The cotton industry has almost entirely opted out of the public legal system, replacing it with one of the oldest and most complex systems of private commercial law.

The cotton industry has almost entirely opted out of the public legal system, replacing it with one of the oldest and most complex systems of private commercial law. Most contracts for the purchase and sale of domestic cotton, between merchants or between merchants and mills, are neither consummated under the Uniform Commercial Code (“Code”) nor interpreted and enforced in court when disputes arise.

Lisa Bernstein*

Rather, most such contracts are concluded under one of several privately drafted sets of contract default rules and are subject to arbitration in one of several merchant tribunals. Similarly, most international sales of cotton are governed neither by state-supplied legal rules, nor by the Convention on the

*Professor, University of Chicago Law School. B.A. University of Chicago, J.D. Harvard. – Ed. Special thanks are due to Douglas Baird and Omri Ben-Shahar for their extensive commentary and critique, and to my mentor, teacher, and friend David Charny, who first got me interested in nonlegal sanctions. I would also like to thank Edward Bernstein, Brian Bix, Jacob Corré, Bob Cooter, Dick Craswell, Richard Epstein, Tamar Frankel, Jesse Fried, Victor Goldberg, Phillip Hamburger, Alon Harel, Claire Hill, Jason Johnston, Louis Kaplow, Avery Katz, Ehud Kamar, Dan Klerman, Eugene Kontorovich, Harriet Kaplan, Saul Levmore, Ronald Mann, Ed Morrison, Ariel Porat, Ofer Grosskopf, Eric Posner, Lorrie Ragland, Alan Schwartz, Warren Schwartz, Keith Sharfman, Steve Shavell, Brian Simpson, Becky Trokki, George Triantis, Eyal Zamir, the staff of the University of Chicago Law Library and participants at the American Law and Economics Association Annual Meeting, panel on norms (1997), the Tel Aviv University Law School Conference on Contract Theory, the Tel Aviv University Law and Economics Workshop, the University of Michigan Symposium on Empirical Research in Commercial Law, the Yale Faculty Workshop, the American Bar Foundation Workshop, and the University of Michigan Law and Economics Workshop. This research is part of a larger project on private commercial law systems that is funded by the National Science Foundation, Grant SBR-9422795. Additional funding was provided by a Georgetown University Law Center Summer Writer’s Grant, the Lynde and Harry Bradley Foundation Fund at the University of Chicago, the Sarah Scaife Foundation Fund at the University of Chicago, and the John M. Olin Foundation at the University of Chicago. Logistical support was provided by the Hebrew University of Jerusalem Faculty of Law and the Tel Aviv University Law School. Susan Demeske, Johanna Hardy, and Renee Liu provided research assistance on this project. Mary LaBrec and Connie Rodgers provided outstanding research assistance and substantive input. Unpublished cotton industry sources referenced in this article are on file with the author. She assumes full responsibility for source cites to interviews and primary industry documents.

1. For an overview of the origins of the cotton industry’s private legal system, see A.W. Brian Simpson, Contracts for Cotton to Arrive: The Case of the Two Ships Peerless, 11 CARDOZO L. REV. 287, 293-314, 321 (1989).

International Sale of Goods, but rather by the rules of the Liverpool Cotton Association.2

The institutions that create and administer the industry’s private legal system work extraordinarily well. The trade rules are periodically revised to respond to technological advancements, market changes, and ambiguities revealed during disputes. Their content is known and understood by most market participants. The arbitration tribunals that resolve disputes do so expeditiously and inexpensively. Their decisions, which are recorded in written opinions, reveal a distinctive and coherent jurisprudential approach. Within the industry, arbitration awards are widely respected and complied with promptly. In short, the industry has succeeded in creating and maintaining a private legal system (“PLS”) in which transactions costs, error costs, legal system costs, and collection costs are low. This system has endured since the mid-1800’s, surviving widespread social change, years of extreme price volatility, and substantial changes in the background public legal regime.

This Article draws on a detailed case study of contractual relations in the cotton industry to examine the ways that the rules, norms and institutions that constitute the industry’s PLS create value for transactors. Part I describes the formal operation of the PLS and discusses the ways that its substantive rules, adjudicative approaches and arbitral procedures improve on those provided by the Uniform Commercial Code (“Code”) and the public legal system. Part II describes the many steps taken by cotton industry institutions to strengthen the social and informational infrastructures of trade. It discusses how these efforts combine to make reputation-based nonlegal sanctions a powerful force in the industry and explores how the availability of these sanctions makes important features of the PLS work better than they would in their absence. It also suggests that the availability of such sanctions may enable transactors to create value-enhancing contract governance structures that might be either unavailable or prohibitively expensive if their transactions were governed by the public legal system. Part III takes a step back and explores how the industry’s efforts to support the legal and extralegal aspects of contracting relationships, together with certain other features of cotton institutions, have succeeded in creating conditions that are conducive to the creation, maintenance and restoration of cooperative contracting relationships. Part IV concludes by suggesting that understanding how the cotton industry’s institutions create value for transactors may help identify other indus

2. E-mail from Linda Mawdsley, Membership Manager, Liverpool Cotton Exchange, to author (Oct. 27, 1997) (noting that the Liverpool Cotton Association trading rules govern approximately 50% of international cotton contracts).

tries and other contexts in which private institutions can play a positive role in supporting trade.


