THE POLITICAL ECONOMY OF INTERNATIONAL SALES LAW



THE POLITICAL ECONOMY OF INTERNATIONAL SALES LAW



Description:
This Article is the United Nations Convention on Contracts for the International Sale of Goods (CISG), the primary treaty that governs the international exchange of goods by contract.

Clayton P. Gillette Robert E. Scott

The dramatic growth of international trade has generated corresponding calls for an increase in uniform sales law to govern these transactions.1 The implicit assumption underlying these efforts is that the lack of uniformity will increase the costs of writing contracts for parties to international sales transactions. They will have to bargain over the legal regime (and the default terms) that will govern their transaction, and the regime that is ultimately selected will be relatively unfamiliar to at least one of them. Uniform international sales law (ISL) purports to cure this situation by creating a legal regime with which commercial parties in different jurisdictions will be familiar and accept without significant additional negotiation.2

Our particular focus in this Article is the United Nations Convention on Contracts for the International Sale of Goods (CISG), the primary treaty that governs the international exchange of goods by contract. To the extent that adoption is a measure of success, the CISG has become the most successful of efforts to create uniform commercial law. As of this writing, the CISG has

been adopted by 63 states. They include most of the major trading nations, although the United Kingdom and Japan are not parties.

* Max E. Greenberg Professor of Law, New York University. We are grateful for the commentary of Herbert Kronke, Alan Schwartz, and other participants at the Conference on Commercial Law Theory and the CISG hosted by NYU Law School in Florence, Italy on September 13-15, 2004. We are also grateful for comments from Bernard Black, Kate Litvak, and participants at faculty workshops at NYU School of Law and the University of Texas School of Law.

* David and Mary Distinguished Professor of Law, University of Virginia

1 See, e.g., Arthur Rosett, Critical Reflections on the United Nations Convention on Contracts for the International Sale of Goods, 45 Ohio St. L. J. 265, 266-67 (1984).

2 See Paul B. Stephan, The Futility of Unification and Harmonization in International Commercial Law, 39 Va. J. Int’l L. 743, 750 (1999) (“Increasing the ability of [legal] advisors to understand and to communicate with each other enhances the value of the service they render independently of any improvement in the legal rules”).

In theory, a uniform sales law confers significant benefits on parties, at least to the extent that it embodies in its default rules the solutions to contracting problems that parties would otherwise choose. This claim follows from the fact that all sales contracts are inevitably incomplete.3 Since contracting costs are finite while states of the world (and possibly partners) are infinite, sales contracts contain gaps. Sales law rules are intended to fill many of those gaps

In this article, we argue that the effort to create uniform ISL has predictably failed to supply contracting parties with the default terms they prefer, thus violating the normative criterion that justifies the law-making process in the first instance. Our argument rests on three claims. First, we contend that the process by which uniform law is drafted will dictate the form

3Contracts can be incomplete in two different senses of the word. A contract is obligationally incomplete when it fails to specify an outcome for a particular contingency. On the other hand, a contract is obligationally complete even though it lumps together various states of the world and provides for the same obligations across the states of each lumped set. Yet, an economist would view such a contract as informationally incomplete because it fails to discriminate within each set between states that optimally call for different obligations. In this article, we use the term incomplete in the economic sense described above. See Robert E. Scott & George G. Triantis, Rules, Standards and Burdens of Proof in Contract Design (mimeo 2005).

