other provision[s] of . . .” the Code to which this sentence refers simply direct the court to fill the “gaps” with the parties’ reasonable expectations, so the end result of Daitom is to replace the section with the law of reasonable expectations. The court acknowledged its indebtedness to James J. White for its solution. White had proposed it in the treatise he coauthored with Robert S. Summers. Both parties in Daitom were “merchants” as the Code defines this term, and the court considered the terms at issue to be “additional” rather than “different” terms, but the decision logically applies to any case in which the parties make a contract by exchanging dissimilar forms. If either party is not a “merchant,” the dissimilar terms in the acceptance presumably do not become part of the contract unless the other party accepts them, so they are “knocked out” and leave “gaps,” just as Daitom held. Likewise, if the dissimilar terms are “different” rather than “additional,” the logic of Daitom would say that the “different” terms in both forms were “knocked out,” again leaving gaps to be “filled in,” as Daitom prescribed. However, Daitom falls short of reasonable expectations in one particular. Sometimes people agree to negotiate with each other toward a final agreement before they agree on all the terms of the final agreement itself. They can also agree further on what shall happen if their negotiations toward a final agreement should fail. They can agree either that there will be

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no deal or that some third party (ordinarily an arbitrator or a court) shall be authorized to complete the contract for them. Daitom fails to allow for the first alternative. It provides no way of enforcing the parties’ agreement to negotiate toward a final agreement while at the same time honoring their agreement that the deal is off if the negotiations fail. Charles L. Knapp published an article in 1969, “Enforcing the Contract to Bargain,”41 in which he concluded that the law should recognize this kind of an agreement as a contract to “bargain . . . in good faith.”42 Not all courts have followed Knapp’s suggestion, but most have, and its sensibleness should ensure that all will eventually accept it.43 The courts could also follow Knapp’s suggestion under the Code, under the authority of Section 1-103, which provides that the common law shall apply any time it is not “displaced by the particular provisions” of the Code. The Permanent Editorial Board for the Code published a proposed amendment of Section 2-207 in 1990.44 The proposal would be an improvement, but it would be better still simply to repeal the section in order to allow courts openly to apply reasonable expectations under the Code, just as they can under the common law. Although Daitom already does this, with the exception noted, it does so in the teeth of the section’s provisions, and of course, some jurisdictions may not follow Daitom.

Warranties and Remedies There is no contract in a “pure” sale. The seller gives the buyer ownership in the goods, and the buyer pays for them. Neither makes any promises. Since there is no contract, there are no remedies for breach of contract. Once the parties have made the sale, they owe no duties to each other. When a seller does say something to a buyer about the goods, he often states it as a fact—“This horse is three years old,” for example. A statement of fact under such circumstances can carry at least three meanings. It can be a condition, which if it is not satisfied entitles the buyer to return the goods and get his money back. It can be a promise, which if it is broken entitles the buyer to damages. Or it can be both. The practice arose centuries ago of calling such statements warranties, probably in order to capture all three meanings they can have without specifying which. For example, if a seller says, “I warrant this horse to be no more than three years old,” the seller commits himself to the horse’s being no more than three years old whether or not he believes it to be the fact. If there are warranties, there are also remedies for their breach. The law distinguishes between implied and express warranties. Implied warranties exist unless the seller disclaims them. Express warranties are

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those the seller expresses. Implied warranties cover aspects of a sale that are generally understood. For example, the implied warranty of title is that the seller owns the goods he is selling. The Code carried forward these traditional concepts by stating a variety of implied warranties, but only two of them are pertinent here. Section 2-314 sets out the so-called warranties of merchantability that are implied in every sale; they concern the quality of the goods. Section 2-315 sets out the so-called warranties of fitness for particular purpose. These apply only if the seller has advised the buyer of the fitness of the goods for a particular purpose, for example, that the seller’s computer will be able to do the work the buyer needs. Section 2-316 authorizes sellers to disclaim any or all of the implied warranties, and Section 2-719 authorizes sellers to limit the buyer’s remedies if any of the undisclaimed warranties are breached, although in neither case is the authority absolute. A warranty disclaimer must be clear and conspicuous to be effective,45 and a remedies limitation is ineffective if, under the circumstances, it would operate unconscionably or defeat the remedies’ essential purpose.46 The conditions on the effectiveness of warranty disclaimers are similar to procedural unconscionability and reasonable expectations in being aimed at providing some assurance that the buyer is warned and understands. On the other hand, the conditions on the effectiveness of remedies limitations are similar to substantive unconscionability and relational torts in providing some protection against unfairness and requiring that a remedy not be so limited that it ceases to provide the protection it should. However, the similarities are only that. With few exceptions, the decisions on Section 2-316 have not interpreted it to require anything like the understanding consent that the law of reasonable expectations requires,47 and the decisions on Section 2-719 have not interpreted it to require anything as specific and definite as some of the relational torts require.48 The greatest weakness of the two sections, however, is the widespread assumption that warranty disclaimers and remedies limitations are mutually exclusive things; a contractual provision supposedly either disclaims warranties or limits remedies but never does both. As a result, a seller can choose which condition to meet; he is not required to meet both. If a seller chooses to draft a provision as a warranty disclaimer, although the provision must be clear and conspicuous to be effective, it can be as unfair and as destructive of the buyer’s rights as the seller likes. On the other hand, if a seller chooses to draft a provision as a remedies limitation, although the provision must be reasonably fair and leave the buyer with enough remedial rights to provide some meaningful protection, the seller is under no obligation to warn the buyer or enable the buyer to understand.49

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In most situations, a producer can achieve the same results by either route. For example, suppose a producer wants no liability for product defects that manifest themselves more than one year after the consumer purchases the product. One way of achieving this would be to require all claims for breach of warranty to be made within one year of purchase. A court would regard this contractual language as a remedies limitation and therefore treat it under Section 2-719. Another way of achieving the same result would be to disclaim all implied warranties and replace them with an express warranty that lasts only one year. A court would regard this language as a warranties disclaimer and therefore treat it under Section 2-316. In the first case, the producer would have breached its warranties even if the defect surfaced after a year, but the consumer would have no remedy for the breach. In the second case, the producer would not have breached its warranties if the defect surfaced after a year, so of course, the consumer would also have no remedy in this case. If a producer can achieve the same results by either route, of course, it will choose the route it thinks it can travel more easily. Ordinarily this will be a warranty disclaimer, because Section 2-316 requires only that the disclaimer be clear and conspicuous, and consumers rarely pay attention to the contents of forms anyway. The producer thus avoids all the substantive protections that Section 2-719 would give the consumer if the producer had chosen the route of a remedies limitation. Not only do the Code’s sections on warranties, warranty disclaimers and remedies limitations fail to provide sufficient protection, they do additional harm by preventing courts from applying the common law reforms. The clear-and-conspicuous requirement for warranty disclaimers protects the consumer less than does the law of reasonable expectations for many reasons, the most important of which is that the former does not require a producer to make the disclaimer’s significance clear. Therefore, if a court gives effect to a warranty disclaimer because it meets the clear-andconspicuous requirement, without examining whether the resulting contract conforms to the consumer’s reasonable expectations, the Code is blocking the application of reasonable expectations. Numerous courts have done this.50 Likewise, if a court refuses to create a relational tort because it would impose a duty on a producer that the Code would allow the producer to disclaim, or because it would give a consumer a remedial right that the Code would allow a producer to limit, the Code is blocking the creation of relational torts. The Texas Supreme Court created an undisclaimable warranty of good and workmanlike quality for services in 198751 but refused to extend it to contracts for the sale of goods in 1990 because the Code allows sellers to disclaim warranties.52 The cases holding sellers

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of expert advice liable for professional malpractice or its equivalent are legion,53 but if the sellers also sell the goods to which their advice relates, the Code allows them to disclaim their liability. The cases holding this are also legion.54 It is as though we allowed physicians to disclaim their professional responsibilities if they sold their own medicines. I will deal further with these and other conflicts between the reforms and the Code in the final chapter.

7 Choices and Prohibitions

PREVIOUS CHAPTERS have treated the reforms individually. This chapter treats them as they relate to one another, to Article 2 of the Code, to contract law as a whole, and to the Constitution. These relationships give rise to certain choices and prohibitions. A court could sometimes use more than one of the reforms to reach the same result, and sometimes Article 2 prohibits, or might prohibit, reaching the result one of the reforms would reach. A second set of choices consists of the means by which we might heal the rift that Article 2 created in contract law; I described this rift in the Introduction. Two lines of decisions by the U.S. Supreme Court impose certain constitutional prohibitions on contract law and on the remedies the law provides in private actions of any kind. One line, I will argue, invalidates the American Rule in certain situations. The other requires sensible standards for punitive damages. Finally, I will describe certain abuses of the reforms and suggest how we might prevent them.

The Choice between Reasonable Expectations and Relational Torts No court has yet addressed the question of which of these approaches it should use in a situation where it could use either to reach the same result, presumably because no court has yet been aware that it had the choice. C & J Fertilizer, Inc. v. Allied Mutual Insurance Co.1 is an example. This is the 1975 decision in which the Iowa Supreme Court refused to enforce a definition of burglary in an insurance policy that limited the term to burglaries leaving visible marks of illegal entry. The Iowa court used reasonable expectations, but a court in a jurisdiction that was pursuing the relational tort development presumably would have applied the covenant of good faith and fair dealing. It presumably would have held that the covenant required an insurer who had sold “burglary insurance” to pay compensation for a burglary in the common meaning of the term. An insurer would not be acting in good faith or dealing fairly if it were to deny coverage on the basis of a hidden and unexpected policy definition. Comunale v. Traders and General Insurance Co.,2 the 1958 decision that began the development of relational torts in California, is an example

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of the opposite situation. The California Supreme Court used the covenant of good faith and fair dealing to require a liability insurer to accept a reasonable settlement offer from a liability claimant. An Iowa court on the same facts might have used reasonable expectations; that is, it might have held that absent a clear warning to the contrary, someone who bought liability insurance would reasonably expect that the insurer had a contractual duty to accept a reasonable settlement offer from a liability claimant. A court should use a relational tort rather than reasonable expectations to create a duty if the duty meets either of two conditions: it serves a public policy, or the typical consumer would lack bargaining power on the subject because he would not understand it. A court should use reasonable expectations to impose the duty in all other cases. The difference is the ability of producers to avoid the duty in the future. The law generally allows one person to contract out of a tort duty he would otherwise owe to another if the duty meets both of two conditions: avoiding it will not violate a public policy, and the parties to the contract have about equal bargaining power on the subject.3 These two concurrent conditions are effectively the opposites of the two alternative conditions I just suggested for determining whether a court should use relational torts or reasonable expectations to create a duty—with one exception. The exception is that whereas the second alternative condition is that the typical consumer would lack bargaining power on the subject, the second concurrent condition is that the parties to the contract have about equal bargaining power on the subject. Therefore, if a court creates a duty as a relational tort, the law will generally limit producers’ ability to contract out of the duty in the future to situations in which public policy will not be violated and the producers and the particular consumers concerned have about equal bargaining power on the subject. On the other hand, if a court uses reasonable expectations to create the duty, the law will allow producers to contract out of it in the future for all consumers, by changing their contracting practices to change consumers’ reasonable expectations on the subject. Using reasonable expectations preserves freedom of contract in all cases; using relational torts limits freedom of contract to special situations. Take, for example, the tort duty everyone owes to everyone else not to negligently harm their person or property. The law presumably would allow a construction company to contract out of this duty with respect to the employees and property of a manufacturer in connection with some work the construction company was doing for the manufacturer. The manufacturer would presumably be knowledgeable enough about construction work to understand the risks involved, and the public policy of protecting people from negligently inflicted personal injuries would not be violated,

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because the manufacturer presumably would have protected its employees under the workers’ compensation laws. On the other hand, the law presumably would not allow a construction company to contract out of this duty for work it was doing on a private residence. The owners and occupants of the residence presumably would not have the protection of the workers’ compensation laws, nor would they be knowledgeable enough about construction work to understand the risks involved. The alternative conditions I have suggested for determining whether to create a relational tort rather than use reasonable expectations are also consistent with the reasons courts have given for creating relational torts in the past. The courts that created relational torts generally justified them on the grounds that the relationship was imbued with “a public interest,” “adhesion,” or “fiduciary responsibility.” “Public interest” in this context meant the producer’s activity served a public policy, “adhesion” meant there was unequal bargaining power, and “fiduciary responsibility” only expressed the need for a relational tort, which the presence of the first two attributes already demonstrated, as I explained in Chapter 4.4 Applying the suggested criteria to the facts of C & J and Comunale leads to the conclusion that a court today should use a relational tort rather than reasonable expectations on both of them. The unexpected definition of burglary that the insurer used in C & J satisfies both criteria. The definition was a fraud under the circumstances, and of course, there is a public policy against fraud. The insurer offered burglary insurance that it knew would not cover certain common situations that the consumer would expect burglary insurance to cover. The justification the insurer in C & J offered was that the definition allowed it to avoid liability for “inside jobs.” These included employee embezzlements or attempts by an insured to defraud his insurer by faking a burglary loss. However, the definition does not effectively serve either purpose. An insured who sought to defraud his insurer by faking a burglary loss could also fake the visible marks of illegal entry. And the definition is not necessary for avoiding liability for embezzlements, because an insurer is not liable for embezzlements under a burglary insurance policy. The unexpected definition also satisfies the second part of the test, because consumers generally would not be capable of accurately estimating the actuarial risks involved in such a definition even if the insurer tried to explain them. The facts of Comunale also satisfy both criteria. Liability insurance serves at least two public purposes, and the duty the court imposed serves at least one of them. Liability insurance provides insureds with protection against potentially ruinous financial loss, and it provides accident victims with financial resources to pay their medical expenses and to compensate them for their lost earnings and earning capacities. At least its ability to

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serve the second purpose is undermined if insurers do not pay the victims’ reasonable settlement offers. One could not reasonably expect to educate the typical consumer well enough in the settling of liability insurance claims to enable him to decide intelligently for himself whether to accept a contract of insurance in which the insurer had waived its duty to accept a reasonable settlement offer. Farm Bureau Mutual Insurance Co. v. Sandbulte,5 on the other hand, is an example of a case in which a court ought still to use reasonable expectations. The insured claimed that his “farm premises only” motor vehicle liability policy covered an accident to one of his trucks that occurred during an 8-mile trip on a public highway from one part of his farm to another. The Iowa Supreme Court affirmed the trial court’s denial of the claim on the ground that this was not reasonable to expect. One can easily imagine farmers who might be willing to pay higher premiums to have insurance that covered such extended trips off the farm premises. If there are such farmers, presumably there are also insurers who would like to sell this kind of insurance to them. There are no evident public policy considerations opposed to such insurance, and the subject is not too difficult for the general consumer to understand.

Reasonable Expectations under the Uniform Commerical Code Reasonable expectations is a means of determining the contents of a contract. The Uniform Commercial Code, therefore, does not prohibit using reasonable expectations unless it would determine the contents of the contract differently. Sections 2-207 and 2-316 are the only sections that might do this. Section 2-316 sets forth certain requirements that a seller must meet in order to disclaim warranties. The section would determine the contents of the contract differently from what a buyer would reasonably expect in some situations if we interpreted these requirements as both necessary and sufficient. A seller who met them would then have succeeded in disclaiming the relevant warranties even if the buyer did not reasonably expect it. The obvious way to avoid this result is to interpret the requirements as necessary but not sufficient. A seller must meet the requirements and arrange the transaction so that the buyer reasonably expects the disclaimers in order that the warranties be disclaimed. Interpreting the section this way should not present a problem, because its principal purpose is to protect buyers. Section 2-207, the offer and acceptance section, presents a major obstacle if one interprets it literally. It operates arbitrarily; the elaborate scheme it sets out for determining the content of the contract will produce the con-

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tract the parties reasonably expected only by accident. However, as I explained in Chapter 6, the line of decisions led by Daitom, Inc. v. Pennwalt Corp.6 effectively reconstructs the section to make it consistent with reasonable expectations. Therefore, there is no obstacle to using reasonable expectations under the Code if a court follows Daitom in interpreting Section 2-207.

Relational Torts under the Uniform Commerical Code The Code is a statute, and relational torts are common laws. The Code therefore prevails over any relational tort with which it conflicts, and if a court determines that the Code governs a situation, it is constitutionally prohibited from creating a relational tort with which the Code would conflict. The question of whether a court can legitimately create a relational tort for contracts governed by the Code therefore reduces to the question of whether the relational tort and the Code would conflict with one another. Section 1-103 expresses the policy that a court is not to find such a conflict lightly. The section reads: § 1–103. Supplementary General Principles of Law Applicable. Unless displaced by the particular provisions of this Act, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other validating or invalidating cause shall supplement its provisions.

The only laws to which this section refers are other laws of contract or laws that explicitly validate or invalidate contracts. The law of principal and agent validates or invalidates contracts that one person makes in the name of another. Bankruptcy laws validate or invalidate the contracts of a bankrupt. The other laws mentioned are parts of the law of contract (although they may also operate elsewhere, as does estoppel, for example). In particular, there is no reference to the law of torts, either generally or to particular parts of it. The drafters must have limited their references in this manner because they assumed that no other kind of law could conflict with the law of contract. This assumption is correct in any event. The only other kind of “conflict” is the one that went under the name of freedom of contract back at the turn of the century: a law “conflicts” with contract law if it provides a right or duty about which people could otherwise have contracted. For example, the U.S. Supreme Court held in Lochner v. New York that a New York state statute limiting the hours bakery employees could work to ten hours a day and sixty hours a week was unconstitutional because it “interfer[ed] . . .

