The Common Sense of Contract Formation

Unlike torts or civil procedure or any area of public law, the rules of promissory exchange apply exclusively to parties who have manifested their assent to be bound. What parties know, and what parties think they know, about contract law affects their contract behavior and in some cases the legal status of their agreements. Drawing on a series of new experimental questionnaire studies, this paper does two things. First, it lays out what information and beliefs ordinary individuals have about how to form contracts with one another. These studies suggest that the colloquial understanding of contract law is almost entirely focused on formalization rather than actual assent, though the modern doctrine of contract formation takes the opposite stance. The second part of the paper tries to get at whether this misunderstanding matters. Whether and when do beliefs and misunderstandings about the nature of legal rules affect parties’ interactions with each other and with the legal system? We find that indeed information that a contract has been legally formed has behavioral effects, enhancing parties’ commitments to a deal even when there are no associated formal sanctions. However, we also document a series of situations in which misunderstandings have limited practical repercussions, because even parties who believe that legal obligation is about formalities take seriously the moral obligations associated with informal expectations, promises and exchanges. We conclude with brief speculations about the implications of these results for consumer contracts. * Assistant Professor of Law and Psychology, University of Pennsylvania Law School. We thank Zev Eigen, Larry Solan, and Greg Mandel for comments on an earlier draft of this paper, and we are also grateful for feedback from participants in the Harvard Law School Law & Economics seminar, the Private Law Consortium at the University of Pennsylvania, and the 2014 Conference on Empirical Legal Studies. The project was made possible by the able research assistance of Kristin Firth. ** James E. Beasley Professor of Law, Temple University Beasley School of Law. 13-Nov-14] Intuitive Contract Formation 2 THE COMMON SENSE OF CONTRACT FORMATION Unlike torts or civil procedure or any area of public law, the laws of promissory exchange only apply to parties who have manifested their assent to be bound. Even so, the moral norms of exchange and promise are quite firmly entrenched and more broadly applicable than legally enforceable contracts. Norms of promise-keeping and reciprocity, interpersonal courtesy, community reputation—these kinds of intangible goods have real effects on contracting behavior. And, although it is perhaps a less exciting claim, it is also the case that the law itself (as it exists or as understood) affects transactional decision-making and parties’ commitments to their interpersonal obligations. This paper presents four new questionnaire studies of commonsense approaches to contract formation in the hopes of making two primary contributions. The first is to survey intuitions about what the law of formation is. In a world in which the vast majority of contracts are signed without the advice of counsel, most people have to make inferences of formation based on their background knowledge and beliefs. We find that the colloquial understanding of contract law is about formalization of an agreement rather than the agreement itself. Our second goal is to tease out the intuitive relationship between formation and obligation—to ask whether and when it matters if individuals believe a contract exists. The law of contracts is very clear that parties’ obligations to one another turn entirely on whether or not they have mutually manifested assent to be bound. And, in fact, we find that behavioral results suggest that legal (or legalistic) formation does enhance commitment to a deal irrespective of its power to impose sanctions; it seems that the law has freestanding normative force at least in this context. However, we also find that the there are cases in which knowing or not knowing the legal rule is essentially irrelevant. In many scenarios, our results suggest that parties’ likelihood to perform or breach is largely determined by their moral and social preferences—reciprocity, altruism, and promise-keeping—rather than the law of contract formation. Contracts scholars have long debated the doctrinal and economic importance of formation, particularly when parties often invest significant resources into negotiating (e.g. Craswell 1996; Craswell 1995). From a policy perspective, the subjective experience of formation is often 13-Nov-14] Intuitive Contract Formation 3 significant because contracts act as reference points (Hart & Moore 2006; Hoffman & Wilkinson-Ryan 2013). Parties treat each other, and their obligations, differently preand post-contract. Once a contract is formed, they take fewer precautions, seeking less information about the market and about one another (Craswell 1988). As