Contract Law Archives - Columbia Law Review

Introduction Contract law has a production problem. Commercial parties require a contract law that is both efficient when it is created and also adapts efficiently when commercial circumstances change. But currently no legal institution exists that can satisfy both of these criteria. Three legal institutions produce commercial contract law today: courts, statutes that regulate discrete areas, and private lawmaking bodies that create general contract law rules.[footnote]The American Law Institute (ALI) and the Uniform Law Commission (ULC) (also known as the National Conference of Commissioners on Uniform State Laws) are the private legislative bodies that create general commercial contract law. The ALI and ULC jointly created the law of sales in Article 2 of the Uniform Commercial Code (UCC) and the ALI created the two contracts Restatements. Henry Gabriel, Uniform Commercial Code Article Two Revisions: The View of the Trenches, 23 Barry L. Rev. 129, 132 (2018).[/footnote] As we will show, each has limitations. Common law courts develop default rules that are efficient when they are created and are updated as economic conditions change. But lawmaking through the judicial process only produces a restricted set of general contract law rules, and updating is slow: These constraints reflect the limited capacity of courts to address more particular commercial practices adequately.[footnote]See Alan Schwartz & Robert E. Scott, The Common Law of Contract and the Default Rule Project, 102 Va. L. Rev. 1523, 1585 (2016) [hereinafter Schwartz & Scott, The Default Rule Project] (describing the mechanism for producing default rules at common law and the twentieth-century push by drafters to develop more default rules tailored to the complex, modern commercial context).[/footnote] In response, both public and private lawmaking institutions have created specialized statutes that specify rules for discrete legal areas such as secured debt, commercial paper, financial transactions, and bankruptcy.[footnote]The ALI and ULC have jointly created a number of specialized commercial statutes that are incorporated into the UCC, including Article 9 (secured credit), Article 3 (negotiable instruments), Article 4 (bank deposits and collection), and Article 5 (letters of credit). Gabriel, supra note 1, at 132–33. Prior to the UCC project, the ULC produced several predecessor statutes, including the Trust Receipts Act and the Negotiable Instruments Law (NIL), which were adopted by many state legislatures. Uniform Commercial Code, Unif. L. Comm’n, https://www.uniformlaws.org/acts/ucc [https://perma.cc/RL2R-8WFE] (last visited Aug. 23, 2021). Congress, on the other hand, is responsible for the various Bankruptcy Acts, including the most recent regulation of business bankruptcies, the Bankruptcy Code of 1978. 11 U.S.C. §§ 101–112 (2018). In addition, administrative regulators, acting under congressional statutory authority, impose contractual requirements in the banking and financial regulatory context. An example is the Federal Reserve Board regulation of Systemically Important Financial Market Utilities, which imposes standardization requirements for derivatives contracting. See Designations, Dep’t of the Treasury, https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/fsoc/designations [https://perma.cc/8T7T-NQAS] (last visited Aug. 23, 2021) (discussing the designation of certain Financial Market Utilities as “systematically important” and their regulation under Title VIII of Dodd–Frank). Regulatory standardization of derivatives contracts was a major factor in mitigating the 2008 financial crisis. See, e.g., infra Part IV (discussing the increasing role of administrative regulation of contract terms); see also infra note 261 and accompanying text.[/footnote] These specialized statutes are useful complements to the general law of contracts. Yet, the rules were enacted at the instance of cohesive interest groups: The public interest was poorly represented in the enactment process.[footnote]Robert E. Scott, The Rise and Fall of Article 2, 62 La. L. Rev. 1009, 1031 (2002) [hereinafter Scott, The Rise and Fall].[/footnote] The felt need for more and better rules governing the general law of contracts led the private lawmaking groups to produce the law of sales in Article 2 of the Uniform Commercial Code (UCC) and the two Restatements of Contracts. These private lawmaking efforts developed new default rules that covered a wider range of contract law issues than the common law, but history has shown that the rules do not adapt to changing circumstances. The source of the difficulties that plague the commercial law production process is the singular fact of obsolescence.[footnote]See Grant Gilmore, On Statutory Obsolescence, 39 U. Colo. L. Rev. 461, 467–77 (1967) [hereinafter Gilmore, Statutory Obsolescence] (introducing the concept of obsolete commercial statutes).[/footnote] A commercial law rule, whether a default rule or a mandatory rule, is obsolete when it is no longer “apt.” An apt rule efficiently solves a “contracting problem” in the current state of the world and also solves the problem in future states of the world that are “relevantly similar” to the current state.