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with the right of contract between the employer and employees, concerning the number of hours in which the latter may labor in the bakery of the employer.”7 The absence of any references in Section 1–103 to regulatory laws such as this, to tort laws, or to other laws that provide rights and duties about which people could otherwise have contracted makes clear that the Code drafters did not intend to revive the old law of freedom of contract. We should consider the old law of freedom of contract as being as dead for the Code as it is for the common law of contract. The courts’ treatment of products liability law makes a good illustration of this proposition. Products liability is tort law. It applies to manufactured products, which are “goods” as the Code defines them. Code Sections 2314 and 2-315 impose essentially the same duties on sellers as the law of products liability imposes on them, but whereas the Code permits sellers to disclaim these duties and to limit the remedies buyers have for the seller’s breach of them, products liability law generally prohibits such disclaimers or remedies limitations. Products liability law thus “conflicts” with the Code in the sense that the old law of freedom of contract conceived of such conflicts. Nevertheless, every state has both the Code and products liability law, and in no state have the courts held that the Code allows sellers to limit or disclaim the liabilities they would otherwise have under the law of products liability. However, the Texas Supreme Court came to a different conclusion for relational torts in Cate v. Dover Corp.8 in 1990. The court had held in Melody Home Manufacturing Co. v. Barnes9 in 1987 that services sold to consumers carry an undisclaimable warranty of “good and workmanlike manner,” but it decided not to extend the warranty to manufactured products in Cate because the Code precluded it. In Cate, the relational tort would conflict with the Code provisions permitting sellers to disclaim warranties. Although it did not do so, the court could have stated its reason in essentially the same words that the U.S. Supreme Court used in Lochner— that, the relational tort would “interfere with the right of contract between seller and buyer, concerning the warranties that shall accompany the sale of goods by the former to the latter.” Cate effectively revived Lochner for Code contracts. The decision was unfortunate because it created an unprincipled distinction. The reasons that led the Texas Supreme Court to conclude that sales of services to consumers should carry undisclaimable warranties apply equally to sales of goods to consumers. The court made matters more difficult for itself in Melody Home, when it called the duty to render services of good and workmanlike quality an “implied warranty.” “Warranty” is the language of contract, not tort. A seller “warrants” something when he expressly or impliedly represents that it is the case. The law cannot imply a warranty except by analogy to the

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contract law meaning of the word. By using the analogy for services, the court made it seem that it would be making law in conflict with the Code if it extended the law to goods. Courts made the same mistake decades ago in the course of developing the law of products liability. Many of them initially called it, too, an “implied warranty.”10 It would be less confusing if we restricted “warranty” to the law of contract and called torts “torts.” The other possible conflict between a relational tort and the Code concerns the duty of a person who sells his expert advice to provide it competently and with due care. If we characterize the person’s occupation as a profession, we generally call a violation of the duty malpractice, but whether or not we thus characterize the occupation, the duty, if the law imposes it, sounds in tort. The possible conflict is with Section 2-316 of the Code, which allows a seller to disclaim any or all of the warranties that other sections impose if the seller meets the requirements that Section 2316 imposes for disclaimers. The pertinent warranties in this case are those of “fitness for particular purpose,” which Section 2-315 imposes. If, in addition to selling goods, a seller offers expert advice on which goods or kinds of goods will best serve the buyer’s particular purposes, Section 2-315 provides, in effect, that he warrants that the advice is correct. However, Section 2-316 allows a seller to disclaim this warranty. On the other hand, if the common law imposes a duty on a person engaged in the occupation concerned, sounding in tort, to provide advice competently and with due care, the law does not allow him to disclaim the duty. Lawyers and physicians cannot disclaim their professional responsibilities, for example. If we allow Section 2-316 to override tort law in this instance, we create an arbitrary distinction. Those who give expert advice and sell the goods to which their advice relates can disclaim their liabilities for giving bad advice, whereas those who give the advice but do not sell the goods cannot disclaim their liabilities. As I noted in Chapter 6, this line of reasoning leads to the conclusion that physicians can contract out of their professional responsibilities if they sell their medicines. We ought not to make this distinction, and if we take the correct view of when the Code conflicts with the common law, Section 2-316 does not require us to make it. We should never regard the Code as conflicting with the law of tort, because the Code presupposes that the rights and duties with which it deals are contractual. Therefore, if the law of tort imposes a duty on those who give a certain kind of advice to provide it competently and with due care, the fact that they also sell the goods to which their advice relates should not allow them to disclaim the duty. In sum, we should not consider the contract law of the Code to preclude courts from creating relational torts any more than we consider the common law of contract to preclude them.

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Bad Faith Breach under the Uniform Commerical Code The conclusions just reached for relational torts also apply to bad faith breach, because bad faith breach is also a tort. One could use the same faulty reasoning that led the Texas Supreme Court to refuse to create a relational tort for contracts governed by the Code to refuse to apply bad faith breach to contracts governed by the Code. Bad faith breach “conflicts” with the Code by providing kinds of damages that the Code does not. In this case, however, the Code has not stood in the way. Courts have used bad faith breach without even noting whether the Code governed the contract. For example, the decision in which the California Supreme Court first spelled out the elements of bad faith breach, Seaman’s Direct Buying Service, Inc. v. Standard Oil Co.,11 involved a contract for the sale of boat fuel. The decision in which the Indiana Supreme Court first set forth the circumstances under which breaches of contract could carry punitive damages liability, Hibschman Pontiac, Inc. v. Batchelor,12 involved a contract for the sale of an automobile. The Code governed the contract in both cases, because both boat fuel and automobiles are “goods.”

The Choice between Legislation and Judicial Lawmaking for Article 2 Article 2 stands in the way of some of the reforms. Section 2-207 stands in the way of a court’s using reasonable expectations in the “battle of the forms,” and the sections on warranties, warranty disclaimers, and remedies limitations stand in the way of a court’s creating certain kinds of relational torts. Although I showed in Chapter 6 how the Daitom line of decisions overcomes the first obstacle, and I explained above how a court could overcome the second obstacle, of course there is no assurance that other courts will follow Daitom or that any courts will accept my explanation. Article 2 is also a problem because it provides a contract law that differs from the common law of contract in numerous respects for which there are no apparent justifications. Moreover, the contract law of Article 2 is generally inferior to the common law insofar as it differs from it, or at least this must be the view of the courts, which have not adopted a single provision of the article into the common law despite the Code’s Official Comments inviting them to do so.13 The solution I propose is to amend the article to give the courts the authority to treat it as though it were common law. Llewellyn proposed this originally, although his proposal and mine differ slightly. Such an amendment would provide the following benefits.

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More Current Laws Amending Article 2 is difficult because amending it would destroy its interstate uniformity unless every state legislature enacted the same amendment, and the article’s interstate uniformity is its principal value. The article has never been importantly amended, although its drafting was complete by 1960 and a majority of state legislatures had enacted it by 1970. The only important amendment even officially proposed has been one to amend Section 2-207, the “battle of the forms” section, which I mentioned in Chapter 6, and the Commissioners on Uniform State Laws have not yet decided whether to propose it, although the Permanent Editorial Board for the Uniform Commercial Code did so in 1990. Moreover, Article 2 needs comprehensive reform. Piecemeal reform like that being considered for Section 2-207 will never be sufficient. No one has even begun to discuss comprehensive reform, although the need for it has long been apparent. On the other hand, the courts’ achievements over the same period have been monumental. They have produced the four major reforms of contract law since about 1960. They have broadly interpreted Article 2 in an effort to make it good law; but for these efforts, the article would need amending even more urgently. Although the pace of some of the reforms has been slower since the middle 1980s, we can attribute most of the slowing to the reforms’ having been largely accomplished. Moreover, the slowing has only been relative to the extraordinarily fast pace of reform that prevailed in the 1960s and 1970s. It is inconceivable that the American judiciary will revert to the rigid formalism of the late nineteenth and early twentieth century that Llewellyn so disparaged. That was based upon a mystical belief in the common law that is quite foreign to the modern temperament. I doubt whether even the most conservative judge today thinks of the common law as a “brooding omnipresence in the sky,” as Oliver Wendell Holmes, Jr., accused judges early in this century of thinking of it.14 This contrast is reason enough to adopt my proposal. We cannot hope to keep Article 2 current by amendment in the usual sense. On the other hand, we have good reason to believe that the courts will quickly bring it up to date and keep it current if we give them the authority to do so. Moreover, enacting the amendment would be a risk-free experiment. The legislatures could take back the authority the amendment granted any time they wanted to, and they could always change any laws the courts had made with the authority the amendment had granted them. Enacting the amendment would not even prejudice anyone who believed that legislation is superior to judicial lawmaking for contract law. Such people

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could continue their efforts at drafting amendments, and the legal community could choose between the results of their efforts and what the courts had achieved in the interim when they offered their proposed amendments for enactment.

More Uniform Laws Llewellyn achieved his goal of a sales law uniform across the states, but all he did for contract law was to create more differences. The courts have not adopted any of the contract law of Article 2 into the common law, and the contract laws of Article 2 and of the common law differ in numerous places. There are just three ways we could eliminate these differences. We could extend Article 2 to the whole law of contract, thereby eliminating the common law of contract entirely; we could amend the article to conform it to the common law; or we could adopt the proposal I have offered, which would authorize the courts to eliminate any of the differences they concluded were unjustified. The first possibility is not worth considering in view of the sorry record of Article 2; it would be a disaster to make the article the law for all contract cases. We should also reject the second possibility. No matter what the amendment was, it would not match the common law of contract in any state, because each state has its own common law of contract, and although the differences among them are rarely important, they are still differences. More important, amending away differences would only be a temporary solution, because the differences would reappear as soon as the courts changed the common law or recognized new distinctions or refinements in it. Adopting the proposal would therefore be the best way of achieving uniformity. There are also reasons for concluding that judicial lawmaking is superior to legislation for achieving uniformity over the long term even if uniform legislation is superior for achieving it initially. A comparison of James J. White and Robert S. Summers’s treatise on Article 2 and E. Allen Farnsworth’s treatise on the common law of contract, which contain about the same numbers of pages, gives one the clear impression that there is much more disagreement about Article 2 than about the common law of contract. This is the case despite two facts that would lead one to expect the contrary. The common law of contract covers much more law than the article does, and disagreements about the articles have had only about twenty-five years to accumulate, whereas the modern common law of contract has existed for about a century. The uniformity that legislation seems to promise is illusory because courts must interpret it. Judicial interpretation of Article 2 is especially destructive of uniformity because there is no highest court with the author-

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ity to resolve conflicting interpretations. The Constitution of the United States requires the federal courts to follow the decisions of the courts of the states in which the federal courts sit,15 and the courts of each state are independent of the courts of every other. All this is true for state common law as well as for state legislation, but judicial interpretations of legislation tend to produce more diversity in the absence of a highest court to resolve their differences than does the making of common law, because courts are not free to base their decisions on principles when they interpret legislation. They are always constrained to at least some extent by the language of the legislation. The principles of the common law of contract are relatively few and well established, whereas the language of Article 2, like the language of any statute, is capable of almost infinitely various interpretation. Interpreting Article 2 is especially difficult, because for most of it, there is neither any meaningful legislative history nor any other reliable source of information about the drafters’ intentions, as I explained in Chapter 6.

Better Laws The reasons why legislatures rather than courts should make certain laws do not apply to contract law, and the reasons why courts rather than legislatures should make certain laws do apply to contract law. We have to use legislation rather than judicial lawmaking if we want to create or modify a government institution (a police force or a social security system, for example) or to raise or spend money, but contract law has no such requirements. We may also want to use legislation rather than judicial lawmaking if the law poses important questions that ought to be answered by the processes of democratic governance, but contract law does not pose such questions. The enactment of the Code demonstrated this. Legislators were only formally involved in enacting it, and they would be only formally involved in enacting any amendments to it for the same reasons. It does not present politically significant issues, and understanding it requires more specialized knowledge than any sensible legislator would consider worth the effort of acquiring. Like any of the major parts of the common law, the primary purpose of contract and sales law is to resolve disputes, in this case, disputes between parties to contracts or sales. Any such law should be a judge-made law, because the judges who resolve the disputes are in the best position to make the law that will resolve them fairly and efficiently. They are the experts, they have the benefit of hearing adversary argument, they are less subject to political pressures than legislators, and they can do it without delay, as soon as the cases presenting the need for change reach them for decision.

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In fact, the laws of sales and contracts are so far outside the normal concerns of legislators that we can safely predict that legislators would not really fashion the legislation that amended Article 2 even if we were to amend it. Scholars would draft the amendments, just as they drafted the article initially. Therefore, the only real choice we have is between judicial lawmaking and scholarly lawmaking, and this choice is easy. Our institutions for judicial lawmaking are greatly superior to our institutions for lawmaking by scholars. Lawmaking by scholars generally begins with the American Association of Law Schools, the American Law Institute, or the Conference of Commissioners on Uniform State Laws. One or more of these organizations sponsors a committee, the committee proposes an amendment, the organizations approve it or send it back for reconsideration, and eventually the organizations offer the final product to state legislatures for enactment. Scholars characteristically have the advantages over judges of leisure and expertise. They are not pressed by heavy caseloads to make their decisions quickly. The organizations that choose the scholars to sit on drafting committees choose them for their demonstrated expertise in the kind of legislation the committee will draft. All these are important advantages, but we would not lose them if we chose to allow judges to make the law of Article 2. Indeed, we would enhance them. Scholars could continue to make their arguments and proposals in articles and books. This method would be superior to having a few scholars compose a drafting committee for several reasons. First, the number of scholars who can write articles or books on a subject is unlimited. Second, there is no need to prejudge a scholar’s qualifications in order to choose a committee, so judges and other scholars could evaluate every scholar’s contribution on its merits. We would avoid the inevitable politicking for a place on a committee, along with its distorting effects on the results. Third, there is no need to mute or distort anyone’s arguments in order to compose a majority; everyone is free to express his or her arguments in their full force and effect. Although one could characterize appellate courts as committees in the sense that at least three judges sit on them, they are less likely than drafting committees to possess the bad attributes of committees, because our judicial systems have evolved means of avoiding these attributes. We do not appoint people for appellate judgeships on the basis of their demonstrated expertise on a particular subject, so a person who seeks an appellate appointment does not need to politick on such a basis. Judges, as a result, are generally not biased on a subject before they make a decision on it. Whereas the members of a drafting committee must reconcile their views on the law if they are to compose a majority, the judges who compose a majority on a result are generally not committed beforehand on the law that would enable them to reach it. (I am not ignoring the obvious fact that those

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who appoint judges often pay close attention to the prospective appointees’ opinions on some public issues, but what I said still remains true as a rule. Judges typically decide thousands of cases on an extremely wide variety of subjects in the course of their careers. Those who appoint them cannot possibly select them for their biases on more than a very small portion of these decisions.) Additionally, judges are not experts with academic reputations to promote and thus have less personal stake in having their own views prevail. The lawyers for the contending parties educate the judges on the case in appellate argument. They do their best to point out the strengths of their own position and the weaknesses of their opponents’. Not only is there no assurance of any such argument on a drafting committee, the selection of the committee members is almost sure to have been motivated by a desire to avoid it. Committees reach their decisions by majority vote. One could not expect a drafting committee to reach a sensible conclusion if one appointed people with diametrically opposed views to sit on it; in fact, drafting committees are generally composed of people whose agreements on the subject greatly outweigh their differences. But above all, judges must decide the cases before them. The laws they make must take into account every relevant fact, no matter how inconvenient. They cannot make a law entirely from theory and compose little stories about “A” and “B” to justify it, as the drafters of our restatements of the law are so fond of doing. Finally, common law is superior to legislation drafted by scholars, because scholars can influence it retroactively. Although only judges can make common law in principle, in practice, scholars exert a major influence by how they treat the decisions after the judges have made them. Scholars write about some decisions and ignore others. They characterize decisions as well or poorly reasoned. Above all, they influence the law the decisions embody by the way they express it. The fact that the common law in the United States is actually the common law of each of the fifty-one jurisdictions greatly increases this last source of scholarly influence. Scholars unavoidably have to generalize when they express “the” law on a subject. The generalizing increases the amount of discretion they have in how they express it, because any expression they choose will give more weight to some decisions than to others. Treatise writers have the most influence, because almost everyone begins his or her research with a treatise and, unless the writer is a scholar, also ends it there, or with one or two decisions from the jurisdiction in which he or she is interested. But the scholars who only write articles also have an influence, because the treatise writers read their articles, and occasionally a practicing lawyer engaged in litigation will also read them. If committees of scholars make inferior lawmakers, we should expect to see some evidence of the fact in Article 2, because scholars working on or

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for committees were the chief drafters of it. There is ample such evidence. I have already noted some, which is the virtually unanimous failure of the courts to adopt the contract law of Article 2 into the common law where the two laws differ. This failure is especially persuasive for having occurred during the most creative period the American common law has gone through since the early nineteenth century. The courts could not have failed to adopt the law of Article 2 because they chose not to change the common law at all; they could only have failed to adopt it because they believed it to be inferior. I have also already noted an example of the article’s inferior law, namely, Section 2-207, the provisions for contract formation in a “battle of the forms.” I will give just one more example, although if space permitted I could give dozens, because Section 2-207 is not typical. It was an attempt to do something almost wholly new at the time, which one might think should excuse its many failures. A more telling example is Section 2-202, the Code’s parol evidence rule. The common law of contract has included the parol evidence rule for more than a century. The drafters of Section 2-202 have only themselves to blame if their product is worse than the common law version. The section reads: § 2-202. Final Written Expression: Parol or Extrinsic Evidence. Terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented (a) by course of dealing or usage of trade (Section 1–205) or by course of performance (Section 2-208); and (b) by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement.

Of course there is no canonical text of the common law parol evidence rule, but the following captures its essence: Evidence of the parties’ prior or contemporaneous oral agreements or their prior written agreements is not admissible to add to or vary the terms of the written contract if it is an integration. An integration is a contract the parties intended to be the final and complete expression of their agreement on the subject.

The confusions in Section 2-202 begin with its title. The parol evidence rule has nothing to do with extrinsic evidence unless it is evidence of the parties’ prior or contemporaneous agreements. There are numerous other rules for determining whether other kinds of extrinsic evidence are admissible. The section’s reference to course of performance is especially con-

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fusing. “Course of performance” evidence of a contract’s meaning is that which one can infer from the parties’ performance of the contract; therefore, it can never consist of agreements they made prior to or contemporaneously with making the contract and thus has nothing to do with the parol evidence rule. Moreover, the references to course of dealing, usage of trade, and course of performance make it seem that these are the only kinds of extrinsic evidence that are admissible to “explain or supplement” a written agreement, but if courts were to give the section this effect, they would often reach incorrect conclusions. There are many other kinds of extrinsic evidence one can legitimately take into account for the purpose of interpreting a written contract. Even more confusing is the section’s splitting of the concept of an integration into two parts and giving the parts different consequences. The common law defines an integration as the parties’ final and complete expression of their agreement, whereas Section 2-202 makes the operation of the rule depend solely on the parties’ intending the written contract to be their final expression of agreement. Then, in Subsection (b), it prohibits evidence of consistent additional terms if and only if the parties also intended the written contract to be the “complete and exclusive” expression of their agreement.16 Nothing in the Official Comments or elsewhere so much as hints at why the drafters split the integration concept in this fashion. One result is to broaden the application of the rule practically without limit. The rule of Subsection (a) applies to any written agreement or confirmatory memorandum, however partial, that the parties intended to be final, and because people ordinarily intend almost any agreement they make to be final until they agree differently, the result is that as a practical matter, the rule applies to any written agreement or confirmatory memorandum. The splitting also makes the Code rule much stricter than the common law rule. If the parties intended the written agreement to be both complete and final, Subsection (b) prohibits evidence of additional terms even if they are consistent with the writing, whereas the common law still allows such evidence under a variety of exceptions, principally under the so-called collateral agreement exception. Finally, the section is confusing on the distinction it intends between supplementing a written agreement and adding to it. “To supplement” means to add to. If the drafters of Article 2 had intended any of these differences, they presumably would have given us their reasons for them, but the Official Comments to the section do not mention any of them. We can only conclude that the differences were unintended, which is to say, they are misunderstandings of the common law parol evidence rule or mistakes of drafting. The only change that the Official Comments say was intended is that a judge is to keep the jury from hearing the evidence of the additional terms to which Subsection (b) refers only if he or she concludes that the parties,

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if they had agreed upon them, would certainly have included them in the writing. This is a change from the common law, because the common law does not impose so strict a standard for excluding such evidence. Yet, the section itself includes nothing on what the comment says this standard should be. All in all, the section reads as though Llewellyn assigned the job of drafting it to people who did not understand the parol evidence rule and only discovered how bad a job they had done after it was too late to change it, so he then tried to salvage at least the one change he intended by including it in the Official Comments.

An Amendment to Authorize Judicial Lawmaking Although the bulk of the contract law of the Code is in Article 2, some of it is in Article 1, so we need to amend both articles. We should amend them to provide that, with certain exceptions,17 a court should henceforth treat them as though they consisted of the decisions of the courts of other jurisdictions. This would make these articles not authoritatively binding on a court except to the extent that the courts of the jurisdiction concerned had interpreted or changed it, in which case those courts’ decisions would have the same authority they would have in any other situation. The amendment ought not to provide that the articles shall have the same authority they would have for a court if they consisted of the decisions of the highest court of the state of the court deciding the case. This would make the article more binding on lower state courts than it now is, and it would constitutionally prohibit the federal courts from making any changes in the article whatever. A lower state court must follow the decisions of its state’s highest court, and the U.S. Constitution requires a federal court to follow the decisions of the highest court of the state in which the federal court sits, on questions of state law.18 Such an amendment would not only free the courts to eliminate the many arbitrary differences between the common law and Articles 1 and 2 and to bring the articles up to date and keep them current, it would also have a freeing effect on legal scholarship. Scholars could concentrate their thinking on what they considered to be better law, without having to try to square their proposals with the articles’ provisions. The amendment would not render previous scholarship obsolete. The authors of the current treatises on Articles 1 and 2 would not need to change a word except to replace their references to the constraints certain provisions impose with recommendations that the courts not follow the provisions. There is no doubt in my mind that Llewellyn would support such an amendment if he were still with us. Enacting it would be a tribute both to him and to the many men and women who became the grand-style judges he hoped they would be.

