The Governance of Contractual Relations: Contracting Traditions

There is widespread agreement that the discrete transaction paradigm— “sharp in by clear agreement; sharp out by clear performance (Macneil, 1974, p. 738)—has served both law and economics well. But there is also increasing awareness that many contractual relations are not of this well- defined kind. A deeper understanding of the nature of contract has emerged as the legal-rule emphasis associated with the study of discrete contracting has given way to a more general concern with the contractual purposes to be served. Macneil’s distinctions among classical, neoclassical, and relational law are instructive.

1. Classical Contract Law 

As Macneil observes, arty system of contract law has the purpose of facilitating exchange. What is distinctive about classical contract law is that it attempts to do so by enhancing discreteness and intensifying “presentiation” (1978, p. 862), where presentiation has reference to efforts to “make or render present in place or time; to cause to be perceived or realized at present” (1978, p. 863, n. 25). The economic counterpart to complete presentiation is contingent claims contracting, which entails comprehensive contracting whereby all relevant future contingencies pertaining to the supply of a good or service are described and discounted with respect to both likelihood and futurity.

Classical contract law endeavors to implement discreteness and present- iation in several ways. For one thing, the identity of the parties to a transaction is treated as irrelevant. In that respect it corresponds exactly with the “ideal” market transaction in economics.1 Second the nature of the agreement is carefully delimited, and the more formal features govern when formal (for example, written) and informal (for example, oral) terms are contested. Third, remedies are narrowly prescribed so that, “should the initial presentation fail to materialize because of nonperformance, the consequences are relatively predictable from the beginning and are not open-ended” (Macneil, 1978, p. 864). Additionally, third-party participation is discouraged (p. 864). The emphasis is thus on legal rules, formal documents, and self-liquidating transactions.

2. Neoclassical Contract Law 

Not every transaction fits comfortably into the classical contracting scheme.

In particular, for long-term contracts executed under conditions of uncertainty complete presentiation is apt to be prohibitively costly if not impossible. Problems of several kinds arise. First, not all future contingencies for which adaptations are required can be anticipated at the outset. Second, the appropriate adaptations will not be evident for many contingencies until the circumstances materialize. Third, except as changes in states of the world are unambiguous, hard contracting between autonomous parties may well give rise to veridical disputes when state- contingent claims are made. In a world where (at least some) parties are inclined to be opportunistic, whose representations are to be believed?

Faced with the prospective breakdown of classical contracting in such circumstances, three alternatives are available. One would be to forgo such transactions altogether. A second would be to remove those transactions from the market and organize them internally instead. Adaptive, sequential decision-making would then be implemented under unified ownership and with the assistance of hierarchial incentive and control systems. Third, a different contracting relation that preserves trading but provides for additional governance structure might be devised. This last brings us to what Macneil refers to as neoclassical contracting.

As Macneil observes, “Two common characteristics of long-term contracts are the existence of gaps in their planning and the presence of a range of processes and techniques used by contract planners to create flexibility in lieu of either leaving gaps or trying to plan rigidly” (1978, p. 865). Third-party assistance in resolving disputes and evaluating performance often has advantages over litigation in serving these functions of flexibility and gap filling. Lon Fuller’s remarks on the procedural differences between arbitration and litigation are instructive:

(Tlherc are open to the arbitrator… quick methods of education not open to the courts. An arbitrator will frequently interrupt the examination of witnesses with a request that the parties educate him to the point where he can understand the testimony being received. This education can proceed informally, with frequent interruptions by the arbitrator, and by informed persons on either side, when a point needs clarification. Sometimes there will be arguments across the table, occasionally even within each of the separate camps. The end result will usually be a clarification that will enable everyone to proceed more intelligently with the case. [1963, pp. 11— 12]

A recognition that the world is complex, that agreements are incomplete, and that some contracts will never be reached unless both parties have confi-dence in the settlement machinery thus characterizes neoclassical contract law.’ One important purposive difference in arbitration and litigation that contributes to the procedural differences described by Fuller is that, whereas continuity (at least completion of the contract) is presumed under the arbitration machinery, that presumption is much weaker when litigation is employed.

Patrick Atiyah’s views regarding “the failure of classical law” are apposite:

The modem commercial transaction is, in practice, apt to include provision for varying the terms of exchange to suit the conditions applicable at the time of performance. Goods ordered for future delivery are likely to be supplied at prices ruling at the time of delivery; rise and fall clauses in building or construction works are the rule and not the exception; currency-variation clauses may well be included in international transactions. And even where such provisions are not included in the contract itself, business people are in practice often constrained to agree to adjustments to contractual terms where subsequent events make the original contract no longer capable of performance on a fair basis. The rewards and penalties for guessing what the future will bring are no longer automatically thought of as being the natural consequences of success or failure in the skill and expertise of business activity. For example, in Government contracts, ex gratia payments are typically made in fixed price contracts, “where unforeseen circumstances have substantially raised costs and caused the contractor to suffer a loss. ” And conversely, contractors who make “excessive profits” in dealings with the Government may well discover that these are not regarded as the reward for abnormal skill and enterprise, but as the result of miscalculation by the Government which they will be compelled to hand over. Nor are such occurrences peculiar to Government or other public authorities. Even between private commercial organizations, the fact that business relationships are so often continuous means that the desire to maintain the goodwill of other contracting parties is often more important than the letter of a contract. (1979, pp. 714-15]

3. Relational Contracting

The pressures to sustain ongoing relations “have led to the spinoff of many subject areas from the classical, and later the neoclassical, contract law system, e.g., much of corporate law and collective bargaining” (Macneil, 1978, p. 885). Progressively increasing the “duration and complexity” of contract has thus resulted in the displacement of even neoclassial adjustment processes by adjustment processes of a more thoroughly transaction-specific, ongoing- administrative kind. The fiction of discreteness is fully displaced as the relation takes on the properties of a “minisociety with a vast array of norms beyond those centered on the exchange and its immediate processes” (Mac- neil, 1978, p. 901). By contrast with the neoclassical system, where the reference point for effecting adaptations remains the original agreement, the reference point under a truly relational approach is the “entire relation as it has developed [through] time. This may or may not include an ‘original agreement’; and if it does, may or may not result in great deference being given it” (Macneil, 1978, p. 890).

The spinoff to which Macneil refers notwithstanding, commercial law, labor law, and corporate law all possess striking commonalities.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.

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