Thursday, October 22, 2009

Too Ignorant to Enter into a Contract

Posted by Neil H. Buchanan

In my new FindLaw column, available here, I continue my recent discussion of the inextricable role of government in making it possible for a country to benefit from a market economy. I focus on the proposed Consumer Financial Protection Agency (CFPA), the brainchild of Harvard Law Professor Elizabeth Warren that would rein in predatory lending and would be designed to allow regular people to engage in responsible borrowing.

My argument in that column is that those who oppose the CFPA on the ground that it inappropriately injects government into private transactions are simply incorrect. Private transactions, and especially loans, are only possible (or appealing) because they are enforceable by government. There is a regulatory system in place that shapes the market for consumer loans, and that system is currently very pro-lender. (I do not even mention the change in the bankruptcy law in 2003 that tilted the playing field even more decidedly in favor of lenders.)

In passing, I mention in the column that it is especially appalling to claim that we can expose the average American to the tender mercies of the consumer loan market when we as a society have failed so abysmally to educate so many of our citizens. If the social Darwinism of our time insists that people must read the contract and protect themselves, then that makes it all the more important that we make sure that they receive the education necessary to be able to understand a contract when one is offered.

This observation might lead us to propose an expansion of the doctrine that provides a defense in contract on the basis of mental deficiency (similar to the doctrine of "infancy," in which anyone under 18 cannot be held to a contract -- even though they can enforce a contract against others). We could essentially say to Congress: "Either give people a decent education, or give them the ability to protect themselves against their own ignorant errors in daily commerce." As initially appealing (or, perhaps, rhetorically delicious) as that idea might be, however, it ultimately misses several key points.

First, as I note in today's FindLaw column, even educated people do not read contracts. Because I am a Contract Law professor, I go out of my way to read as many contracts as I can, but I click through licensing agreements as fast as anyone. The presumption that we could have a system of contract with fewer or no equitable defenses if only everyone had a J.D. is fatuous. Contracts are often inherently complicated and often require more education than could reasonably be provided to the vast majority of citizens. (The consumer loan contract in Williams v. Walker-Thomas Furniture, the famous "unconscionability" case, is a great example of a contract that is impenetrable even after multiple readings by people with years of higher education.)

Second, the classical ideal of face-to-face, issue-by-issue negotiations that underlies contract law is simply inapt for the modern economy. Acting as if we can simply give people better educations and then send them out on their own in a world of basic contract law ignores the change that mass consumerism wrought on the notion of contracting. Contracting is now too expensive to be done the old fashioned way. When the assembly line replaced individual craftsmanship, non-negotiated contracts replaced old-fashioned customized contracts. The law has never really caught up to that change, notwithstanding Llewellyn's best efforts. Pushing the education angle inadvertently pushes us back in the direction of this outmoded way of thinking about contracting.

Finally, third, the "either educate them or protect them from harsh contract outcomes" approach would almost certainly lead to a disastrous conclusion: that it is much cheaper to change the law of contracts (to treat adults as if they were infants or mentally defective) than it would be actually to educate them. In fact, it would not ultimately be cheaper, because the choice to give up on people's education would undermine future economic prosperity. However, in exactly the same way that going cheap on bridge repairs looks financially appealing until it is too late, the high cost of failing to educate people would not be obvious until it is much too late. (The non-economic benefits of education are arguably even more important.)

When I was clerking in Oklahoma (which at the time ranked 45th in the country in overall educational attainment, if I recall correctly), I discovered up close what a truly uneducated populace is like. Commerce simply did not work as smoothly as in other places that I have lived. One consequence of mass ignorance, moreover, is that education is not respected. As one prominent Oklahoman put it to me, with an exaggerated and sardonic twang: "We're just too dumb to educate ourselves." We must always resist any temptation to make it seem acceptable to keep people in ignorance.


Patrick S. O'Donnell said...

Seems to me that this would be a nice opportunity to re-visit the hallowed notion of "adhesion contracts" which seem to be the legal sanction for one party to take advantage of another owing to egregious differences in bargaining power (e.g., that 'knowledge is power' thing).

Patrick S. O'Donnell said...

You did bring up the "unconscionability" thing....

Neil H. Buchanan said...

Thanks to Patrick O'Donnell for your comments. Adhesion contracts are simply a description of the pre-written contracts that have become ubiquitous in modern commerce. Declaring a contract adhesive is not a sanction but simply a description. Such contracts can be completely innocuous, but they are held to a slightly higher level of scrutiny in situations where a consumer claims something like unconscionability.