[footnote]A contracting problem is an obstacle to the creation of a surplus-maximizing contract. As examples, parties may want to create an incentive for the seller to invest efficiently in increasing the value of the traded product for the buyer; or, in a long-term contract, to ensure that neither party defects prematurely to an outside option.[/footnote] But if in a future state the contracting problem takes a different form, the apt solution to the problem can change as well. An obsolescence concern exists, therefore, when a legal rule becomes inapt: That is, the rule does not solve the contracting problem in its current form.[footnote]The UCC Article 2 warranty provisions illustrate the obsolescence problem. Article 2 primarily regulates quality issues with the implied warranty of merchantability: Goods must be “fit for the ordinary purposes for which such goods are used” and “pass without objection in the trade.” U.C.C. § 2-314(2) (Am. L. Inst. & Unif. L. Comm’n 2002). This regulation was once efficient when sellers traded homogenous standard goods to large numbers of similarly situated buyers. However, because many sellers now trade heterogeneous—that is, customized—goods to buyers with particular needs, sellers commonly disclaim the warranty. Robert E. Scott, The Paradox of Contracting in Markets, 83 Law & Contemp. Probs. 71, 98 (2020) [hereinafter Scott, The Paradox]. The UCC solution thus is no longer “apt.” Because the UCC is a statute, however, it necessarily continues to supply the original solution until it is amended. Though the UCC solution does not fit very many parties’ contracting problem of how best to allocate between them the risk that the goods will be nonconforming, parties still face these quality issues and the need for a term to regulate them. For further discussion of obsolete warranty terms, see infra section II.A.2.[/footnote] Obsolescence is a significant concern because the commercial world of today is dissimilar in significant ways from the world that existed when our leading commercial laws were created.[footnote]See, e.g., Lisa Bernstein & Brad Peterson, Managerial Contracting: A Preliminary Study 2–3 (2020) (on file with the Columbia Law Review ) (unpublished manuscript) (footnotes omitted). Bernstein and Peterson show: Over the past four decades a number of technological and other changes have strongly affected American manufacturing—among them: firms outsourcing all but core competencies, shorter product cycle times, the increased pace of technological change, the widespread adoption of just-in-time inventory methods, the outsourcing of design and innovation not just production, and the need to meet a variety of competitive challenges including those created by the introduction of high quality Japanese products in the early 1980s. These changes, in turn, have led to new problems that procurement contracts have to solve and have fundamentally changed the nature of contractual relationships in manufacturing. Id. (footnotes omitted); see also John L. Pence & P. Saacke, A Survey of Companies That Demand Supply Quality, in 42nd Annual Quality Congress Transactions (1988) (documenting that companies decreasingly relied on warranties to ensure quality and instead used other quality control measures). For additional discussion of the many ways that contracting practices have changed over recent years, see infra section I.A.[/footnote] UCC Article 2 took its current form by 1952, and the Restatement (Second) of Contracts was completed by 1979.[footnote]See Restatement (Second) of Conts., at vii (Am. L. Inst. & Unif. L. Comm’n 1981) (Foreword); Scott, The Rise and Fall, supra note 4, at 1031.[/footnote] Neither body of law has been materially amended since then.[footnote]For discussion, see Scott, The Rise and Fall, supra note 4. An institution called “The Permanent Editorial Board” is supposed to keep the UCC current, but the Board’s recommendations must be approved by the ALI and ULC before being recommended to the states for adoption. The Board has made few significant recommendations and fewer have been adopted. See id. at 1049; Permanent Editorial Board for Uniform Commercial Code, Unif. L. Comm’n, https://www.uniformlaws.org/committees/community-home?CommunityKey=ffaa1a04-3d69-40f5-95bd-7adac186ef28/ (on file with the Columbia Law Review ) (last visited Aug. 23, 2021) (documenting the activities of the Permanent Editorial Board). Similarly, the ALI has no institution for updating Restatements. For discussion on the failed efforts to revise Article 2 and the Restatement, see infra sections III.B.1–.2.[/footnote] The obsolescence concern is also present in discrete legal areas like bankruptcy that enact specific statutory solutions. The reorganization chapters of the Bankruptcy Code were last comprehensively redone in 1978.[footnote]See David A. Skeel, Jr., Debt’s Dominion: A History of Bankruptcy Law in America 176 (2001) [hereinafter Skeel, Debt’s Dominion].[/footnote] But today many insolvent firms are directly sold to the market through an ill-defined process rather than reorganized under the Code’s elaborate rules.