A. The Formal Operation of the Private Legal System

There are numerous sources of private commercial law in the domestic cash markets for the purchase and sale of cotton.3 Most merchant-to-mill transactions

are governed by the Southern Mill Rules (“SMRs”),4 a set of trade rules that is jointly adopted by the American Cotton Shippers Association (“ACSA”),5 a trade

association representing merchants, and the American Textile Manufacturers In

stitute (“ATMI”),6 a trade association representing mills.7 Most merchant-to

merchant transactions are governed by the trade rules of one of four regional cotton shippers associations, all of which are members of ACSA,8 or by the rules of

3. A cash market for a commodity is one in which the commodity is bought and sold – on any of a variety of payment terms – for actual delivery.

4. Minutes of the American Cotton Shippers Association-American Textile Manufacturers Institute Joint Meeting (1984) (75-80% of the cotton bought by United States mills is subject to the SMRs).

5. ACSA “is the spokesman for private cotton merchants of the United States.” Am. Cotton

Shippers Ass’n, Southern Mill Rules, in SOUTHERN MILL RULES FOR BUYING AND SELLING OF AMERICAN COTTON 2 (1996), available at 20Rules/about_acsa.html [hereinafter SMRS]. This rulebook also includes the Rules and Regulations of the Cotton States Arbitration Board [hereinafter, CSAB Rules] and an Outline of Services Available for Quality Arbitrations By Cotton States Arbitration Board and Technical Arbitrations By the Board of Appeals Under Southern Mill Rules [hereinafter, Outline of Services]. Id.

6. The ATMI is the “trade association for manufacturers of textile mill products . . . [Its] members . . . . process some 75 percent of all domestically grown cotton consumed annually in the United States.” Id.

7. The ACSA and ATMI rules committees meet together at least once a year to consider revising the SMRs. However, because the associations’ interests are often antagonistic, and amendments must also be ratified by the membership of both organizations, the revision process is slow. See Letter from R. C. Dickerson, Executive Vice-President and Secretary of ACSA, to R. K. Vincent (January 21, 1952), in connection with SEAB Case No. 61 (“With regard to your suggestions about clarifying some of the Southern Mill Rules, beg to say that this is a long and tedious process . . . it is very difficult to secure any changes and it usually takes a couple of years at least before such changes can be effective.”).

8. These organizations are the Western Cotton Shippers Association (“WCSA”), the Atlantic Cotton Association (“ACA”), the Southern Cotton Association (“SCA”), and the Texas Cotton Association (“TCA”). A fifth organization, the Arkansas-Missouri Cotton Trade Association, existed as late as 1990, but is now defunct. Its former members were absorbed by the other regional associations. In the past, there were also numerous local and regional cotton exchanges. Today, with

the Memphis Cotton Exchange (“MCE”), whose ninety member firms typically “handle about 75 percent of the U.S. cotton trade and about 35 percent of the world’s cotton trade.”9

Both shippers’ associations and regional exchanges provide arbitration services.10 Most require members to arbitrate disputes with other members as a

condition of membership.11 In addition, the ACSA and the ATMI have created a

joint arbitration tribunal, the Board of Appeals (“BoA”),12 to arbitrate contract

disputes that arise under the SMRs.13 They have also created a separate tribunal,

the Cotton States Arbitration Board (“CSAB”), to make binding quality determinations.14 Although merchants and mills are not required to contract under the

SMRs, or to arbitrate disputes with one another as a condition of membership in their respective trade associations, most merchant-to-mill contracts nevertheless provide for BoA arbitration.15

the exception of the Memphis and Greenwood Exchanges most are either defunct or have greatly curtailed their activities.

9. Charles Conner, Julien Fall Year Ago Changed Industry, COM. APPEAL, Jan. 20, 1991, at C1.

10. A modest fee is charged for these services, see MEMPHIS COTTON EXCHANGE BY-LAWS, Art.

IV, § 9 (1993) [hereinafter MCE BY-LAWS] (providing that “[i]n all cases of Arbitration concerning cotton, the charges shall be as determined by the Board of Directors”).

11. See, e.g., id. at Art. IV, § 8 (“Any member refusing to submit to an arbitration when asked for by another member or a non-member, providing the Arbitration Committee consider [sic] there exist good grounds for an arbitration, or to abide by any award or decision of said Committee when rendered,” may be expelled from the exchange).

12. In earlier years, these organizations sponsored two sets of trade rules and two arbitration boards. One of these boards, the New England Board of Appeals (“NEBoA”), resolved disputes in the New England region. The other, the South Eastern Appeal Board (“SEAB”), resolved disputes in the Southern region. Today, the Southern Mill Rules and the Board of Appeals (“BoA”), sometimes referred to as the “Southeastern Appeal Board,” are used to resolve all disputes regardless of where in the country they arise. Am. Cotton Shippers Ass’n, Outline of Services, supra note 5. Although these tribunals are referred to as “appeals” boards, they are tribunals of first instance.