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The only other person to my knowledge who has addressed the question of whether judicial lawmaking would be preferable to amending Article 2 is David A. Rice; he reached conclusions similar to mine in an article he published in 1992.19

Constitutional Considerations Legal actions between private persons rarely raise constitutional issues because there is rarely any “state action” if a government is not a party. However, if a claim or defense rests on a law that is unconstitutional or that operates unconstitutionally under the circumstances, the law itself provides the state action. The U.S. Supreme Court has recognized that contract actions can present due process issues on this basis in two lines of decisions.

Standards for Punitive Damages The more recent line consists of six decisions handed down from 1986 to 1994 on the constitutionality of punitive damage awards under the Eighth Amendment’s excessive fines clause and the substantive and procedural due process clauses of the Fourteenth Amendment.20 The penultimate decision in the line, TXO Products Corp. v. Alliance Resources Corp.,21 failed to produce a majority opinion on the subject. Justice Stevens wrote the opinion for the Court, acknowledging that punitive damages violate substantive due process if they are “grossly excessive.” However, it was irrelevant that they were 526 times the compensatory damages in the case. The relevant comparison was to the badness and potential profitability of the “scheme” or “larger pattern” of conduct out of which the wrongful conduct arose. All the Justices except Scalia and Thomas agreed with the “grossly excessive” standard, but only the Chief Justice, Justice Blackmun, and Justice Stevens agreed that the comparison with the compensatory damages was irrelevant. Justice O’Connor claimed it was relevant in her dissent, which Justices Souter and White joined. Justice Kennedy did not address this issue, but argued that the important thing was the reasons the jury had for reaching the result rather than the result itself. Justices Scalia and Thomas argued that there is no federal substantive due process right against excessive punitive damages. Justice Stevens’s opinion for the Court is consistent with the conclusions I reached in Chapter 6. I concluded that the basic measure of the punitive damages should be the profitability of the company policy out of which the defendant’s wrongful conduct arose and that the traditional requirement that punitive damages not be disproportionate to the compensatory dam-

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ages was incorrect. Compensatory damages and punitive damages serve different purposes; there is no reason why they should be similar in amount. If the comparison is to be made at all, lower compensatory damages should justify higher punitive damages and vice versa, because the lower the compensatory damages, the higher the punitive damages must be in order to punish the defendant by a given amount. The U.S. Supreme Court never overturned a state court punitive damages award until its last decision, and all it then held was that the state law was unconstitutional because it barred any review of the amount of punitive damages a jury awarded.22 The Court’s apparent reluctance to try to articulate standards itself is understandable. The vast majority of decisions imposing punitive damages are state court decisions because the cases arise under state law. A federal court other than the Supreme Court can obtain jurisdiction over a case that does not arise under federal law only if there is diversity of citizenship and the out-of-state defendant removes the case to the federal system. The defendant in such a case can seldom do this, because the defendants in these cases are usually corporations, and federal law defines diversity of citizenship for corporations very narrowly.23 The only court in the federal system that can review a punitive damages decision of a state court is the Supreme Court, which can review decisions of a state’s highest court if they present federal questions.24 However, there is no sign yet that the Court’s decisions have persuaded a state supreme court to rethink the subject.25 Perhaps a bold federal district court judge could begin the process by invalidating as unconstitutional some parts of the state law that she or he would otherwise have to follow in a removal case.26

Limitations on the American Rule The second line of decisions goes back to 1970. The Court held in these cases that the “property” the due process clause protects is anything the state concerned recognizes as a legal right. A contract right is property under this definition, and some of these decisions involved contract rights. This line of decisions involves procedural due process, but there is no reason to think that the definition of “property” the Court has offered will not also apply for substantive due process.27 A 1985 decision, Walters v. National Association of Radiation Survivors,28 is especially pertinent. A federal statute enacted in the nineteenth century prohibits a lawyer from accepting more than $10 for his services in contesting a claim against the Veterans Administration. The Court upheld the statute on the ground that even though it effectively deprived veterans of the services of lawyers in prosecuting claims against the Veterans Administration, the agency’s procedures were still constitutionally sufficient

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because they worked effectively without lawyers. The Court also accepted the agency’s claim that the presence of lawyers would make the procedures more expensive and less effective for most veterans. Walters rests on two assumptions. First, lawyers are necessary to make procedures constitutionally sufficient if the laypersons who use the procedures need lawyers in order to use the procedures effectively. Second, a system deprives people of lawyers if it prevents paying reasonable remuneration to them. The decision therefore makes the American Rule unconstitutional under certain circumstances. People with small contract claims can bring them in small claims courts, which work effectively without lawyers. People with large contract claims generally can afford to pay lawyers reasonable remuneration despite the fact that they cannot recover their payments from the defendants if they win. However, the American Rule deprives people with middle-level contract claims of any effective way of collecting them, because their claims are too large for small claims courts but not large enough to permit them to pay lawyers reasonable remuneration. The U.S. Court of Appeals for the Ninth Circuit interpreted Walters as giving rise to the same two implicit assumptions upon which this argument is based, although the decision did not involve the American Rule.29 Walters logically would also invalidate the American Rule for the defendant if it would invalidate it for the plaintiff. That is, the defendant, if he won, would be entitled to reimbursement of his litigation costs from the plaintiff if Walters would operate to entitle the plaintiff, if he won, to reimbursement of his litigation costs from the defendant in the same case. Two reasons lead to this conclusion. First, if the amount at stake is not large enough to warrant the plaintiff’s hiring a lawyer, it presumably is also not large enough to warrant the defendant’s hiring a lawyer. Second, settlement negotiations are biased in favor of the party who is entitled to reimbursement of his litigation costs if he wins if the other party is not so entitled, as I explained in Chapter 5. There would be no need for a constitutional ground for limiting or abolishing the American Rule if the rule were entirely common law, but it is not. There are statutes incorporating it for special situations in virtually every state. For example, Section 10111 of the California Insurance Code provides that “in life or disability insurance, the only measure of liability and damage is the sum or sums payable in the manner and at the times provided by the policy.” Enacted in 1935, Section 10111 barred recoveries of litigation costs in life and disability insurance cases until the California Supreme Court used its previous holdings that the covenant of good faith and fair dealing sounds in tort to avoid the section’s operation in 1985. Statutes like Section 10111 should be unconstitutional under Walters insofar as they operate to prohibit winning plaintiffs from recovering their litigation costs for middle-level contract claims.

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Moreover, Walters should be an important influence even if no statutory prohibition exists. The American Rule has existed in practice for two centuries. Although courts did not issue explicit rulings on the point until late in the nineteenth century, the inability of lawyers to obtain adequate compensation from the costs the courts imposed on the parties had required clients to resort to giving their lawyers “gifts” in order to get good representation since colonial times. Judges who would otherwise be reluctant to change a rule so well established should now realize that they have no choice.

Preventing Abuses Many people believe that the reforms have allowed consumers to bring too many actions and to recover overly high damages. There is no doubt that consumers are bringing more actions and recovering more damages than they were thirty years ago, but of course it does not follow that they ought not to be. However, there are some respects in which the new rights have undoubtedly led to abuses. The question is not whether this is true, but why it happened. In many cases, analysis shows that the fault is not with the reforms but with something else in the situation. I treated two sources of abuse of the tort of bad faith breach in Chapter 5: the vagueness in the tort’s definition that still exists in some jurisdictions, and the practice of allowing the jury to decide whether the defendant’s conduct had a reasonable basis in law, which exists in almost every jurisdiction. A similar practice is an important source of abuse in suits resting on relational torts, especially in the insurance area. Many of the duties that the new laws place upon insurers require the insurer to make a legal judgment. For example, the duty to accept a reasonable settlement offer from a liability claimant requires the insurer to make legal judgments about how persuasive the claimant’s evidence would be with the jury and how persuasive the claimant’s legal arguments would be with the judge. Yet the practice virtually everywhere is to allow the jury to decide whether the insurer made these judgments correctly. Typically, each party brings in a lawyer who is expert in the area to testify on the issue, and the jury chooses which lawyer to believe. Surely, judges rather than juries should be making these decisions. They are questions of law and of the practice of law, which judges could decide much more competently. Another source of abuse in the insurance area is the measure of damages for an insurer’s failure to accept a reasonable settlement offer. The measure is the amount of the so-called excess judgment, which is the amount by which the judgment against the insured exceeds the amount the insurance covers. This measure is logical if the insured has sufficient assets to pay the

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excess judgment, but the practice is to use it even if the insured does not have sufficient assets. Because insureds typically assign their rights against the insurer to liability claimants in exchange for the latter’s promising not to levy excess judgments against them,30 the result is to allow liability claimants to recover more from the insurer alone than they could have from the insured and the insurer together if the insurer had accepted the settlement offer. The difference can be substantial. I consulted on a case in which the insurance coverage was $15,000 and the insurer ended by owing the liability claimant over $7 million. The prospect of hitting such a jackpot leads lawyers to try almost anything to induce the insurer not to accept settlement offers, and the prospect of having to pay such a jackpot leads insurers to try to settle any case that carries the potential of a large excess judgment regardless of its factual or legal merits. The remedy is obvious. The courts should work out a measure of damages that takes account of an insured’s inability to pay the excess judgment. There are also abuses in the employment area. Employers have had difficulty in discharging employees who have not performed their jobs adequately, without being liable for lost compensation and in many cases for emotional distress damages in addition. The fault here is with the civil service laws and private employment contracts, most of which derive from nineteenth-century conceptions of employment that are no longer accurate. Most manual or clerical work in the nineteenth century was simple and repetitious. This fact enabled us to measure a person’s job performance by objective factors: so many bricks well laid per hour or so many words accurately typed per minute, for example. Civil service laws and private employment contracts were drafted accordingly. They guaranteed the employee the job indefinitely unless the employer could prove he or she had fallen short of the objective norms that existed for his or her kind of work. Almost all civil service laws and many private employment contracts also guaranteed the employee hearings before impartial boards in which the employer had to prove the employee’s shortcomings before it could discharge him. Of course many simple and repetitious jobs still exist, but they no longer constitute a majority, and they are not typically covered by civil service laws or the kinds of employment contracts that are patterned on them. For example, although most of the jobs in fast food restaurants are simple and repetitious, the men and women who have these jobs typically have no contractual guarantees of employment; their employers can fire them at will. On the other hand, the jobs that are now covered by civil service laws or good private employment contracts are generally not simple and repetitious, and a person’s performance of one of them cannot be adequately judged by objective factors. For example, my university employs people whose jobs require that they work frequently or primarily with alumni,

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faculty, students, or members of the news media. Moreover, they generally work in close association with other employees, all doing parts of common tasks. People have to be courteous and friendly and possess at least a decent demeanor and appearance to perform one of these jobs properly. They have to be willing to do more than their usual share sometimes because teamwork inevitably sometimes falls more heavily on particular members of the team. They should be honest in minor matters as well as major ones; for example, they should admit mistakes and not take illness absences unless they are ill. Most of these jobs also require highly developed skills. Not even considering the faculty members, practically all of whom have doctoral degrees, there are numerous professionals, scientists, technicians, and members of skilled trades. Even the office work now generally requires competence in word processing and in the operation of technical devices or systems for telephone services, mathematical computation, accounting, or recordkeeping of other kinds. Yet the employment contracts that cover these people require the university to prove by objective criteria that they performed their jobs inadequately before they can be discharged. At a hearing at which I was present some years ago, for example, the hearing board decided that a hospital could discharge an employee whose job required him to perform tests so that physicians could learn the results in time to know what medical procedures to use on patients in the emergency rooms. The hospital had documented instances in which the employee had left his workplace without leaving word where he was. It is frightening to contemplate the damage this employee may have done before the hospital was able to gather sufficient documentation of his poor performance to justify removing him from his job. Unless public policy considerations are involved, as they are for tenured faculty, for example, we should change the civil service laws and employment contracts to replace guaranteed tenure with rights of involuntary severance pay for jobs for which there are not adequate objective measures of performance. For example, an employee could earn an entitlement to one month’s involuntary severance pay for each year of work. An employer could discharge an employee without severance pay if the employer could prove inadequate job performance by objective criteria, just as an employer currently can, but an employer could also discharge an employee without such proof by paying the severance pay. Most employers would thereby save substantial sums while not reducing the value of their employees’ rights at all. Employers would save the costs of having to keep badly performing employees in their jobs, the costs of the hearing procedures, and the costs of contesting discharged employees’ cases in court. The employees, on the other hand, would ordinarily end up with at least as much as they would get now, because they would get their severance pay without having to incur any costs. Discharged employees

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who bring actions against former employers currently ordinarily have to pay their lawyers about 50 percent of what they win. Guaranteed severance pay would also protect employees against a device by which employers can sometimes evade the current employment contracts or civil service laws. If the employer can make it seem that it has independent reasons for reorganizing the section or department in which the employee works, so as to eliminate the employee’s job, it can discharge the employee without liability under many such contracts or laws. Finally, the American Rule is a source of abuse insofar as it still protects a losing plaintiff’s lawyer with a contingency fee from having to pay the defendant’s litigation costs. Lawyers will continue to bring unmeritorious suits, and defendants with deep pockets, such as insurance companies, will continue to buy them off with big settlements, as long as the law allows the lawyers to make big profits if they win but to pay only their costs of operation if they lose. I explained the unfair and distorting effects of the American Rule in Chapter 5. It will require legislation to change the civil service laws, and of course only employers can change their employment contracts. The courts cannot change the American Rule insofar as legislatures have incorporated it in statutes, but in certain situations the courts have the constitutional duty, as well as the authority, to abolish the American Rule whether or not legislatures have incorporated it in statutes, as I explained earlier in this chapter. By and large, therefore, the courts have the authority to “reform the reforms” as I have here proposed, because, with the exceptions just noted, all the laws and practices I have described are common law. However, although all these abuses have been evident almost since the reforms began, not a single state highest court has yet changed the law to try to prevent them. They should. Even judges who oppose the reforms should be willing to prevent abuses of them.

Making Promises Binding Again The principal purpose of contract law is to make certain kinds of promises binding. Before the recent reforms, producers could use their superior bargaining powers to defeat this purpose. They could make contracts that did not include the promises they had made, and they could breach their contracts with impunity. These results were unjust because they systematically favored producers over consumers, and they were socially harmful because they weakened the incentives for producers to produce safe products and products of good quality. The reforms make producers’ promises binding again. Reasonable expectations requires that contracts reflect the promises made. Relational

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torts impose duties on producers for aspects of their products or contracts that one cannot reasonably expect consumers to understand. Bad faith breach deters producers from breaking their promises or evading the liabilities that breaking them should impose. The new or expanded remedies provide incentives for producers not to breach and adequate compensation for consumers if they do. All the reforms except the first also impose public responsibilities on producers. Relational torts impose such responsibilities directly. The remedies reforms help to enforce the public responsibilities by imposing sufficient damages to deter producers from engaging in socially harmful conduct if the compensatory damages to which the plaintiff is entitled would not be enough. The duties that the tort of bad faith breach imposes are public responsibilities, both because producers cannot contractually avoid them and because the damages for a bad faith breach are designed to go beyond compensating the plaintiff in order to deter the breacher and others from engaging in similar wrongful conduct in the future. American contract law since 1960 has been undergoing its first great reform since the English and American courts completed their creation of modern contract law at the end of the nineteenth century. Now, as before, courts have played the leading role, but this time legal scholars have also made major contributions. Scholars largely drafted the Uniform Commercial Code, they publicized and analyzed the new judicial lawmaking decisions, and they made proposals for new laws to the courts. The fact that American common law consists of the independent common laws of fiftyone jurisdictions has had a stimulating influence. It greatly increases the chances that a judge will have the authority to put new ideas into effect long enough for scholars and other judges to notice them. The history of the reforms demonstrates the superiority of judicial lawmaking over legislation for contract law. Although scholars contributed to both the judicial lawmaking and the legislation, their efforts proved to be much more successful when they were combined with the efforts of judges than when they drafted the laws for legislatures to enact. I have tried in a modest way to express my admiration for our judicial lawmaking system by dedicating this book to the American common law judge.

Notes

Introduction 1. Mark Peterson et al., Rand Corp., Punitive Damages: Empirical Findings viii (1987). The survey found punitive damages awarded in 35 percent of the contract cases in which judgment was for the plaintiff. This almost certainly demonstrates that more than 50 percent of the cases involved a relational tort, because California law requires that there be a commission of a tort if there are to be punitive damages, even though many commissions of a relational tort do not entitle the winning plaintiff to punitive damages. Additionally, virtually all of the 35 percent must have involved bad faith breaches, because under California law there is virtually no way of obtaining punitive damages in a contractual situation unless the defendant breached in bad faith. Chapter 1 1. Alfred W. B. Simpson, A History of The Common Law of Contract: The Rise of the Action of Assumpsit 227–58 (1975); Oliver Wendell Holmes, Jr., The Common Law Lecture V, at 182–200 (1938). 2. Sources for freedom of contract and the developments associated with it, some of which are also specifically cited herein, are: Patrick S. Atiyah, An Introduction to the Law of Contract (2d ed. 1971); Patrick S. Atiyah, The Rise and Fall of Freedom of Contract (1979); Paul Brest & Sanford Levinson, Processes of Constitutional Decision-making: Cases and Materials 215– 34 (2d ed., 1983); Maurice Cranston, Annotation, “Liberalism,” 4 Encyclopedia of Philosophy 458, 458–61 (1967); Patrick Gardiner, Annotation, “Schopenhauer, Arthur (1788–1860),” 7 Encyclopedia of Philosophy 325, 325–32 (1967); James Gordley, The Philosophical Origins of Modern Contract Doctrine (1991); Charles M. Haar & Daniel W. Fessler, The Wrong Side of the Tracks 15, 109–54 (1986); Louis Hartz, The Liberal Tradition in America (1955); Holmes, Jr., supra note 1; Morton J. Horwitz, The Transformation of American Law, 1780–1860, at 160–210 (1977); Jerome C. Knowlton, “Freedom of Contract,” 3 Mich. L. Rev. 619 (1905); Anthony T. Kronman & Richard A. Posner, The Economics of Contract Law ch. 7, at 230–67 (1979); John E. Nowak et al., Constitutional Law § 11.4 (3d ed. 1986); Simpson, supra note 1; Alfred W. B. Simpson, “Innovation in Nineteenth Century Contract Law,” 91 Law Q. Rev. 247, 260–61 (1975); Richard H. Tawney, Religion and the Rise of Capitalism (1958); Samuel Williston, “Freedom of Contract,” 6 Cornell L.Q. 365 (1921). 3. Winterbottom v. Wright, 152 Eng. Rep. 402 (Ex. 1842). 4. MacPherson v. Buick Motor Co., 111 N.E. 1050 (N.Y. 1916). 5. Edward H. Levi, An Introduction to Legal Reasoning 7–19 (1949); Robert L. Rabin, “The Historical Development of the Fault Principle: A Re-Interpretation,” 15 Ga. L. Rev. 925, 936–38 (1981).