[footnote]A bankruptcy specialist recently explained: The market-sale process arose although it was not the means of restructuring that the 1978 Code favored or even anticipated. Even today, the sale derives its authority from two broad, open-ended sentences in the Code that lack texture, standards, specifics, and instructions. Nevertheless, the market sale has become a prime system of industrial restructuring in the United States. Market conditions prevailed over statutory structure and, one can probably say, over congressional intent. Mark J. Roe, Three Ages of Bankruptcy, 7 Harv. Bus. L. Rev. 187, 189 (2017). For a discussion of the political economy issues that prevent updating of bankruptcy law, see infra section III.C.[/footnote] An obsolete term in a restatement, statute, or even a private contract is not innocuous.[footnote]Even with the help of market institutions, commercial parties are often unable to update their contracts themselves. The causes and consequences of commercial parties’ inability to revise obsolete terms are discussed infra Parts III–IV.[/footnote] There are two concerns. First, suppose that a UCC sales law default rule efficiently solved a contracting problem when enacted, but the world has evolved to a different state in which the problem takes a different form. The private lawmaking groups created the UCC default rule because it was too costly for contracting parties to solve the problem themselves.[footnote]Three reasons explain why the private sector underproduces contract innovation: (1) A contracting dyad would bear the full costs of innovation but could appropriate only a fraction of the gains; (2) Parties who develop innovative solutions bear significant legal risks. Because the legal system retains the power over interpretation and enforcement, parties cannot be certain what effect will be given to any solution to a contracting problem until it is tested in litigation; (3) Accumulated experiences are important in creating solutions to contracting problems. Individual parties may lack this experience, but the state can aggregate the experiences of numerous parties. In sum, the common justification for state-supplied default rules is that the state can create an apt rule more cheaply and skillfully than individual parties can. It was this logic that led to the adoption of the many default rules in the UCC. For more discussion on the role of the state in filling contractual gaps, see Charles J. Goetz & Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Interactions Between Express and Implied Contract Terms, 73 Calif. L. Rev. 261, 273–76 (1985) [hereinafter Goetz & Scott, The Limits of Expanded Choice].[/footnote] If it remains too costly for private agents to solve the problem efficiently in its current form, obsolescence causes parties to treat the problem with second-best solutions.[footnote]For a discussion of the problem of second-best solutions, see infra section I.B.[/footnote] The second concern with obsolescence is that a vestigial default could transition from being harmless but unhelpful to being dangerous. Such transitions can occur when a default applies linguistically , but not substantively, to the current version of the parties’ contracting problem. A party behaving strategically may then attempt to exploit the linguistic fit to generate an unfair or inefficient judicial interpretation in its favor.[footnote]Standard form contracts in the sovereign debt market illustrate this danger of obsolescence. In 2016, activist creditors successfully held out from a debt restructuring offer by Argentina after asserting a novel—and widely condemned—interpretation of the historic pari passu clause found in almost all sovereign debt contracts. See Stephen J. Choi, Mitu Gulati & Robert E. Scott, The Black Hole Problem in Commercial Boilerplate, 67 Duke L.J. 1, 19–21 (2017) [hereinafter Choi, Gulati & Scott, The Black Hole Problem]. In the common understanding, the obsolete pari passu clause was an inconsequential clause in the agreement between the lender and each borrower, specifying how much the creditor would be repaid. The holdout creditors, however, claimed that the clause instead was an agreement among the creditors. As such, the agreement would be breached if some but not all of the creditors accepted the debtor’s settlement offer. The creditors who objected thus could enjoin the other creditors from receiving any payment. The bonds’ ancient language permitted strategic creditors to force a billion-dollar settlement, though the result was inconsistent with current practice and probably inefficient. And the pari passu clause has been difficult to update: Bonds worth many billions of dollars were sold under the clause for years after the holdouts initially mounted a challenge. See id. For a discussion of the costs and persistence of obsolete boilerplate terms in large interdependent markets, see infra section II.C.