4 In theory, the public goods justification for contract law argues for the state to create standardized contract terms for various populations of contracting parties so to reduce the errors that inhere in incomplete contracting. Standardized terms and understandings that are recognized and publicized by the state bring a collective wisdom and experience that parties are unable to generate individually. This process produces an expanding supply of mature, customary default terms that individual parties could not replicate merely by the expenditure of additional time and effort. For most parties, the argument goes, such defaults are not only cheaper, but they are also better than do-it¬yourself ones. Charles J. Goetz & Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Intereractions Between Express and Implied Contract Terms, 73 Cal. L. Rev. 261, 276,278 (1985)

that many provisions take. Second, we contend that the legal form dictated by the drafting process has significant substantive consequences, particularly for the policy objectives of uniform ISL.5 That leads to our third claim. We predict that in order to achieve ISL that is widely adopted, those involved in the drafting process will systematically promulgate many vague standards that contracting parties would not choose for themselves. These defaults cannot be justified as the inevitable cost of achieving an optimal level of uniformity.6 A uniform ISL is justified only to the extent that it reduces parties’ contracting costs. If the products of a uniform ISL are default terms that parties do not want, then the underlying justification for the law¬making function vanishes. In that case, parties governed by ISL will be motivated to abandon the uniform law and instead choose among legal regimes that compete to supply parties with more desirable substantive terms.

As the preceding suggests, in this Article we focus on the incentives of those who draft ISL in order to make predictions about the form of the default rules that will emerge from the law making process. The goal of the analysis is to determine the extent to which ISL as it is actually promulgated coincides with the provisions that would apply if drafters acted in a manner consistent with the normative goal of drafting legislation that optimally reduces contracting costs. Initially, one might think that ISL would demonstrate a high level of coincidence between goals and practice. The political economy literature typically attributes any deviation from normative goals in the legislative process to the presence of interest groups that are able to gain disproportionate influence. That seems less of a concern, however, in the case of ISL. That body of law regulates the conduct of buyers and sellers of goods in transnational markets. These groups are generally not at loggerheads about ideal law. Buyers in one transaction, after all, are likely to be sellers in the next. Thus, the asymmetrical interests that lead interest groups to divert legislative behavior away from the social interest appear to have little application in this context.

5 See Alan Schwartz & Robert E. Scott, The Political Economy of Private Legislatures, 143 U. Penn. L. Rev. 595, 597 (1995). ( “the form and substance of a law are significantly endogenous to the law-creating institution.”).

6 Other commentators have alluded to the risk that the primary sources of ISL contain provisions that are highly susceptible to nonuniform interpretation. But those commentaries frequently conclude that these imperfections are a necessary and somewhat remediable cost of creating ISL.

The reasons for concern, therefore, do not lie primarily in asymmetries in the interests of buyers and sellers. Rather they lie in the unique processes by which uniform ISL is generated. These processes must simultaneously deal with conflicting political and commercial issues. Political interests arise from the fact that uniform ISL must meld different legal, governmental, and economic interests. The theory of uniform law that we elaborate predicts that efforts to accommodate these diverse political considerations will cause the law to be drafted at a high level of abstraction, explicitly to authorize numerous exceptions to the law’s uniform application, and implicitly to tolerate significant variation in the interpretation of the (formally) uniform law. On the other hand, commercial interests require legal certainty and predictability so that parties involved in international trade are able to price the risks, including legal risks, that their contracts entail.7 Drafting good commercial law thus requires both extensive staffs and expertise to write the complex rules needed to govern heterogeneous economic environments–such as the global economies contemplated by an ISL. Our analysis reveals, however, that the process of drafting ISL has been dominated by individuals concerned with political, rather than commercial interests. As a result, where commercial and political interests conflict, the ISL-creation process has subordinated the former to political concerns.

The article proceeds as follows. We begin in Part I with a description of the process by which the CISG was created. In Part II we develop the normative criterion for a good ISL: A successful ISL provides standardized default terms that minimize contracting costs and that parties in consequence prefer. In Part III, we develop a framework for analyzing the ISL drafting process that focuses on the identity and motivations of the drafters. That Part explains how such a drafting process predictably generates many ambiguous terms and vague standards that deviate from the substantive goal of minimizing contracting costs. In Part IV, we examine the provisions of the CISG in some detail and show that the substantive characteristics we predict will result from the drafting process do, in fact, appear in that treaty. Part V considers the alternatives to a uniform ISL. We conclude that if the criterion is to provide the contract rules that commercial parties want, then a regime in which jurisdictions compete to have firms

7 See, e.g., Stephan, The Futility of Unification, supra note – at 746 (1999).

that engage in international trade choose the law to govern their contracts will dominate attempts to draft uniform ISL.

