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An Embedded Options Theory of Indefinite Contracts


George S. Geis


University of Virginia School of Law


Minnesota Law Review, Vol. 90, 2006

Abstract:     
Option theory is beginning to generate robust insights in the legal literature, and it is particularly well-suited to contract law. This Article develops an embedded options theory of indefinite contracts, focusing on the proper scope of the indefiniteness doctrine - a core principle of contract law invalidating contracts that are too vague. This approach offers answers to two puzzling questions. First, why do parties write deliberately vague contracts, especially when they can contract with precise, verifiable metrics at a low cost? Second, what should a court do when confronted with an indefinite contract? Should it throw out the entire contract, impose a popular term, or do something else? This Article shows how the use of indefinite terms plus active judicial gap-filling can create an embedded option - the valuable opportunity to take action in the future based on outcomes that are uncertain today. It then argues that these embedded options can be problematic from an economic point of view because they are unlikely to be fully appreciated by both parties to the contract. This means that embedded interpretative options will sometimes distort efficient trade and investment decisions. In short, there are under-explored costs to contractual gap-filling. Ultimately, then, courts should resist the temptation to instinctively plug gaps and recognize that the indefiniteness doctrine has a meaningful role to play in contract law.

Number of Pages in PDF File: 50

Keywords: contract theory, law and economics, option theory, indefiniteness doctrine, incomplete contracts

JEL Classification: K12

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Date posted: October 12, 2005 ; Last revised: August 19, 2009

Suggested Citation

Geis, George S., An Embedded Options Theory of Indefinite Contracts. Minnesota Law Review, Vol. 90, 2006. Available at SSRN: http://ssrn.com/abstract=817171

Contact Information

George S. Geis (Contact Author)
University of Virginia School of Law ( email )
580 Massie Road
Charlottesville, VA 22903
United States

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