13. The BoA requires each litigant who is a member of ACSA or ATMI to pay a filing fee of $400 per case, but refunds the fee to the prevailing party. When cases are filed by non-members or their attorneys, a fee of the larger of $800 or the actual cost of the arbitration is charged. Id. at 38.

14. See SMRs, supra note 5, at Art. XI, § 43 (authorizing the CSAB – which is supervised by representatives of both ATMI and ACSA – to arbitrate quality disputes between shippers and mills). In 1972, however, “[t]he Executive Committee [of the CSAB] made arrangements with the Board of Supervising Cotton Examiners . . . now the Quality Control Section, of the U.S. Department of Agriculture in Memphis, to perform [quality] arbitration services for the industry.” Outline of Services, supra note 5, at 34.

15. Supra note 4. This is usually achieved by incorporating the SMRs into the contract.

The formal operation of the cotton industry’s PLS can best be understood by looking at the procedural rules, substantive rules, adjudicative approaches, and judgment enforcement mechanisms that have been adopted by the two most important private commercial law institutions in the domestic cash cotton trade:16

the BoA, which resolves disputes between merchants and mills, and the MCE arbitration tribunal,17 which resolves disputes primarily between merchants.

1. Procedural Rules

The BoA is composed of one arbitrator appointed by the president of the ATMI and one appointed by the president of the ACSA.18 Arbitrators are selected

for their “experience in their respective industry and their reputation for integrity and fairness.”19 The BoA does not hold hearings. It decides cases solely on

16. The importance of these institutions is suggested by, among other things, the fact that the MCE Trading Rules and By-Laws, the SMRs and BoA procedures, and the trading and arbitration rules of the Liverpool Cotton Association are an important focus of the curriculum at the educational institute for new industry participants held at Rhodes College each summer. See infra note 225 and accompanying text.

17. Unless otherwise noted, the expression “MCE arbitration tribunal,” refers to the Ex

change’s “regular standing Arbitration” tribunal. TRADING RULES OF THE MEMPHIS COTTON

EXCHANGE, R. 34, cl. 2 [hereinafter MCE TR]. Since the early days of the exchange, this tribunal has handled disputes between members, between members and non-members, and even, on occasion, disputes between two non-members. In 1995, however, in an attempt to create a public perception of fairness, the MCE established a separate tribunal for disputes involving nonmembers. This tribunal operates under its own, somewhat different, procedural rules. The arbitration panel consists of three arbitrators, arbitrators are chosen by agreement of the parties, and there are no appeals. If the claim is for less than $25,000 and the parties agree, only one arbitrator need hear the case. Non-binding pre-arbitration mediation is also available if agreed to by the parties.

One of the more striking differences between regular MCE arbitrations and these special arbitrations is that the special tribunal’s procedures make it easier for parties to get information from one another. See id. at R. 43, cl. 4 (“Upon the request of any party to the arbitration made in writing with notice to the other party, the Chairman of the Rule 43 Arbitration Committee shall issue subpoenas as provided in the Federal Arbitration Act and/or the Tennessee Uniform Arbitration Act.”). This provision was considered undesirable by the MCE board, but was adopted on the advice of a prominent industry attorney who told the board that it was needed in order to maintain the perception that the tribunal was fair to non-members. Telephone Interview with MCE Executive (Feb. 1997).

18. See Outline of Services, supra note 5, at 35. When the arbitrators do not agree, they are authorized to jointly appoint a third arbitrator. From 1975 to 1996, however, the BoA heard twentyeight cases, none of which required the appointment of a third arbitrator. See BoA opinions 1975-1996.

19. Outline of Services, supra note 5, at 35.

the basis of briefs and documentary evidence, most commonly: verified copies of confirmations, correspondence, mail receipts, telephone logs, weight slips, quality determination reports, and affidavits from lawyers and employees who played roles in the questioned transaction. All evidence has the names of the parties redacted.

The MCE arbitration tribunal is composed of seven arbitrators, appointed annually by the Exchange’s board of directors. It holds oral hearings,20 complete

with the calling of witnesses and cross-examination.21

Neither the BoA nor the MCE tribunals permit unconstrained party-initiated discovery, though both permit the arbitrators to request additional information.22

The SMRs do not contain a general limitations period, but they do contain rules specifying the proper time frame for raising certain types of objections.23 The

MCE trading rules provide that all claims are to be reported to the arbitration committee “within thirty days after the matter in controversy arises,”24 and also

20. See, e.g., Case Record, MCE Case No. 832 (1985) (noting that multiple hearings were held)

21. MCE arbitrators also take an active role in questioning the parties and witnesses. See, e.g., Questions Reference, typewritten sheets filed with the case record for MCE Case No. 835 (1991) (listing questions for the arbitrators to ask the parties)

22. See Outline of Services, supra note 5, at 36 (noting that the BoA can “ask either of the parties for additional information or clarification of statements made in their briefs”)

23. See SMRs, supra note 5, at Art. VII, § 32 (“Claims for loss in weight or payment for gain in weight must be made within seven business days from receipt of the cotton, or of the last portion of the shipment.”)