I. THE CREATION OF THE CISG – A BRIEF POLITICAL HISTORY.

A. The Drafting History

The United Nations Commission on International Trade Law (UNCITRAL) organized the effort to create the CISG in response to the failure of prior efforts to create widely acceptable uniform sales law.8 The International Institute for the Unification of Private Law, or UNIDROIT, had previously undertaken a three-decade effort that resulted in the 1964 promulgation of two treaties, the Uniform Law for International Sales (ULIS) and the Uniform Law on the Formation of Contracts for International Sales (ULF). Neither attracted adoption in more than nine states, in part because the result was considered to have been dominated by European legal concepts that were not recognized elsewhere. 9 UNCITRAL believed that it could increase adoptions by revising the prior treaties to reflect a more international flavor. UNCITRAL’s membership was organized to ensure broad representation in drafting projects. Membership is limited to delegations from 36 states selected by the United Nations General Assembly,10 and is allocated along geographic lines. States from Africa, Asia, Eastern Europe, Latin America, and “Western Europe and Others” all have membership assured under the UNCITRAL charter.11 Thus, the project of reforming the ULIS and ULF necessarily involved representation from affluent and developing countries, common law and civil law systems, and (recall that the project pre-dated democratic movements in Eastern Europe) market-based and

8 The following history is extracted from Bianca and Bonell, and JOHN HONNOLD, UNIFORM LAW FOR INTERNATIONAL SALES 7-12 (3d ed. 1999).

9 See JOHN HONNOLD, UNIFORM LAW, supra note — at 9

10 See Stephan, supra note – at 753.

11 See John Honnold, The United Nations Commission on International Trade Law: Mission and Methods, 27 Am. J. Comp. L. 201, 207 (1979).

Socialist economies.12

UNCITRAL traditionally employs Working Groups to create initial drafts before submitting a proposed treaty to a conference of delegates from a broader range of states. The Working Group consists of representatives from a diverse set of political and economic systems. Working Groups meet for two to three weeks annually and work primarily from preparatory materials provided by the Secretariat of UNCITRAL, a full-time body composed largely of international lawyers.13 The materials prepared by the Secretariat include draft statutory texts with alternatives that are intended “to facilitate debate and decision with a minimum of confusion or misunderstanding.”14 Working groups apparently work by consensus and rarely take formal votes on their proposals. Indeed, proceeding outside of formal majority rule appears to be a matter of pride for some involved in the Working Groups.15

In the case of the CISG effort, UNCITRAL created an initial Working Group comprising representatives from a broad geographic, political, and cultural range of states.16 UNICITRAL charged the Working Group with the development of legislation that would be acceptable “by countries of different legal, social, and economic systems.”17 The Working Group met in nine sessions from 1970 through 1977. While the Working Group initially proposed revisions to the ULIS and the ULF, UNCITRAL ultimately decided to consolidate the two treaties into a single document. UNCITRAL thus established a Drafting Committee for this purpose composed of representatives from Chile, Egypt, France, Hungary, India, Japan, Mexico, Nigeria, the USSR,

12 Id. at 207-08.

13 Honnold, Mission and Methods, supra note — at 209

14 Honnold, Mission and Methods, supra note — at 209.

15 Honnold.

16 The original representatives were from Brazil, France, Ghana, Hungary, India, Iran, Japan, Kenya, Mexico, Norway, Tunisia, USSR, the United Kingdom, and the United States. Representatives from Austria, Czechosolovakia, the Philippines, and Sierra Leone were added later. See Bianca and Bonell at 6.

