June 18, 2001

By Steven P. Garmisa
Hoey & Farina
garmisa@hoeyfarina.com

Courts play a useful role in contract cases even if they are "radically incompetent," according to University of Chicago Law School Professor Eric A. Posner.

"I do not believe that courts always misunderstand contracts," the professor cautions, "though I do believe that they often do." In fact, Posner says, "many elements of our legal system make most sense if we understand them to be a response to the regrettable but unavoidable fact that our courts are incompetent when it comes to enforcing contracts."

The professor's point is that "even if courts are radically incompetent, people would still voluntarily enter into legally enforceable contracts." "A Theory of Contract Law Under Conditions of Radical Judicial Error," 94 Northwestern Univ. L.Rev. 749.

"[C]ourts have trouble understanding the simplest of business relationships," Posner says, pointing to a survey of consumer credit cases. "This is not surprising. Judges must be generalists, but they usually have narrow backgrounds in a particular field of the law. Moreover, they often owe their positions to political connections, not merit."

Even if judges understand basic business principles, "we must take their interpretation of facts on faith. Judges' reasoning can be evaluated only against the canned facts described in the opinion, which themselves are the result of a fact-finding process that does not inspire confidence.

Parties can reasonably believe that -- given the varying sophistication of trial judges, lawyers, and juries, the accidents of discovery, the varying credibility of witnesses, the vagueness of the law and so on -- the chance of winning a breach-of-contract suit is pretty much random." And a jury "can be considered the randomizer par excellence."

Courts recognize their own limitations. As Posner points out, "Skepticism about the quality of judicial decision-making is reflected in many legal doctrines, including the business judgment rule in corporate law, which restrains courts from second-guessing managers and directors."

Posner's hypothesis is that courts can "deter opportunistic behavior," even if they can't reliably decide questions about breach and damages. "This claim might sound implausible, but the key to it is that parties [by choosing whether to enter into a legally enforceable contract] choose when they want to use courts and when they do not, so even an uncomprehending court can serve useful purposes as long as it allows itself to be manipulated by the parties."

Even if courts do a poor job in contract cases, "Parties use the courts as a commitment device, which allows them to make credible promises to perform an action and allows them to rely on the promises of the other."

When a contracting party would obtain a big benefit from breaching (and there is a strong motive for opportunistic behavior), the other party is protected by having entered into a legally enforceable contract. "But the protection does not result from the ability of courts to punish the party that breaches. It is assumed [under Posner's model of contract law] that courts are not able to acquire the information that they would need in order to determine liability and harm. The protection results because the victim of the breach, if he cares about his reputation, can credibly threaten to inflict mutual harm by bringing a negative-sum lawsuit."

In Posner's model of how courts can deter "high-value opportunism" even if they are incompetent, "It is as though two parties to a relationship agreed that if they had a dispute, both parties would have a finger chopped off by a government agent. Neither party cheats, because he believes that the other would retaliate by invoking his right to have the mutual sanction imposed. The cheated party will credibly retaliate with a lawsuit, because otherwise he risks obtaining a reputation as a softie, in which case he will be unable to avoid being cheated the next time he plays this game.

"The government agent's role is just to chop off fingers if one person complains. The government is like a parent, who punishes both children who are fighting rather than only the child who started the dispute. Even if you do not know which child is at fault, you can discourage future misbehavior, for each child knows he will be punished if he engages in such misbehavior.

"Like the parent, the government does not have to determine who is right and who is wrong. The purpose of contract law is to enable the parties to have the government penalize both if they have a dispute; and contract doctrines merely give the parties a reliable way to indicate ex ante their desire for such government involvement, and to limit the size and variance of the penalty to something close to what should be sufficient: a finger rather than a head."

Although his model of contract law might seem "improbable and perverse," Posner points out "an extremely important non - or semi-legal institution for dispute resolution -- in every major country and in every period of history before the 20th century -- has been the duel."

Like trial by combat, "the outcome of the dispute depends on skill with arms, and not on reliable discovery of fault." However, Posner says, "The history of dueling reveals many practices that took away this advantage, including the practice of giving the challenged person the choice of weapons and, in the case of pistols, forcing the parties to use highly inaccurate pistols at great distance."

"By analogy, efforts over time to make courts harder or easier to use, to make liability rules more or less expansive, to make damages more or less generous -- all of this is like increasing or reducing the distance between duelists, modifying the weapons they use, adding or subtracting the armor they wear, and so on. These practices made the outcomes of the duel a matter of luck, much as the outcome of a dispute before a radically incompetent court is a matter of luck."

Dueling in court with modern contract litigation, "People do not cheat because they fear being subjected to enormous losses; they do not settle because they fear being thought to be cowards."