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Text and Context: Contract Interpretation as Contract Design

Ronald J. Gilson

Stanford Law School; Columbia Law School; European Corporate Governance Institute (ECGI)

Charles F. Sabel

Columbia University - Law School

Robert E. Scott

Columbia University - Law School

February 1, 2014

Columbia Law and Economics Working Paper No. 469
Stanford Law and Economics Olin Working Paper No. 457

Contract interpretation remains the most important source of commercial litigation and the most contentious area of contemporary contract doctrine and scholarship. Two polar positions have competed for dominance in contract interpretation. In a textualist regime, generalist courts cannot consider context; in a contextualist regime, they must. Underlying this dispute are contrary assumptions about the prototypical contract each interpretive style addresses. For modern textualists, contracts are bespoke, between legally sophisticated parties who embed as much or as little of the contractual context as they wish in an integrated writing, and prefer to protect their choices against judicial interference by an interpretive regime including parole evidence and plain meaning rules. For contextualists in contrast, contracts are between legally unsophisticated parties in two prototypical settings. The first is the mass market, standardized contract between sophisticated sellers and unsophisticated consumers, who cannot bargain over contractual terms; the second involves commercial parties doing business in a deeply nuanced world where formal and informal understandings mix and the meaning of a particular contract can be illuminated by the parties' course of dealings. For the contextualist, willfully restricting a court's access to information bearing on the parties' real relationship in both cases degrades judicial interpretation.

We argue that the narrow focus on which prototype should apply universally has erroneously framed discussion of the parties’ choices and led to an inconclusive and limited debate about the role of courts in contract interpretation. The range of options for parties and generalist courts is much more diverse and variegated than the choice between ex ante party autonomy and ex post adjudication. We present a typology of transactional settings — the design space for contract — sufficiently rich to capture the breath of current contractual experience but sufficiently parsimonious to clarify the central relationship between the factors that shape the design of any given contract and the role of courts in interpreting it. We show that design and judicial response depends, first, on the level of uncertainty and, second, on the thickness of the market — whether there are many traders or few engaged in a similar class of transactions. The higher the level of uncertainty, the less workable complete, state-contingent contracts become, and the more parties develop interpretive mechanisms based on rich and regular exchange of information on a project’s progress that allows each to gauge the other’s capacity to define and produce a product. The greater the number of traders engaged in a transaction, the more likely that the interpretive regime — terms adapted to current need — will be provided by a trade association or, given collective action problems, a public regulator. The interplay of uncertainty and scale illuminates new forms of contracting among legally sophisticated parties unanticipated in discussions of textualist prototypes, and recasts the contextualist prototypes as special cases that demand novel institutional responses, including generalist courts sufficiently versed in the parties’ practices that they resemble early courts of equity. More generally, our analysis reveals a surprising complementarity between public regulation and common law adjudication in a variety of settings. Contractual interpretation today should attend to today’s contracts and courts: Our aim is to escape the stalemate between textualists and contextualists and open the way for doctrine and debate to support the novelty of contemporary contracting practices.

Number of Pages in PDF File: 84

Keywords: contract interpretation, contract design, contract ABD innovation

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Date posted: February 13, 2014 ; Last revised: March 12, 2014

Suggested Citation

Gilson, Ronald J. and Sabel, Charles F. and Scott, Robert E., Text and Context: Contract Interpretation as Contract Design (February 1, 2014). Columbia Law and Economics Working Paper No. 469; Stanford Law and Economics Olin Working Paper No. 457. Available at SSRN: http://ssrn.com/abstract=2394311 or http://dx.doi.org/10.2139/ssrn.2394311

Contact Information

Ronald J. Gilson (Contact Author)
Stanford Law School ( email )
559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-723-0614 (Phone)
650-725-0253 (Fax)
Columbia Law School ( email )
435 West 116th Street
New York, NY 10025
United States
212-854-1655 (Phone)
212-854-7946 (Fax)
European Corporate Governance Institute (ECGI)
B-1050 Brussels
Charles F. Sabel
Columbia University - Law School ( email )
435 West 116th Street
New York, NY 10025
United States
Robert E. Scott
Columbia University - Law School ( email )
435 West 116th Street
New York, NY 10025
United States
212-854-0072 (Phone)
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