17 See JOHN HONNOLD, DOCUMENTARY HISTORY OF THE UNIFORM LAW OF SALES 3 (1989).

and the United Kingdom.18 That Committee completed its work in 1978. UNCITRAL approved the draft that resulted and requested the United Nations to convene a Diplomatic Conference to consider it. That Conference was held at Vienna during a five-week period in 1980. Representatives of 62 states attended.19 Representatives from a variety of non-governmental and intergovernmental agencies interested in international trade attended as observers.20 Two committees performed most of the work for what became known as the Vienna Conference. One committee prepared the substantive provisions of the CISG, while the other prepared the “final clauses,” which dealt with such issues as reservations, declarations, and ratification by Contracting States.21 Members of the Conference debated the text of each article, but ultimately approved the CISG unanimously. The CISG was then submitted to states for their approval according to domestic processes for adopting international treaties. According to its terms, the CISG was to become effective among signatories, denominated “Contracting States,” approximately one year after the tenth state deposited with the United Nations an instrument indicating its acceptance of the treaty.22 China, Italy, and the United States became the ninth,

18 Bianca and Bonell at 6.

19 Argentina, Australia, Austria, Belgium, Bolivia, Brazil, Bulgaria, Burma, Byelorussian Soviet Socialist Republic, Canada, Chile, China, Colombia, Costa Rica, Cyprus, Czechoslovakia, Denmark, Ecuador, Egypt, Finland, France, German Democratic Republic, Germany, Federal Republic of, Ghana, Greece, Hungary, India, Iran, Iraq, Ireland, Israel, Italy, Japan, Kenya, Libyan Arab Jamahiriya, Luxembourg, Mexico, Netherlands, Nigeria, Norway, Pakistan, Panama, Peru, Philippines, Poland, Portugal, Republic of Korea, Romania, Singapore, Spain, Sweden, Switzerland, Thailand, Tunisia, Turkey, Ukrainian Soviet Socialist Republic, Union of Soviet Socialist Republics, United Kingdom of Great Britain and Northern Ireland, United States of America, Uruguay, Yugoslavia and Zaire. Venezuela sent an observer. See 19 I.L.M. 668 (1980).

Some commentators characterize the participants by reference to their political cultures. Thus, Garro notes that “Sixty-two nations were represented at the Vienna Conference. Roughly speaking, twenty-two from the ‘Western developed’ part of the world, eleven from ‘socialist regimes,’ and twenty-nine from ‘Third World’ countries.” Alejandro M. Garro, Reconciliation of Legal Traditions in the U.N. Convention on Contracts for the International Sale of Goods, 23 Int. Law. 443, 443 (1989).

20 These included the World Bank, the Bank for International Settlements, the Central Office for International Railway Transport, the Council of Europe, the European Economic Community, the Hague Conference on Private International Law, the International Institute for the Unification of Private Law, and the International Chamber of Commerce. Id. Pre-Conference proposals for the convention were circulated to these observers, and they made

comments on various provisions. See HONNOLD, DOCUMENTARY HISTORY at 392. For instance, the ICC

recommended the deletion of an article, similar to present Article 8, concerning a general rule on interpretation. See id. at 394.

21 Bianca and Bonell at 6.

22 Article 99.

tenth, and eleventh Contracting States in December 1986. As a result, the CISG became effective among then-Contracting States as of January 1, 1988. As we noted above, as of this writing, 63 nations have become Contracting States.

The actual participants in UNCITRAL projects, including the CISG, tend to come from either universities or ministries in their home state.23 They are appointed by the governments of their various states, rather than by the United Nations. Appointing authority varies among the states. In some instances (for instance, Italy), the office of the Secretary of State makes the appointment

Participants receive no remuneration from UNCITRAL. They do, however, typically receive reimbursement for expenses and a per diem allowance from their home states. Participation, therefore, is not a full-time occupation. Participants continue to hold their academic or ministerial positions while serving as participants in the process of drafting the uniform law.

23 Honnold, Mission and Methods, supra note – at 209.

24 We are grateful to Professor Franco Ferrari, former Legal Officer at the United Nations Office of Legal Affairs, International Trade Law Branch, for this information.