24. MCE TR, supra note 17, at R. 34, cl. 1.

specify time frames for raising particular types of objections.25

Both tribunals produce written opinions. Most opinions include a statement of the facts, a short discussion of the rule to be applied, a few paragraphs discussing the arbitrators’ reasoning, and an award.26 Some opinions, however, simply state

the outcome of the case.27 BoA opinions are circulated to all ACSA and ATMI members.28 The names of the parties are redacted,29 but the names of the arbitra

25. See id. at R. 5, cl. 5 (“[A]ny rejection for differences in grade and/or staple will only apply on cotton if it is shipped out of the point of origin or resampled within ninety (90) days from date of payment by Buyer.”)

26. BoA Case No. 135 (1992)

27. See, e.g., MCE Case No. 835 (1991) (stating only that “[t]he Arbitration Committee of the Memphis Cotton Exchange based on written evidence supplied by both parties as well as the oral testimony of both parties rules that [Defendant] is not entitled to carrying charges and [Plaintiff] is not entitled to penalties. This decision was the unanimous decision of this Arbitration Committee”)

28. The ATMI and the ACSA keep BoA opinions, along with the briefs and evidence submitted, on file for inspection by their members. They occasionally receive requests for further information about cases or copies of the supporting papers. See, e.g., Letter from the Chairman of the Board of [very large] Cotton Company, to the ACSA Executive Secretary (June 19, 1967), in connection with BoA Case No. 98 (“I think there is something in the libel laws which prevents you from naming the buyer and the seller in this case, but I think it is proper for you to give the name of the seller on request and I do hereby request that you give us the name of the seller who refuses to be bound by a trade arbitration because an Act of God (crop failure) makes it impossible for him to deliver what another seller has offered to deliver at 8¢ higher.”). Such requests are more common when the BoA’s opinion does not contain a clear description of the facts found and the reasoning used. Telephone Interview with ACSA Executive (no date)

In earlier years, the associations routinely circulated briefs and supporting evidence with the opinions. See, e.g., ACSA Series A-Circular Letter No. 41 (Dec. 21, 1951) (“We are enclosing herewith for your information and guidance copies of briefs and summary of question [sic] submitted together with decision and minority report in Southeastern Appeals Board Case No. 62. This case is rather involved, but we recommend that it be studied carefully by all shippers to domestic mills.”). Although the reasons for this practice are unclear, giving transactors access to the same information as the tribunal makes it easier for them to determine whether the tribunal was im

tors are given. MCE opinions contain the names of both the parties and the arbitrators, but they are not made public. Neither tribunal formally accords prior decisions precedential authority.30

The BoA’s awards are final judgments, but the MCE tribunal gives parties the right to appeal to a three-person appeals board in cases where the decision of the original panel was not unanimous .31 At the BoA, the rules require the time from

partial. Establishing its impartiality might have been especially important to the BoA, which resolves disputes between defined groups of market participants with often conflicting interests. Today, these supporting materials are only circulated in exceptional circumstances. See, e.g., ACSA Series A-Circular No. 96 (Feb. 25, 1987), addressing BoA Case No. 124 (noting that in addition to the opinion, the association was “also enclosing ‘Seller’s Statement of Facts’ and ‘Seller’s Argument and Brief.’ Supporting documents on pages 15-17 are also provided. We did not deem intervening documentation necessary for reproduction”).

29. Although in important BoA cases, parties’ identities become quickly known through gossip, Telephone Interview with ACSA Executive (June 1996)

30. In the past, BoA opinions sometimes mentioned prior opinions as persuasive or controlling authority. See, e.g., NEBoA Case No. 181 (1924) (citing NEBoA Case No. 97 as controlling authority for the interpretation of Rule 61, defining “receipt of cotton”)

31. MCE BY-LAWS, supra note 10, at Art. IV, § 5. From 1944 to 1991, only four of the ninety-two decisions rendered by the MCE arbitrations tribunal were not unanimous. Of these four deci

filing to the close of evidence to be between fifteen and thirty days. Decisions are rendered as soon thereafter as possible .32 At the MCE, the length of time from filing to disposition varies, but is typically just over a month.33 Both the BoA and the MCE require prompt payment of awards .34

2. Substantive Rules

The BoA decides contract disputes by applying the SMRs,35 a comprehensive set of bright-line contract default rules36 that cover contract formation, performance, quality, delay, payment, repudiation, excuse, and damages, and include

sions, three were appealed. Two of the decisions were affirmed. See MCE App. Case No. 28 (1952)

32. Outline of Services, supra note 5, at 36-38

33. Based on information in the moving papers and opinions in all MCE cases decided from 1978-1991, the average time from filing to disposition was thirty-nine days. The longest case took eighty-four days, while the shortest took eleven days. Although the MCE Rules do not dictate a precise time frame for resolving a dispute, the fact that a the defendant is given only three days to respond to a claim before the committee is permitted to hear the case ex-parte, suggests that the Exchange considers prompt dispositions important. MCE TR, supra note 17, at R. 34, cl. 1.

34. The MCE rules also attempt to ensure payment by requiring the defendant to post a prearbitration bond in the amount of the claim. MCE BY-LAWS, supra note 10, at Art. IV, § 4. In the past, strict compliance with the rule was enforced, but today bonds are not always required in practice. Telephone Interview with MCE Executive (no date).

