There is good evidence that the level of detail in legal contracts may crowd out moral intentions in relation to the agreements that the contracts represent. And despite the evidence seen in my prior blog on the importance of fairness to the law (see Fairness piercing the veil, and filling gaps in the law), it seems that there are increasing moves to squeeze fairness out from legal considerations, at least in the US legal system. Unsurprisingly perhaps, that is only to the law’s detriment, and to society’s.

Pennsylvania law professor Tess Wilkinson-Ryan found that, generally, people are averse to breaching contracts, and typically believe that those in breach should make higher pay-outs than efficiency might indicate was necessary. Typically, contract law expects the wronged party to mitigate their loss – for example seeking an alternative provider of a contracted-for widget rather than just ceasing all production and blaming the delinquent supplier. But Wilkinson-Ryan finds that most people think that the delinquent supplier should be held accountable for more than this mitigated loss.

She also finds, however, that if a contract includes a liquidated damages clause, most people’s response to any contractual failure is less morally activated, and tends to accept that the damages built into the contract are appropriate. This particular consequence of the sense of fairness means that breach of contract becomes more acceptable: “it seems reasonable to conclude that subjects’ moral qualms deter efficient breach, but that the presence of a liquidated-damages clause in a contract reduces those qualms and, in turn, encourages breach”. 

At its core, the finding is that: “it is not clear that breaching a contract with a liquidated-damages clause comes firmly within the category of breaking a promise”. Wilkinson-Ryan contrasts this attitude with that of a contractual breach that requires a lawsuit or the appointment of an authoritative body to assess what is the fair recompense for that breach. At such points, considerations of fairness and morality come into play; not so much if the contract has detailed an agreed level of damages.

A somewhat similar finding emerged from a sociological study considering trust in markets where contracts are complete or not complete. In this case, the quality of the relevant goods was variable. Where the contract enforced a level of quality, trust did not develop in supply relationships. However, in contrast, where the quality was not subject to contract, trust and fair treatment became vital parts of supply chain relations as the clear alternative provider of a degree of quality control. The development of such trusting and fair relationships had important and positive knock-on consequences: concern for one’s own reputation and considering others’ reputations, and a greater sense of commitment to trading partners. There are benefits from leaving space in contracts for fairness and trust to develop.

The long-term positives from such a commitment are shown in a second similar study, where again the quality of goods was either subject to contract or not capable of being contracted for. Where contracts were complete and included details on quality, trading relationships were less durable: 90% lasted less than 3 periods. In contrast, when trust and fair treatment were needed to fill the gaps in the contracts, trading relationships generally lasted much longer. 

This consistent finding that deploying fairness rather than detailed legal agreements brings clear benefits makes the recent tendency in the US legal system to squeeze out fairness altogether still more concerning. In my forthcoming book, I highlight the way in which the US law in the areas of antitrust (rules against monopolist behaviours and other abuses of competitive position) and bankruptcy has been interpreted such that fairness no longer plays a part. Formerly, fairness featured heavily in the legal approach to both issues. The consequences of this shift aren’t great.

A key study considers recent changes to the US antitrust regime that have essentially meant it abandons considerations of fairness to consumers and focuses solely on narrow interpretations of the concept of economic efficiency. It argues that these changes mean that the law has failed “to control the nefarious consequences of unrestrained market power”.

With regard to bankruptcy, the key legal precedent was a Delaware Supreme Court decision in 2007, North American Catholic Educational Programming v Gheewalla. This essentially removed the previous prioritisation given to equitable treatment of creditors – an expectation of fairness – and required instead a strict contractual approach to be applied. Since that abandonment of fair treatment of creditors by failing companies, battles have ensued between different finance houses over their carcases (part of so-called ‘bankruptcy hardball’). Though the US Chapter 11 bankruptcy process in theory gives heavy weight to the post-bankruptcy survival and prosperity of the stricken business, often this battling between finance houses leaves little value within the business to give it any chance of later prosperity. 

According to Harvard Law School professor Jared Ellias and Brown Rudnick lawyer Robert Stark, the consequences are profound:

“The slow moving trains of justice here have broader consequences than denying justice to one particular plaintiff or another. It emboldens the entire private equity industry to extract excessive dividends from portfolio firms, knowing that it might take more than a decade to litigate the fraudulent transfer action, by which time every employee currently at the private equity firm will be gone.”

Contracts are being written to crowd out fairness; the law (at least in the US) is often being understood to squeeze out fairness and lean instead on narrow contractual or economic readings. That isn’t good for the legal system, and it seems that it isn’t good for society either.

See also: Unfairness overwhelms bankruptcy
Fairness piercing the veil, and filling gaps in the law

I am happy to confirm as ever that the Sense of Fairness blog is a purely personal endeavour

Do Liquidated Damages Encourage Breach? A Psychological Experiment, Tess Wilkinson-Ryan. Michigan Law Review 108, 2010

The Emergence of Exchange Structures: An Experimental Study of Uncertainty, Commitment, and Trust, Peter Kollock. American Journal of Sociology, 100, No 2, 1994

Relational Contracts and the Nature of Market Interactions, Martin Brown, Armin Falk, Ernst Fehr. Econometrica 72, No 3, 2004

The antitrust F word: Fairness considerations in competition law, Sandra Marco Colino. Journal of Business Law, 2019

North American Catholic Educational Programming Foundation, Inc v Gheewalla, Delaware Supreme Court 930 A.2d 92 (Del. 2007)

Bankruptcy Hardball, Jared Ellias, Robert Stark. 108 California Law Review 745, 2020