we have previously argued, if ordinary individuals think they are in a contract, but the law treats them as strangers, they can be exploited by their counter-parties. Indeed, the converse vulnerability also exists, for parties who think they are still negotiating but are in fact already legally committed. To date, there has been almost no investigation of when individuals act like contracting parties. This Article undertakes to fill that gap in the literature by relating a series of experiments and studies regarding lay attitudes and behaviors surrounding contract formation. We proceed as follows. Parts 1 and 2 provide context for the empirical project, with a literature review of what we know about lay attitudes about formation, including the law’s inconsistent perspective on whether such attitudes matter. Part 3 reports the methods and results of four original surveys and experiments. Part 4 proposes a framework for thinking about these results and their relevance to doctrinal and policy debates in contract. 1. THE LAW OF SUBJECTIVE ASSENT Like many scholars writing in law and psychology, we take a broad view of what it means for particular beliefs and judgments to have “legal implications.” There are various ways that a legal system might take notice of parties’ intuitions and beliefs about contracts even when they have no obvious doctrinal role (Solan 2007; Joo 2000; Ricks 2004). However, contract formation is a somewhat unusual area in which there are also legal mechanisms for taking into account parties’ subjective beliefs about the legal status of manifestations of assent. In this section, we take up the doctrinal mechanisms for taking subjective assent seriously, before turning in the next section to the behavioral ramifications of subjective assent or lack thereof. 1.1 Subjective Interpretations of Objective Manifestations of Assent Courts and contracts professors doggedly intone that that contract parties’ secret views on the enforceability of their agreements are irrelevant to actual legal enforceability. The 1907 case of Embry v. Hargadine, McKittrick Dry Goods Co. provides a vivid example. In Embry, the plaintiff, a term employee, approached his boss, McKittrick, in December to inquire about the subsequent year’s employment. 1 McKittrick responded 1 Embry v. Hargadine, McKittrick Dry Goods Co., 105 S.W. 777, 777 (Mo. Ct. App. 13-Nov-14] Intuitive Contract Formation 4 “Go ahead, you’re all right. Get your men out, and don’t let that worry you.” Embry thought they had a deal; McKittrick denied intending to enter into a legally binding relationship. The court, of course, found a contract, and indeed Embry is typical. In Lucy v. Zehmer, defendant Zehmer asserted that he never intended to enter into a contract to sell his land to his neighbor, and was drunk and/or joking the whole time. Calling the defense “unusual, if not bizarre,” the Court enforced Lucy’s demand for specific performance, ruling that only the party’s objective manifestations of assent, not their secret reservations, mattered. Cases like Embry and Lucy present specific examples of a general puzzle: does contract law care if its subjects are aware of its premises? In some areas, the answer is definitely “no.” A murderer-for-hire may not recover against his employer by arguing that he was unaware of the proposition that illegal contracts are unenforceable. Nor may a party depending on oral promises argue that a court should enforce them notwithstanding conflicting provisions of a written agreement because she did not know about the parol evidence rule or the statute of frauds. And, indeed, Zehmer’s belief that manifesting assent in inebriated jest prevented a meeting of the minds was wrong and irrelevant. But in the law of mutual assent, parties’ beliefs about contract formation sometimes actually influence case outcomes. In Embry, for example, McKittrick’s lack of specific intent to form a contract was not relevant, but Embry’s was: the promisee must actually believe in the existence of the contract he is suing under. Cases like Embry and Lucy express a principle of “formation estoppel”: Professor Larry Solan identifies a number of cases “when both parties agree that a commitment has been made, the promisor is bound, and when neither believes that a promise has been made, the promisor is not bound. Objective considerations are irrelevant.” (Id. at 356). That said, examples of such shared agreement cases addressing formation rather than interpretation are few and far between. Most of the examples that Professor Solan identifies are ones where interpretation has bled into formation, or are implied based on dicta. For perhaps obvious reasons, there are relatively few cases where both parties intend to enter into a legally binding relationship but a reasonable person would not, and even fewer where they mutually understand themselves to be unbound but a reasonable person would find them to be. 1.2 Promissory Estoppel According to the Restatement (2 nd ) of Contracts, the triggering condition for