Smoke, Mirrors & Contract Law

Contract law is set up to be transaction enforcing, that is, to be binding. Binding means two different but related things. First, “binding” means that the contract is valid as between the parties (because it satisfies contract law’s formation requirements) and, second, it means that the rights and obligations set forth in that contract will be enforced by the state on behalf of one of the parties over the objection of the other, now resisting party. Modern contract law uses several well-established assumptions about the contracting parties, including the way they behave when contracting, and the roles of the market and state, to justify binding people to their contracts. The problem with making contracts binding, however, is that all of the assumptions are wrong both theoretically and in practice. They are wrong in theory as the work of the Legal Realists, Critical Legal Studies scholars, relational contract theorists and, more recently, behavioral law and economics scholars show. They are also wrong in practice as an examination of a subprime mortgage loan hypothetical, one that implicates disclosure statutes, will demonstrate. Because the assumptions are wrong, modern contract law cannot justify holding parties to their contracts. Nevertheless, contract law continues to do just that. Consequently, continuing to bind parties to their contracts, absent the justification that the assumptions provide, is an unmitigated exercise of state power. Contract law’s formation rules and disclosure statutes help justify this grant of power by masking the power imbalance embedded in the modern contract law system and by diverting critical attention and analysis away from that system as a whole. As a result, making contracts binding comes with unacknowledged costs, all of which work to the detriment of parties with less bargaining power, regardless of whether they are individuals or business entities. Specifically, the extent of state power that actually exists within the modern contract law system and its uses are concealed. As a specific consequence, unequal bargaining power becomes institutionalized within the system such that the party with superior bargaining power can, if it so chooses, impose bad bargains on its contracting partners with impunity. Exploring the premise that contracts are made Professor of Law, Southwestern Law School; LL.M. Harvard Law School; J.D. William S. Richardson School of Law, University of Hawaii; B.A. Whitman College. This article benefitted greatly from a presentation at the 2005 AALS Mid-Year Meeting on Contracts and Commercial Law in Montreal, Canada, the Joint Western Law Teachers of Color and Conference of Asian Pacifica American Law Faculty Conference at the Unviersity of Denver Sturm College of Law, April, 2008, and the Spring Conference on Contracts at the University of Las Vegas William S. Boyd School of Law, February, 2010. Southwestern Law School provided generous research support. My sincere thanks go to Jay Feinman, Katherine Sheehan, David Fagundes, Gowri Ramachandran, Nancy Kim, Michael Dorff, Arthur McEvoy, Hila Keren, Roman Hoyos, Ronald Aronovsky, Keith Aoki, Thomas Joo, Eric Yamamoto, Paul Horwitz, and Dean Bryant Garth for reading and commenting on various drafts of this article. Thanks also go to my research assistants Aaron Power, Jose Arambulo, Daniel Csillag, Georgina Lepe, Erika Tarankow, Matthew McAleer, Stephanie Foster, Natalie Rodriguez, Margaret Leidy, and Lilit Tovmasyan. Smoke, Mirrors & Contract Law 2 binding thus allows us to see the powerful role that the state plays in creating and maintaining a deeply flawed contract law system, one in which imbalances of power, not freedom and consent, are the hallmark. These imbalances are so deeply embedded that even mediocre remedial efforts, like disclosure statutes, reify rather than mitigate them. This result should be troubling for contract scholars and others who adhere to the notion that freedom and individuality are epitomized in the freedom of contract ideal. Introduction 2 II. Binding Contracts 10 A. The Modern Contract Law System 10 B. Disclosure Statutes as a Modern Contract Remedial Tool 20 III. Contracts and State Power 25 A. The Assumptions in Theory and in Practice. 25 1. The Market is Not Self-Regulating or Largely Outside of State Control 25 2. Contracts Are Not Voluntary 32 3. Contracts Are Public, Not Private 36 4. The State's Role is Neither Nor Minimal and, Therefore, Contracts Are Not Just Between Two Private Parties 38 5. Individuals Do Not Act Rationally in the Marketplace, Nor Are Contracts the Product of Informed Choice 38 6. Parties Do Not Bargain At Arm's-Length and They Are Not Most Likely Strangers to One Another 43 B. The Universe of Contracts 48 IV. Contracts and Unequal Bargaining Power 52 A. Synergy: State Power and Unequal Bargaining Power 53 B. Institutionalizing Unequal Bargaining Power 54 C. Smoke and Mirrors 60 V. Conclusion 63

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