[/footnote] The persistence and significant costs of obsolescence demand a critical reexamination of the institutional features of the commercial law production process. This Article focuses specifically on the comparative institutional question: How have private markets and the three legal institutions governing commercial contract law—courts, public and private rules for managing specialized areas, and general contract law codifications—fared in their responses to the obsolescence concern? We begin that inquiry by briefly reviewing how the developments over the past one hundred years have produced our modern commercial law. For around 700 years, from 1200 to 1900, only one institution—common law courts—functioned in England and America to produce commercial law.[footnote]See generally A.W.B. Simpson, Innovation in Nineteenth Century Contract Law, 91 Law Q. Rev. 247 (1975) (describing the role of early common law courts). This situation changed in England in 1898 with the Sale of Goods Act and changed in America in 1906 with the Uniform Sales Act. These statutes, however, largely replicated the common law.[/footnote] Courts could function unaided for so many years because intrinsic to common law adjudication is a mechanism for generating a particular subset of efficient contract law rules. Consider, for example, a case of first impression in which the parties’ contract lacks a term to resolve their dispute, so the court has to fill the gap.[footnote]For an earlier description of how the common law functions, see Schwartz & Scott, The Default Rule Project, supra note 2, at 1546–51.[/footnote] The court’s decision may become a rule when future parties recognize that the initial court’s resolution of the case faces them with a choice: to respond to the first case with an express term that regulates the same dispute or to leave a gap in the contract. If a subsequent contracting dyad leaves a gap, the first case becomes a precedent in the sense that the court will resolve the later dyad’s dispute with the rule that it used to resolve the initial dispute. Rules in cases thus become default terms in contracts that are written later unless parties contract out.[footnote]Id. To further illustrate this process, suppose that in the first case a retail store rejects a tire shipment but does not notify the seller in time for the seller to cure the defect or to substitute a conforming tender. The parties’ contract did not cover the notification issue, but the initial court holds that buyers have a duty to notify their sellers promptly of defective deliveries. Now consider claims of late notice by sellers in a dispute between a farmer and a grain elevator, a battery maker and an auto company, and a fiber optic maker and a telecom company. In each of these cases, suppose the parties’ contract did not contain a term dealing with the time for rejection of defective goods. And in each case the court, citing the first case, holds that buyers have a duty to give timely notification of breach. In this way, the initial court’s decision became a precedent in three cases in three different industries: It has become the law.[/footnote] A court’s decision can function as an efficient precedent, however, only if four conditions are satisfied: (1) Parties in other commercial contexts face the same contracting problem as the parties in the first case; (2) The solution to the problem conditions on verifiable information;[footnote]Information is verifiable if (a) parties can observe it, and (b) it would be cost justified for parties to prove its existence in court. For example, market prices are verifiable because they are easy for both parties to observe and cheap to prove. In contrast, buyers usually cannot observe their seller’s costs, and production functions are costly to prove. Hence, a good remedy default would condition on market prices but seldom on seller costs. See Robert E. Scott & George G. Triantis, Incomplete Contracts and the Theory of Contract Design, 56 Case W. Rsrv. L. Rev. 187, 191–92, 195 (2005).[/footnote] (3) The later parties left a contract gap: Their agreements did not otherwise regulate the problem, thereby creating the opportunity for later courts to rule on the issue; and (4) The initial court’s ruling solved the problem as the parties would have solved it had they contracted over it. But condition (4) implies condition (3): The future parties will have left a contract gap only because the rule in the first case efficiently solved their problem. This sketch of the common law adjudication mechanism shows that a common law contract rule has two key properties. First, the rule is “transcontextual”: The rule efficiently solves a contracting problem for parties functioning in diverse contexts.[footnote]The process by which common law courts develop transcontextual default rules that apply across many disparate industries is developed formally in Schwartz & Scott, The Default Rule Project, supra note 2, at 1546–51.[/footnote] If the rule in the first case lacked this property, the rule would be a historical curiosity only. Future parties in other areas would not have left a contract gap, but rather would have contracted about the problem for themselves.[footnote]See id. at 1550.