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Commercial impraticability

Even the sacred repositories of a doctrine may occasionally contravene its tenets: fond of the powerful tools at their disposal and eager to show how far it is possible to go along the preferred track, they may get trapped by the fascination of minor details and lose sight of the polar star. But lack of coherence does not pay. Sooner or later, the latent inconsistency surfaces, denouncing the non sequitur between the premises and the alleged developments, so that achievements are paired by failures.

I suspect the economic analysis of contract law did not succeed in shunning such a danger. Let me offer a couple of examples, starting from the hotly debated issue of commercial impracticability.

The conventional wisdom is well known. It dictates that a basic function of contract law is filling out the parties' agreement by interpolating missing clauses. This task becomes crucial when the omission concerns the allocation of risks. When a risk materializes that is not explicitly allocated and one party seeks to be excused from performing its contractual obligation, the court must intervene. Sometimes the court can infer from the terms of the contract an implicit assignment of risk for the frustrating contingency, and the omission boils down to a problem of interpretive incompleteness, which is no incompleteness at all. But in other instances, neither the four coners of the contract nor the surrounding circumstances offer any guide. So, the court cannot assume an implicit allocation of risk by inquiring into the intentions of the parties. Instead, the missing term must be provided exogenously. Standard economic theory suggests that, in the wake of the imperative to pursue efficiency, liability should be assigned to the party that was the cheaper preventer of, or insurer against, the contingency that frustrated the contract. The rule is said to be advantageous not only because it minimizes the total cost to society created by such risks, but also because it comes close to a reasonable reconstruction of the will of the parties, had they thought to assign the unallocated risk. In fact, as Posner underlines, they have a mutual interest in minimizing the cost of performance (or, if you prefer, to maximize the surplus from contracting they can share9, and the court can use this interest to fill out a contract along lines that the parties would have approved at the time of making the contract. At any rate, the rationale behind the rule is clear enough: creating a default rule, so that the future contracting parties may rely on it or, if they prefer --but this should turn out to be a marginal occurrence, unless we have to deal with so called penalty default rules--, write the contract in a way which permits to achieve a different result. "Thus", quoting Ulen and Cooter, "if parties do not want the cheaper preventer of, or insurer against, to be saddled with the risk of non-performance if that contingency comes to pass, thay should say so explicity". So far, so good, since the directive which appears to me the driving force of the economic analys in the field is patently privileged.

Actually, the strength of the above propositions is hardly questionable if incompleteness is due to vagueness in the contract language, or to absent-mindedness. In both cases, the judicial outcome is going to be harsh for the inadvertent loser, but the lesson is unmistakable: future parties will be more careful in drafting their deals.

But there are contingencies which escape the reasonable foresight of the economic actors. And here the picture gets obscured. George Stigler won a deserved Nobel prize explaining that there is a threshold beyond which gathering further information makes no sense. If the cost of visiting an additional shop exceeds the discount in price that can be reached, shopping should be halted. The same obtains for negotiations. As Joskow once put it, the basic normative question is not whether the parties could have foreseen the supervening events --after all, Saint Anselm teaches everything can be foreseen, including the most fancyful disasters--, but whether they should have done and consequently make those events a basis for the contract terms: a more demanding test, which should promote a more efficient use of the available information and, in the long run, should expel from the market the actors who do not employ efficiently the information about the alternative states of the world, exactly as it would happen in a competitive market, not penalized by transaction costs.

Be it as it may, we must admit some contingencies are so remote and unlikely to occur that, instead of undergoing the costly process of divising how to deal with them if they materialize, the best answer is to ignore them completely. Leaving aside the diffiiculties we might experience in trying to select the eligible situations (although I tend to support a relative evaluation, ready to consider unforeseeable events that the parties are fully aware may occur, whenever the costs of careful drafting to deal with them exceeds the benefits discounted by the low probability that the contingency will actually occu), it is important to stress the neglect choice qualifies as rational --we are obviously referring ourselves to bounded rationality--, since the waste of resources involved in the attempt to govern so marginal a risk is unwarranted.

The consequences are manifold. First, every contract is bound to be, from the point of view we are examining, incomplete to a certain degree; overall coverage is warranted only for the contingencies that can be rationally foreseen. Second, the maverick risk is not allocated, and rightly so, since nobody should be blamed for such omission. As between the parties, the gap filling by the court will be, by definition, arbitrary. One will get a windfall gain, the other will suffer a windfall loss, both undeservedly: but this happens whenever a unanticipated risk is allocated ex post. Third,, and more intriguing, the teaching value of the default rule vanishes. The parties of future dealings will cope with the same informational trade-off as the one surprised by the unexpected contingency; and will rationally come to the same decision to neglect it. If we stick to the premises of our argument, it is necessary to admit that the hard task of tracing, ex post, the cheaper preventer won't help, since, in thesis, there is nothing worth preventing. And, as far as the better capability of covering by insurance is concerned, Pietro Trimarchi has convincingly showed that the main circumstances we are alluding to --extraordinary and unforeseeable events which affects society as a whole or large sections of it, for instance a sudden burst of inflation, a dramatic rise or slump inthe price of a product as a consequence of, international crisis and so forth-- are the very ones which make insurance, when not impossible, at least unworkable, whereas the criterion of placing the risk on the superior insurer could only play a role in situations where insurance is readily available.

Summing up. In contexts where no risk allocation should occur, the implementation of the recipe suggested by the mainstream economic analysis fails the goal of providing a more palatable means of resolving these kinds od disputes than has heretofore offered. Not only will the party, called to absorb a risk for which it was not retributed, sense a fierce stigma of injustice, but the hope that "more perfect contracts would be written in the future" is condamned to a fate of futility, since signals, if any, are dispersed on subjects that cannot gather them. Such an economic interpretation appears, on the whole, no less capricious than the ones it should replace: being incapable both of rendering justice and of teaching how to behave in the future, it will reveal the same qualities of a decision taken by flipping a coin or of a judicial response granted on the ground of the blue eyes of the plaintiff.

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