25 Honnold, Mission and Methods, supra note – at 209. Honnold’s assertion is borne out by a review of the institutional affiliations of the participants we have been able to trace.

26 HONNOLD, DOCUMENTARY HISTORY at 187-88.

B. The Structure of the CISG

Given the objective of creating uniform ISL, the CISG is notable both for what it contains and for what it omits. The first Part, containing 13 Articles, deals with the statute’s sphere of application. Article 1(1) recites that the CISG applies to “contracts of sale of goods between parties whose places of business are in different States.” Nevertheless, neither the term “sale” nor the term “goods” is defined within the CISG, except for exclusions of particular transactions,27 and the definition of “place of business” leaves significant ambiguity about what law governs where a party has multiple places of business.28 Part II concerns the formation of contracts. Part III contains numerous articles that cover substantive provisions of a contract, such as the obligations of buyers and sellers, remedies for breach, passage of risk, anticipatory breach, and damages. The final Part concerns procedural issues for the CISG, such as the ability of those who wish to become Contracting States to declare their unwillingness to be bound by certain provisions, and the terms under which the CISG becomes effective among Contracting States.

The CISG explicitly excludes certain aspects of sales law, however. Article 4 recites that matters of contract validity and the effect of a contract on property rights in the goods sold are beyond the CISG’s jurisdiction. Thus, nothing in the CISG addresses issues such as unconscionability, capacity defenses, or the rights of a bona fide purchaser to goods that turn out to have been stolen. Of perhaps greater importance, the CISG does not provide any mechanism for resolving disputes that might arise with respect to its own meaning. Article 7(b) requires that matters governed by the CISG that are not expressly settled in it are to be resolved in accordance with the “general principles” on which it is based.29 One searches in vain, however, for a recitation of such principles, with the possible exception of Article 7(a). That provision

27 See Article 2 (excluding certain transactions from the scope of “sale”), Article 3 (excluding certain transactions in which the buyer supplies materials for goods or in which the “seller” primarily provides labor or services).

28 For discussion, see Stephan, supra note — at 774.

29 In the absence of such principles, Article 7(b) directs that matters are to be resolved “in conformity with the law applicable by virtue of the rules of private international law.”

admonishes those interpreting CISG provisions to promote “the observance of good faith in international trade.” The quoted phrase, however, is not even accompanied by a definition as indefinite as the “observance of reasonable commercial standards of fair dealing,” the definition of good faith within the Uniform Commercial Code.30 Tribunals that apply the CISG, moreover, are directed to consider the treaty’s “international character and the need to promote uniformity in its application,” a phrase that is typically understood to encourage uniform interpretation and to induce national courts and arbitrators to avoid injecting domestic law concepts into their interpretations of the CISG. The underlying assumption appears to be that courts of one nation will treat opinions on the provisions of CISG from courts of other nations as at least evidentiary of the correct interpretation of that provision, even if the foreign opinion is neither authoritative nor binding precedent. As one commentator indicates, it would seriously jeopardize the objective of “world-wide uniformity” if “those called on to apply the Convention would resort, in case of ambiguities or obscurities in the text, to principles and criteria taken from a particular domestic law.”31

One way to achieve the uniformity objective would be to have an international commercial court hear cases under the CISG, or at least serve as a court of last resort to resolve conflicts between domestic courts. But the CISG creates no such apparatus. The reason, apparently, has less to do with the merits of uniform interpretation than with practical politics. As Bonell concludes, “[t]o expect that all adhering States, notwithstanding their different social, political and legal structure, could even agree on conferring to an international tribunal the exclusive competence to resolve divergencies between the national jurisdictions in the interpretation of the uniform rules, would be entirely unrealistic.”32

This summary suggests that while the CISG creates law that is formally uniform at the time of adoption (that is, statutory law that is identical in linguistic form in all jurisdictions that

