Plain Meaning vs. Broad Interpretation: How the Risk of Opportunism Defeats a Unitary Default Rule for Interpretation

TLDR: In this paper, the authors argue that it is wrong to assume that courts must make a dichotomous choice always to prefer extrinsic evidence or always to exclude it, and they identify a number of factors that may help to resolve which methodology will achieve those goals in different factual settings.

Abstract: The problem of contract interpretation presents courts with significant questions about the nature and methodology of judicial intervention into privately arranged affairs. The court often assumes an active role in interpreting the words of a written contract in part because words have more than one meaning or because a contract is incomplete. When a court chooses amongst variable meanings, or interprets contracts to craft limitations on parties' behavior when express limits do not exist, its choice must be then justified using a framework explored in this essay. Traditionally, commentators have advocated one of two general approaches to supply the methodology to govern judicial choices of contract meaning. The first restricts interpretation to the words used in the contract and the other accepts extrinsic evidence about what one or both of the parties to the contract intended that the words would mean or objective evidence of the meaning supplied by context or evidence of how ordinary commercial parties in a trade used the term or behaved in the current contract. This essay argues that it is the wrong to think that courts must make a dichotomous choice always to prefer extrinsic evidence or always to exclude it. Sometimes the appropriate interpretive methodology should explicitly forego extrinsic evidence while at other times it should embrace extrinsic evidence. The choice between the two methodologies should depend upon an assessment in each case about which interpretive methodology is most likely to (1) curb opportunistic behavior; (2) implement the parties' actual intentions, and (3) achieve these overall goals, in each case in a cost-effective way and thereby maximize gains from trade. The essay identifies a number of factors that may help to resolve which methodology will achieve those goals in different factual settings.

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Case Western Reserve University Case Western Reserve University
School of Law Scholarly Commons School of Law Scholarly Commons
Faculty Publications
2007
Plain Meaning vs. Broad Interpretation: How the Risk of Plain Meaning vs. Broad Interpretation: How the Risk of
Opportunism Defeats a Unitary Default Rule for Interpretation Opportunism Defeats a Unitary Default Rule for Interpretation
Juliet P. Kostritsky
Case Western University School of Law
, juliet.kostritsky@case.edu
Follow this and additional works at: https://scholarlycommons.law.case.edu/faculty_publications
Part of the Contracts Commons
Repository Citation Repository Citation
Kostritsky, Juliet P., "Plain Meaning vs. Broad Interpretation: How the Risk of Opportunism Defeats a
Unitary Default Rule for Interpretation" (2007).
Faculty Publications
. 538.
https://scholarlycommons.law.case.edu/faculty_publications/538
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Plain Meaning vs. Broad Interpretation:
How
the Risk
of
Opportunism
Defeats
a Unitary
Default Rule For Interpretation
1
Juliet
P.
Kostritsky2
W
ITHOUT
interpretation
many
contracts would remain uncertain
of
meaning and incapable
of
enforcement. Courts
interpreting
contracts
must grapple with
what
the words
of
a contract
mean
as well
as
how to
make that determination.
3
These
questions are likely to
be
troubling
when
the plaintiff and
defendant
have dueling interpretations
of
the
meaning
of
a contract's terms.
4
The
problem
of
contract interpretation presents courts with significant
questions about
the
nature and methodology
of
judicial intervention into
private arrangements.
The
court often assumes an active role in
interpreting
the words
of
a written contract
5
in part because words have more than
one meaning or because a contract
is
incomplete.
6
When
a court chooses
amongst variable meanings, or interprets contracts to craft limitations
on parties' behavior
when
express limits do
not
exist, its choice
must
be
justified using a justificative framework explored below.
Traditionally, commentators have advocated
one
of
two general
approaches to supply the methodology to govern judicial choices
of
contract meaning.
7
The
first restricts interpretation to the words used in
I
This
article
was
selected by the Program Commirree
of
the American Law and
Economics Association for presentation at the annual meeting
of
the American
La~
and
Economics Association that was held
MayS
and
6,
2007
at
Harvard Law School and presented
on May
6,
2007.
2 John Homer Kapp
Professor
of
Law, Case Western Reserve University School
of
Law. I am grateful for helpful comments from Professors Ronald J. Coffey,
Peter
M. Gerhart
and Avery Katz. I
am
grateful for
the
research assistance provided by Michael Dory (J.D.
University
of
Chicago Law School 2007).
3 Judges or juries or arbitrators make these determinations.
See
Richard
A.
Posner,
The
Law and
Economics
of
Contract
Interpretation,
83
TEx.
L.
REv.
IS8J, I s8z (zoos). Interpretation
must precede any judicial determination
of
whether
a breach has occurred and what perfor-
mance
is
due under the terms of the contract.
4
Of
course without "a real uncertainty about meaning, the challenge [of plaintiff or de-
fendant] will present no interesting question
of
interpretation." !d.
s Steven Shavell,
On
the
Writi11g
and
the
lnterpretatiotJ
of
Contracts,
22
J.L. EcoN. &
ORG.
289, 290 (zoos).
6
See
i11fra
note 42.
7
These
approaches assume that
the
difference
in
meaning has not prevented contract
formation.
If
the variability
is
roo
great and there
is
no way for a court
ro
choose, it may find
43

