Thursday, November 3, 2005
Few subjects in contract law are getting more attention these days than the problems of "indefinite contracts." In the specific situation in which sophisticated parties deliberately leave gaps in their agreements, when should courts intervene to fill them?
George Geis (Alabama) thinks that option theory has some useful things to tell us about that situation. His analysis is set out in An Embedded Options Theory of Indefinite Contracts, forthcoming in the Minnesota Law Review. Here's the abstract:
Option theory is beginning to generate robust insights in the legal literature, and it is particularly well-suited to contract law. This Article develops an embedded options theory of indefinite contracts, focusing on the proper scope of the indefiniteness doctrine - a core principle of contract law invalidating contracts that are too vague. This approach offers answers to two puzzling questions. First, why do parties write deliberately vague contracts, especially when they can contract with precise, verifiable metrics at a low cost? Second, what should a court do when confronted with an indefinite contract? Should it throw out the entire contract, impose a popular term, or do something else?
This Article shows how the use of indefinite terms plus active judicial gap-filling can create an embedded option - the valuable opportunity to take action in the future based on outcomes that are uncertain today. It then argues that these embedded options can be problematic from an
economic point of view because they are unlikely to be fully appreciated by both parties to the contract. This means that embedded interpretative options will sometimes distort efficient trade and investment decisions.
In short, there are under-explored costs to contractual gap-filling. Ultimately, then, courts should resist the temptation to instinctively plug gaps and recognize that the indefiniteness doctrine has a meaningful role to play in contract law.