30 See UCC § 2-103(1)(b),

31 Bianca and Bonell, supra note — at 75.

32 Id. at 89.

have adopted it33), subsequent litigation will create many opportunities for nonuniform interpretations of the treaty’s provisions. As a result the CISG will, over time, fail to supply a standard language in which solutions to common contracting problems can be cast. But this erosion of the treaty’s linguistic and interpretive uniformity is not the only or even the principal concern. Evolving nonuniformity is perhaps inevitable in any legislation that is intended to apply to heterogeneous situations. Our claim, however, is stronger. Recall that we began with the assumption that the normative goals of a uniform ISL are to provide the substantive solution to particular contracting problems that most contracting parties want. In the next Part, we suggest that most parties would want a commercial law statute to minimize both the costs to the parties of embodying contracting solutions in written agreements (legal knowledge costs) and the costs to the parties of solving contracting problems (problem solving costs). We claim in subsequent Parts that the CISG systematically fails to accomplish this objective, and fails because of structural defects inherent in the processes by which ISL is drafted.

II. THE NORMATIVE GOALS OF ISL

In order to evaluate whether the CISG is a successful commercial law statute, we must first identify more precisely just what goals should be pursed in the drafting effort. As we suggested above, there is a broad consensus that a lack of uniformity in international sales will increase costs of embodying contracting solutions in written agreements. Parties will have to bargain generally about the legal regime that will govern their transaction, and, in particular, about the array of default rules that will be incorporated as implied terms into their sales contracts. Uniform ISL purports to cure this situation by supplying a standard language in which solutions to common contracting problems are cast. The standard language reduces drafting costs and also reduces uncertainty if courts will interpret the words parties use in various

33 See Robert E. Scott, The Uniformity Norm in Commercial Law: A Comparative Analysis of Common Law and Code Methodologies in JODY S. KRAUS AND STEVEN D. WALT, THE JURISPRUDENTIAL FOUNDATIONS OF CORPORATE AND COMMERCIAL LAW 149 (2000). Given the international nature of the CISG, the statement in the text is a bit of an overstatement. The CISG has been adopted in six equally authoritative versions, Arabic, Chinese, English, French, Russian and Spanish. Moreover, it must be translated into other languages in states that do not primarily use one of the “authoritative” languages. Thus, the text is not literally identical in all states. For various texts, see http://cisgw3.law.pace.edu/cisg/text/text.html.

contracts in the same way. Over time, commercial parties in different jurisdictions will become familiar with the standard language and will accept the contracting solutions it embodies without significant additional negotiation. Implicit in this broad statement of purpose, however, are two distinct (and potentially conflicting) objectives.

A. Minimizing Contracting Costs: Legal Knowledge Costs and Problem Solving Costs.

The first objective of a successful uniform sales law is to reduce the costs of writing sales contracts by reducing the costs to particular parties of learning about the legal consequences of any particular set of sales law rules. A standard legal language and method of categorizing and interpreting legal rules results in a pro tanto reduction in these “legal knowledge costs” (the cost involved in learning about the meaning and legal consequences of express and implied contract terms).34 Indeed, this notion of a uniform legal language and a “filing system” that permits the storage and retrieval of key information (such as judicial interpretations of particular provisions) was one of the strongest justifications advanced by Karl Llewellyn in the 1950’s for the adoption of a uniform sales law in the United States.35

But the benefits of a uniform law in reducing legal knowledge costs depends on a second objective: In a large global economy some sets of parties will dislike particular default terms. A default rule typically is justified as doing for parties at less cost what they would have done for themselves. So, it follows that when the cost of creating their own term to govern a particular situation is less than the gain to them, the parties should be permitted to supplant the uniform statutory rule. If parties are free to supplant or modify the uniform terms, it follows that the law maker should attempt to maximize the size of the set of parties that will find any statutory term acceptable. Put another way, the law maker should seek to minimize the parties’ costs of solving

34See Steven Walt, Novelty and the Risks of Uniform Sales Law, 39 Va. J. Int’l L. 671 (1999)

35 Karl Llewellyn, Why We Need the Uniform Commercial Code, 10 U. Fla. L. Rev. 367, 369 (1957). For discussion, see Robert E. Scott, The Rise and Fall of Article 2, 62 La. L. Rev. 1009 (2002).