44
KENTUCKY
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96
the contract and
the
other
accepts extrinsic evidence about what one or
both
of
the
parties
to
the
contract
intended
that
the
words would mean
or objective evidence of
the
meaning supplied by context
8
or evidence
of
how ordinary commercial parties in a trade used
the
term or behaved in the
current contract.
9
This
article argues that it
is
wrong to
think
that courts must make a
dichotomous choice always to prefer extrinsic evidence or always
to
exclude
it.
10
Sometimes
the
appropriate interpretive methodology should explicitly
forego extrinsic
evidence
while
at
other times it should embrace extrinsic
evidence.
The
choice
between
the
two methodologies should
depend
upon
an assessment in each case about which interpretive methodology
is
most
likely to
(1)
curb opportunistic behavior;
and
(2)
implement
the parties'
actual intentions and overall goals,
11
in a cost-effective way to maximize
gains from trade.
12
The
drive to curb opportunism
under
conditions
of
bounded rationality
has
been
the
focus of much
of
the
work in
new
institutional economics
no contract.
See
i11jra
note
39·
8
See
supra note 3·
9
The
primary proponents
of
this broader approach were Corbin and Traynor. Avery
Katz,
The
Ecouomics
of
Fom1
aud
Substa11ce
i11
Co11tract
fllterpretatioll,
104
CoLUM.
L.
REv.
496,
50I (2004).
10
The
dichotomous approach may
be
thought
of
more flexibly when thought
of
"in
probabilistic terms" (with some regimes more willing
to
admit
a broader base of context evi-
dence and
other
regimes less likely
to
do so).fd. at 517.
Professor Avery Katz similarly rejects
the
dichotomous choice and suggests that
the
choice
of
interpretation for parries will
depend
on
matters such
as
the
degree
of
risk averse-
ness
of
the parries (with more risk averse parries favoring substantive interpretation since
that approach reduces risk
of
improper interpretation),
the
transaction costs both
ex
aute and
ex
post (with formality
being
preferred where circumstances require quick decision-making),
effect
of
interpretation
on
performance incentives (with direction being paid
to
inefficient
precautions from erroneous interpretation), effect
of
ex
post renegotiation costs (with formality
dominating when parties can renegotiate
at
low cost to achieve efficient results), presence of
reliance-based transaction-specific investments (with substantive interpretation being pre-
ferred where it can reduce
the
risk
of
hold up following investment), the relative presence
of
rent-seeking
at
the
ex
a11te
and
ex
post stage
of
contracting (with formality being preferred
where rent
seeking
ex
post likely
and
vice versa),
the
presence
of
"small and infrequent trad-
ers" (with substantive interpretation being preferred
due
to
the
inability
to
recoup the up front
"fixed" cost
of
negotiation over a large
number
of
transactions), and
the
robustness
of
internal
sanctioning networks.
!d.
at
525-36.
I r In
some
cases actual intentions may
not
exist and
the
court will
then
look
to
the
par-
ries' overall goals, including
joint
wealth maximization.
I 2 Courts
seeking
an interpretive methodology should strive to save parties drafting
costs while
not
increasing
enforcement
costs
by
an
amount
in
the
excess
of
the
amount
saved
in drafting costs.
See
Posner, supra
note
3,
at
1583 (explaining that "[b]ecause methods for re-
ducing contractual transaction costs, such as litigation, are themselves costly, careful tradeoffs
are
required").