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6. Sir Henry S. Maine, Ancient Law ch. IX, at 331–88 (1861). 7. Printing Co. v. Sampson, 19 L.R.-Eq. 462 (1875). 8. Id. at 465. 9. Williston, supra note 2, at 373 & n.10. 10. Lochner v. New York, 198 U.S. 45 (1905). 11. Id. at 53. 12. Coppage v. Kansas, 236 U.S. 1 (1915). 13. State v. Coppage, 125 P. 8, 10 (1912). 14. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations bk. 1, ch. 8 (1776). 15. Coppage, 236 U.S. at 17. 16. Compare, e.g., Mitchell v. Lath, 160 N.E. 346 (N.Y. 1928) (the rule in a strict form) with Pacific Gas & Elec. Co. v. G. W. Thomas Drayage & Rigging Co., 442 P.2d 641 (Cal. 1968) (the rule greatly ameliorated). The current status of the rule is described in E. Allen Farnsworth, Farnsworth on Contracts § 7.2 (2d ed. 1990). 17. Farnsworth, supra note 16, § 2.9a; Daniel A. Mathews, Comment, “A Common Law Action for the Abusively Discharged Employee,” 26 Hastings L.J. 1435, 1438–42 (1975). 18. Collins v. Parsons College, 203 N.W.2d 594 (Iowa 1973). 19. John Leubsdorf, “Toward a History of the American Rule on Attorney Fee Recovery,” 47 Law & Contemp. Probs. 9, 10–27 (1984). 20. Cal. Civ. Proc. Code § 1021 (West 1980). 21. See, e.g., Lytle v. State, 17 Ark. 608, 669–71 (1857); Adams v. Stevens & Cagger, 26 Wend. 451, 455–57 (N.Y. Sup. Ct. 1841); Bayard v. McLane, 3 Del. (3 Harr.) 139, 220–21 (1840). 22. See, e.g., Reggio v. Braggiotti, 61 Mass. 166 (1851), quoted in Leubsdorf, supra note 19, at 23 n.96; St. Peter’s Church v. Beach, 26 Conn. 355 (1857), quoted in Leubsdorf, supra note 19, at 15 nn.32, 23 nn.97–98. 23. John D. Calamari & Joseph M. Perillo, Contracts 646 (3d ed. 1987). 24. Adams v. Lindsell, 106 Eng. Rep. 250 (K.B. 1818). 25. Id. at 251. 26. Household Fire & Carriage Accident Ins. Co. v. Grant, 4 Ex. D. 216, 221 (1879). 27. Dickenson v. Dodds, 2 Ch. D. 463 (1876). 28. Id. at 473. 29. Restatement (First) of Contracts § 43 (1931). 30. Restatement (Second) of Contracts § 43 (1981). 31. Holmes, supra note 1, Lecture VIII, at 304–05. 32. Grant Gilmore, The Death of Contract 35–53 (1974). 33. Hotchkiss v. National City Bank of New York, 200 F. 287, 293 (S.D.N.Y. 1911). See also Eustis Mining Co. v. Beer, Sondheimer & Co., 239 F. 976, 984–85 (S.D.N.Y. 1917) (Hand, J., stating that “The whole House of Bishops might satisfy us that he had intended something else, and it would make not a particle of difference in his obligation”). 34. John D. Calamari & Joseph M. Perillo, The Law of Contracts § 9-42, at 328–29 (2d ed. 1977).

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Chapter 2 1. Contracts created by the doctrine of promissory estoppel can have this effect. If the promisee reasonably relies on the promise to its substantial detriment, the law may make the promise a contract whether or not the promisor expressed its intention that it be a contract. 2. James J. White & Robert S. Summers, Uniform Commercial Code § 4-9, at 205 (3d ed. 1988). 3. A Lexis search (unconscion! and “uniform commercial code” or ucc and date aft(1990)) on July 6, 1992, turned up eighty-three cases. Both parties were corporations in 40 percent of the cases. In addition, I noticed that a sizable fraction of the individual parties in these cases were farmers, and farming, of course, is a business. 4. For a discussion of implied warranties as applied to leases and the sale of residences, see Myron Moskovitz, “The Implied Warranty of Habitability: A New Doctrine Raising New Issues,” 62 Cal. L. Rev. 1444 (1974); Peter J. Shedd, “The Implied Warranty of Habitability: New Implications, New Applications,” 8 Real Est. L.J. 291, 303–06 (1980). 5. E.g., John E. Murray, Jr., Murray on Contracts § 226 (relaxation of certainty requirements), § 232 (expansion of allowance of damages for mental suffering) (2d rev. ed., Grismore on Contracts 1947) (1974). 6. Gary T. Schwartz, “Foreword: Understanding Products Liability,” 67 Cal. L. Rev. 435 (1979). 7. W. Page Keeton et al., Prosser and Keeton on the Law of Torts §§ 39–40 (5th ed. 1984) (expansion of res ipsa loquitur). 8. E.g., U.C.C. §§ 9-503 to 9-505 (1983). 9. See, e.g., Robert E. Keeton, Basic Text on Insurance Law (1971). 10. See, e.g., White & Summers, supra note 2, § 4-2, at 184. The opinion expressed on this point in the 1980 second edition of the treatise was stronger, however, as one might expect. James J. White & Robert S. Summers, Uniform Commercial Code § 4-2, at 149 (2d ed. 1980). 11. See Henningsen v. Bloomfield Motors, Inc., 161 A.2d 69, 87 (N.J. 1960). 12. Wilson Trading Corp. v. David Ferguson, Ltd., 244 N.E.2d 685 (N.Y. 1968). 13. Wetherbee v. United Ins. Co., 71 Cal. Rptr. 764, 765 (Cal. Ct. App. 1968), aff’d on second appeal, 95 Cal. Rptr. 678 (Cal. Ct. App. 1971). 14. Duncan Kennedy, “Distributive and Paternalist Motives in Contract and Tort Law, with Special Reference to Compulsory Terms and Unequal Bargaining Power,” 41 Maryland L. Rev. 563 (1982). 15. Stewart Macaulay, “Non-Contractual Relations in Business: A Preliminary Study,” 28 Am. Soc. Rev. 55, 60–62 (1963). 16. Lake River Corp. v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985). 17. Id. at 1289. 18. Alan Schwartz & Louis L. Wilde, “Intervening in Markets on the Basis of Imperfect Information: A Legal and Economic Analysis,” 127 U. Pa. L. Rev. 630 (1979). 19. Douglas G. Baird & Robert Weisberg, “Rules, Standards and the Battle of the Forms: A Reassessment of § 2-207,” 68 Va. L. Rev. 1217 (1982).

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20. Schwartz & Wilde, supra note 17, at 632–39, 671–82. See also W. David Slawson, The New Meaning of Contract: Transformation of Contract Law by Standard Forms 21, 42–46 (1984) (describing both articles’ arguments in greater detail). 21. See, e.g., Harlow & Jones, Inc. v. Advance Steel Co., 424 F. Supp. 770, 773 (E.D. Mich. 1976); Construction Aggregates Corp. v. Hewitt-Robbins, 404 F.2d 505, 508 (7th Cir. 1968). Chapter 3 1. Robert E. Keeton, “Insurance Law Rights at Variance with Policy Provisions” (pt. 1), 83 Harv. L. Rev. 961 (1970); Robert E. Keeton, “Insurance Law Rights at Variance with Policy Provisions” (pt. 2), 83 Harv. L. Rev. 1281 (1970). 2. Keeton, “Insurance Law Rights” supra note 1, at 967. 3. Gerhardt v. Continental Ins. Co., 225 A.2d 328 (N.J. 1966). 4. Id. at 332. 5. Kenneth S. Abraham, “Judge-Made Law and Judge-Made Insurance: Honoring the Reasonable Expectations of the Insured,” 67 Va. L. Rev. 1151 (1981). Abraham went deeper into the theoretical justifications in a 1986 book, but he continued to assert essentially the same justifications. See Kenneth S. Abraham, Distributing Risk: Insurance, Legal Theory, and Public Policy 104–09 (1986). 6. Robert E. Keeton & Alan I. Widiss, Insurance Law: A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices (1988). 7. Id. at 634–36. 8. Mark C. Rahdert, “Reasonable Expectations Reconsidered,” 18 Conn. L. Rev. 323, 323–25 (1986). 9. Roger C. Henderson, “The Doctrine of Reasonable Expectations in Insurance Law after Two Decades,” 51 Ohio St. L.J. 823, 838 (1990). 10. Robert H. Jerry II, Understanding Insurance Law § 61 (1987). 11. Hunter v. Jefferson Standard Ins. Co., 86 S.E.2d 78 (N.C. 1955). The quotation is from Jerry, supra note 10, §61, p. 269. 12. Jerry, supra note 10, § 61. 13. See, e.g., id.; John A. Appleman, Insurance Law and Practice (1987); George C. Couch, Couch on Insurance (2d ed. 1984); John F. Dobbyn, Insurance Law (2d ed. 1989). 14. See, e.g., Keeton & Widiss, supra note 6; Kenneth S. Abraham, Insurance Law and Regulation (1990); Kenneth H. York & John W. Whelan, Insurance Law: General Practice (2d ed. 1988). 15. See Lawrence E. Blades, “Employment at Will vs. Individual Freedom: On Limiting the Abusive Exercise of Employer Power,” 67 Colum. L. Rev. 1404 (1967). Professor Blades’s article not only reported the earliest developments, but also had a major influence on the course of the law after its publication. For example, see the New Jersey Supreme Court’s use of it in Pierce v. Ortho Pharmaceutical Corp., 417 A.2d 505 (N.J. 1980). 16. Wagner v. Sperry Univac Div. of Sperry Rand Corp., 458 F. Supp. 505 (E.D. Pa. 1978), aff’d without opinion, 624 F.2d 1092 (3d Cir. 1978). 17. For the current law on the subject, see Michael A. DiSabatino, Annotation,

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“Modern Status of Rule that Employer May Discharge At-Will Employee for Any Reason,” 12 A.L.R. 4th 544, §§ 7–11 (1982 & Supp. 1992). 18. Karl N. Llewellyn, Book Review, 52 Harv. L. Rev. 700 (1939). 19. Karl N. Llewellyn, The Common Law Tradition: Deciding Appeals (1960). 20. Friedreich Kessler, “Contracts of Adhesion,” 43 Colum. L. Rev. 629 (1943). 21. Id. at 637. 22. See Gray v. Zurich Ins. Co., 65 Cal.2d 263, 419 P.2d 168, 171 (1966). 23. Arthur Alan Leff, “Contract as Thing,” 19 Am. U. L. Rev. 131, 131–47 (1970). 24. Id. at 144–47. 25. Id. at 147–57. See also Arnold L. Rotkin, “Standard Forms: Legal Documents in Search of an Appropriate Body of Law,” 1977 Ariz. St. L.J. 599 (making the same suggestion and expanding on it). 26. W. David Slawson, “Standard Form Contracts and the Democratic Control of Lawmaking Power,” 84 Harv. L. Rev. 529 (1971). 27. W. David Slawson, “Mass Contracts: Lawful Fraud in California,” 48 S. Cal. L. Rev. 1 (1974). 28. Restatement (First) of Contracts § 20 (1932); Arthur L. Corbin, Corbin on Contracts § 3 (1963). 29. Restatement (First) of Contracts §§ 20, 230, 233 (1932); Samuel Williston, Contracts §§ 603-04, 607 (3d ed. 1961). 30. Kenneth S. Abraham, Insurance Law and Regulation: Cases and Materials 28–31 (New York: Foundation Press, 1990). 31. Todd D. Rakoff, “Contracts of Adhesion: An Essay in Reconstruction,” 96 Harv. L. Rev. 1174 (1983). 32. Id. at 1283–84. 33. “Restatement (Second) of Contracts (Presentation of Tentative Draft No. 5),” 47 A.L.I. Proc. 485, 523–37 (1970). 34. See generally id. 35. Id. at 524. 36. Id. at 535–36. 37. Llewellyn, The Common Law Tradition, supra note 19, at 370. 38. Id. at 525. 39. Id. at 524–27. 40. Id. at 533. 41. Darner Motor Sales, Inc. v. Universal Underwriters Ins. Co., 682 P.2d 388, 396–99 (Ariz. 1984) 42. C & J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169, 176–77 (Iowa 1975) (using a tentative draft of the section). 43. Bond Bros., Inc. v. Robinson, 471 N.E.2d 1332 (Mass. 1984). 44. C & J, supra note 42, 227 N.W.2d at 176. 45. Farm Bureau Mut. Ins. Co. v. Sandbulte, 302 N.W.2d 104, 112 (Iowa 1981); Cairns v. Grinnell Mut. Reinsurance Co., 398 N.W.2d 821, 825 (Iowa 1987); Lepic v. Mut. Ins. Co., 402 N.W.2d 758, 761 (Iowa 1987); AID (Mut.) Ins. v. Steffen, 423 N.W.2d 189, 192 (Iowa 1988); Grinnell Mut. Reinsurance Co. v. Voeltz, 431 N.W.2d 783, 786 (Iowa 1988); Moritz v. Farm Bureau Mut. Ins. Co., 434 N.W.2d 624, 626 (Iowa 1989); Weber v. IMT Ins. Co., 462 N.W.2d 283, 288 (Iowa 1990).

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46. Henderson, supra note 9, at 842–53. 47. Ilan v. Shearson/American Express, 632 F. Supp. 886, 891 (S.D.N.Y. 1985). 48. Forell v. United States, 16 Cl. Ct. 700, 720 (1989). 49. Edwin W. Patterson, “The Delivery of a Life Insurance Policy,” 33 Harv. L. Rev. 198 (1919). 50. Id. at 222. 51. Friedrich Kessler, “Contracts of Adhesion—Some Thoughts about Freedom of Contract,” 43 Colum. L. Rev. 629 (1943). 52. Graham v. Scissor-Tail, Inc., 623 P.2d 165, 171–73 (Cal. 1981); see also Perdue v. Crocker Nat’l Bank, 702 P.2d 503 (Cal. 1985). 53. Obstetrics and Gynecologists v. Pepper, 693 P.2d 1259, 1260–61 (Nev. 1985). 54. Leong v. Kaiser Found. Hosps., 788 P.2d 164, 168 (Haw. 1990). 55. Anderson v. Union Pac. R.R. Co. 790 P.2d 438, 441–42 (Kan. Ct. App. 1990). 56. Hartland Computer v. Insurance Man Inc., 770 S.W.2d 525, 527–28 (Mo. Ct. App. 1989). 57. Bishop v. Washington, 480 A.2d 1088, 1094 (Pa. Super. Ct. 1984). 58. Slawson, supra note 23, at 549–61. 59. Wassink v. Hawkins, 763 P.2d 971, 974 (Alaska 1988); Batterman v. Wells Fargo AG Credit Corp., 802 P.2d 1112, 1116 (Colo. Ct. App. 1990); McRand, Inc. v. Van Beelen, 486 N.E.2d 1306, 1314 (Ill. App. Ct. 1985); In re Estate of Szorek, 551 N.E.2d 697, 700 (Ill. App. Ct. 1990); Agrimerica, Inc. v. Mathes, 557 N.E.2d 357, 362 (Ill. App. Ct. 1990); Morris v. Metriyakool, 344 N.W.2d 736, 742–43 (Mich. 1984); Ryoti v. Paine, Webber, Jackson & Curtis, Inc., 371 N.W.2d 454, 455 (Mich. Ct. App. 1985); Muscat v. Lawyers Title Ins. Corp., 351 N.W.2d 893, 896 (Mich. Ct. App. 1984); Interfund Corp. v. O’Byrne, 462 N.W.2d 86, 88–89 (Minn. Ct. App. 1990); Hoiland v. Minneapolis Child. Medical Ctr., 457 N.W.2d 241, 243 (Minn. Ct. App. 1990); In re Baby M, 525 A.2d 1128, 1159 (N.J. Super. Ct. Ch. Div. 1987); Albuquerque Tire v. Mountain States Tel. & Tel., 697 P.2d 128, 131–32 (N.M. 1985); Guthmann v. La Vida Llena, 709 P.2d 675, 678–79 (N.M. 1985); Rozeboom v. Northwestern Bell Tel. Co., 358 N.W.2d 241, 242–43 (S.D. 1984); Southwestern Bell Tel. v. Delanney, 762 S.W.2d 772 (Tex. Ct. App. 1988); Calarco v. Southwestern Bell Tel. Co., 725 S.W.2d 304 (Tex. Ct. App. 1986). 60. See, e.g., C & J, supra note 42. 61. James J. White & Robert S. Summers, Uniform Commercial Code §1-2 (3d ed. 1988). 62. See discussion of warranties and remedies infra chapter 6. 63. James J. White & Robert S. Summers, Uniform Commercial Code § 12-12 (3d ed. 1988). 64. Patterson v. Meyerhofer, 97 N.E. 472 (N.Y. 1912). 65. E. Allan Farnsworth, Contracts § 8.16 (1982). 66. Silberg v. California Life Ins. Co., 521 P.2d 1103 (Cal. 1974). 67. See also Tymshare, Inc. v. Covell, 727 F.2d 1145 (D.C. Cir. 1984); Best v. United States Nat’l Bank, 739 P.2d 554 (Or. 1987). 68. Ellsworth Dobbs, Inc. v. Johnson, 236 A.2d 843, 856–57 (N.J. 1967); Allied Van Lines v. Bratton, 351 So. 2d 344 (Fla. 1977) (McKnab portion of holding).

