The Value of Accuracy in Contract Interpretation

45 Pages Posted: 27 Oct 2021

See all articles by Omer Pelled

Omer Pelled

Bar Ilan University School of Law

Ohad Somech

Federmann Cyber Security Research Center, The Hebrew University of Jerusalem

Date Written: August 5, 2021

Abstract

The economic argument for textualism rests on two tenants: that rules of interpretation are majoritarian defaults and that risk-neutral and sophisticated parties do not care about the courts’ accuracy in interpreting their agreement. In this Essay, we challenge this second tenant.

Risk-neutrality, we show, implies indifference to accuracy when it comes to the parties’ ultimate objective of maximization, namely their joint surplus. But this does not mean that parties are also indifferent to accuracy in interpretation. On the contrary, whenever accuracy can affect their joint-surplus risk-neutral parties seek to maximize accuracy in interpretation. There are two additional reasons sophisticated parties care about accuracy. Accuracy, or the lack thereof, may entice parties to adopt inefficient terms, and it may also affect the contractual price. Both suggest that accuracy affects the preferences of sophisticated commercial parties.

Showing the value of accuracy is the first significant contribution of this Essay. Its second contribution is to harmonize the other considerations affecting the parties' preferences. Where rules of interpretation are considered majoritarian defaults and accuracy is believed to be unimportant, finding the factors that determine the parties' preferences became a fertile ground for research. Drafting costs, litigation costs, settlement costs, contractual uncertainty, market thickness, and types of terms were all offered as factors controlling the parties' preferences. This myriad of sometimes conflicting and often seemingly unrelated factors makes an eventual determination of majoritarian preferences challenging to achieve. We argue that appreciating the value of accuracy can create order in this fragmented picture.

A preference for accuracy in interpretation, we show, can also account for existing contracting practices. We illustrate this by using examples of MAC clauses in merger and acquisition contracts, force majeure clauses, acceleration rights in loan agreements, and alternative dispute resolution clauses.

Keywords: Contract Law, Contract Interpretation, Law and Economics, Textualism, Contextualism

JEL Classification: K12

Suggested Citation

Pelled, Omer and Somech, Ohad, The Value of Accuracy in Contract Interpretation (August 5, 2021). Available at SSRN: https://ssrn.com/abstract=3915639 or http://dx.doi.org/10.2139/ssrn.3915639

Omer Pelled

Bar Ilan University School of Law ( email )

Ramat Gan, 52900
Israel

Ohad Somech (Contact Author)

Federmann Cyber Security Research Center, The Hebrew University of Jerusalem ( email )

Jerusalem
Israel

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