Do Networks Govern Contracts?

Abstract

An influential literature in private law argues that the legal system interferes with modern markets’ “private ordering.” Private ordering refers to parties relying upon informal institutions, like social norms and reputational sanctions, to enforce legal obligations. This informal governance is made possible by thick networks of social or commercial relationships, which circulate information about parties’ behavior. Social networks, not the state, govern commerce.

This Article argues that the private ordering literature has overlooked a paradox at the heart of its theory. The same networks that circulate reputational information also provide conduits for valuable technical information to leak from one company to another. In many 21st century markets, where innovation is crucial for a company’s survival, those technological spillovers are highly salient. The trading network becomes a cost, not just a benefit.

This Article provides new empirical evidence that parties in highly innovative markets actually rely heavily on the formal legal system to address the risks that networks create. It shows that parties increasingly use formal contracts as they become more connected in a market, just the opposite of what private ordering theory predicts.

Innovative companies “creatively order” the development of new technology with formal law, not with old-fashioned informal sanctions. Creative ordering recaptures a role for the state in modern markets, leading to important normative implications in two settings. The first is contract law, where creative ordering provides a new basis for rejecting calls for minimalistic contract enforcement. It also elevates the social benefits of spillovers as a key normative value at the heart of contract enforcement, rather than a peripheral issue specific to, for instance, employment contracting. The second setting is industrial policy, where creative ordering provides the administrative state with a new tool to promote economic development. In fact, creative ordering is already playing this role, as the U.S. federal government’s and European Union’s strategy of contracting for Covid-19 vaccine innovation illustrates.

Keywords: contract law, contract design, private ordering, innovation, social networks