35. The SMRs, however, “reserve [to the BoA] the privilege of refusing action on any dispute submitted if it feels the case at point has disagreements not involving SMR[s] or it does not have sufficient evidence to properly judge the issues.” Outline of Services, supra note 5 at 35-36

36. See SMR, supra note 5, at Art. XVII, § 54 (“Buyer and seller shall have the privilege of incorporating any other rules, not in conflict with the spirit of the above rules, in their contracts.”).

numerous industry-specific definitions of terms like “prompt,”37 “raingrown,”38 and “long staple.”39 The MCE decides cases on the basis of the Exchange’s own Trading Rules,40 which also define numerous industry-specific terms and contain primarily bright-line provisions. Although most SMRs and MCE Trading Rules

would be enforceable under the Code if included in a contract,41 they nonetheless differ from the Code in fundamental ways.

First, the industry-drafted trade rules do not, for the most part, include the types of standard-like words such as “reasonable,”42 “seasonable,” and “without objection in the trade,” that permeate the Code. Rather, they contain primarily clear, bright-line, rules.

37. Id. at Art. IV, § 16.

38. Id. at Art. III, § 13.

39. Id. at Art. III, § 10.

40. See MCE TR, supra note 17, at R. 2, cl. 1 (“These Trading Rules shall apply to all purchases and sales between members of the Memphis Cotton Exchange unless otherwise agreed in writing.”). The MCE Trading Rules contain only two mandatory provisions. Id. at R. 31, cl. 1 (“Any exception to these rules can be made by mutual agreement at time of sale excepting Rule 1, Clause 4 and Rule 2.”)

41. Some trade rules, however, would be of questionable validity if included in a contract adjudicated under the Code. First, at times when cotton prices were very low, the trade rules that provide for the payment of a ½ cent per pound penalty, might, if included in a contract subject to the Code, might have been vulnerable to attack under U.C.C. § 2-718 (1991) and the relevant case law, on the grounds that they were invalid penalties since they were not a genuine attempt to pre-estimate damages. See, e.g., Equitable Lumber Corp. v. IPA Land Dev. Corp., 344 N.E.2d 391 (N.Y. 1976). Today, however, these damage measures, if included in a contract subject to the Code, would most likely be enforceable, since their magnitude is, given world cotton prices, insignificant. Second, SMR Art. XIX, § 56, SMRs supra note 5 which provides that, “[i]f either party to the contract enters bankruptcy or admits insolvency, the other party may cancel the undelivered portion of the contract, with the market difference to be adjusted between the buyer and the seller, with one-half cent per pound penalty against the party in bankruptcy or admitting insolvency,” might be deemed an invalid ipso facto clause under the 1978 Bankruptcy Code.

42. The SMRs use it once. See SMRs, supra note 5, at Art. XI, § 47 (requiring the buyer to “exercise all reasonable care of rejected bales”). The MCE Rules use it twice. See MCE TR, supra note 17, at R. 43, cl. 2 (requiring complaints filed in arbitration to be written “in reasonable detail”)

Second, the types of damage measures available in the private system differ in important ways from the measures used in the public system. The Code’s damage measures are designed to protect the expectancy interest by putting the “aggrieved party . . . in as good a position as if the other party had fully performed.”43 In contrast, the SMR and MCE damage measures tend to be under

compensatory .44 Under the SMRs, the aggrieved party is entitled only to market

difference damages plus a one-half cent per pound penalty that is trivial given contemporary cotton prices.45 The recovery of consequential damages is not per

mitted, although the SMRs do impose fixed fines for certain types of misbehavior .46 The MCE uses the same measure for breach of contract,47 and also imposes a

variety of other fines such as per-day fines for delayed delivery48 and late pay

43. UCC § 1-106 (1991).

44. See infra note 135 and accompanying text (explaining that the market difference measure is so under-compensatory, particularly in merchant-to-mill transactions).

45. SMRs, supra note 5, at Art. IV, § 18C. See also BoA Case No. 139 (1996) (although the buyer claimed $158,500 in consequential damages in its brief, this was not mentioned in the arbitrators’ opinion and no consequential damages of any kind were awarded). The rules further provide that the market price shall be determined from “three bona fide offers on the identical quality and with identical terms to that contracted,” given to the aggrieved party, and that “[a] buyer’s purchase [when the seller breaches] . . . shall be based on the lowest of the three offers. [While a] seller’s sale [when the buyer breaches] . . . shall be based on the highest of the three offers.” Id. In addition, “[t]he party to receive market differences must present [a] detailed settlement amount in writing to the other party within three business days. [And t]he party receiving bona fide settlement invoice must pay with good funds within five business days of receiving [sic] such invoice.” Id. In the ACSA-ATMI debates over the adoption of the three-quote rule, the shippers “felt it would be better to have an understanding [of the magnitude of damages] at the time [of breach], rather than after the fact, and thus avoid referring matters to the Board of Appeals.” Minutes of the ACSA-ATMI Joint Meeting (1976).

