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“NO CONTRACTUAL RIGHTS WITHOUT PERFECTION RITES” REINVENTING THE FREEDOM OF CONTRACT WITH FORMALITY Gastón de los Reyes, Jr. A DISSERTATION in Ethics and Legal Studies For the Graduate Group in Managerial Science and Applied Economics Presented to the Faculties of the University of Pennsylvania in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy 2014 Supervisor of Dissertation ________________________ Alan Strudler, Professor, Legal Studies & Business Ethics Graduate Group Chairperson _________________________ Eric Bradlow K.P. Chao Professor, Marketing, Statistics and Education Dissertation Committee Alan Strudler, Professor, Legal Studies & Business Ethics Thomas Donaldson, Mark O. Winkelman Professor, Legal Studies & Business Ethics Richard Shell, Thomas Gerrity Professor, Legal Studies & Business Ethics &Management “NO CONTRACTUAL RIGHTS WITHOUT PERFECTION RITES” REINVENTING THE FREEDOM OF CONTRACT WITH FORMALITY COPYRIGHT 2014 Gastón de los Reyes, Jr. Dedication page Given the enormity of the project for me, I would like to thank several people by name whose special mark is deeply embedded—directly or indirectly—in this work. For the architecture of the arguments that follow, I have to give special thanks to Lon Fuller and Oliver Williamson. Williamson identifies the groove of the governance problem that courts exacerbate with the way they enforce contracts. Just as importantly, he provides a systematic and lucid (and Nobel award-winning) account of the way that legal doctrine can impact governance. Lon Fuller also studies law’s role in economic governance, and he goes beyond the reaches of the comparative ranking methodology Williamson develops. Not only can we can rank legal doctrines in terms of their governance consequences, we can aspire for principles towards the natural laws of organizational life that teach us how legal doctrine needs to evolve to reengineer social institutions accordingly. Fuller calls this study eunomics, and my aspiration in this dissertation is to elucidate the eunomics of contract law in governing economic relations. To Karl Marx, who inspired me to see through the normative superstructure of society to the wheels of economic development, with hope to reinvent social relations to free human potential. To Alan Strudler, advisor who identified weaknesses in my evolving position uncompromisingly, providing feedback indefatigably on my way to more defensible claims. To Thomas Donaldson, committee member who showed me the analytical power of linking business ethics and governance with contract theory at the nexus. To Richard Shell, committee member who encouraged and helped me to articulate a doctrinal argument with normative bite and managerial relevance. To Eileen de los Reyes, my mother and educator who inspired me, inter alia, by completing her dissertation, The Moral Empire: United States Relations with Cuba, 1822-1903, when I was 16. To Gastón de los Reyes, my father and engineer who taught me to tinker with ideas for their inner beauty and also scrappily, iterating continuously between prototype and drawing board. To René de los Reyes, my brother who, being self-taught in the matters below, puts my schooling in perspective when he easily cuts to the heart of my most sophisticated arguments. To Inigo and Eliam de los Reyes, my sons who both reinforce my commitment to social justice and show me how naturally overriding care for one’s children so easily veers us towards injustice. To Alexa, the light of my life who gave me the will to get this far. iii ACKNOWLEDGMENT I would like to thank the Department of Legal Studies and Business Ethics, the Wharton School and the University of Pennsylvania for housing and supporting my research so generously. In addition, I would like to thank the Ph.D. Project for its ongoing support and encouragement of my doctoral studies and career as a business school professor. I would like to thank the members of my committee, Alan Strudler, Thomas Donaldson and Richard Shell for their ongoing support of this research project and their insightful feedback. I would also like to thank Amy Sepinwall, Kenneth Simons and David Zaring for commenting on earlier drafts of research in this project. Lynn Sehat stepped in at the very end of the process to provide detailed editorial comments at a moment’s notice, substantially improving the readability of several chapters. I would like to recognize my professors at the Boston University School of Law, especially Pnina Lahav, Kenneth Simons, Gerry Leonard and Daniela Caruso, for inspiring me with a love for the law and the dream to become a professor. I would like to acknowledge the inspiration for the title—and the research overall—that comes from Tae Wan Kim’s emphasis on the centrality of the ritual element in business ethics. In addition and above all, I would like to thank all my teachers—formal and informal—across the span of my life without whom I could not have gotten to see what I got to see by doing this research. iv ABSTRACT “NO CONTRACTUAL RIGHTS WITHOUT PERFECTION RITES” REINVENTING THE FREEDOM OF CONTRACT WITH FORMALITY Gastón de los Reyes, Jr. Alan Strudler Contracts provide managers and entrepreneurs an instrument of governance through which legally distinct parties can pursue transactions—from supply agreements to joint ventures—that the market has not standardized and priced. The willingness of common law courts to enforce contracts—with nothing more than evidence of an exchange—lubricates the economy with a valuable source of commitment that nourishes enterprise. Unfortunately, the social benefit of contract law is compromised by the opportunism that often results from the formalistic approach courts take to enforcing contracts, which is to construct contract terms to apply at all events unless expressly qualified. The party who bargained to receive performance is armed by law to sue even where the deal was disrupted by circumstances the parties did not plan for or price into the bargain. By welcoming opportunistic lawsuits, courts diminish the attractiveness of contracts for economic governance. Tempering the potential injustice of such lawsuits, courts have developed excuse doctrines that justify discharging the defendant from liability notwithstanding the implications of formalistic construction. To date, all efforts to optimize contract law in respect of disruption have sought to strike the right balance between some and no excuse. This dissertation argues that what requires reinvention is not excuse doctrine but rather contract law’s doctrine of construction. Formalistic construction should give way to “perfectionistic” construction, meaning that courts should withhold enforcement unless there is sufficient evidence that parties “perfected” the v allegedly breached obligation by planning for and pricing terms for a disruption like the one that undermined the deal. With the support of strong yet overlooked precedents, this position is defended through four arguments, each anchored in a commitment to the freedom of contract. First, courts committed to enforcing those and only those contract terms parties selected should demand the formality of perfection. Second, perfectionistic construction better advances party autonomy than formalistic construction, with or without excuse. Third, perfectionistic construction pulls the rug out from formalistic opportunism, enhancing the attractiveness of contracts for economic governance. Fourth, requiring parties to undertake the formality of perfection resonates with the legislative aspirations of contract as an autonomous instrument of governance. vi TABLE OF CONTENTS ACKNOWLEDGMENT ................................................................................................. iv ABSTRACT ....................................................................................................................... v TABLE OF CONTENTS ............................................................................................... vii LIST OF TABLES ........................................................................................................... ix LIST OF ILLUSTRATIONS ........................................................................................... x LIST OF ABBREVIATIONS ......................................................................................... xi PREFACE ........................................................................................................................ xii CHAPTER 1: CONTRACTS IN BARGAINS ............................................................... 1 1.1 Contracting and Bargaining ................................................................................................. 2 1.2 Bargaining and Commitment ............................................................................................... 6 1.3 Forms of Commitment ......................................................................................................... 8 1.4 Contract Law and the Modes of Governance ..................................................................... 13 1.5 Comparative Statics ........................................................................................................... 21 1.6 Varieties of Opportunism ................................................................................................... 22 1.7 Formalistic Construction, Introduced ................................................................................ 24 1.8 Excuse Doctrine, Introduced .............................................................................................