The issue isn't that the doctrines don't exist in contract law to protect consumers but that they are so severely limited as to be useless except in the most extreme cases. Deliberately expanding their use would be a good thing, in my opinion, especially given how complicated financial contracts have become. The direction in the courts has been quite the opposite for the last thirty years, however.

egarber said...
This comment has been removed by the author.
egarber said...

Neil, nice Findlaw piece.

I'd like to pull in another dynamic. For all the talk about tort reform, isn't this kind of regulatory structure the kind of thing that limits liability for big companies? In other words, if the new board approves a practice, that seems like massive firepower for a potential civil defense against claims of predatory lending, fraud, etc. That certainty is a good thing for companies.

Patrick S. O'Donnell said...

Adhesion contracts makes sense when the parties are both business entities, but as Hugh Collins notes, "When businesses impose standard form contracts upon consumers, however, the terms are likely to give expression solely to the expectations of the business." This means one side has monopolized the power in a power relation and thus there is no longer JOINT self-regulation but in fact unilateral regulation by one party, hence the use of standard clauses to allocate risks onto the consumer. Adhesion conracts involving consumers are structured so as to accord the business disparate bargaining power in any post-breach negotiations:

"When the consumer makes a complaint, the business can point to clauses that exculpate or greatly diminish the responsibility of the business for default, which serve to discourage the pursuit of the complaint. On the other hand, the standard form often contains many devices enabling self-enforcement by the business against the debtor, so that there is no need for negotiation at all. The message to the consumer is to pay up or the goods will be repossessed, and any defects in the goods are not the responsibility of the business."

This disparity in bargaining power doesn't (typically) apply to routine commercial transactions and is exacerbated in the case of consumers owing to the fact that, in consumer markets, consumers "are unlikely to demand to extend their search for goods beyond price and quality comparisons," thus "the business retains a discretion under the contract over whether or not to perform the contract and over the level of quality which it will provide" (i.e., they are structurally advantaged to exploit a kind of market failure).

As Neil says, doctrinally or theoretically consumers are protected, but consider the following:

"A typical provision permits judges to invalidate unfair, unreasonable, or unconscionable terms. If a dispute with a consumer reaches court, therefore, there exists a strong chance that a fierce exclusion clause will be declared invalid and not binding on the consumer. It should be evident, however, that this style of private law regulation is unlikely to have any impact on the use and content of adhesion contracts. Since it is not unlawful in itself to use the oppressive terms in a standard form contract, there is no reason to leave them out. Even if the terms are of doubtful validity, there is in fact good reason for leaving them in as a source of bargaining strength in post-breach negotiations. Since the consumer is most unlikely to litigate the issue before a court because of the expense involved, the objectionable clauses will never be formally invalidated, and so they can be relied upon at least for the purposes of negotiating or imposing a settlement on the consumer. These considerations still apply even if a court determines that the clause is invalid, for there is no reason to refrain from using the clause as a bargaining counter in contracts with other consumers. These customers are most unlikely to be able to discover whether or not a court has declared a clause invalid, and the precedent may always be distinguished by introducting a minor alteration in the contract. If the purpose of this regulation includes an attempt to discourage the use of oppressive clauses in adhesion contracts, then plainly it is poorly designed to achieve compliance."

There are other problems identified by Collins with this kind of private law regulation but this will have to suffice. (Please see his useful book, Regulating Contracts, 1999)

Neil H. Buchanan said...

Between egarber's and Patrick S. O'Donnell's comments, I have the basis of my post for next week! Thanks.

Neil H. Buchanan said...

I've decided that I will use the comments here as the starting point for my next FindLaw column, 11/5/09, rather than next week's DoL post. Thanks.

budopjuruh said...

everythings bout law..

michael a. livingston said...

Is this post tongue in cheek or does Prof. Buchanan really intend to insult the intelligence of an entire region of the country? If people in Oklahoma are so stupid, why did he decide to clerk there? No surprise the Democrats do poorly in the south is there?

Michael C. Dorf said...

Michael, how does it insult the intelligence of the people of a state (much less a region of which the state is a part) to say that they are relatively ignorant as a result of an inadequate education? Neil said nothing whatsoever about intelligence. He was talking about what people in Oklahoma didn't know because of how their educational system had failed them, relative to the educational systems in other parts of the country.

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