contracting problems. From this point of view, it would be wrong of the law maker to enact a default term that a large number of parties will dislike, because then those parties would have to expend resources drafting their own term.36

From this analysis we derive the normative criterion we suggested above: The default terms in an ISL will be socially optimal precisely and only because they do for the parties what the parties cannot as easily do for themselves. Thus, good sales law defaults will reflect the solution to contracting problems that most parties would prefer. If they do, then the parties’ “problem-solving costs” are reduced. If they do not, then parties will predictably opt out of the uniform default terms and instead negotiate for any number of party-specific terms that better suit their contracting goals. Any significant exit from the default terms supplied by the uniform statute will thus exacerbate rather than ameliorate the parallel problem of reducing legal knowledge costs. A contract containing many party-specific terms undermines the advantages of standard language defaults and increases interpretive uncertainty. If the problem-solving objective of a uniform ISL is not met, therefore, the product will be linguistically uniform upon enactment, but subsequently parties will either abandon the law entirely or opt out of disfavored provisions thus undermining even the initial benefits of the standard terms.

B. Why Parties Write Incomplete Contracts

Determining the solutions to common contracting problems that most contracting parties would prefer requires that we answer yet another question: Why do parties write incomplete contracts? Most commercial contracts negotiated between sophisticated parties are drafted with the assistance of legal counsel. Unsurprisingly, therefore, most of these contracts are in writing with detailed terms and specifications. Yet, whenever a dispute subsequently arises, it turns out that the contract was seriously incomplete. The parties will have failed to reach an express

36 Commentators and law makers often argue for sales law rules on the ground that these rules are fair. A focus on fairness would be innocuous if the set of fair rules and the set of efficient (or party preferred) rules perfectly overlapped. But to the extent that they diverge, then choosing a default rule on the basis of some normative conception of fairness would be wrong. It would not increase the amount of fair contracts in the world, but it would increase the amount of contracting costs in the world, as parties contract out of the “fair” but inefficient default terms. If more than one possible default rule would be efficient, then a decisionmaker could choose among these rules on some fairness criterion.

understanding about who should bear a particular risk that has materialized in the interim, or the contract term that purports to allocate the risk in question will be framed in terms of a broad standard that requires subsequent interpretation by a court. Why would commercial parties ever leave such important questions unresolved in their contract?

One possible answer is that contracting parties systematically fail to write complete contracts (that is to specify the consequences of possible contingencies that may affect their performance) because the transactions costs of writing complete contracts are too high. One cost of writing complete contracts is the resource costs of negotiating and reducing to a written form the agreed upon allocations of risk. Those resource costs, in turn, include not only the time and effort to negotiate and draft the clauses in question, but also the possibility that in doing so the parties might make a mistake in their written contract. A clause that they regard as perfectly clear may, upon subsequent examination, appear ambiguous or vague.37 This “formulation error” may then lead to costly litigation over the appropriate meaning that should be given to the clause in question.38

Another significant transaction cost is the burden of adequately identifying in advance all the possible contingencies that might occur and then specifying the appropriate outcome for each one. Given the limits of human cognition, some (or all) parties may simply be unable to identify and foresee all of the uncertain future conditions or may be incapable of characterizing adequately the complex adaptations required to accommodate all the possibilities that might

37Although often ignored by courts, there is a linguistic distinction between vague and ambiguous language. A word is vague to the extent that it can apply to a wide spectrum of referents, or to referents that cluster around a modal “best instance,” or to somewhat different referents in different people. For classic examples, see Frigaliment Importing Co. v. B.N.S. Int’l Sales Corp, 190 F. Supp. 116 (S.D.N.Y. 1960) (does “chicken” include all types of chicken or only a subset?)