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69. Morin Bldg. Prods. Co. v. Baystone Constr., Inc., 717 F.2d 413 (7th Cir. 1983). 70. Id. at 414. 71. Id. at 416. 72. Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772 (9th Cir. 1981). 73. U.C.C. §§ 1-205 & 1-201(3) (1983). 74. Nanakuli, 664 F.2d at 794–805. 75. Arthur L. Corbin, Corbin on Contracts § 1, at 1 (1950). 76. C & J Fertilizer, Inc., v. Allied Mut. Ins. Co., 227 N.W.2d 169 (Iowa 1975). 77. Rodman v. State Farm Mut. Ins. Co., 208 N.W.2d 903, 918 (Iowa 1973). 78. Farm Bureau Mut. Ins. Co. v. Sandbulte, 302 N.W.2d 104 (Iowa 1981). 79. Henderson, supra note 9, at 843–46. 80. Darner Motor Sales, Inc. v. Universal Underwriters Ins. Co., 682 P.2d 388 (Ariz. 1984); Gordinier v. Aetna Casualty & Surety Co., 742 P.2d 277 (Ariz. 1987). 81. Henderson, supra note 9, at 846, 851. 82. Davis v. M.L.G. Corp., 712 P.2d 985 (Colo. 1986). 83. Hurtig v. Terminix Wood Treating & Contracting Co., 692 P.2d 1153 (Haw. 1984) (dissenting opinion); Sturla, Inc. v. Fireman’s Fund Ins. Co., 684 P.2d 960 (Haw. 1984). 84. Transamerica Ins. Co. v. Royle, 656 P.2d 820 (Mont. 1983) (alternative holding). 85. Sparks v. St. Paul Ins. Co., 495 A.2d 406 (N.J. 1985); Werner Indus., Inc. v. First State Ins. Co., 548 A.2d 188 (N.J. 1988). 86. Great Am. Ins. Co. v. C. G. Tate Constr. Co., 279 S.E.2d 769 (N.C. 1981), rev’d on other grounds, 340 S.E.2d 743 (N.C. 1986). 87. Tonkovic v. State Farm Mut. Auto Ins. Co., 521 A.2d 920 (Pa. 1970). 88. Elliot Leases Cars, Inc. v. Quigley, 373 A.2d 810 (R.I. 1977) (applying the doctrine to an automobile leasing contract). 89. Estrin Constr. Co., Inc. v. Aetna Casualty & Surety Co., 612 S.W.2d 413 (Mo. Ct. App. 1981); Spychalsky v. MFA Ins. Co., 620 S.W.2d 388 (Mo. Ct. App. 1981). 90. Pauline Afuso, Reference Librarian at the Law Center, University of Southern California, ran the computer tests on WESTLAW on November 8, 1994, for all reported state and federal decisions for the calendar years 1992 and 1993. 91. Slawson, supra note 26, at 544. 92. The U.S.C.A. General Index 1992 contains approximately 200 entries for debtor and creditor, and West’s Cal. Codes Ann. General Index 1992 contains approximately 300 entries for debtor and creditor. 93. The U.S.C.A. General Index 1992 contains approximately 550 entries for insurance, and West’s Cal. Codes Ann. General Index 1992 contains approximately 3,000 entries for insurance. 94. A copy can be found in Kenneth S. Abraham, Insurance Law and Regulation: Cases and Materials 439–48 (1990). 95. Weber v. IMT Ins. Co., 462 N.W.2d 283 (Iowa 1990). 96. See, e.g., Kenneth S. Abraham, Distributing Risk: Insurance, Legal Theory, and Public Policy 100–32 (Yale U. Press, 1986) (describing reasonable expectations as “judge made insurance”); Richard Craswell, “Property Rules and Liability

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Rules in Unconscionability and Related Doctrines,” 60 U. Chi. L. Rev. 1, 27–29 (1993). 97. Jean F. Rydstrom, Annotation, “Application of ‘Clearly Erroneous’ Test of Rule 52(a) of Federal Rules of Civil Procedure to Trial Court’s Findings of Fact Based on Documentary Evidence,” 11 A.L.R. Fed 212 (1972). 98. Restatement (Second) of Contracts § 212(2) (1981). 99. Keeton & Widiss, supra note 6, at 643–45. Chapter 4 1. The reader should not confuse “relational torts” with certain other uses of “relational.” Ian R. Macneil uses “relational contracts” to mean contracts that define the parties’ long-term working relationships with each other. See, e.g., Ian R. Macneil, “Relational Contract: What We Do and Do Not Know,” 1985 Wis. L. Rev. 483 (1985). Leon Green originated the phrase, “torts to relational interests,” to describe torts that harmed interpersonal relationships, and torts scholars still use it for this purpose. See, e.g., Leon Green, “Relational Interests,” 29 Ill. L. Rev. 460 (1934), 29 Ill. L. Rev. 1041 (1935), 30 Ill. L. Rev. 1 (1935), 30 Ill. L. Rev. 314 (1935), 31 Ill. L. Rev. 35 (1936); Nancy Levit, “Ethereal Torts,” 61 Geo. Wash. L. Rev. 136, 146–50 (1992). 2. E. Allan Farnsworth, Contracts § 12.18 (2d ed. 1990). 3. Id. §§ 8.3, 8.5–.7, 8.22. 4. Id. §§ 8.15–.18 (pointing out that the doctrine of substantial performance works to the same effect). 5. James J. White & Robert S. Summers, Uniform Commercial Code § 8-4 (3d ed. 1988) (discussing U.C.C. § 2-608). 6. Hibschman Pontiac, Inc. v. Batchelor, 362 N.E.2d 845 (Ind. 1977). 7. Farnsworth, supra note 2, § 8.16. 8. Henningsen v. Bloomfield Motors, Inc., 161 A.2d 69 (N.J. 1960). 9. 4 American Law of Products Liability 3d, § 60:28 (Timothy E. Travers et al. eds., 1991). 10. Jay M. Zitter, Annotation, “Strict Products Liability: Recovery for Damage to Product Alone,” 72 A.L.R. 4th 12 (1989). 11. See Robert E. Keeton, “Liability Insurance and Responsibility for Settlement,” 67 Harv. L. Rev. 1136 (1954). 12. Comunale v. Traders and Gen. Ins. Co., 328 P.2d 198, 200 (Cal. 1958). Some of the facts recited can only be found in the opinion of the lower court, 321 P.2d 768 (Cal. Ct. App. 1958). 13. Id. 14. Id. at 200. 15. Id. at 200–01 (quoting Hilker v. Western Auto. Ins. Co., 231 N.W. 257, 258 (Wis. 1930), aff’d on reh’g, 235 N.W. 413 (Wis. 1931)). 16. Comunale, 328 P.2d at 201. 17. Robert E. Keeton, Basic Text on Insurance Law § 7.8(a) (1971). 18. Comunale, 328 P.2d at 203. 19. Georgetown Realty v. Home Ins. Co., 831 P.2d 7 (Or. 1992) (en banc). See also Joel M. Pollack, “Georgetown Realty v. Home Insurance Company: Oregon

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Recognizes a Duty Independent of Liability Insurance Contracts,” 71 Or. L. Rev. 707 (1992). 20. Allan D. Windt, Insurance Claims and Disputes §§ 2.02, 2.04, 2.19, 4.01 & 5.01 (1982 & Supp. 1993). 21. See Robert H. Jerry II, Understanding Insurance Law §§ 40–46, 63C, 65, 96, 133, & 135A (1987). 22. Palmateer v. International Harvester Co., 421 N.E.2d 876 (Ill. 1981). 23. Vermillion v. AAA Moving and Storage, 704 P.2d 1360 (Ariz. 1985). 24. Michael A. DiSabatino, Annotation, “Modern Status of Rule That Employer May Discharge At-Will Employee for Any Reason,” 12 A.L.R. 4th 544, §§ 3, 6–14. 25. Id. 26. Restatement (Second) of Torts § 46 (1965). 27. Dennis P. Duffy, “Intentional Infliction of Emotional Distress and Employment at Will: The Case against ‘Tortification’ of Labor and Employment Law,” 74 Boston U. L. Rev. 387 (1994); James. F. Bleeke, “Intentional Infliction of Emotional Distress in the Employer at Will Setting: Limiting the Employer’s Manner of Discharge,” 60 Ind. L.J. 365 (1985). 28. Dean v. Ford Motor Credit Co., 885 F.2d 300 (5th Cir. 1989). 29. Wilson v. Monarch Paper Co., 939 F.2d 1138 (5th Cir. 1991). 30. Leo Bearman Jr., “Caveat Emptor in Sales of Realty—Recent Assaults upon the Rule,” 14 Vand. L. Rev. 541 (1961). 31. White & Summers, supra note 5, § 9-7, at 408; Alphonse M. Squillante & John R. Fonseca, 2 Williston on Sales §§ 15-19 to 15-21 (4th ed. 1974). 32. Humber v. Morton, 426 S.W.2d 554 (Tex. 1968). 33. Bearman, supra note 25, at 542–43; Annotation, “Liability of Builder-Vendor or Other Vendor of New Dwelling for Loss, Injury, or Damage Occasioned by Defective Condition Thereof,” 25 A.L.R. 3d 383 (1969 & Supp. 1992). 34. Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349, 352, 355 (Tex. 1987). 35. Frickel v. Sunnyside Enters., Inc., 725 P.2d 422 (Wash. 1986). 36. Lenawee County Bd. of Health v. Messerly, 331 N.W.2d 203 (Mich. 1982). 37. Schepps v. Howe, 665 P.2d 504 (Or. 1983). 38. Frona M. Powell, “Disclaimers of Implied Warranty in the Sale of New Homes,” 34 Vill. L. Rev. 1123, 1143 (1989). 39. Richard R. Powell & Patrick J. Rohan, 2 Powell on Real Property ¶’s 230, 231, 233, & 234 (1993). 40. Melody Home, 741 S.W. 2d at 352, 354, 355–56. 41. W. Page Keeton et al., Prosser and Keeton on the Law of Torts §§ 1, 32 (5th ed. 1984). 42. See, e.g., Cal. Bus. & Prof. Code §§ 7065 (West 1975 & Supp. 1994) (contractors); id. §§ 6520–26 (barbers); id. §§ 3320–27 (hearing aid dispensers); id. §§ 9989.31–.32 (motor vehicle mechanics); id. §§ 7520, 7526.0–.4 (private investigators); Cal. Food & Agric. Code §§ 11701–09 (West 1986 & Supp. 1994) (pest controllers). 43. Keeton et al., supra note 41, § 32, at 185. 44. Id. 45. Data Processing Servs. Inc. v. L. H. Smith Oil Corp., 492 N.E.2d 314, 319– 20 (Ind. Ct. App. 1986).

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46. Diversified Graphics, Ltd. v. Groves, 868 F.2d 293 (8th Cir. 1989). 47. Ellsworth Dobbs, Inc. v. Johnson, 236 A.2d 843 (N.J. 1967). 48. Id. at 850. 49. Id. at 850–52, 857. 50. Id. at 857–59. 51. Id. at 856–57. 52. Sonja A. Soehnel, Annotation, “Modern View as to Right of Real Estate Broker to Recover Commission from Seller-Principal Where Buyer Defaults under Valid Contract of Sale,” 12 A.L.R. 4th 1083, § 3 (1982 & Supp. 1992). 53. Id. § 4. In addition, although the annotation lists New Hampshire as still holding to the old view, see id. § 3, the New Hampshire Supreme Court has indicated that it favors the new view in Dunn v. Staples, 248 A.2d 635 (N.H. 1968). See id. § 3 n.10, § 5. 54. Strout Realty, Inc. v. Milhous, 689 P.2d 222 (Idaho Ct. App. 1984); Bushnell Real Estate, Inc. v. Nielson, 672 P.2d 746 (Utah 1983); Kuga v. Chang, 399 S.E.2d 816 (Va. 1991). 55. Restatement (Second) of Agency §§ 1, 13 (1958); William E. Sell, Sell on Agency §§ 2, 39 (1975). 56. Uniform Partnership Act §§ 20, 21 (1976); Harold G. Reuschlein & William A. Gregory, Agency and Partnership § 188 (1979). 57. E.g., Model Rules of Professional Conduct Rule 1.7 (1983) (lawyers). 58. Deborah A. DeMott, “Beyond Metaphor: An Analysis of Fiduciary Obligation,” 1988 Duke L.J. 879, 880–88, 903–10, 916–21 (1988). 59. John D. Calamari & Joseph M. Perillo, Contracts §§ 9–10, 9–11 (3d ed. 1987); Farnsworth, supra note 2, §§ 4.11, 4.20, 4.27; Christopher M. Guidroz, Note, “Use of Non-Confidential Relationship Undue Influence in Contract Recision,” 49 Notre Dame L. Rev. 631, 632–33 (1974). 60. DeMott, supra note 58, at 892–902 (1988). Franchisor and franchisee, see also Arnott v. American Oil Co., 609 F.2d 873 (8th Cir. 1979), cert. denied, 446 U.S. 918 (1980); see generally Harold Brown, “Franchising—A Fiduciary Relationship,” 49 Tex. L. Rev. 650 (1971). Manufacturer and distributor, see also Hospital Prods., Ltd. v. U.S. Surgical Corp., 55 A.L.R. 417 (Austl. 1984), rev’g 2 [1983] N.S.W.R. 157 (N.S.W. Ct. App. 1983). Bank and borrower, see also Barrett v. Bank of Am., 229 Cal. Rptr. 16 (Cal. Ct. App. 1986); Klein v. First Edina Nat’l 196 N.W.2d 619 (Minn. 1972). Bank and depositor, see also Commercial Cotton Co. v. United Cal. Bank, 209 Cal. Rptr. 551 (Cal. Ct. App. 1985); see generally Annotation, “Existence of Fiduciary Relationship between Bank and Depositor or Customer So as to Impose Special Duty of Disclosure upon Bank,” 70 A.L.R. 3d 1344 (1976). Holders of interests in oil and gas estates, see also Manges v. Guerra, 673 S.W.2d 180 (Tex. 1984). 61. Austin W. Scott, The Law of Trusts (4th ed. 1987). 62. Austin W. Scott, “The Fiduciary Principle,” 37 Cal. L. Rev. 539, 540 (1949). 63. J. C. Shepherd, Law of Fiduciaries 96 (1981). 64. DeMott, supra note 58, at 910–13. 65. Id. at 915. 66. Farnsworth, supra note 2, § 2.15(a), at 120–22 (esp. n.10); see generally id. § 7.17(a).

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67. Id. § 2.15(a). See, e.g., Tymshare, Inc. v. Covell, 727 F.2d 1145 (D.C. Cir. 1984) (Scalia, J.); Best v. U.S. Nat’l Bank, 739 P.2d 554, 558 (Or. 1987). See generally Farnsworth, supra note 2, § 2.13. 68. Farnsworth, supra note 2, § 2.13. 69. Id. § 8.4. 70. Id. See also Morin Bldg. Prods. Co. v. Baystone Constr., Inc., 717 F.2d 413 (7th Cir. 1983). 71. K.M.C. Co. v. Irving Trust Co., 757 F.2d 752 (6th Cir. 1985). 72. Charles L. Knapp & Nathan M. Crystal, Problems in Contract Law: Cases and Materials 528–29 (3d ed. 1993). 73. Federal Trade Commission Act, 15 U.S.C. § 45(a)–(m) (1982). 74. Anthony P. Dunbar, Note, “Consumer Protection: The Practical Effectiveness of State Deceptive Trade Practices Legislation,” 59 Tul. L. Rev. 427, 427–29 (1984); Donald P. Rothschild & David W. Carroll, Consumer Protection Reporting Service pt. III, ch. 4 (1986 & Supp. 1992). 75. Cal. Bus. & Prof. Code § 9884.9 (West 1971); Nev. Rev. Stat. Ann. § 487.035 (Michie 1965); N.Y. Veh. & Traf. Law § 398(d) (Consol. 1974); Ohio Admin. Code § 109:4-3-13 (1978); Va. Code Ann. § 59.1-207.3 (Michie 1989). 76. Ohio Admin. Code § 109:4-3-05 (1978). 77. Magnusen-Moss Federal Trade Commission Improvement Act, 15 U.S.C. §§ 2301–12 (1975). 78. Seaman’s Direct Buying Serv., Inc. v. Standard Oil Co., 686 P.2d 1158 (Cal. 1984). 79. Id. at 1166–67. 80. Ellsworth Dobbs, Inc. v. Johnson, 236 A.2d 843, 856–57 (N.J. 1967). 81. Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349, 352, 354–55 (Tex. 1987). 82. F. D. Borkholder Co. v. Sandock, 413 N.E.2d 567, 571 (Ind. 1980). 83. Guido Calabresi, The Costs of Accidents (1970). 84. Kenneth S. Abraham, Insurance Law and Regulation: Cases and Materials 586 (1990). 85. William K. Jones, “Product Defects Causing Commercial Loss: The Ascendancy of Contract over Tort,” 44 U. Miami L. Rev. 731 (1990). See also Elizabeth A. Heiner, Note, “Sunnyslope Grading, Inc. v. Miller, Bradford & Risberg, Inc.: What Recovery for Economic Loss—Tort or Contract?,” 1990 Wis. L. Rev. 1337 (1990) (reaching similar conclusions). 86. Spencer L. Kimball, Cases and Materials on Insurance Law 486–513 (1992); Spencer L. Kimball, Teacher’s Manual to Cases and Materials on Insurance Law 73–78 (1992). See also, Robert H. Jerry, II “The Wrong Side of the Mountain: A Comment on Bad Faith’s Unnatural History,” 72 Texas R. Rev. 1295 (1994). 87. See Kimball, Cases and Materials, supra at 495–97, and Teacher’s Manual, supra at 75–76. 88. See Kimball, Cases and Materials, supra at 513–22, and Teacher’s Manual, supra at 78. 89. Crisci v. Security Ins. Co., 426 P.2d 173 (Cal. 1967). See also DiMare v. Crisci, 17 Cal. Rptr. 265 (Cal. Ct. App. 1961).

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90. Crisci, 426 P.2d at 176. 91. See John Alan Appleman & Jean Appleman, 8 Insurance Law and Practice § 4831 (1981); Stephen L. Liebo, supra (Supp. 1993). 92. Mark S. Rhodes, Couch on Insurance 2d (rev. ed.) §§ 45:679 & 45:721 (1981 & Supp. 1994). 93. Richard Craswell, “Passing on the Costs of Legal Rules: Efficiency and Distribution in Buyer-Seller Relationships,” 43 Stan. L. Rev. 361 (1991). 94. Henningsen v. Bloomfield Motors, Inc., 161 A.2d 69, 87 (N.J. 1960). 95. George L. Priest, “A Theory of the Consumer Product Warranty,” 90 Yale L.J. 1297, 1317–18 (1981); Daniel S. Schecter, “Consequential Damage Limitations and Cross-Subsidization: An Independent Approach to Uniform Commercial Code Section 2–719,” 66 S. Cal. L. Rev. 1273 (1993). 96. Wilson Trading Corp. v. David Ferguson, Ltd., 244 N.E.2d 685 (N.Y. 1968). 97. Craswell, supra note 93, at 374. 98. Hadley v. Baxendale, 156 Eng. Rep. 145 (Ex. 1854). 99. Schecter, supra note 95, at 1283–89. 100. Farnsworth, supra note 1, § 5.2. Chapter 5 1. Comunale v. Traders and Gen. Ins. Co., 328 P.2d 198 (Cal. 1958). 2. E.g., Valentine v. General Am. Credit, Inc., 420 Mich. 256, 262–63, 362 N.W.2d 628 (1984); Restatement (Second) of Contracts § 353 (1981) (allowing damages for emotional distress if “the contract or the breach is of such a kind that serious emotional disturbance was a particularly likely result”); Restatement (First) of Contracts § 341 (1932) (also allowing such recoveries, but only if the breach was “wanton or reckless”); Charles M. Louderback, “Standards for Limiting the Tort of Bad Faith Breach of Contract,” 16 U.S.F. L. Rev. 187, 204–05 (1982). See also Allen v. Jones, 163 Cal. Rptr. 445 (Cal. Ct. App. 1980); Lamm v. Shingleton, 55 S.E.2d 810 (N.C. 1949) (burial contract). 3. John D. Calamari & Joseph M. Perillo, Contracts § 14-3 (3d ed. 1987). 4. Restatement (Second) of Contracts § 353 (1981); Dan B. Dobbs, Handbook on the Law of Remedies § 12.4 (1973); Calamari & Perillo, supra note 3, § 14-5(b). 5. Calamari & Perillo, supra note 3, § 14-8. 6. W. Page Keeton et al., Prosser and Keeton on the Law of Torts § 2 (5th ed. 1984). 7. Crisci v. Security Ins. Co., 426 P.2d 173 (Cal. 1967). See also DiMare v. Crisci, 17 Cal. Rptr. 265 (Cal. Ct. App. 1961), opinion vacated, 373 P.2d 860 (Cal. 1962). 8. Fletcher v. Western Nat’l Life Ins. Co., 89 Cal. Rptr. 78 (Cal. Ct. App. 1970). 9. Wetherbee v. United Ins. Co., 71 Cal. Rptr. 764 (Cal. Ct. App. 1968), aff’d on second appeal, 95 Cal. Rptr. 678 (1971). 10. Keeton et al., supra note 6, § 12. 11. Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (Cal. 1973). 12. Seaman’s Direct Buying Serv., Inc. v. Standard Oil Co., 686 P.2d 1158, 1166–67 (Cal. 1984). 13. Id. at 1160–62.