2007-
2008]
PLAIN
MEANING
VS.
BROAD
INTERPRETATION
45
on rationalizing governance structures.
13
These
works
seek
to explain
the
"organizational imperative" to control opportunism in a cost-effective way,
particularly where specific asset
investment
makes a simple
exit
from a
contract relationship costly.
14
This
paper
presents an analytical framework
for choosing an interpretive methodology
that
can curb opportunism and
implement
the parties' goals to maximize joint gains.
It
is
associated
with the law and economics branch
of
contract theory and
thus
seeks
interpretive rules
that
will maximize
15
ex
ante
efficiency. However,
it
posits
that
to achieve those goals and efficiency, courts
must
do more than promote
standardization through giving judicial approval
of
a predefined
set
of
"contractual signals for future parties"
16
through law-supplied.default terms
and interpret terms to recognize private efforts
to
trump
the
state-supplied
terms "when necessary to avoid an ill-fitting [state] formulation."
17
Courts
must
be willing to actively
interpret
contracts to curb opportunism even
if
it
does not result in a stock
of
standardized terms that all parties can use in
future contracts.
Of
course, the parties are always free to choose the interpretive
methodology that a court should use to
interpret
the contract.
18
That
choice
might
seem
to obviate the
need
for a methodology to guide courts. Parties
could, for example, control
the
interpretive process in part
by
limiting
interpretation to
the
actual words
of
the contract, including a merger clause
that
would theoretically restrict the court's role to
the
written document.
19
This
does not solve the interpretive problem, however.
The
parties
often do not so specify, in which case courts
must
adopt
an interpretive
methodology that
not
only supplies
that
term
but
also appreciates
the
fact
that
the
parties failed to do so. Moreover,
even
when
the
parties supply
an interpretive methodology, perhaps by including a merger clause that
restricts extrinsic
evidence,Z
0
that
provision
must
itself
be
interpreted
and
I3
See
OLIVER
E.
WILLIAMSON,
THE EcoNOMIC
INSTITUTIONS
OF
CAPITALISM
FIRMS,
MARKETS
AND
RELATIONAL
CONTRACTING
32 (I 985).
I4
ld.
IS
Robert
E. Scott,
The
Case
for Formalism
i11
Relotio11ol
Coutroa,
94
Nw.
U.
L.
REV.
847,
849
(2000).
I6
ld.
I 7 Charles
J.
Goetz
&
Robert
E.
Scott,
The
Limits
of
Expouded
Choice:
Au Au a
lysis
of
the
luteroaiou Betwem
E:>.press
oud
Implied
Coutroct
Terms,
73
CAL.
L.
REv.
26I,
28I (I985).
I 8
Professor Avery Katz focuses
on
these
types
of
parties'
private
choices in
interpretive
methodology
and
proposes a
"taxonomy
of
economic
considerations"
that
will affect
parties'
choices
between
a more formal and
more
substantive
method.
Katz, supra
note
9,
at
500.
I9ld.at5I9.
20
This
clause indicates
to
courts
that
a
contract
is
completely
integrated.
If
the
court
accepts
that
proposition,
the
merger
clause will
bar
the
admissibility
of
any
extrinsic evi-
dence,
whether
to
supplement
or
to
contradict
the
written
contract.
See
E.A.
FARNSWORTH,
CoNTRACTs
§ 7·3 (4th ed., 2004).