[/footnote] The second property is that the rule roughly tracks changing commercial patterns. When commerce materially changes, parties do different deals under new contracts. If the future parties’ contracts nevertheless also leave a gap where a solution to the problem could be found, the rule in the first case continues to function as a precedent: The rule has been “updated.” But if parties functioning in new commercial situations create contracts that expressly govern the issue, the rule in the first case becomes vestigial: It has no current function. However, the common law mechanism, triggered by current disputes, will then create new rules when the four conditions specified above are satisfied.[footnote]This explanation for how contract law is made complements the standard narrative. In that narrative, great judges—Mansfield, Cardozo, Hand—created rules that last. The mechanism explanation is consistent with this view: The more commercially sophisticated and competent the judge is in the first case, the more likely the judge is to solve the parties’ contracting problem efficiently. And then later parties are more likely to leave a gap into which the first court’s rule can fit. But the mechanism explanation does not rely on unusual judicial creativity. The rule in the first case, whether artfully or poorly conceived, will stick if the rule satisfies the four conditions; otherwise, it will not. Put another way, we do not claim that the common law in general is efficient or that courts have a particular expertise in creating efficient common law rules. Rather, we argue that an efficient contract law rule is the joint product of a plausible judicial solution to a contracting problem together with the uncoordinated decisions of heterogeneous contracting parties to accept that solution.[/footnote] The updating feature of the common law mechanism has an inherent limitation, however. Parties in different commercial contexts often require solutions that are specific to their circumstances. But generalist courts are ill-equipped to supply specific solutions to particular industries. The solution they suggest for a specific problem will likely not be the outcome that the parties would have specified had they contracted over the issue. That failure, in turn, implies that future parties in the industry would not leave a gap in their contract, and no default rule would be formed. Private lawmakers responded to this regulatory gap by creating discrete bodies of commercial law, including secured credit to regulate transactions between creditors and their debtors, and commercial paper and bank deposits to regulate short-term financing transactions.[footnote]See, e.g., U.C.C. art. 9 (Am. L. Inst. & Unif. L. Comm’n amended 2010); id. arts. 3, 4 (Am. L. Inst. & Unif. L. Comm’n amended 2002).[/footnote] Many of these discrete lawmaking efforts have been regularly updated as focused interest group pressures stimulate reform proposals.[footnote]Article 9 of the UCC regulating secured credit has been updated twice—in 1978 and again in 1999. It was subsequently amended in 2010. Article 3 on negotiable instruments and Article 4 regulating bank deposits and collections were revised in 1990 and amended in 2002. For discussion of the interest group pressures that stimulate updating of specialized commercial fields, see generally Alan Schwartz & Robert E. Scott, The Political Economy of Private Legislatures, 143 U. Pa. L. Rev. 595 (1995) [hereinafter Schwartz & Scott, The Political Economy] (applying structure-induced equilibrium theory to show that interest group pressures in the ALI and ULC produce current rules that advance the groups’ goals).[/footnote] Yet, this focused response to the risk of obsolescence raises a further concern: Interest group pressure produces specialized commercial rules that are privately efficient but not necessarily socially efficient.[footnote]Article 9 of the UCC is an apt example of the potential divergence between private and public interests. Article 9 rationalized numerous pre-Code statutes governing the priority of secured creditors’ claims and in the process simplified and reduced the costs of issuing secured debt. But critics have long argued that the priority Article 9 gives to secured creditors functions to redistribute wealth away from unsophisticated creditors, particularly tort claimants, employees, and small suppliers. See, e.g., Lynn M. LoPucki, The Unsecured Creditor’s Bargain, 80 Va. L. Rev. 1887, 1941–47 (1994). For a discussion of the political economy of the recent revisions to Article 9, see infra section IV.B.1.[/footnote] This disregard for the public interest justifies a continuing role for general contract law rules that take broader social interests into account.[footnote]The supplementary role of contract law as the backstop to specific statutory regulation is made explicit, for example, in U.C.C. § 1-103(b) (Am. L. Inst. & Unif. L. Comm’n 2020), which states: “Unless displaced by the particular provisions of [the Uniform Commercial Code], 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, and other validating or invalidating cause supplement its provisions.”