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14. Id. at 1167. 15. The parties settled out of court on remand. Superior Ct. of Humboldt County, No. 57371 (1985) (documents on file with author). 16. Seaman’s, 686 P.2d at 1166–67. 17. Adams v. Crater Well Drilling, Inc., 556 P.2d 679 (Or. 1976). 18. Seaman’s, 686 P.2d at 1167 (quoting Adams, 556 P.2d at 681). 19. Seaman’s, 686 P.2d at 1167. 20. Id. 21. Id. at 1162–64. 22. Id. at 1168. 23. See, e.g., White v. Western Life Ins. Co., 710 P.2d 309 (Cal. 1985). 24. Brandt v. Superior Ct., 693 P.2d 796 (Cal. 1985). 25. Keeton et al., supra note 6, §§ 119–21. 26. Brandt, 693 P.2d at 798–99. 27. White, 710 P.2d 309. 28. Slottow v. American Casualty Co., 1 F.3d 912, 919 (9th Cir. 1993). 29. Careau & Co. v. Security Pac. Business Credit, Inc., 272 Cal. Rptr. 387, 404–06 (Cal. Ct. App. 1990). 30. See, e.g., Joseph Ryan, Jr., “The Bad Faith Blast,” 28 For the Defense 20 (Mar. 1986). 31. C. Delos Putz, Jr. & Nona Klippen, “Commercial Bad Faith: Attorney Fees—Not Tort Liability—Is the Remedy for ‘Stonewalling,’ ” 21 U.S.F. L. Rev. 419, 458–60 (1987). 32. Preble Stolz, Judging Judges (1981); Robert S. Thompson, “Judicial Retention Elections and Judicial Method: A Retrospective on the California Retention Election of 1986,” 61 S. Cal. L. Rev. 2007 (1988). 33. Foley v. Interactive Data Corp., 765 P.2d 373 (Cal. 1988). 34. Id. at 393. 35. Seaman’s Direct Buying Serv., Inc. v. Standard Oil Co., 686 P.2d 1158, 1167 (Cal. 1984). 36. Id. at 1168. 37. David J. Jung & Richard Harkness, “Life after Foley: The Future of Wrongful Discharge Litigation,” 41 Hastings L.J. 131 (1989). See also Air-Sea Forwarders, Inc. v. Air Asia Co., 880 F.2d 176, 184-85 (9th Cir. 1989) (reviewing the California decisions); Oki Am., Inc. v. Microtech Int’l, Inc., 872 F.2d 312, 315 (9th Cir. 1989) (Kozinski, J., concurring); Careau & Co., 272 Cal. Rptr. at 404–05. 38. 1995 WL 521453. 39. The sixteen jurisdictions that broadly recognize the tort of bad faith breach are as follows: Connecticut: L. F. Pace & Sons, Inc. v. Travelers Indem. Co., 514 A.2d 766 (Conn. App. Ct. 1986) (recognizing tort where defendant refused to give payment and performance bonds). District of Columbia: Wagman v. Lee, 457 A.2d 401 (D.C. 1983), cert. denied, 459 U.S. 912 (1984) (recognizing a tort action for breach of a fiduciary duty based on a contractual obligation although not calling it “bad faith”). Georgia: McDevitt & Street Co. v. K-C Air Conditioning Serv. Co., 418 S.E.2d 87, 93 (Ga. Ct. App. 1992), cert. denied, 1992 Ga. LEXIS 486 (Ga. 1992) (recogniz-

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ing tort cause of action against surety for breach of surety contract if breach was in “bad faith”); Tate v. Aetna Cas. & Sur. Co., 253 S.E.2d 775, 777 (Ga. Ct. App. 1992) (“It is well settled that misfeasance in the performance of a contractual duty may give rise to a tort action. . . . The duty, for the breach of which an action ex delicto lies, must be a duty imposed by law as to some relationship, general or special, as applied to that class of cases where the alleged duty arises out of a contract.”). Hawaii: Chung v. Kaonohi Ctr. Co., 618 P.2d 283 (1990) (holding that extracontractual damages for emotional distress were allowable in ordinary commercial contract situations when the defendant acted maliciously or with willful disregard of another’s rights). Indiana: Hibschman Pontiac, Inc. v. Batchelor, 362 N.E.2d 845, 847 (1977) (recognizing the tort “when . . . elements of tort mingle with the breach” and punitive damages “whenever the elements of fraud, malice, gross negligence or oppression mingle in the controversy”). Maine: Marquis v. Farm Family Mut. Ins. Co., 628 A.2d 644, 651–52 (1993) (refusing to recognize tort of bad faith breach of insurance contract on ground of preemption by legislation that provided for recoveries of attorneys’ fees and statutory interest under certain circumstances); Boivin v. Jones & Vining, Inc., 578 A.2d 187, 189 (Me. 1990) (punitive damages are available for breach of contract if plaintiff proves by clear and convincing evidence that defendant acted with malice or malice is implied by the outrageous nature of the conduct). Thus, it appears that the substance of the tort of bad faith is broadly applicable in Maine even if the name is forbidden. Massachusetts: Massachusetts Consumer Protection Act, ch. 93A, Mass. Gen. Laws Ann., ch. 93A, §§ 1–11 (West 1971 & Supp. 1994) (conferring private rights of action on individual consumers for punitive in addition to compensatory damages and attorneys’ fees for “unfair or deceptive practices,” expressly including bad faith breach); Gloria Ann Aloise, “The Massachusetts Consumer Protection Act, Chapter 93A—A Look at Provisions for Double and Treble Damages, the Written Demand for Relief, and Reasonable Attorneys’ Fees,” 16 N.E. L. Rev. 449 (1981). Mississippi: Sessoms v. Allstate Ins. Co., 634 So. 2d 516, 519 (1994); Independent Life & Accident Ins. Co. v. Peavy, 528 So. 2d 1112, 1115 (Miss. 1988). Montana: Nicholson v. United Pac. Ins. Co., 710 P.2d 1342 (Mont. 1985) (awarding commercial lessor punitive damages for lessee’s breach of covenant), modified by Story v. City of Bozeman, 791 P.2d 767, 776 (Mont. 1990) (confining the tort of bad faith to “contracts which necessarily give one party a superior position,” but not overruling Nicholson). New Mexico: Bourgeous v. Horizon Healthcare Corporation, 872 P.2d 852 (1994) (recognizing a duty of good faith and fair dealing in every contract not to do anything to injure the rights of the other party to receive the benefit of the contract and a remedy of punitive damages if this duty is breached, although refusing to hold that the duty sounds in tort); Romero v. Mervyn’s, 784 P.2d 992, 998–99 (1989) (recognizing the right to recover punitive damages for bad faith breach in every contract and “a more relaxed standard” for such a recovery in insurance contracts).

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Nevada: Hilton Hotels Corp. v. Butch Lewis Productions, Inc., 862 P.2d 1207, 1209 (Nev. 1993) (recognizing the tort “in certain circumstances” including the case at hand, in which the plaintiff, a large corporation, was suing a heavyweight boxing promoter). North Carolina: Ostreicher v. American Nat’l Stores, 225 S.E.2d 797, 809 (N.C. 1976) (stating that the independent tort of bad faith breach might be appropriate in breach of contract actions that “smack of tort because of the fraud and deceit involved”). Oklahoma: Rodgers v. Tecumseh Bank, 756 P.2d 1223, 1226–27 (recognizing the tort for “all types of insurance contracts” and, in addition, any contract in which the breach involves “gross recklessness or wanton negligence”). Oregon: Georgetown Realty, Inc. v. Home Ins. Co., 831 P.2d 7 (1992) (recognizing that contractual relationships that give one party broad discretionary powers over the interests of the other also give rise to duties of competence and care sounding in tort, and applying this standard to liability insurers in particular); Pfeifer v. Copperstone Restaurant and Bar, 693 P.2d 644, 649 (Or. Ct. of App. 1985) (recognizing right to recover punitive damages for aggravated torts); but see Farris v. U.S. Fid. and Guar. Co., 587 P.2d 1015 (1978) (holding that the State Insurance Fair Practices Code’s penalties for certain kinds of bad faith conduct by insurers preempt rights to punitive damages). Vermont: Myers v. Ambassador Ins. Co., 508 A.2d 689 (Vt. 1986) (recognizing a liability insurer’s duty of good faith to its insured but not addressing whether it also sounds in tort or whether an insured might recover punitive damages in an appropriate case); Albright v. Fish, 422 A.2d 250, 255 (1980) (recognizing that punitive damages can be recovered if “the breach [of any contract] has the character of a wilful and wanton or fraudulent tort”); Phillips v. Aetna Life Ins. Co., 473 F. Supp. 984 (Vt. 1979) (recognizing tort of bad faith breach under Vermont law in first-party insurance cases). Wisconsin: Anderson v. Continental Ins. Co., 271 N.W.2d 368, 371–72 and passim (1978) (recognizing the tort for insurers and other defendants who were not insurers, but nevertheless basing the tort on the existence of a special relationship). 40. The eight jurisdictions in addition to California that only narrowly recognize the tort are as follows: Alabama: Keeton v. Bank of Red Bay, 466 So. 2d 937 (Ala. 1985). Alaska: State v. Transamerica Premier Ins. Co., 856 P.2d 766, 773–74 (1993). Idaho: Black Canyon Racquetball Club, Inc. v. Idaho First Nat’l Bank, N.A., 804 P.2d 900 (Idaho 1991). Maryland: Republic Ins. Co. v. Board of County Comm’rs, 511 A.2d 1136 (Md. Ct. Spec. App. 1986). New Hampshire: Lawton v. Great Southwest First Ins. Co., 392 A.2d 576, 580 (N.H. 1978) (“A breach of contract standing alone does not give rise to a tort action.”). North Dakota: Pioneer Fuels, Inc. v. Montana-Dakota Util. Co., 474 N.W.2d 706, 709–10 (N.D. 1991) (holding that breach of contract, even in bad faith, is not enough to convert a contract action into a tort action).

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Ohio: Motorists Mut. Ins. Co. v. Said, 590 N.E.2d 1228, 1232 (1992). Texas: Natividad v. Alexsis, Inc., 875 S.W.2d 695, 698 (1994). 41. The thirteen jurisdictions that recognize the tort but have not ruled on its scope are as follows: Arizona: Noble v. National American Life Ins. Co., 624 P.2d 866 (Ariz. 1981) (recognizing the tort in first- and third-party insurance contracts); Rawlins v. Apodaca, 726 P.2d 565 (Ariz. 1986) (holding that tort recovery may be appropriate where contract is characterized by elements of public interest, adhesion, and fiduciary responsibility); Wagenseller v. Scottsdale Memorial Hospital, 710 P.2d 1025, 1040 (Ariz. 1985) (declining to declare the employment relationship a “special relationship” like the insurance relationship for the purpose of prohibiting discharges except for cause). Arkansas: American Health Care Providers, Inc. v. O’Brien, 318 Ark. 438, 886 S.W.2d 588, 590 (1994) (“We have thus far limited the tort of bad faith to insurers,” citing Quinn); Quinn Cos., Inc. v. Herring-Marathon Group, Inc., 299 Ark. 431, 773 S.W.2d 94, 95 (Ark. 1989) (declining to extend the tort beyond the insurance area “in this case”). Colorado: Travelers Ins. Co. v. Savio, 706 P.2d 1258 (Colo. 1985) (recognizing tort in first-party insurance cases); Farmers Group, Inc. v. Trimble, 691 P.2d 1138 (Colo. 1984) (extending tort to third-party insurance cases); Farmers Group, Inc. v. Williams, 805 P.2d 419 (Colo. 1991) (state’s No-Fault Act, which provides for treble damages for “willful or wanton failure” to pay appropriate benefits, does not preempt tort of bad faith). Delaware: Casson v. Nationwide Ins. Co., 455 A.2d 361 (Del. Super. Ct. 1982) (allowing tort in first-party insurance contracts); Hostetter v. Hartford Ins. Co., 1992 Del. Super. LEXIS 284 (Del. Super Ct. 1992) (holding that tort recognized in thirdparty cases only if third party was explicitly an intended beneficiary of policy). Illinois: There are no relevant decisions of the state supreme court, although several intermediate courts of appeal have recognized the tort for insurance. E.g., Koehler v. First Nat’l Bank, 597 N.E.2d 1261, 1264 (Ill. Ct. of App., 5th Dist. 1992) (declining to recognize the tort outside the insurance area and others where there are “compelling policy reasons” for recognizing it). Iowa: Dolan v. Aid Ins. Co., 431 N.W.2d 790 (Iowa 1988) (recognizing tort in first-party cases). Kentucky: Curry v. Fireman’s Fund. Ins. Co., 784 S.W.2d 176 (Ky. 1989) (holding that tort exists in breach of both first- and third-party insurance contracts). Louisiana: Ins. Co. of North America v. Solari Parking Co., 370 So. 2d 503 (La. 1979) (recognizing the tort in insurance cases, based on a statute, Louisiana being a code state). Missouri: There are no supreme court decisions on point, and the lower courts recognize the tort for “special relationships.” See, e.g., Rigby Corp. v. Boatmen’s Bank and Trust Co., 713 S.W.2d 517, 536–37 (Mo. Ct. App. 1986) (recognizing the tort “where the contract places the contractors in a special relationship or status which the law protects,” citing Zumwalt v. Utilities Ins. Co., 228 S.W.2d 750 (Mo. S. Ct. 1950)). New York: Gordon v. Nationwide Mut. Ins. Co., 285 N.E.2d 849 (N.Y. 1972), cert. denied, 410 U.S. 931 (1973) (allowing tort in third-party insurance cases where

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plaintiff has made “extraordinary showing of a disingenuous or dishonest failure to carry out a contract”); Neil A. Goldberg, Thomas F. Segalla, & Richard J. Cohen, “Can the Puzzle Be Solved: Are Punitive Damages Awardable in New York for First-Party Bad Faith?,” 44 Syracuse L. Rev. 723 (1993) (concluding that the State Court of Appeals has not answered the question and the lower court decisions are mixed). Rhode Island: Bibeault v. Hanover Ins. Co., 417 A.2d 313 (R.I. 1980) (extending tort to all first-party insurance cases except those arising out of fire insurance contracts); Voccia v. Reliance Ins. Co., 703 F.2d 1 (1st Cir. 1983) (allowing tort in third-party insurance cases). South Carolina: Nichols v. State Farm Mut. Auto. Ins. Co., 306 S.E. 2d 616 (S.C. 1983) (recognizing independent tort of bad faith in insurance cases); Ludwick v. This Minute of Carolina, Inc., 337 S.E.2d 313 (S.C. 1985) (allowing recovery in tort for breach of employment contract). Wyoming: Drake v. Cheyenne Newspapers, Inc., 1995 WL 90316, p. 2 (1995) (recognizing the tort only when there are “special relationships,” seemingly without regard to the character of the breach itself); McCullough v. Golden Rule Ins. Co., 789 P.2d 855, 858 (Wyo. 1990) (“There are certain classes of contracts which create a relation out of which certain duties arise as implied by law independently of the express term of the contract. If the negligent breach of contract is also a breach of such duty the remedy is ex contractu and ex delicto.”). 42. AM/PM Franchise Ass’n v. Atlantic Richfield Co., 542 A.2d 90 (1988), 584 A.2d 915 (1990) (holding that the facts did not give rise to the question); Standard Pipeline Coating Co. v. Solomon & Teslovich, Inc., 496 A.2d 840, 843–44 (1985) (declining to recognize the tort). 43. Hal Taylor Associates v. Unionamerica, Inc., 657 P.2d 743, 750 (Utah 1982) (declining to find a basis for punitive damages for breach of contract in the absence of the commission of an “independent tort indicating malice, fraud or wanton disregard for the rights of others”); Beck v. Farmers Ins. Exch., 701 P.2d 795 (Utah 1985) (the contractual relationship in first-party insurance cases does not give rise to duties sounding in tort). 44. Moreover, in one of these the state supreme court has held that a bad faith failure to perform one’s contractual obligations “may give rise to liability in tort.” Cherberg v. Peoples Nat’l Bank of Wash., 564 P.2d 1137, 1143 (Wash. 1977). 45. A WESTLAW Key No. 217k602.10(2) search conducted on March 27, 1994, revealed the jurisdictions that allowed such recoveries. The figure of 33 represents a minimum, however, because the key number presumably does not identify litigation cost recoveries in insurance cases that are not grounded on a special law for insurance cases. 46. Vernon Fire & Casualty Ins. Co. v. Sharp, 349 N.E.2d 173, 180 (Ind. 1976) (“tortious in nature,” defendant an insurer); Hibschman Pontiac, Inc. v. Batchelor, 362 N.E.2d 845, 847 (Ind. 1977) (“elements of fraud, . . . [etc.] mingle in the controversy,” defendant an automobile dealer); F. D. Borkholder Co., Inc. v. Sandock, 413 N.E.2d 567, 571 (Ind. 1980) (emphasizing high degree of public trust, defendant was a construction contractor). 47. Hibschman, 362 N.E.2d 845. 48. Id. at 848.

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49. John A. Sebert, Jr., “Punitive and Nonpecuniary Damages in Actions Based upon Contract: Toward Achieving the Objective of Full Compensation,” 33 UCLA L. Rev. 1565 (1986). 50. Id. at 1615. 51. Michelle A. Harrington, “Punitive Damages for Breach of Contract: A Core Sample from the Decisions of the Last Ten Years,” 42 Ark. L. Rev. 31, 62–77, 79, 80, 86–88 (1989). 52. Id. at 77–81. 53. Seaman’s Direct Buying Serv., Inc. v. Standard Oil Co., 686 P.2d 1158, 1167 (Cal. 1984). 54. Richard A. Posner, Economic Analysis of the Law 82–93 (2d ed. 1977); Robert L. Birmingham, “Breach of Contract, Damages Measures and Economic Efficiency,” 24 Rutgers L. Rev. 273 (1970); Charles J. Goetz & Robert E. Scott, “Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach,” 77 Colum. L. Rev. 554 (1977); Thomas S. Ulen, “The Efficiency of Specific Performance: Toward a Unified Theory of Contract Remedies,” 83 Mich. L. Rev. 341 (1984). For a history and critique of the “theory of efficient breach,” see Ian R. Macneil, “Efficient Breach of Contract: Circles in the Sky,” 68 Va. L. Rev. 947 (1982). 55. Careau & Co. v. Security Pac. Business Credit, Inc., 272 Cal. Rptr. 387, 404–06 (Cal. Ct. App. 1990). 56. R. Kent Livesay, “Leveling the Playing Field of Insurance Agreements in Texas: Adopting Comparative Bad Faith as an Affirmative Defense Based on the Insured’s Misconduct,” 24 Tex. Tech L. Rev. 1201 (1993); Ronald S. Range, “The ‘Set Up’ Defense and the Comparative Fault Defense: New Wrinkles in Bad Faith Claims against Insurers,” 45 Wash. & Lee L. Rev. 321 (1988); Patrick E. Shipstead & Scott S. Thomas, “Comparative and Reverse Bad Faith: Insured’s Breach of Implied Covenant of Good Faith and Fair Dealing as Affirmative Defense or Counterclaim,” 23 Tort & Ins. L.J. 215 (1987). 57. See Ryan, supra note 30, at 20. 58. Oki Am., Inc. v. Microtech Int’l, Inc., 872 F.2d 312, 315 (9th Cir. 1989) (Kozinski, J., concurring). 59. John C. McCarthy, Punitive Damages in Bad Faith Cases § 2.26 (4th ed. 1987 & Supp. 1992) (honest belief is question of fact); Keeton et al., supra note 6, at 880 (judge determines reasonable basis in malicious prosecution). 60. Tan Jay Int’l, Ltd. v. Canadian Indem. Co., 243 Cal. Rptr. 907 (Cal. Ct. App. 1988); Joseph Ryan, Jr., “The Bad Faith Blast,” 28 For the Defense 20 (Mar. 1986). 61. See, e.g., Comunale v. Traders & Gen. Ins. Co., 328 P.2d 198 (Cal. 1958); Crisci v. Security Ins. Co., 426 P.2d 173 (Cal. 1967); Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (Cal. 1973). 62. E.g., Velli v. Rutgers Casualty Ins. Co., 608 A.2d 431 (N.J. Super. Ct. App. Div. 1992); Boykin v. Parker 134 S.E.2d 531 (Ga. Ct. App. 1963). 63. Valentino v. Elliott Sav-On Gas, Inc., 247 Cal. Rptr. 483, 485 (Cal. Ct. App. 1988); Caldwell Banker Commercial Group, Inc. v. Hegge, 770 P.2d 1297, 1299 (Colo. Ct. App. 1988). 64. Deborah R. Hensler, “Simple Stories, Hard Facts,” Paper presented at the American Bar Association Annual Meeting (Aug. 1992).

