The effect of many of the rules that you will learn in law school can be altered by agreement of the parties. Rules that the parties can contract around are often called default or gap filling rules. Just as word processing software establishes default margins that a user can alter by changing the settings, many rules are merely legal presumptions that only govern when the parties have remained silent, in the absence of agreements to the contrary. Default rules can be established by common law courts or by legislatures. When a court decision says, as Judge Cardoza wrote in Jacob and Young versus Kent, that future parties are, quote, free by apt and certain words, unquote, to contract for an alternative result, the decision is announcing a default rule. When a statute prescribes a rule that will apply, quote, unless otherwise indicated, unquote, in a private contract, it is announcing a default rule. But many times, statutes and decisions will not expressly address whether a particular rule can be altered by private agreement, or what words would be sufficient to accomplish such altering. When a rule is merely a default, it's important to understand the necessary and sufficient requirements for opting out of it, or what are known as altering rules. The UCC, the Uniform Commercial Code, section 22061a, for example, establishes the default that an offer invites acceptance, quote, in any manner and by any medium reasonable in the circumstances, unquote. The same section provides that the default will obtain, quote, unless otherwise unambiguously indicated, unquote, by the offer or. The reasonable medium rule is the default, and the unambiguously indicated requirement provides the altering rule. Not every contract rule can be contracted around. Those that can not be changed are termed mandatory or immutable rules. Mandatory rules are established by both courts and legislators. The common law has also established immutable limits, for example, on the maximum amount of damages that parties can contract for. These are restrictions on so-called liquidated damages, and limits on the maximum length of covenants not to compete. The duty of good faith is a mandatory part of every agreement, although standards of good faith can within reason be altered by agreement. In the last 60 years, legislative and administrative bodies have promulgated a host of immutable rules that restrict freedom of contract. Some types of transactions, such as those concerning insurance and employment, have to large extents been removed from the general law of contract, and are now subject instead to a host of specific mandatory statutory rules. Since 1964, for example, employers have had an immutable duty not to discriminate on the basis of race or gender when making employment decisions. Many other commercial activities are subject to more limited mandatory rules covering issues such as antitrust, consumer protection, and anti-terrorism. Even the relatively simple construction of a private home is awash with immutable duties. Default rules are not just about contract law, though. Every realm of law can be characterized as a mixture of default and mandatory provisions. Every area of law has this mixture. The law of intestacy is the default legal treatment of people who die without a will. Corporate law is awash with default rules, and again, a mixture of mandatory rules as well. Cumulative voting used to be the default rule of corporate democracy, but now straight or noncumulative voting is the legal default. Even constitutional law is a mixture of default and mandatory laws. For example, Article IV of our Constitution includes the mandate that full faith and credit shall be given in each state to the public acts, records, and judicial proceedings of every other state. That's the full faith and credit clause. But then it immediately goes on to say that, quote, Congress may by general laws prescribe the effect thereof, unquote, thus suggesting that the effects of the states' full faith and credit duty can be altered by Congress. For the rest of your legal education, indeed, for the rest of your life in the law, it's useful whenever you learn a new rule to identify whether the rule can be contracted around, and if so, how? Indeed, a worthwhile exercise after reading each case is to consider what contractual provisions would be sufficient to reverse the course's decision. If there is no language that could reverse the decision, make the losing party win, no altering rules for displacing this default result, then the court is applying a mandatory rule. It's also important to think about the policy considerations that are relevant to setting legal defaults and altering rules. As an initial normative matter, you should always question whether it's reasonable to limit freedom of contract by making a legal rule immutable. I'll be talking about this in the next lecture. If a particular rule is not going to be immutable, how should the lawmakers set the default? The traditional answer is giving the parties what they would have hypothetically contracted for if they had expressly contracted. But this hypothetical contracting rule is often devilishly difficult to apply in practice. It's hard to know what terms two parties would have arrived at given their individual interests, relative bargaining power, other opportunities, and so forth. Often the best a court can do is adopt instead a majoritarian approach and seek out which terms most parties in similar circumstances would prefer. For example, in the sale of goods contracts covered by the Uniform Commercial Code, if the parties fail to name a price, the