[/footnote] The American legal establishment long recognized, therefore, that a modern economy benefits from a law that applies to contracts generally, but for several reasons, American lawyers were unsatisfied with the common law mechanism. The first reason follows from our earlier analysis: Default rules are slow to form.[footnote]See Schwartz & Scott, The Default Rule Project, supra note 2, at 1531 (noting how the creation of default rules through the common law courts slowed after the merger of law and equity).[/footnote] Litigation must proceed over time in different contexts before a default rule is fully formed. Consequently, most of the common law default rules were developed in the nineteenth century following the Industrial Revolution, and the process of rule development slowed considerably thereafter.[footnote]See id. at 1534–37 (“[A]s the Industrial Revolution took hold first in England and then the United States, courts continued to imply terms by default in order to interpret disputed commercial contracts.”).[/footnote] Because the process of developing default rules had slowed, courts had relatively few general rules with which to fill gaps in incomplete contracts.[footnote]Id. at 1535, 1542, 1550.[/footnote] This stasis in common law rule development followed from the second reason: Courts are poor regulators of a modern economy. Courts cannot find facts, apart from case records, and so they cannot hold accurate views of the context in which a possible rule will function and the effects of current rules. In addition, judges are generalist lawyers. The typical judge has little commercial expertise and cannot effectively resolve the economic issues that a possible rule may pose. Another rule-generating mechanism was required. Widespread dissatisfaction with the common law process produced the two major interventions that sought to change contract law itself. The first effort at a codification of contract law occurred at the turn of the twentieth century when the Uniform Law Commission (ULC) produced the Uniform Sales Act.[footnote]The Uniform Sales Act was promulgated in 1906 and ultimately adopted in thirty-four states. Robert Braucher, The Uniform Commercial Code—Documents of Title, 102 U. Pa. L. Rev. 831, 831 n.4 (1954).[/footnote] That effort soon proved obsolete, however, and throughout the interwar period only the courts were able to keep sales law current with changing commercial practice.[footnote]See Gilmore, Statutory Obsolescence, supra note 5, at 469–71.[/footnote] This led to the second effort by the American Law Institute (ALI) and the ULC in the mid-twentieth century to codify the general law of contracts.[footnote]The first Restatement was adopted in 1932, followed by the UCC project which was completed in 1952. The Second Restatement followed in 1979. See The Story of ALI, Am. L. Inst., https://www.ali.org/about-ali/story-line/ [https://perma.cc/6MC4-SQFD] (last visited July 22, 2021).[/footnote] Article 2 of the UCC governing sales transactions has since been enacted in every state (except Louisiana), and it was followed by the Restatement (Second) of Contracts, which usefully summarized important contract doctrines for common law courts.[footnote]Robert E. Scott & Jody S. Kraus, Contract Law and Theory 39–40 (5th ed. 2013).[/footnote] The Restatement also had a distinct policy focus, identifying some contract rules as better solutions to a given contracting problem than others.[footnote]For example, the Restatement adopted a contextual approach to problems of parol evidence and interpretation in lieu of the textualist rules that had emerged from the common law. See Restatement (Second) of Conts. §§ 209–223 (Am. L. Inst. & Unif. L. Comm’n 1981).[/footnote] The justification for the codification of general contract law rules follows from the dissatisfaction with the common law process. UCC drafters and the ALI members responsible for particular restatements are thought to be more expert and to have more real-world knowledge than the typical common law judge.[footnote]Schwartz & Scott, The Political Economy, supra note 25, at 603–04.[/footnote] Moreover, the felt need for more default rules is genuine: Private parties will not solve every contracting problem that they face.[footnote]See Goetz & Scott, The Limits of Expanded Choice, supra note 14, at 292–93 (explaining the bargaining difficulties private parties face in contract disputes).[/footnote] Contracting parties seldom can internalize the full gain from creating a useful solution to a common contracting problem—others can copy their innovation—but nonetheless they bear the full cost.[footnote]See id. at 292 (“The limits of copyright law create an initial barrier to innovation by denying contractors substantial property rights in their formulations. An inherent free-rider problem thus retards the production of innovative formulations for emerging relationships.”).[/footnote] When the cost exceeds a contracting dyad’s share of the gain, the problem will not be solved efficiently without outside help. Private lawmakers can use their expertise and knowledge to solve these common problems and supply contracting parties with the solutions in the form of UCC or Restatement sections. In prior work we have criticized the rationale for this method of supplying contract terms on the ground that the ALI and ULC are also institutionally limited.