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65. Thomas D. Rowe, Jr., “Predicting the Effects of Attorney Fee Shifting,” 47 Law & Contemp. Probs. 139, 148 (1984). 66. Id. at 155. 67. John J. Donohue III, “Opting for the British Rule, or If Posner and Shavell Can’t Remember the Coase Theorem, Who Will?,” 104 Harv. L. Rev. 1093, 1094 (1991). 68. See generally Note, “State Attorney Fee Shifting Statutes: Are We Quietly Repealing the American Rule?,” 47 Law & Contemp. Probs. 321 (1984). For a detailed analysis of this proposition in civil rights fee-shifting statutes, see Dan B. Dobbs, “Awarding Attorney Fees against Adversaries: Introducing the Problem,” 1986 Duke L.J. 435 (1986). 69. Edward A. Snyder & James W. Hughes, “The English Rule for Allocating Legal Costs: Evidence Confronts Theory,” 6 J.L. Econ. & Org. 345, 377–78 (1990), and cases cited therein. 70. Note, “State Attorney Fee Shifting Statutes,” supra note 68, at 323, 330–42. 71. Id. at 345–46. 72. See id. at 347. The publication, originally titled Federal Attorney Fee Shifting Awards Reporter, ceased publication in August 1990. During its last few years, it reported bimonthly. 73. Gregory G. Sarno, Annotation, “Recoverability of Compensatory Damages for Mental Anguish or Emotional Distress for Breach of Service Contract,” 54 A.L.R. 4th 901 (1987), lists decisions from eighteen states supporting the rule stated in the text. In addition, in Beck v. Farmers Ins. Exch., 701 P.2d 795, 798–801 (Utah 1985), a case the annotator evidently missed, the Utah Supreme Court held that although an insurer’s failure promptly to pay a reasonable first-party claim does not constitute a tort under Utah law, it is a breach of contract; the insured may recover damages for emotional distress if the breach proximately caused them and they were a reasonably foreseeable result of the insurer’s breach of contract. 74. Douglas J. Whaley, “Paying for the Agony: Recovering for Emotional Distress Damages in Contract Actions,” 26 Suffolk U. L. Rev. 935 (1992) (arguing that the traditional contract foreseeability and certainty requirements constitute sufficient standards for emotional distress awards). 75. Restatement (Second) of Contracts § 351 cmt. a (1981). 76. See supra note 52 (citing authorities for the doctrine of “efficient breach”). 77. See, e.g., Egan v. Mutual of Omaha Ins. Co., 620 P.2d 141, 146 (Cal. 1979). 78. “Developments in the Law: Class Actions,” 89 Harv. L. Rev. 1318, 1604 (1976) (entire law review issue dedicated to topic). 79. Philip Marcus, Antitrust Law and Practice § 401 (1980). 80. E.g., Cal. Civ. Code § 1916-3 (West 1935); 41 Pa. Cons. Stat. Ann. §§ 501, 502 (1974); Wis. Stat. Ann. § 138.05 (West 1981). 81. See, e.g., Pac. Mut. Life Ins. Co. v. Haslip, 499 U.S. 1, 19–20 (1991) (instructing jury to consider the character of the defendant’s wrongful conduct and the necessity of preventing similar wrong). 82. Dobbs, supra note 4, § 3.9 (evidence of a defendant’s wealth is admissible as a factor in determining the amount of the punitive damages award). See also Sandoval v. Southern Cal. Enters., 219 P.2d 928, 936 (Cal. 1950); Wetherbee v. United

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Ins. Co., 71 Cal. Rptr. 764 (Cal. Ct. App. 1968), aff’d on second appeal, 95 Cal. Rptr. 678 (Cal. Ct. App. 1971) (compensatory damages of $1,050 and punitive damages of $200,000 were justified as being less than a week’s after-tax income of the defendant). The California Supreme Court used the net worth and annual profits of the defendant as a guideline for determining whether a punitive damage award was excessive in Neal v. Farmers Ins. Exch., 582 P.2d 980, 985 (Cal. 1978), and the defendant’s annual profits in Egan, 620 P.2d at 149. 83. Dobbs, supra note 4, § 3.9; see also Richard L. Blatt et al., Punitive Damages: A State-by-State Guide to Law and Practice § 1.4 (1991). 84. Kenneth S. Abraham & John C. Jeffries, Jr., “Punitive Damages and the Rule of Law: The Role of Defendant’s Wealth,” 18 J. Legal Stud. 415, 417 n.3 (1989). 85. See supra note 80. 86. Wayne R. LaFave & Austin W. Scott, Jr., Criminal Law 568 (2d ed. 1986). 87. Gregory P. Joseph, Civil RICO: A Definitive Guide 2–3 (1992). 88. Restatement (Second) of Torts § 909 (1979), following, almost word for word, Restatement (Second) of Agency § 217C (1958). See, e.g., Egan, 620 P.2d at 147–48. 89. Michael Rustad, “In Defense of Punitive Damages in Products Liability: Testing Tort Anecdotes with Empirical Data,” 78 Iowa L. Rev. 1, 8 (1992). 90. Mark Peterson et al., Rand Corp., Punitive Damages: Empirical Findings 4–5, 27, 56 (1987). In this study, the authors surveyed attorneys who were parties to cases where punitive damages were requested and the cases were tried by juries. A “usable response” was one where the case was closed and at least one of the attorneys involved returned the survey and indicated the final payment. Between 1960 and 1984, nearly 17,000 jury trials were held in San Francisco and Cook counties. The authors sent a follow-up survey to cover the years 1979 to 1984; the statistic provided in the text is from that follow-up survey. There were sisty-eight usable responses in the follow-up survey, ten of which indicated a punitive damages award of over $500,000 initially. Nine of these awards were subsequently reduced. 91. James Fleming, Jr. & Geoffrey C. Hazard, Jr., Civil Procedure § 8.1 (1985). 92. E.g., Theodore Sedgwick, Measure of Damages § 352 (9th ed. 1912). 93. Tan Jay Int’l, Ltd. v. Canadian Indem. Co., 243 Cal. Rptr. 907 (Cal. Ct. App. 1988); Joseph Ryan, Jr., “The Bad Faith Blast,” 28 For the Defense 20 (Mar. 1986). 94. Rustad, supra note 87, at 9 n.28. 95. Rowlett v. Anheuser-Busch, Inc. 832 F.2d 194 (1st Cir. 1987) (advance sheet). 96. Id. at 207 (official reporter). 97. See, e.g., Egan v. Mutual of Omaha Ins. Co., 620 P.2d 141, 149–56 (Clark and Richardson, JJ., concurring in part and dissenting in part). 98. Richard J. Mahoney & Stephen E. Littlejohn, “Innovation on Trial: Punitive Damages versus New Products,” 246 Science 1395, 1395–99 (Dec. 1989); Peter W. Huber, “Putting Punitive Damages into Perspective,” 20 Manhattan Inst. for Pol’y Res. (Mar. 26, 1990). 99. Linda Williams, “Perspective on the Drug Firm Merger: Creating ‘Critical Mass,’ ” L.A. Times, July 29, 1989, at D1.

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Chapter 6 1. Robert Braucher & Arthur E. Sutherland, Commercial Transactions: Selected Statutes x-xi (1964 ed.); see also Ziporah B. Wiseman, “The Limits of Vision: Karl Llewellyn and the Merchant Rules,” 100 Harv. L. Rev. 465, 473–75 (1987); see generally William L. Twining, Karl Llewellyn and the Realist Movement 322–23 (1973). 2. National Conference of Commissioners on Uniform State Laws, Report and Second Draft of the Revised Uniform Sales Act 3–6 (1941) [hereinafter Conference of Commissioners]. 3. Id. at 15–17; Karl N. Llewellyn, “Across Sales on Horseback,” 52 Harv. L. Rev. 725 (1939); Karl N. Llewellyn, “The First Struggle to Unhorse Sales,” 52 Harv. L. Rev. 873 (1939). 4. James J. White & Robert S. Summers, Uniform Commercial Code § 5-1 (3d ed. 1988). 5. Conference of Commissioners, supra note 2, at 15–16, 18, 21, 24–26. 6. 1 Restatement (Second) of Contracts at v (1981). 7. Compare, e.g., id. § 203 with U.C.C. § 1-205 (1983), Restatement (Second) of Contracts § 322 (1981) with U.C.C. § 2-210(2) (1983), and Restatement (Second) of Contracts § 208 (1981) with U.C.C. § 2-302 (unconscionability) (1983). 8. See, e.g., Restatement (Second) of Contracts § 89 (1981). 9. See, e.g., id. § 54. 10. Despite its title, Daniel A. Murray, “Under the Spreading Analogy of Article 2 of the Uniform Commercial Code,” 39 Fordham L. Rev. 447 (1971), does not contradict the statement in the text. White & Summers, supra note 4, § 4 n.18, lists a number of decisions using a Code provision by analogy, but none of them did this to change a common law rule. 11. National Conference of Commissioners on Uniform State Laws, Report and Second Draft of the Revised Uniform Sales Act (1941), reprinted in 1 Elizabeth S. Kelly, Uniform Commercial Code Drafts 269, 302 (1984) [hereinafter Kelly]. 12. Memorandum from Karl N. Llewellyn to the Executive Committee on Scope and Program, NCC Section of Uniform Commercial Acts (circa 1940), in Twining, supra note 1, app. E, at 524–29; Karl N. Llewellyn, “On Warranty of Quality, and Society” (pt. 2), 37 Colum. L. Rev. 341, 381 (1937). 13. Karl N. Llewellyn, The Common Law Tradition: Deciding Appeals 35– 45 (1960); Karl N. Llewellyn, “The Theory of Rules” ch. 4 (circa 1939) (unpublished manuscript), reproduced in William L. Twining, The Karl Llewellyn Papers 81–96 (1968); Twining, supra note 1, at 309, 321–23; Wiseman, supra note 1, at 498–501. 14. Llewellyn, The Common Law Tradition, supra note 13, at 26. 15. E.g., U.C.C. § 2-308 (1983) (place of delivery). 16. E.g., id. § 2-305 (price). 17. Id. § 2-708. 18. Kelly, supra note 11, at 309. 19. U.C.C. § 1-102. 20. Vitauts M. Gulbis, Annotation, “Modern Status of Rule That Acceptance of

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Check Purporting to be Final Settlement of Disputed Amount Constitutes Accord and Satisfaction,” 42 A.L.R. 4th 12 (1985). 21. Vitauts M. Gulbis, Annotation, “Application of U.C.C. § 1-207 to Avoid Discharge of Disputed Claim upon Qualified Acceptance of Check Tendered as Payment in Full,” 37 A.L.R. 4th 358 (1985). 22. Robert Braucher, “The Legislative History of the Uniform Commercial Code,” 58 Colum. L. Rev. 798, 800–01 (1958); Wiseman, supra note 1, at 477–78. 23. Soia Mentschikoff, “The Uniform Commercial Code: An Experiment in Democracy in Drafting,” 36 A.B.A. J. 419 (1950). The members of the advisory groups are listed on the cover of each of the drafts of the U.C.C., beginning with the draft of 1944. 24. One commentator counted over 700 legislative amendments to the U.C.C. by 1967, almost all of which had been made in the original process of enactment, although almost half of these were to Article 9. William A. Schnader, “Short History of the Preparation and Enactment of the Uniform Commercial Code,” 22 U. Miami L. Rev. 1, 10 (1967). This may seem like a large number, but it is not. It averages only seven per state outside of Article 9, which leaves less than one for each of the remaining eight articles. A better indication of the uniformity of Article 2 is that law professors in every state routinely teach it from nationally distributed copies of the U.C.C., even though most of their students will practice within the state. 25. U.C.C. Section 2-302 reads as follows: § 2-302. Unconscionable Contract or Clause. (1) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result. (2) When it is claimed or appears to the court that the contact or any clause thereof may be unconscionable the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination. 26. The leading critique of this kind was Arthur Allen Leff, “Unconscionability and the Code—the Emperor’s New Clause,” 115 U. Pa. L. Rev. 485, 537–38 (1967). See also E. Allen Farnsworth, Farnsworth on Contracts § 4.28, at 310 (2d ed. 1990) (making the same observation as in text and citing other examples from the time). 27. Farnsworth, supra note 26, § 4.28. 28. Williams v. Walker-Thomas Furniture Co., 350 F.2d 445 (D.C. Cir. 1965). 29. Id. at 449. 30. Karl N. Llewellyn, Book Review, 52 Harv. L. Rev. 700 (1939). 31. Llewellyn, The Common Law Tradition, supra note 13, at 370. 32. See, e.g., People v. Two Wheel Corp., 525 N.E.2d 692 (N.Y. 1988); Frank’s Maintenance & Eng’g v. C.A. Roberts Co., 408 N.E.2d 403, (Ill. App. Ct. 1980). See also Jonathan A. Eddy, “On the ‘Essential’ Purposes of Limited Remedies: The Metaphysics of U.C.C. Section 2–719(2),” 65 Cal. L. Rev. 28, 41–42 n.56 (1977); White & Summers, supra note 4, § 4.7, at 200.

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33. Walker-Thomas, 350 F.2d at 449. 34. Jane P. Mallor, “Unconscionability in Contracts between Merchants,” 40 Sw. L.J. 1065 (1986) (results not determined by character of party); supra chapter 2, note 3 (40 percent of claims involve business consumers). 35. For example, although the Iowa Supreme Court’s first decision using reasonable explanations also rested on unconscionability, see C & J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169 (Iowa 1975), its next decision using reasonable expectations did not mention unconscionability, see Farm Bureau Mut. Ins. Co. v. Sandbulte, 302 N.W.2d 104 (Iowa 1981), and none of its decisions using reasonable expectations have mentioned unconscionability since. 36. Farnsworth, supra note 26, § 3.13, at 229. 37. Id. § 3.21. 38. U.C.C. Section 2-207 reads as follows: §2-207 Additional Terms in Acceptance or Confirmation. (1) A definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms. (2) The additional terms are to be construed as proposals for addition to the contract. Between merchants such terms become part of the contract unless: (a) the offer expressly limits acceptance to the terms of the offer; (b) they materially alter it; or (c) notification of objection to them has already been given or is given within a reasonable time after notice of them is received. (3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In such case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act. 39. White & Summers, supra note 4, § 1-2. 40. Daitom, Inc. v. Pennwalt Corp., 741 F.2d 1569 (10th Cir. 1984). See also Westinghouse Elec. Corp. v. Nielsons, Inc., 647 F. Supp. 896 (D. Colo. 1986); Egan Machinery Co. v. Mobil Chem. Co., 660 F. Supp. 35 (D. Conn. 1986) (following Daitom). The Daitom court cited Southern Idaho Pipe & Steel Co. v. Cal-Cut Pipe & Supply Co., 567 P.2d 1246 (Idaho 1977), cert. denied, 434 U.S. 1056 (1977), for the approach it took. A number of courts have taken the approach, citing Southern Idaho rather than Daitom. 41. Charles L. Knapp, “Enforcing the Contract to Bargain,” 44 N.Y.U. L. Rev. 673 (1969). 42. Id. at 685. 43. Lon L. Fuller & Melvin A. Eisenberg, Basic Contract Law 491–526 (5th ed. 1990). See also W. E. Shipley, Annotation, “Validity and Enforceability of Contract which Expressly Leaves Open for Future Agreement or Negotiation the Terms of Payment for Property,” 68 A.L.R. 2d 1221 (1959); Daniel E. Feld, Annotation, “Validity and Enforceability of Provision for Renewal of Lease at Rental to Be Fixed by

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Subsequent Agreement of Parties,” 58 A.L.R. 3d 500 (1974); Farnsworth, supra note 26, § 3.29. 44. “Permanent Editorial Board for the Uniform Commercial Code,” PEB Study Group for the Uniform Commercial Code Article 2: Preliminary Report (1990). The proposals for amendment are based on the ideas of Professor John E. Murray, Jr. See John E. Murray, Jr., “A Proposed Revision of Section 2-207 of the UCC,” 6 J.L. & Com. 337 (1986). See also John E. Murray, Jr., “The Chaos of the ‘Battle of the Forms’: Solutions,” 39 Vand. L. Rev. 1307 (1986). 45. U.C.C. Section 2-316 reads as follows: §2-316. Exclusion or Modification of Warranties. [T]o exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability and . . . be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous. Although Section 2-316 also allows sellers to make disclaimers in other ways, the courts have generally read the clear-and-conspicuous requirement into all of them. White & Summers, supra note 4, §12-5; Charles L. Knapp & Nathan M. Crystal, Problems in Contract Law: Cases and Materials 1147 (3d ed. 1993). 46. U.C.C. Section 2-719 states: §2-719. Contractual Modification or Limitation of Remedy. .... (2) Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act. (3) Consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable. Limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not. 47. White & Summers, supra note 4, § 12-5. 48. Id. §§ 12-8 to 12-12. 49. Id. § 12-12. 50. White & Summers, supra note 4, § 12-5. 51. Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349 (Tex. 1987). See discussion supra chapter 4, “Services Generally.” 52. Cate v. Dover Corp., 790 S.W.2d 559 (Tex. 1990). 53. See discussion supra chapter 4, “Services Generally.” 54. U.C.C. § 2-316(2) explicitly permits a seller to disclaim an implied warranty of fitness for a particular purpose, and of course, the courts have generally followed the section in this respect. White & Summers, supra note 4, §§ 12-5 & 12-6. Chapter 7 1. C & J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169 (Iowa 1975). 2. Comunale v. Traders and Gen. Ins. Co., 328 P.2d 198 (Cal. 1958). 3. W. Page Keeton et al., Prosser and Keeton on the Law of Torts § 92 (5th ed. 1984).

