Contract Law, Party Sophistication and the New Formalism
44 Pages Posted: 8 Sep 2009 Last revised: 23 Jul 2013
Date Written: August 9, 2009
With increasing frequency, courts are mentioning party sophistication as relevant to whether a contract has been formed, whether a contract is enforceable, how the contract should be interpreted, and even, in some instances, the determination of an appropriate remedy. Sophisticated parties are held to a different set of rules, grounded in freedom of contract. It is presumed that a sophisticated party was aware of what to bargain for and read (or should have read) and understood (or should have understood) the terms of a written agreement.
But, just what do courts mean when they call a contracting party “sophisticated”?
“Sophistication” is a slippery word. Courts and scholars have not established instructive criteria, and often presume that parties to a commercial transaction are sophisticated. Widely cited and highly regarded works in the area of contract law have stated that their theories only apply to sophisticated parties, without a serious attempt to explain who falls into that category. Likewise, all too often, courts label parties “sophisticated” without any analysis.
Part I of this Article positions the discussion in theoretical context, and describes the significance of party sophistication as a compromise between formalist and realist concerns. Part II collects examples of contexts in which courts have used party sophistication as a tool to organize the world of contracting parties and, with that, the applicable legal principles. For sophisticated parties, in answering a wide array of contracts questions, courts employ a formalist approach. Part III begins descriptively and addresses the general lack of meaningful assessment of party sophistication. Drawing upon review of hundreds of cases, Part III details the attributes common among parties that courts have deemed sophisticated, and begins to draw the contours of a standard for sophistication.
Finally, Part IV presents the central normative claim of the Article: courts should undertake a more exacting, fact-driven approach in addressing party sophistication. Drawing upon the extensive review of case law, Part IV provides a definition of sophistication that assesses information and resource asymmetries among the contracting parties. The proposed standard assesses whether a party, relative to the other parties to the contract, has sufficient experience and access to information and resources that that person or entity understands or should understand the intricacies, risks and consequences of the transaction. This standard takes into account the theoretical underpinnings of applying the sophistication label: for knowledgeable and experienced parties dealing in familiar industries, private autonomy should prevail over normative concerns. However, where a party lacks relative knowledge and experience, normative concerns may outbalance the literalism and private autonomy championed by formalism.
As it stands now, however, in the absence of a meaningful definition of sophistication, courts are not actually addressing the context of the deal. Rather, they are simply reciting well-worn clichés about “sophisticated parties dealing at arms’ length.”
Keywords: contracts, formalism, formation, interpretation, enforceability, damages, sophistication, reliance waiver, exculpatory clause, forum selection, arbitration, employment
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