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Thursday, March 23, 2006

Contract as Statute

Aaa_17 Aaa_18 The point of contract interpretation, we are often told, is to figure out what the parties to the contract meant.  But parties to the contract frequently use standard terms that they did not actually draft themselves.  Terms like those in the standard real estate contract may be used by hundreds of thousands of parties, and frequently neither party has read or understood the term.

So how do we go about interpreting such terms when we have an interpretation problem?   Looking at what the parties meant may not help, because neither of them may have meant anything at all with respect to the clause.  In a new paper, Contract as Statute, Stephen Choi (NYU) and Mitu Gulati (Georgetown) offer their own take, at least in cases involving sophisticated parties: look at what the drafters of the clause meant at the time it was drafted.  Here's the abstract:

Formalists contend that courts should apply strict textual analysis in interpreting contracts between sophisticated commercial parties.  Sophisticated parties have the expertise and means to record their intentions in writing, reducing the litigation and uncertainty costs surrounding incomplete contracts. Moreover, to the extent courts misinterpret contracts, sophisticated parties may simply rewrite their contracts to clarify their true intent. We argue that the formalist approach imposes large costs on even sophisticated parties in the context of boilerplate contracts. Where courts make errors in interpreting boilerplate terms, parties face large collective action problems in rewriting existing boilerplate provisions. Any single party that attempts to change a boilerplate term will face a large market discount for deviating from the market standard. In such situations, a court erroneous interpretation that reduces overall contracting surplus may persist in an industry. We also contend that taking a more contextual approach, including evidence on course of conduct and industry custom, to contract interpretation will not ameliorate the difficulties inherent in the interpretation of boilerplate terms. The specific parties to a boilerplate contract often have no understanding of what the disputed boilerplate clause means. Where such parties attempt to supply their own ex post understandings, they may not represent the interests of the entire industry that relies on the particular boilerplate clause. We provide a new approach to the interpretation of boilerplate terms between sophisticated contracting parties. Courts should bypass an inquiry into the understanding of the parties to the current contract and instead go back to the point in the past when the disputed clause first became part of the boilerplate.

Much like the enacting legislative body for a statute, the original drafting parties provide the best source of information on the original meaning of boilerplate contract terms. The original drafting parties will have spent the most time and resources in negotiating the contract term (and thus represent a true “meeting of the minds”). In a market populated with sophisticated parties on all sides, the drafting parties necessarily must balance the interests of all sides for a contract term to gain at least initial widespread acceptance in the industry. The drafters will also enjoy an expertise advantage over any court attempting to interpret a term. Taking a historical approach to the interpretation of boilerplate terms will create an incentive for standard setters to arise in industries comprised of sophisticated contracting parties to supply boilerplate terms and a detailed historical record of the meaning of the terms.

[Frank Snyder]

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