NOTES TO CHAPTER 7

199

4. See discussion supra chapter 4, “Analysis.” 5. Farm Bureau Mut. Ins. Co. v. Sandbulte, 302 N.W.2d 104 (Iowa 1981). 6. Daitom, Inc. v. Pennwalt Corp., 741 F.2d 1569 (10th Cir. 1984). See also discussion supra chapter 3. 7. Lochner v. New York, 198 U.S. 45, 53 (1905). 8. Cate v. Dover Corp., 790 S.W.2d 559 (Tex. 1990). 9. Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349, 351 (Tex. 1987). 10. Keeton et al., supra note 3, at 679–81. 11. Seaman’s Direct Buying Serv., Inc. v. Standard Oil Co., 686 P.2d 1158 (Cal. 1984). 12. Hibschman Pontiac, Inc. v. Batchelor, 362 N.E.2d 845 (Ind. 1977). 13. U.C.C. § 1-102, Official Comment 1. See discussion supra chapter 6, “The Reasons for Creating Article 2.” 14. Southern Pac. Co. v. Jensen, 244 U.S. 205, 222 (1916) (Holmes, J., dissenting). 15. Erie R.R. v. Tompkins, 304 U.S. 64 (1938). 16. I did not want to interrupt the argument in the text in order to point out still another instance of bad lawmaking in the section. “Exclusive” is either arbitrary or redundant. If a writing is the complete expression of the parties’ agreement, it must also be the only expression of it, unless the drafters’ intention was to exclude from the operation of the parol evidence rule writings that the parties’ had partially duplicated in other writings, and there is no apparent reason for such an exclusion. 17. It would unduly prolong the argument in the text to try to describe the exceptions, but they might include the provisions that deal just with property law and the Statute of Frauds provisions. The latter have been embodied in statutes since the English Parliament enacted An Act for Prevention of Frauds and Perjuries in 1677. 18. Erie R.R., supra note 15. 19. David A. Rice, “Lessons about the Realities of Contract for U.C.C. Article 2 Revision and a Future Software Contract Statute,” 2 Rutgers Comp. & Tech. L.J. 499 (1992). 20. Aetna Life Ins. Co. v. Lavoie, 475 U.S. 813 (1986); Bankers Life & Casualty Co. v. Crenshaw, 486 U.S. 71 (1988); Browning-Ferris Indus., Inc. v. Kelco Disposal, Inc. 492 U.S. 257 (1989); Pacific Mut. Life Ins. Co. v. Haslip, 499 U.S. 1 (1991); TXO Prod. Corp. v. Alliance Resources Corp., 113 S. Ct. 2711 (1993); Honda Motor Co., Ltd. v. Olberg, 62 Law Week 4627 (1994). For a well-reasoned analysis of these decisions and some of the issues they raise, see Timothy S. Lykowski, “Tightening the Constitutional Noose around Punitive Damages Challenges: TXO, What It Means, and Suggestions That Address Remaining Concerns,” 68 So. Cal. L. Rev. 203 (1994). 21. TXO Prod. Corp. v. Alliance Resources Corp., 113 S. Ct. 2711 (1993). 22. Honda Motor Co., Ltd. v. Oberg, supra note 20. 23. 28 U.S.C. 1332(c)(1) (“For the purposes of this section . . . a corporation shall be deemed to be a citizen of any State by which it has been incorporated and of the State where it has its principal place of business, except that in any direct action against the insurer of a policy or contract of liability insurance, whether incorporated or unincorporated, to which action the insured is not joined as a partydefendant, such insurer shall be deemed a citizen of the State of which the insured

200

NOTES TO CHAPTER 7

is a citizen, as well as of any State by which the insurer has been incorporated and of the state where it has its principal place of business”). 24. Charles Alan Wright, Law of Federal Courts § 107 (4th ed. 1983). 25. Many state legislatures have enacted statutes restricting punitive damages, but they do not seem to have been motivated by the U.S. Supreme Court’s decisions. See Michael Rustad, “In Defense of Punitive Damages in Products Liability: Testing Tort Anecdotes with Empirical Data,” 78 Iowa L. Rev. 1, 6–9 (1992). 26. The U.S. district court and court of appeals used the U.S. Supreme Court decisions on punitive damages to review the state law of Arkansas in Robertson Oil Co. v. Phillips Petroleum Co., 61 Law Week 2344 (8th Cir. 1994) (en banc), but they found it constitutional and thus did not decline to follow it. 27. Stephen G. Breyer & Richard B. Stewart, Administrative Law and Regulatory Policy: Problems, Text, and Cases 708–814 (3d ed. 1992). 28. Walters v. National Assoc. of Radiation Survivors, 473 U.S. 305 (1985). 29. National Assoc. of Radiation Survivors v. Derwinski, 994 F.2d 583 (9th Cir. 1992), cert. denied sub nom. National Assoc. of Radiation Survivors v. Brown, 114 S. Ct. 734 (1993). 30. John A. Appleman, Insurance Law and Practice § 8885 (Supp. 1994).

Index

Cases are listed separately at the end of this index. Items may be indexed under analytic headings or under such generic headings as Uniform Commercial Code. Abraham, Kenneth S., 45 Abuses, too many actions, 170 adhesion, contracts of, 56–57, 91, 107, 153 agent, definition of, 19 agreement of rescission. See rescission of a contract agreement as Uniform Commercial Code defines it, 61 Aliyah, Patrick S., 13 American Rule civil cases, 120 contract litigation, 37, 96, 117, 120–21, 151 limitations on, 168 litigation costs, recovery of, 16–17, 109, 117, 191n.45 mental suffering and, 97 plaintiffs only, 120 source of abuse, 173 appellate court judges, 162 arguments in opposition, 39. See also opposing arguments assignments, 9 Attorney Fee Shifting Statutes Reporting Service, 121 attorney’s fees, 17. See also American Rule bad faith beyond contract, 116 bad faith breach. See breach, bad faith Baird, Douglas G., 41 bargaining power competition and, 29 consumer’s, 4 different conceptions of, 37 effects of unequal, 22–24, 33, 35, 91, 101 employee’s, 14 producer’s, 26–27 reasonable expectations and, 72 relational torts and, 91 “second round,” 37, 132 superior, conceptions of, 37–38 technology and, 26

battle of the forms, 145–46. See also standard contracts better cost-avoider, 92–94, 118 better cost-spreader, 92–94, 118 bilateral contract, 135 Bird, Chief Justice Rose, 107 Blades, Lawrence E., 49, 178n.15 Braucher, Robert, 54, 134 breach bad faith, 3–4, 95, 104, 111–12, 114, 121, 131–32, 158 material or serious, 75 of warranty, 63 brokers’ commissions, 86 burglary, 152–53 buyers, large volume, advantages of, 42 California Business and Professional Code, 84 California Code of Civil Procedure, Section 1021, 17 California Insurance Code, Section 10111, 169 caveat emptor, 82 charges and concerns, 130. See also concerns, criticisms, opposing arguments Chrysler Motor Company, 33 civil wrongdoing, 123 claim settlement, 92 Clark, Justice William P., 130 classical contract, 3, 9–12 Code. See Uniform Commercial Code common callings, 9, 13, 74 common law v. legislation, 162–63 compensation of persons wrongfully injured. See American Rule competition, economic, 11 concerns, 68. See also charges and concerns, criticisms, opposing arguments Conference of Commissioners on Uniform State Laws, 138

202 confidential relationships. See fiduciary relationships consensus ad idem, 12 consent, objective manifestations of, 51. See also real consent constitutional law, 161, 166–68 limitations on the American Rule, 168 standards for punitive damages, 167 construction companies, 152–53 construction services, 82 consumer, definition of, 24 consumer laws, 4. See also consumer protection legislation consumer protection legislation, 90. See also consumer laws Consumer Reports, 27 contingent fees, 117–18, 120, 173 contra proferentem, 44, 46, 50, 70 contract classical definition of, 3–9, 51, 72 consent and, 51 definition of, 23 relational, 182n.1 contracting power, 3, 5, 36, 65 Corbin, Arthur L., 63 course of performance, evidence of meaning, 164 Court of Chancery, 19 Court of Exchequer, 12, 18 criticisms, 98. See also charges and concerns, concerns, opposing arguments Crosskey, Judge H. Walter, 110, 115 cross-subsidization, 99–101 damages abuse, source of, measure of damages, 170 compensatory, 113, 122–24 emotional distress, 104–105, 186n.21 exemplary, 122 (see also punitive damages) foreseeability rule of, 102 liquidated, 40, 74–75 litigation costs, 16, 96, 117, 104, 117 ( see also American Rule, mental suffering, 97) punitive, 104, 113 , 122–25, 127 , 129, 131, 167, 175n.1 (Introduction), 193– 194n.82, 194n.90 (see also exemplary damages) Darwin, Charles, 12 Demott, Deborah A., 87 deterrence, 122

INDEX

discretionary powers, 88 dishonesty, 114, 125 Donahue, John J., III, 120 Doyle, Judge William E., 146 efficiency, 41, 45 efficient breach of contract, 114 emotional distress damages for, 121, 132 employees, discharge of, 171, 193n.73 intentional infliction of, 81 employees, discharge of, 171–73. See also wrongful discharge from employment employment contracts, 13–16, 48. See also wrongful discharge from employment equity, 45 estoppel, 45, 47–48, 155, 177n.1 Farnsworth, E. Allan, 134, 160 Federal Sales Act, 133 Federal Trade Commission Act, 90 Feldman, Justice Stanley G., 64 fiduciary, definitions of, 87–88 fiduciary duties, 87, 153 fiduciary relationships, 87, 91–92 Florida Medical Association, 120 foreseeability rule of contract law, 102. See also damages law, foreseeability, rule of forfeitures, 75 formalism, 135–36 Francis, Justice John J., 86 fraud, 112, 113, 123, 129, 143, 153 freedom of contract classical contract, 3, 9–10, 12–16, 35 limitation of, by relational torts, 74 limitations on, in classical contract, 74 restrictions on, in Uniform Commercial Code, 74 full payment check, 138 Gibson, Chief Justice Phil S., 78 Gilmore, Grant, 20 good faith and fair dealing, 59, 78, 88–89 goods, definition of, 6 grand-style judging, 135–36, 138 Hand, Judge Learned, 20 Harrington, Michelle A., 114 Harris, David, 63 Henderson, Roger C., 46, 64 Hoffman, Judge Walter E., 61

203

INDEX

Holmes, Oliver Wendell, Jr., 20, 159 horizontal contracts, 32 Hunter limitation, 48 indebitatus assumpsit, 95 industrial revolution, 9 insurance, 44 contracts, 34, 44, 46 estoppel in, 47–48 justifications of reasonable expectations in, 45 litigation, 64–65 risk distribution, 45 Jerry, Robert H., II, 47 Jessel, Sir George, 13 Jones, William K., 94 judge and jury. See role of judge and jury Kaufman, Judge Marcus M., 105, 107 Keeton, Robert E., 44–45, 52, 62, 79 Keeton, W. Page, 84 Kennedy, Duncan, 37 Kessler, Friedrich, 49 Kimball, Spencer L., 95 King’s Bench, 18 Knapp, Charles L., 147 Kozinski, Judge Alex, 115 laissez faire, economic doctrine of, 11 landlord and tenant, 83 last-shot rule, 145–46 Law of Sales prior to 1922, 133 Leff, Arthur Allen, 50 level playing field, disappearance of, 31 liability automobile manufacturers’, 23, 32 manufacturers’, 12–13 liberalism, 10 litigation costs, recovery of. See American Rule Llewellyn, Karl N., 6, 49, 55, 133, 135–37, 139, 159–60, 166 Lochner era, 13–17, 35, 48, 80 McCormick, Mark, 63 MacNeil, Ian R., 182n.1 Magnusen-Moss Federal Trade Commission Improvement Act, 90 Maine, Henry, 13 malicious prosecution, 109–10 malpractice, medical, 120

malpractice, professional, 157 manufacturers’ liability. See liability, manufacturers’ Mentschikoff, Soia, 139 merchant, definition of, 24 mirror-image rule, 145 New York Court of Appeals, 33–34 New York Court of Appeals’ application of Uniform Commercial Code, 34 objective theory of contract, 20–21, 29 offeree, 18–19 oil companies, 106, 126 opposing arguments, 39. See also arguments in opposition, charges and concerns, concerns, criticisms Origin of Species, 12 parol evidence rule, 47, 54–55, 134, 164 Patterson, Edwin W., 56 penalty, 75 person, definition of, 24 personal injuries, 152 plain-language laws, 28 Posner, Judge Richard, A., 40 Powell, Frona M., 83 price discrimination and contracts, 41 Priest, George L., 119 privity of contract, lack of, 13 producer, definition of, 24 producer, reputation of, 26–27 product, definition of, 24 product dependence, 22 products, modern, harmfulness of, 22 products liability, 27–28, 76–77 economic losses and, 76, 94 manufactured goods, 156 relational torts and, 76, 156 promises, binding, 173 property, right of private, 14–15 Prosser, William L., 84 public lawmaking, 65–66 public policy actions in conformity with, punishment for, 81 insurance law, rules resting on, 80 relational torts and, 81, 152–53 Rahdert, Mark C., 46 Rakoff, Todd D., 53 Rand Corporation, 4, 175n.1 (Introduction)

204 real consent, 20 reasonable expectations acceptance by courts, 44–46 binding promises and, 173 breach of the covenant of good faith and fair dealing and, 107 future of, 73 general contract law and, 52–53 insurance law and, 48, 54, 64, 151 law, as a question of, 71 limits on contracting power, 65 products liability and, 52 unconscionability and, 143–44 Uniform Commercial Code and, 49, 154 reasonable settlement of liability insurance claim, 79, 92, 154 reforms of contract law abuses of, 173 achievement of courts, 159 arguments in opposition to, 39 choices and prohibitions related to, 151 remedies reform, 131, 174 role of reasonable expectations in, 72 relational torts. See torts, relational reliance, detrimental, 48 remedies limitations, 33–34, 36, 147–48 remedies reform, 3, 39–40, 104 rescission of a contract, 75–76 Restatement (First) of Contracts, 20 Restatement (Second) of Contracts, 4, 54, 70, 134 Section 211, Topic 3 , Chapter 9, 54, 56, 63 Restatement (Second) of Torts, 4 retribution, 122 revocation of offer, indirect, rule of, 20 rewards, 123, 128 Reynoldson, W. W.., 63 Richardson, Frank K., 130 risk distribution, 45 roles of judge and jury, 70, 115, 127–28 rule of indirect revocation. See revocation of offer, indirect, rule of sale of goods. See Uniform Commercial Code sales of new dwellings, 82 satisfaction clauses, 89 Schecter, Daniel S., 102 scholars, contributions, 162, 174 Schwartz, Alan, 41

INDEX

Scott, Austin W., 88 Sebert, John A., Jr., 113 services, 83 settlement of claims. See claim settlement Shepherd, John C., 88 Shoemaker, Judge Daniel R., 105 Slawson, W. David, 51, 54 Smith, Adam, 10 special knowledge, effect of, 71 standard contracts benefits of, 30 contracts as “things,” 50 effects on bargaining power, 30 insurance industry, 53 reasonable expectations and, 62, 68–70 See also adhesion, contracts of; battle of the forms standard forms. See standard contracts Standardized agreements. See standard contracts; adhesion, contracts of Statute of Frauds, 108–109, 199n.17 strike suits, 119 Summers, Robert S., 160 Supreme Court of California, 60, 77, 91–92, 108, 111–12, 114, 130, 152 Supreme Court of Hawaii, 56 Supreme Court of Indiana, 75, 113 Supreme Court of Iowa, 62, 67, 151, 197n.35 Supreme Court of Kansas, 14 Supreme Court of Michigan, 82 Supreme Court of New Jersey, 86 Supreme Court of North Carolina, 47 Supreme Court of Oregon, 82, 108 Supreme Court of Texas, 83, 156 Supreme Court of Washington, 82 Thesiger, Lord Justice, 18–19 tort abuses of, 170–72 bad faith breach, of, 112, 187–88n.39, 189n.40 California, in, 77, 79 employment contracts and, 49 insurance and, 80 intentional infliction of emotional distress, 81, 106 law, 3, 10–11 mental distress and, 106 tort, relational criticism of, 98 freedom of contract and, 74, 90–91, 103 good faith and fair dealing, 89

205

INDEX

insurance and, 80, 151 liability claimants, 9 malicious prosecution, 109–110 reasonable expectations and, 68 See also wrongful discharge from employment transactions in goods, 135 trial by jury, right to, 127

U.S. Court of Appeals for the District of Columbia Circuit, 140 U.S. Court of Appeals for the Ninth Circuit, 61 U.S. Court of Appeals for the Seventh Circuit, 60 U.S. Court of Claims, 56 U.S. Supreme Court, 127, 151, 167–68

U. C. C. See Uniform Commercial Code unconscionability, 25, 57, 70, 135, 140–43, 177n.3, 197n.35 unfair contracts, 34–35 Uniform Commercial Code Article 1, 5, 134, 166 Article 2, 5, 57–58, 89, 133–37, 145, 151, 158–160, 196n.24 Section 1–103, 147, 155 Section 1–205, 164 Section 1–207, 138–39 Section 2–104, 25 Section 2–202, 164 Section 2–207, 58, 70, 145, 147, 154, 159, 164, 197n.28 Section 2–208, 164 Section 2–209 (1), 140 Section 2–302, 140–141, 145 , 196n.25 Section 2–314, 85, 148 Section 2–315, 85, 148, 157 Section 2–316, 58, 70, 148, 154, 155, 157, 198n.45 Section 2–601, 75 Section 2–608, 75 Section 2–718, 75, 136 Section 2–719, 58, 70, 148, 198n.46

vertical contracts, 32 Veterans Administration, 168 warranties, 56 breaches of, 75 implied, 85, 147–48, 156–57 sales of new dwellings, 82 services, 83 warranty disclaimers, 85, 148 warranty of fitness for particular purpose, 85, 148 warranty of habitability, 82–83 warranty of merchantability, 66, 147–48 warranty rights, 75 Wealth of Nations, 10 Weisberg, Robert, 41 White, James J., 160 Widiss, Alan I., 45 Wilde, Louis L., 41 will, philosophies of, 12 will theory of contract, 17–20 Willard, Charles Hastings, 56 Windt, Allan D., 80 workers’ compensation, 153 Wright, Judge J. Skelly, 140–41 wrongful discharge from employment, 80

Table of Cases Adams v. Crater Well Drilling, Incorporated, 107–108 Adams v. Lindsell, 18 Brandt v. Superior Court, 109 C & J Fertilizer, Inc. v. Allied Mutual Insurance Co., 62–63, 151 Careau & Co. v. Security Pacific Business Credit, Inc, 110 Cate v. Dover Corp., 156 Comunale v. Traders and General Insurance Co., 77–79, 104, 151–52

Coppage v. Kansas, 14 Crisci v. Security Insurance Co., 96 Daitom Inc. v. Pennwalt Corp., 146, 155 Dickenson v. Dodds, 19 Ellsworth Dobbs, Inc. v. Johnson, 86 F. D. Borkholder Co. v. Sandock, 91 Farm Bureau Mutual Insurance Co. v. Sandbulte, 154 Fletcher v. Western National Life Insurance Co., 105, 126

206

INDEX

Foley v. Interactive Data Corp, 111 Freeman & Mills, Inc. v. Belcher Oil Co., 111–12 Frickel v. Sunnyside Enterprises, Inc., 82

Palmateer v. International Harvester Co., 81 Patterson v. Meyerhofer, 59 Printing Company v. Sampson, 13

Gerhardt v. Continental Insurance Co., 45

Schepps v. Howe, 82 Seaman’s Direct Buying Service, Inc. v. Standard Oil Co., 91, 106–108, 126, 158 Silberg v. California Life Insurance Co., 59–60

Hadley v. Baxendale, 102 Henningsen v. Bloomfield Motors, Inc., 33, 76, 86, 99 Hibschman Pontiac, Inc., v. Batchelor, 75, 113, 158 Humber v. Morton, 82–83 Hunter v. Jefferson Standard Insurance Co., 47–48

Tan Jay International, Ltd. v. Canadian Indemnity Co., 127 TXO Products Corp. v. Alliance Resources Corp., 167

K. M. C. Co. v. Irving Trust Co., 89 Lake River Corp. v. Carborundum Co., 40 Lenawee County Board of Health v. Messerly, 82 Lochner v. New York, 155–56 McPherson v. Buick Motor Company, 13 Melody Home Manufacturing Co. v. Barnes, 82–83, 91, 156 Morin Building Products Co. v. Baystone Construction, Inc., 60 Nanakuli Paving and Rock Co, v. Shell Oil Co., 61

Vermillion v. AAA Moving and Storage, 81 Walters v. National Association of Radiation Survivors, 168–69 Weber v. IMT Insurance Co., 67 Wetherbee v. United Insurance Co., 105 White v. Western Life Insurance Co., 110 Williams v. Walker-Thomas Furniture Co., 141 Wilson Trading Corp. v. David Ferguson, Ltd., 33, 99–100 Winterbottom v. Wright, 12