[footnote]See Schwartz & Scott, The Default Rule Project, supra note 2, at 1526, 1528; Schwartz & Scott, The Political Economy, supra note 25, at 597–98, 624.[/footnote] The focus here, however, is on the deeper institutional problem. As discussed above, a public program of supplying contract law rules must satisfy two conditions: The rules must first solve contracting problems as the parties would have solved them; and second, the rules must update promptly as economic conditions change. In this Article, we show that even if the ALI and ULC once supplied rules that parties themselves would have chosen, these private groups no longer do so: Their rules remain but the problems have changed. This Article proceeds as follows. Part I describes the dramatic changes in contemporary contracting practices that have rendered state-supplied default rules, as well as those we designate as “quasi-mandatory” rules, obsolete.[footnote]See infra section I.B.[/footnote] We develop an economic theory that shows parties will reject an obsolete state-supplied default because the term cannot solve the current version of their contracting problem and bad faith parties could exploit the term strategically.[footnote]See infra section I.B.[/footnote] But parties are unlikely to create a new term equivalent to an apt state-supplied default because of its excessive cost.[footnote]See infra section I.B.[/footnote] The theory predicts that parties instead will replace the obsolete default term with second-best solutions.[footnote]See infra section I.B.[/footnote] Yet, the obsolete default lives on. Similarly, parties can only escape the constraints imposed by an obsolete quasi-mandatory rule by costly contracting around the rule. Finally, Part I analyzes the coordination problems that may prevent private parties from revising obsolete terms in standardized interdependent contracts.[footnote]See infra section I.C.[/footnote] Part II provides evidence of the persistence and costs of obsolete terms.[footnote]See infra Part II.[/footnote] Here we show how the theory developed in Part I explains many of the contracting patterns we observe as parties attempt to adjust to the constraints imposed by obsolete default and quasi-mandatory rules.[footnote]See infra Part II.[/footnote] Consistent with the theory, parties avoid obsolete terms by settling on less efficient alternatives.[footnote]See infra Part II.[/footnote] This Part also presents evidence that parties in large, multilateral markets often fail to revise standardized obsolete terms notwithstanding the heightened level of litigation risk that they face as a result.[footnote]See infra Part II.[/footnote] Part III considers the several systemic reasons that explain why UCC Article 2, the Restatement, and the Bankruptcy Code remain rocks in the river of changing commercial practice.[footnote]See infra section III.A.[/footnote] Obsolescence persists when coordination on an efficient replacement fails because individual parties would bear too much of the cost and internalize too few of the gains to reward efforts to initiate legal change.[footnote]See infra section III.A.[/footnote] The private lawmaking bodies that created today’s obsolete contract law rules also are poorly equipped institutionally to create current ones.[footnote]See infra section III.A.[/footnote] These institutions meet episodically: They have little incentive to update the rules by adopting controversial reforms, and interest group competition can instantiate a status quo bias.[footnote]See Schwartz & Scott, The Default Rule Project, supra note 2, at 1529 n.17 (“The drafters sometimes create standards to avoid deciding difficult political questions . . . .”); Schwartz & Scott, The Political Economy, supra note 25, at 650–51 (“In particular, theory suggests that a private legislature with a membership similar to that of the ALI and NCCUSL and procedures similar to theirs will have a strong status quo bias and sometimes will be captured by powerful interests.”).[/footnote] And when the rulemaking process is captured by insiders, as in the case of bankruptcy, specialized rules also can become “sticky.”[footnote]See infra note 76; see also infra section I.B.1.[/footnote] Part IV revisits commercial law’s production problem by asking how other institutions that supply commercial law rules have responded to the obsolescence concern. Some private interests have created specialized contract terms that parties are then invited to adopt in their contracts,[footnote]See infra section IV.B.[/footnote] but this solution to updating is still underproduced.[footnote]See infra section IV.C.[/footnote] The two public institutions that are largely free from persistent obsolescence are specialized lawmaking bodies and common law courts. Organized interest groups that supply rules for specialized fields can update their rules but at the cost of promoting private interests over the public interest.[footnote]See infra section IV.C.