UCC fills the gap with a reasonable price default. Most parties are probably, these kinds of parties probably contract for a reasonable price. Who wants an unreasonable price? Which is normally going to be cashed out as closely related to the market price. Indeed, any time you see the word reasonable included in the description of a default, there's a good chance that hypothetical or majoritarian gap filling is at work. But the law sometimes chooses to fill gaps with terms that do not accord with the hypothetical contracting approach. Whereas the UCC will fill in a missing price with a reasonable price, it does not fill in quantity gaps by trying to divine what would have been a reasonable quantity. Instead, the impact of the UCC's statute of fraud is often to create de facto a quantity default of zero. The contra proferentem rule, which is Latin to say, to resolve a contractual ambiguity by interpreting the contract against the drafting party. This contra proferentem rule seems to aim to penalize sloppy drafting rather than attempting to divine what the parties would have expressly contracted for if they had been asked to resolve the ambiguity themselves. These departures might at times make good sense. Sometimes it might be useful to establish defaults that penalize one or both parties in ways that encourages the parties to provide information by contracting around the default. Penalty defaults or information forcing defaults that intentionally penalize a contractor failing to fill a gap can further both equity and efficiency by giving a contractor the incentive to expressly say to the other party and to the world what they want. A penalty default rule is a rule that the contractors would not have wanted. Its presence in the right case will provide contractors an incentive to contract around the default rule, and therefore to choose affirmatively the contract provision they prefer. In contrast to the received wisdom, penalty defaults are purposely set at what the parties would not want, in order to encourage the parties to reveal information to each other, or to third parties, especially courts. When strategic consideration cause a more knowledgeable party not to raise issues that could improve contractual efficiency, a penalty default that penalizes the more informed party may encourage the revelation of information. The Hadley rule, which limits consequential damages to those that are foreseeable by the breaching party, is arguably an information forcing default of just this kind. It gives the party with hidden information about its unforeseeable losses. In this case, in the case of breach, it gives them a new reason to share that information with the other side. Only by revealing that you as a buyer are likely to suffer unusual losses in the case of sell or breach, will you be able to recover extra damages from a breaching seller. In fact, there are a host of reasons besides information forcing that can cause a minoritarian default. That is a default that only a minority of contracting parties would actually prefer. Minoritarian rules might be justified by differences in private cost of contracting, differences in private cost of failing to contract, differences in the public cost of filling gaps, differences in private information about the law. At the end of the day, the choice of an efficient default does not boil down merely to a choice between the majoritarian rule for which most contractors would've contracted and a penalty default designed to induce a contractor to reveal information about her type. Instead, efficiency-minded lawmakers will often need to consider a host of factors to decide whether it is more efficient to chose a default that only a minority values. Finally, once lawmakers have decided that a rule should be contractable, and decided whether to adopt majoritarian or minoritarian default, they must still establish separate rules governing how private parties can contract around the default legal treatment. Altering rules establish the necessary and sufficient conditions for displacing a default. Usually, lawmakers try to facilitate contractual freedom and efficiency, will allow multiple altering means, so as to minimize the cost of contracting around a default. But as with the default setting, the setting of altering rules should take into count the costs of altering, the cost of various kinds of error, and the possibility that altering can impose negative externalities on others. There are two broad reasons for structuring altering rules that deviate for merely minimizing transaction costs. First, at times it'll be more important to minimize the cost of party error, especially non-drafter error and third-party error, especially judicial error, than it is to minimize the cost of altering. Second, when externality concerns or paternalistic concerns to protect the contractors themselves are insufficient to justify a full-blown mandatory rules, lawmakers might at times impose impeding altering rules, which intentionally deter subsets of contractors from contracting for legally disfavored provisions. Impeding altering rules produce an intermediate category of quasi-mandatory or sticky defaults which manage but do not eliminate externalities and paternalism concerns. What is the last legal rule that you learned? Is it a mandatory or a default rule? Identify a mandatory rule on your word processing system. Identify a default rule of your word processing system. And describe in detail the altering rules associated with that default. Would it be better for contract law to set the reasonable quantity as the default quantity for contracts?