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[Vol. 96
there are often exceptions that are crafted by courts, providing an occasion
for judicial interpretation.
Whether
a court
is
interpreting
the
words
of
the
contract or
the
interpretive
directions of
the
parties or filling a gap in a contract, the methodology the
court uses should not
be
artificially separated from a normative theory
that will identify interpretations
that
will be value maximizing
for
the
parties.
Nor
can a court isolate
the
interpretive question from
the
context
of the problems that
the
contractual language was crafted to solve or the
transaction costs associated with crafting solutions
to
those problems.
21
The
interpretive process
must
therefore start by understanding the normative
justification for any judicial intervention in private arrangements, paying
attention
to
the bargaining problems
that
parties face, including the costs
of
anticipating future contingencies and future behaviors, the potential gains
from effectively controlling opportunism (and
the
deadweight
loss
from
failing to control
it),Z
2
while minimizing
the
costs
of
doing so, including the
likely error and litigation costs from particular interpretive approaches in
particular types
of
contexts dealing with parties' various problems.
The
role
of
courts in contract cases
is
to preserve the autonomy of the
parties by preserving
the
bargain they negotiated and maximizing the
returns from
the
bargain. If, however, a contract
is
incomplete in ways
that will be explored in this article,
the
court will have
to
judge, using
an appropriate interpretive methodology, how to minimize occasions for
opportunism by
the
parties
23
while simultaneously minimizing drafting
costs for the parties and enforcement costs.
24
Opportunism
is
a threat
e;t
ante
to
the bargainers' ability (and
the
ability
of
other
potential contracting
parties)
to
maximize their gains from trade. Opportunism
is
the
enemy
of
bargains and
of
efforts to achieve
the
maximum benefits
of
bargains.
Alternative goals
of
contract interpretation
that
vie with curbing
opportunistic behavior include: "uniformly [i.e., predictably] interpreting
the contract terms chosen
by
contracting parties" and "standardization"
2 I
Schwartz
and
Scott
emphasize
the
importance
of
goal achievemeni:,
including
surplus
maximization, in
the
interpretation
process
but
they
emphasize
the
need
whew
strictly to
the
"parties'
solution"
in
order
w
implement
that
goal. Alan Schwartz &
Robert
E. Scot[,
Co11tract
Theory
a11d
the
Limits
ojCo11tract
Law, I I3
YALE
L.J.
54
I, 569 (2003).
22
Deadweight
loss
refers
w
the
aggregate
shortfall
members
would
suffer
"from
a fail-
ure
W
cooperate."
ROBERT
C.
ELLICKSON,
ORDER WITHOUT
LAW:
How
NEIGHBORS
SETTLE
DISPUTES
172 (1991).
If
parties
could
control
opportunism,
they
might
avoid
these
losses
because
they
would
contract
in cases
where
they
would
refuse w
contract
were
the
opportun-
ism uncontrolled.
23
Robert
E.
Scot[,
The
U11ijormity
Norm
i11
Commercial
Law,
i11
ThE
JuRISPRUDENTIAL
FoUNDATIONS
OF
CONTRACT
AND
CoMMERCIAL
LAW
152 (Kraus & Walt, eds., zooo).
24
There
is
always a tradeoff.
If
courts
intervene
with
terms
that
save
parties
drafting
costs,
rhe
courr
should
be
aware
that
it
should
not
intervene
if
the
cosr
of
enforcement
that
comes
from
having
w actively
interpret
a
term
(or
fill a gap)
outweighs
any
savings in drafting
costs w
the
parties.
See
Posner,
s11pra
nore 3·

Frequently asked questions

Q1. What is the example of a fact pattern in which admission of evidence of the flexible quantity?

Colttmbia Nitrogen is a good example of a fact pattern in which admission of evidence of the flexible quantity trade usage would possibly promote counter-opportunism. 

Q2. What is the typical justification for a law-supplied term or rule?

The typical justification for a law-supplied term or rule posits that where transaction costs prevent parties from reaching an optimal or first-best outcome, the law should seek to supply a term that the parties would have agreed on absent transaction costs. 

Q3. Why would parties be reluctant to opt into all types of context evidence?

Because the range of contextual evidence currently includes a broad spectrum of proof including course of performance, course of dealing and usage of trade and because the parties may have different preferences on admissibility corresponding with different types of context evidence, parties might be reluctant to opt into all types of context evidence even if they want some types of trade practices to govern. 

Q4. What is the argument that parties should be forced to signal to the court that they want private meaning?

83Schwartz and Scan argue that because there can be multiple private trade meanings that parties may invoke after the fact, parties should be forced to signal to the court ex ante that they want those private meanings to govern. 

Q5. What is the argument that a minority of contracts are written in private languages?

162 The argument that since "a minority of contracts are written largely in private languages ... fewer parties would have to contract out of a default that supposed them to be written in majority talk." 

Q6. Why is it difficult for parties to identify all of the specific trade usages and practices that may?

Because of transaction costs, it may be difficult for parties to identify all of the specific trade usages and practices that may be relevant. 

Q7. What is the argument for forcing the parties to use plain meaning in a dictionary sense?

In some instances, where the parties operate on the basis of private assumptions that create a private meaning and a reluctance to disclose one's status as a bigamist, but one's intentions were clear that the word wife meant the non-legal wife, one can argue that forcing the party with the unusual marriage status to use plain meaning in a dictionary sense would defeat the parties' intentions, a great cost, without significantly increasing the predictability of common words in the future. 

Q8. What is the argument for requiring the parties to expressly incorporate trade usages and practices?

Requiring the parties to expressly incorporate trade usages and practices to have them govern a contract is premised on assumptions about the effects that the announced rule-no trade practices if not expressly written into the contract-wi!! 

Q9. What is the reason why courts are hesitant to enforce trade usages?

Courts also seem to be hesitant to enforce trade usages when it appears as though doing so will simply shift the potential for one-sided opportunism from one party to another, and do nothing to eliminate it.