[/footnote] What remains are common law courts, the institution with which we began. Courts’ rules are efficient and update over time, but at first blush do not appear to cover much of the ground. We show, however, that once artificial institutional boundaries are set aside, the activity of common law courts is more vibrant than is commonly assumed. Part V concludes that the splintering of our general contract law into contract laws for specialized fields—such as corporate, bankruptcy, and financial contracting—points to an emerging institutional response to the externalities that the specialized laws create. We have two closing observations. First, the common view is that general contract law is created by two institutions: common law courts and “private legislatures” such as the ALI and the ULC that produce UCC Article 2 and the Restatements. This view is incorrect because the contract law products of the ALI and the ULC are largely obsolete.[footnote]There is an important distinction between the UCC and the Restatement. The UCC is an enacted statute and thus when parties escape an obsolete UCC rule, the obsolete rule lives on and imposes costs on subsequent parties. The Restatement is directed to courts. An obsolete Restatement rule thus becomes law once it is used strategically in litigation to advance a client’s claim and a court is persuaded to adopt the rule, even though it is not, in fact, an apt solution to the contracting problem in question. In assessing the cost of obsolescence, the UCC statute imposes greater costs than the obsolete Restatement rule, because a court may never be persuaded to adopt the Restatement rule, and if a court does so, the rule ultimately will disappear as parties choose not to leave a gap that can be filled by the obsolete rule. However, once an obsolete Restatement rule is adopted by a court, it cannot be readily discarded and replaced by a more current default. The Restatement occupies a much different status in judicial interpretation than an emerging common law default rule that is found in some but not all states. The Restatement presents itself as the “uniform approach” that other courts have (or should have) adopted. Indeed, that is the whole point of the imprimatur of the ALI: to promote uniformity in rule formation. Thus, once adopted, a Restatement default takes on a quasi-statutory status. So long as contracting parties perceive the obsolete Restatement rule as having a special status, just as with an obsolete UCC provision, they will turn to second best options rather than attempting to formulate the efficient default. See infra section I.B.2.[/footnote] Today, there are courts and episodic, specialized interventions. The question we raise is whether this is the best American law can do. Second, we note the novelty of our analysis. There are two significant prior contributions. Grant Gilmore observed that early twentieth-century codification efforts became obsolete, but for reasons that differ from ours. According to Gilmore, these uniform law codifications were intended to “embalm[] the past”—that is, to solve yesterday’s doctrinal problems and enact the solutions into law.[footnote]Gilmore, Statutory Obsolescence, supra note 5, at 467–68.[/footnote] A codification that does this will inevitably become obsolete because the future poses different doctrinal problems.[footnote]See id.[/footnote] But the UCC and Restatement were not so much meant to solve old legal problems as to solve, in the form of default and quasi-mandatory rules, current economic problems. In contrast to Gilmore, we show that such laws become obsolete only when the economic problems either disappear or take new forms. Guido Calabresi wrote an important book about obsolete statutes and judicial responses.[footnote]Guido Calabresi, A Common Law for the Age of Statutes (1982).[/footnote] Calabresi’s subject was the statute that had outlived its animating purpose but that continued to affect behavior because it was a statute.[footnote]See id. at 6.[/footnote] He then asked how courts respond to an obsolete law by analyzing the strengths courts exhibit and the constraints they function under when attempting to make such laws current.[footnote]See id. at 7.[/footnote] We also observe that obsolescence occurs for statutes that are difficult to update. But, in contrast to Calabresi, we analyze the case of an obsolete commercial law that no longer affects behavior because parties contract out of the law’s terms. As a consequence, our subject concerns how parties respond when a law that was supposed to solve the parties’ contracting problems no longer does so. Thus, the comparative question this Article asks—which legal institution can best create an efficient law to regulate commercial contracting—is entirely novel. Nor has any prior work analyzed contract obsolescence as a discrete problem to ask why and where such obsolescence exists and how it can persist. We recognize, however, that our more important contribution may be to introduce the subject of comparative institutional analysis to private law fields.

Contract Law

OBSOLESCENCE: THE INTRACTABLE PRODUCTION PROBLEM IN CONTRACT LAW

THE SOCIAL COST OF CONTRACT