46. See SMRs, supra note 5, at Art. V, § 26 (requiring a penalty of one-half cent per pound in addition to interest when the buyer does not pay the draft or invoice within five business days after delivery)

47. See MCE TR, supra note 17, at R. 22, cl. 2.

48. See id. at R. 11, cl. 1 (“The penalty for failure on the part of the Seller to deliver cotton within the required time under above rules, shall be 10 ¢ per bale per day minimum to be paid by the Seller to Buyer and in no event shall this penalty exceed 25 ¢ per bale per day, but any excess over and above the 10 ¢ per bale per day is to be subject to the Buyer’s being able to furnish sufficient proof of loss for such excess.”).

ment .49 Neither set of rules requires the aggrieved party to reveal any firmspecific information – such as profit margins, inventory stocks, or the identity of other customers or suppliers – in order to obtain a monetary recovery.50

Another notable difference between the trade rules and the Code is the absence of a trade rule equivalent of the Code’s nonwaivable duty of good faith. Although briefs often make arguments based on good faith,51 no such duty is im

plied by the arbitrators52 and notions of good faith and fairness do not appear to affect case outcomes. However, arbitrators sometimes do note in their opinions

49. Id. at R. 11, cl. 2 (“The penalty for failure on the part of the Buyer to pay for cotton or furnish shipping instructions in accordance with the above rules shall be 10 ¢ per bale per day plus storage, insurance and interest accumulated against the Seller during delay. Penalties accruing against the Buyer shall be added to the invoice, and those accruing against the Seller shall be deducted from the invoice.”).

50. In addition, the MCE’s sensitivity to transactors’ possible desire to keep information private is reflected in MCE TR, supra note 17, at R. 11, cl. 1 reprinted in part supra note 48 (providing for late penalties a buyer can get without revealing any firm-specific information, and larger penalties he is permitted to seek if he reveals additional information.).

51. See, e.g., Buyer’s Brief at 23, BoA Case No. 135 (1992)

52. From 1944-1990 good faith was mentioned in only one MCE arbitration opinion. See MCE Case No. 816 (1966) (noting that the “[d]efendant acted in good faith and did everything he could to expedite the shipment

that they consider a particular outcome to be unjust,53 or that one or both of the parties engaged in undesirable business practices.54

3. Adjudicative Approaches

The most important difference between courts applying the Code and cotton industry arbitration tribunals applying the trade rules lies in their adjudicative approaches. Broadly speaking, the Code directs courts to look to immanent business norms reflected in course of dealing, course of performance, and usage of trade, to fill gaps and interpret contracts,55 and directs them to take parties’ ac

tions under a contract as the best indication of what they intended their contract to mean .56 In contrast, despite the fact that cotton arbitrators are chosen for their

53. BoA Case No. 122 (1987) (where BoA arbitrators considered the result they reached under the rules so unjust that their opinion contained a non-binding “recommendation” that the Seller give the Buyer a type of offset that many other sellers in the market were giving to their buyers at that time)

54. See, e.g., BoA Case No. 137 (1996) (“This Board’s opinion is that the contract was poorly handled by both parties under unusual circumstances and that their gross misunderstanding should be shared.”)

55. This philosophy is reflected in numerous Code provisions and Official Comments. See, e.g., U.C.C. § 1-102 (b) (1991) (“Underlying purposes and policies of this Act are . . . to permit the continued expansion of commercial practices through custom, usage and agreement of the parties . . . .”)

56. See id. at § 2-208 cmt. 1 (“The parties themselves know best what they have meant by their words of agreement and their action under that agreement is the best indication of what that meaning was.”).

industry expertise, they use a relatively formalistic adjudicative approach that gives little explicit weight to elements of the contracting context.57

Cotton trade rules do not contain provisions making course of performance or course of dealing relevant to gap filling or interpretation and arbitrators are reluctant to take these considerations into account.58 Similarly, unlike the Code,

cotton trade rules do not have a general provision making usage relevant to the interpretation of either contract provisions or trade rules .59 Unlike courts applying the Code,60 BoA arbitrators do not permit custom to trump or vary trade rules or explicit contractual provisions.61 In practice, BoA arbitrators only look to custom when there are no trade rules or contract provisions on point.62 On the

57. Given the expertise of these arbitrators, however, these considerations may enter the moving papers and/or the arbitrators’ decision-making process in ways too subtle to detect.

58. When ten merchants who had served as MCE arbitrators were asked “if the parties could establish that despite what was written in their contract they always behaved in a different way, would you apply this different, informal understanding, rather than the relevant trade rule,” two said yes, seven said no, and one was uncertain, explaining that it would depend on the identity of the parties. Briefs occasionally make arguments based on course of performance or course of dealing, but these considerations do not appear to influence arbitral decisions. See, e.g., Record, BoA Case No. 122 (1987) (where both briefs contain numerous references to course of performance and course of dealing, but these considerations are not mentioned in the arbitrator’s opinion).

59. However the MCE Trade Rules contain one particularized reference to custom, see MCE TR, supra note 17, at R. 23, cl. 1 (“Rules 20, 21, and 22 are in no way to change or nullify the present rules and customs of handling sales of consigned or F.O.B. cotton when sold on actual samples.”), and in quality arbitrations conducted by the CSAB, custom may be looked to when there are gaps not covered by the contract or relevant trade rules, see CSAB rules, supra note 5. (“All arbitrations will be held strictly in accordance with the letter and intent of contract and in case all points of any contract are not covered by the rules . . . such points are to be arbitrated according to the general interpretation of the trade in regard to the same . . . .”).

