Rules vs. Standards in Private Ordering

Abstract

The tradeoff between bright-line rules and general standards is one of the bedrocks of law design. This tradeoff determines how legal norms are composed. The tradeoff between rules and standards pervasively affects private ordering as well: it determines how contractual norms are composed. Yet, scholars exploring the rule vs. standard dichotomy have either entirely overlooked the tradeoff taking place in private orderings or equated it with the public tradeoff that dominates lawmaking.

This Article is the first to systematically examine the rule vs. standard tradeoff in private orderings. The Article carries out this task by identifying and analyzing the fundamental asymmetries between the contractual rule vs. standard tradeoff and the parallel tradeoff taking place in lawmaking. The two tradeoffs differ from each other in three fundamental respects: (1) Contractual standards, unlike legal standards, do not gradually transform into rules over time; (2) The standards’ indeterminacy at the onset of contractual relationships allows the parties to generate and realize the benefits of mutual trust and collaborative knowledge acquisition—a benefit never present in legal standards; and (3) The enforcement of contractual rules and standards does not generate a linear aggregation of social welfare: rather, it involves a strategic give-and-take bargaining that accounts for the benefits of all contractual parties.

The Article explains these asymmetries and unfolds a comprehensive analysis of the rule vs. standard tradeoff in private orderings. This analysis generates a recipe for the choice between contractual rules and standards and yields several insights critical for understanding the design and interpretation of contracts generally and, in particular, for understanding the design and interpretation of sophisticated corporate contracts. Specifically, the Article reveals the impact of the rule vs. standard tradeoff on the choice between debt and equity financing and governance and on the design of the most intensely negotiated provisions in corporate acquisition agreements.

Keywords: Rules, Standards, Contracts, Corporations, Legal Theory