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Monday, August 14, 2006

Enforcing No-Modification Clauses

Aaa_65 Sophisticated parties frequently agree to provisions in their agreements that prevent future modifications.  Courts just as frequently strike these down on one or another ground.  The classic argument in favor of such clauses is that allowing parties to agree to restrict their own future contractual power enhances their own contracting power.  More recently, economists have argued that there may be good economic reasons to enforce such clauses.

The latter argument is the target of Kevin Davis (NYU) in a new paper, The Demand for Immutable Contracts: Another Look at the Law and Economics of Contract Modifications, forthcoming in the NYU Law Review.  Here's the abstract:

One of the most challenging questions in contract law is whether parties should be free to create contracts that limit their own freedom of contract and thereby, in effect, contract over the scope of freedom of contract itself. So far the debate has revolved around the enforceability of "anti-modification clauses," which state that subsequent modifications to the contract in which they are contained will be unenforceable. The courts appear reluctant to enforce anti-modification clauses. Some prominent law and economics scholars have argued that in certain circumstances parties would benefit from being able to make their contracts immutable and that courts therefore should enforce anti-modification clauses.

This Article advances several claims that contradict the underlying premises of this argument. It begins by setting out a variety of reasons why the demand for immutable contracts, or at least those created by adopting anti-modification clauses, might be low.  The central claim is that although anti-modification clauses may be unenforceable, contracting parties can duplicate their economic effects by using a technique labeled the "representative trustee technique."  The essence of this technique is that the parties agree to turn over the benefits of any modification to a trust with a large number of beneficiaries.  The conceptual building blocks of the representative trustee technique are all familiar, yet there is no indication of its use in practice.  If valid, these observations are inconsistent with the idea that there is a significant demand for enforceable anti-modification clauses.  It is, however, possible that, contrary to the primary argument in this Article, contracting parties are unaware of the possibility of adopting the representative trustee technique.  In that case, the analysis here is still relevant because it suggests that once the technique is publicized it will satisfy at least some of the demand for enforceable anti-modification clauses. In any case, there seems to be no compelling reason to heed calls to enforce anti-modification clauses.

[Frank Snyder]

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