60. See Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms, 144 U. PA. L. REV. 1765 (1996) (discussing the ways that courts applying the Code permit custom to vary or trump explicit contractual provisions).

61. See, e.g., SEAB Case No. 77 (1956) (noting the buyer’s contention that when “mills buy cotton from . . . Group B . . . according to precedent and established custom . . . it is understood to be compressed cotton,” but rejecting it on the grounds that “while we recognize that precedent and established custom play a part in any transaction, the terms of the purchase [in this case] were definitely stated as subject to Southern Mill Rules and under Rule XVI, Section 53, DENSITY is covered . . . we therefore think Seller is right”)

62. In one case decided in 1935, the BoA looked to custom to define a term used but not fully defined in the either the contract or the trade rules. See NEBoA Case No. 313 (1935) (holding that because the contract used but did not define the term “Western Growth,” and the relevant trade

whole, references to custom or usage in BoA opinions are extraordinarily rare,63 perhaps because given the amount of detail in the trade rules cases involving contractual gaps are uncommon.

The MCE rules are silent on the applicability of custom. Some MCE arbitrators express a willingness to consider it, but in practice they do not seem to take it explicitly into account. Although custom is sometimes mentioned in parties’ briefs, from 1944 to 1991, of the ninety-one opinions issued by the MCE, only three contain references to custom.64

In general, cotton arbitrators decide cases in a highly formalistic manner,65 even when their sense of fairness suggests that additional considerations are relevant or that a contrary result should be reached.66 As one arbitrator ex

rules did not define it either, “the Board must therefore base this decision on trade custom”)

A similar approach to the role of custom in adjudication is used at the WCSA. See, e.g., Telephone Interview with WCSA Executive (May 28, 1997) (“Whether [custom and usage] are viewed as relevant [in arbitration] depends on whether it relates to a subject about which there is a trade rule. If there is a trade rule on point, the custom is irrelevant. If there is not, then it might be looked to, to fill a gap, assuming that the contract too is silent on the point.”).

63. For example, from 1929-1951, only four of the 42 opinions issued by the BoA even mentioned custom or usage of trade. See NEBoA Case No. 313 (1935) supra note 63

64. See MCE Case No. 807 (1960) (holding that the plaintiff prevailed since it shipped on a route “usually used by shippers to this destination”)

65. Formalistic adjudicative approaches are not uncommon in merchant-run private commercial law systems. See, e.g., Bernstein, supra note 60 (describing the formalistic adjudicative approach of the National Grain and Feed Association’s merchant arbitration system)

Lisa Bernstein, Private Commercial Law, in THE NEW PALGRAVE ENCYCLOPEDIA OF ECONOMICS AND THE LAW (Peter Newman ed., 1998) [hereinafter Bernstein, PALGRAVE].

66. See, e.g., BoA Case No. 97 (1967) (revised) (“In most appeal cases, there are statements made by one side or the other, or both, that should in all fairness be taken into consideration in a friendly settlement. However, the Appeal Board must adhere strictly to the rules. To deviate

plained, “We look to the contract and then to the trade rules

4. Enforcement

The awards of both the BoA and the MCE’s arbitration tribunals can be enforced by seeking an entry of judgment in court.68 However, this is rarely neces

sary. Failure to comply with a BoA award is grounds for expulsion from most shippers’ associations, and failure to abide by an MCE award is grounds for expulsion from the Exchange.69 Expulsions are widely publicized. Because mem

bership in a shippers association strongly affects the profitability of a merchant’s domestic business70 and is essential to participation in the international cotton

trade, these association and exchange imposed penalties, together with their attendant social and reputational sanctions,71 are usually sufficient to induce mer

therefrom would cause endless confusion and arguments. This Board can rule only upon the written contract.”)

67. Telephone Interview with Merchant #4, retired BoA arbitrator (Mar. 1997).

68. See Outline of Services, supra note 5, at 37 (“Should either party seek to have judgement entered upon the award pursuant to the 9USC § 9, they may do so by applying to a court of competent jurisdiction located in Memphis, Tennessee.”)

69. MCE BY-LAWS, supra note 10, at Art. IV, § 8. The MCE has also implemented another safeguard against the judgment-proof problem. In addition to paying the annual membership fee, member are required to purchase a membership in the Exchange. The By-Laws provide that when a member fails to pay an arbitration award, the prevailing party has a right to make a claim against his membership. If the non-complying party still refuses to pay, his membership is auctioned off and the award is paid from the proceeds. At one time these memberships were valued at about $20,000, Telephone Interview with MCE Executive (Feb. 1997), although their value appears to have fluctuated widely, at least when sold at forced auctions. See Keyer v. MCE, 135 Tenn. 414, 420 (1916) (noting that an MCE membership sold for $2,500)

70. See infra notes 176-178 (discussing how a merchant’s membership status in these associations affects mills’ willingness to deal with him).