38For a more complete discussion of the different ways that parties can err in expressing their mutual understanding as to who bears what risk and how, see Goetz & Scott, The Limits of Expanded Choice, supra note– at —..

materialize. 39 Moreover, some contingencies may be of such low probability that it is not worth providing for them, notwithstanding that the parties are cognizant of it.

There is a second reason why commercial parties may choose to write incomplete contracts. The information relevant to the clause may be private or hidden from one of the parties, even though it is available the other. Where such problems of asymmetric information exist, a rational actor would not expend efforts to draft clauses that condition on the information, because compliance can neither be observed by that party nor verified to a third party, such as a court. Assume, for example, that a buyer is unable to monitor and observe the amount of effort her seller exerts in fabricating the contract goods. Under those conditions, it would be foolish for the buyer to require a particular effort level. Rather, she might write an incomplete contract even where the transactions costs were quite low. To do otherwise would require parties either to disclose information that they wish to keep private or to have enforcement turn on facts that one or both could not observe or establish in court. Writing an incomplete contract is preferable to these unpalatable alternatives.40

C. Default Rules and Default Standards

The realization that parties may have good reasons to leave contracts incomplete leads to the next logical question: How should the drafters of an ISL assist the parties to incomplete contracts by providing standardized solutions to common contracting problems? If high transactions costs are the primary reasons why commercial parties write incomplete contracts, then the law properly should fill the gaps with default terms that solve those problems, assuming that the drafters’ contracting costs are lower than the sum of the costs to contracting parties. But this argument rests on the crucial assumption that the drafting bodies that create ISL are capable of devising cost-effective default rules that would be suitable for many parties. Any rule maker, whether a statutory drafter or court adjudicating a disputed contract, has finite resources, and so faces many of the constraints that private parties face. Thus, creating good default rules may not

39For an elaboration of the ways in which contracting parties cope with the problems of uncertainty and complexity, see Charles J. Goetz & Robert E. Scott, Principles of Relational Contracts, 67 Va. L. Rev. 1089 (1981).

40 See Alan Schwartz, Incomplete Contracts, 2 New Palgrave Dictionary of Economics and Law 277 (1997).

be cost justified. Indeed, the project of providing default rules for parties who have not created their own terms often founders either because 1) the costs of creating complex rules for modern, heterogenous economies exceed the social gains, or 2) simple rules, which may be cost-effective, seldom can solve complex commercial problems.

The challenge rule-makers face in creating cost-effective default rules is illustrated by the (relatively small) set of default rules governing sales law that have evolved under the Anglo-American common law and the few bright line default rules that are found in Article 2 of the Uniform Commercial Code.41 For example, consider the difference between two possible contractual gaps.42 In the first case, a fire destroys the seller’s plant prior to manufacture of the contract goods. Here there are only two relevant future states: A fire could occur or not. A legal rule-maker with limited resources can attack problems such as the risk of a fire because they often can be solved with a simple rule: The seller is (or is not) excused when the goods are destroyed without fault while in her possession. Now assume in the second case that the parties agree to agree subsequently upon a price in a volatile market, but fail to do so. In the case of price uncertainty, there are a very large number of possible future states, many of which are likely. The rule maker, therefore, can not easily create an optimal contract term to solve price volatility problems because it would be too costly to regulate all of the states that could arise in all of the existing markets. Instead of creating a rule, therefore, law makers faced with such a challenge create a standard: “The price is a reasonable price at the time of delivery.”

As we suggested above, creating a default rule may not even be possible where there is asymmetric information. Defaults must condition on information that the enforcing authority is able to observe. A default rule that conditions on unverifiable information would create moral hazard. The possibility that contracts are incomplete because of hidden information or other related factors further complicates the task for drafters of ISL seeking to create useful default rules for contracting parties. If the parties themselves would not choose to base contractual

41 See ROBERT E. SCOTT & JODY K. KRAUS, CONTRACT LAW & THEORY 2 ( 3D. ED. 2002).

42 This example is drawn from Alan Schwartz & Robert E. Scott, Contract Theory and The Limits of Contract Law, 113 Yale L.J. 541 (2003).