71. See infra notes 177-179 and accompanying text (providing evidence that transactors are very reluctant to deal with expelled members).

chants to promptly comply with arbitration decisions unless they are bankrupt or in severe financial distress.72

72.Moreover, even when the non-complying party is in financial distress, the associations, most notably the shippers’ associations, have succeeded in creating an implicit bankruptcy system that increases the likelihood that intra-industry debts, even those that are discharged in whole or in part in the public bankruptcy system, will nevertheless eventually be paid in full.

When a member of a cotton shippers’ association becomes insolvent or files for bankruptcy, his membership in both his regional association and the ACSA is suspended. ATL. COTTON ASS’N BY-LAWS, Art. VI, § 2 (1995) [hereinafter ACA BY-LAWS]

http://www. acsacotton. org/About_ACSA/

Search%20Rules/about_acsa.html [hereinafter ASCA BY-LAWS]. Members of these associations are then notified of the action through association-promulgated circulars. See, e.g., ACSA Letter to Members (Oct. 19, 1995) (noting that [name of shipper] filed for reorganization “under Chapter 11 of the Federal Bankruptcy Act [and that] [t]he Southern Cotton Association has suspended the membership of . . . the above firm in accordance to their By-Laws pending further review and any action by their Board of Directors.”). If, after going through the public bankruptcy process, a merchant wants to reenter the cotton business, he will, as a practical matter, have to gain readmission to an association. See infra notes 176-178 and accompanying text (discussing transactors’ reluctance to deal with someone who has been suspended or expelled from a shippers’ association). However, an affirmative vote of a large percentage of both the board of directors and the membership-at-large is required for readmission, and every member has the right both to object to a membership candidate and to publicize the reason for his objection at the association’s expense. As a consequence, a former debtor who applies for readmission without arranging to repay his intra-association creditors in full is unlikely to be readmitted, even though the rules provide that readmission is formally contingent “upon establishing, through the presentation of sufficient proof, that all outstanding financial obligations have been fully satisfied or that the repayment schedule for all existing financial obligations is current.” ACA BY-LAWS, supra. There have been instances where a former debtor was denied readmission for failure to comply with the repayment norm, subsequently paid his former creditors in full, and was then readmitted. Telephone Interview with SCA and ACA Executive (July 1996) (describing such incidents at the SCA and ACA)

The ATMI does not expel mills that fail to comply with arbitration decisions, perhaps because ATMI membership is not a prerequisite for maintaining a profitable mill and such a sanction would have little force. However, in part because there are far fewer mills than merchants, when mills do not comply with arbitration awards, their non-compliance quickly becomes known throughout the merchant and banking communities and the mill typically finds itself either unable to purchase cotton, or able to purchase it only at a relatively high price or for cash prior to delivery. As a result, noncompliance with arbitral decisions is uncommon unless the mill is in severe financial distress.

B. Comparison of the Private and Public Legal Systems

Some of the more important benefits created by the PLS stem from rather straightforward ways that its formal structures improve on aspects of the public legal system.73

reputational harm if he engages in enough wrongdoing that he is unlikely to be readmitted to a shippers’ association even if he makes good his debts). The availability of these non-momentary sanctions, like the punishment of incarceration rather than, or in addition to, a fine in the criminal context, in turn, mitigates the incentive of a transactor in financial distress to engage in endperiod opportunism.

73. Some of the benefits of the private system could be partially captured through the public system, or through straightforward public legal system reform. Some of the benefits of the PLS’s adjudicative procedures, for example, could be obtained if cotton contracts simply provided for American Arbitration Association (“AAA”) administered arbitration. However, AAA-administered arbitration is often as costly and delay-prone as litigation. See Herbert M. Kritzer & Jill K. Anderson, The Arbitration Alternative: A Comparative Analysis of Case Processing Time, Disposition Mode, and Cost in the American Arbitration Association and in the Courts, 8 JUST. SYS. J. 6, 18 (1983) (concluding that “[o]ne does not save money by going to the AAA,” rather than state or federal court for claims above $5,000). In addition, because the AAA’s general arbitration rules give arbitrators wide-ranging discretion to grant continuances, see AM. ARBITRATION ASS’N,


RULES OF THE AMERICAN ARBITRATION ASSOCIATION 20-21, 27 (1993) (discussing the granting of

“postponements” and “extensions of time”), and because unlike cotton industry tribunals, the AAA cannot put any special pressures on parties to comply with its judgments, both pre- and post-award delay would likely remain a significant problem.

It is possible, however, that careful drafting of an arbitration clause and the adoption of special rules regarding the selection of industry-expert arbitrators and avoidance of delay might reduce or eliminate these problems. At least one of the AAA’s industry specific tribunals has at

tempted these sorts of reforms. See, e.g., AM. ARBITRATION ASS’N, WIRELESS INDUSTRY ARBITRATION RULES (1997), available at (providing the option of “fast-track” arbitration with a “45- day ‘time standard’ for case completion” in front of a panel staffed by experts who are “engaged directly in the telecommunications industry”).

The procedural rules reduce the cost and delay of obtaining and enforcing a judgment. They provide a streamlined process that, compared to the public system, makes it more likely that transactors will enter into new contracting relationships,74 makes it easier for large and small firms to transact with each other,75 makes smaller-sized transactions viable,76 limits the ability of transactors to use