1. Tacit Intent Plus Transactional Necessity

Some terms enforced by contract law follow in a straightforward way from choices people make and do not require a normative justification beyond a commitment to implementing peoples’ choices. An example is a clear express term (by which we mean a term that people think and communicate about when they make a contract), in the absence of vitiating circumstances (like duress or mistake). Of course, the commitment to implementing peoples’ choices itself requires normative justification (we justify it by the value of autonomy), but once this commitment is made, no further justification is required for enforcing the term itself (though further justification might well be required with respect to how the term is enforced).

Terms that people tacitly intend are like clear express terms. They require no further normative justification beyond a commitment to implementing people’s choices. The classic example of tacit intent is when a parent requests that a babysitter teach their child a game. In the context, the babysitter knows the parent intends a child-appropriate game even though the parent does not say this and may not think this. Similarly, when a traveler books a hotel room on the phone, saying nothing about furnishings, the hotelier knows the traveler intends a room with a bed.Footnote ²⁰

These are easy cases, which easily comply with the “officious bystander test” for determining when a term can legitimately be implied. According to this test, which is often taken to be outdated,Footnote ²¹ “that which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common ‘Oh, of course!’”Footnote ²²

Traditional theorists go much further than that. They suggest that implication can account for a large swath of contract law, including rules on damages, rules governing contract termination, and the duty of good faith, even though these terms cannot be described as intended in the way the traveler intends a hotel room to come with a bed. Peter Benson offers the most powerful recent articulation of this view. Loyal to the traditionalist normative conviction in which “parties can be bound only to what they have done,” Benson insists that these legal rules are implications of the parties’ particular “self-regulating” transaction.Footnote ²³ Objectively construed, he argues, “enforceable agreements are not contractually incomplete.” Rather, they have “all the internal resources needed to determine what can and should be implied.” By spelling out “what is reasonably required to make sense and to secure the full and fair value of the terms actually agreed to,” implication can “specify” the “‘secondary’ or ‘dependent’ terms and conditions” of a transaction, which “fill out, qualify, and further determine the performances owed as between the parties.” Implication must follow the presumed intent of the parties of the actual transaction. It “refers to what the parties to a given contract must reasonably have intended because necessary to avoid,” so that their contract won’t be “futile, without value or benefit, or just manifestly absurd.”Footnote ²⁴

We agree with Benson that terms that meet this demanding test of “transactional necessity” do not require further normative justification beyond a commitment to implementing peoples’ choices.Footnote ²⁵ We think these terms might also meet the “officious bystander” test.

In the U.S., routinely supplied terms are described as “default rules.” Some of these default rules may be explained by transactional necessity. Cardozo’s famous ruling in Wood v. Lucy, Lady Duff-Gordon is an example. Cardozo acknowledged that Wood did not “promise in so many words that he will use reasonable efforts to place the defendant’s endorsements and market her designs,” but nonetheless concluded “that such a promise is fairly to be implied.” The implication, Cardozo explained, is necessary because Lady Duff-Gordon’s promise to give up the right to market her own endorsements during the period of the contract would be senseless, or in Benson’s words “manifestly absurd,” without a return obligation by Wood to expend efforts in marketing them. Thus, while “[A] promise may be lacking,” the parties’ agreement is “‘instinct with an obligation,’ imperfectly expressed.”Footnote ²⁶

In the case, transactional necessity sufficed to resolve the only issue before the court, which was whether Wood had an obligation to Lady Duff-Gordon to satisfy the consideration requirement. If Lady Duff-Gordon had brought a claim for breach of this obligation, then transactional necessity could not resolve the question of the specific content of Wood’s obligation. Courts have struggled in answering this question in other exclusive dealing cases. A leading case, Bloor v. Falstaff Brewing Corp.,Footnote ²⁷ suggests multiple standards without settling on one. Obviously, the choice among these standards is not a matter of transactional necessity or presumed intent.

2. Beyond Tacit Intent and Transactional Necessity

Wood v. Lucy Lady Duff Gordon shows that while some default terms can be explained by transactional necessity (that Wood was under some obligation) many others cannot (the specific content of Wood’s obligation). Many default rules presented by judges as implied terms cannot be explained by implication or transactional necessity.Footnote ²⁸

Take Taylor v. Caldwell, another contract casebook classic, in which the defendant’s music hall burned down prior to the time it was supposed to be used by the plaintiff for the purpose of presenting a series of concerts. The court wrote that the contract should be subject to “an implied condition” to “fulfill the intention of those who entered into the contract.” But the only reason it offered for ascribing this intent to the parties was that “from the nature of the contract there is an implied condition of the continued existence of … a given person or thing [so that] the impossibility of performance arising from the perishing of the person or thing shall excuse the performance.”Footnote ²⁹ At least insofar as things (as opposed to people) are concerned, this reason must be wrong.Footnote ³⁰ Certainly, the parties neither consciously nor tacitly intended that the contract be conditioned on the hall not being destroyed (all we know about their state of mind is that they didn’t anticipate this possibility).Footnote ³¹ Nor can the supplied condition be explained as a matter of transactional necessity. The defendant could have been held liable under the contract and ordered to pay damages, which is, of course, the standard remedy for breach.Footnote ³²

Back to Cardozo, this time to his celebrated Jacob & Youngs v. Kent “Reading” pipe decision,Footnote ³³ which Benson treats as one of his primary examples of implication based on transactional necessity.Footnote ³⁴ Cardozo, however, is quite clear that the substantial performance rule he embraces does not pass the strict test of transactional necessity. This rule, he wrote, is prompted by “[c]onsiderations partly of justice and partly of presumable intention”; but for Cardozo the former—preventing “harshness” and “oppression”—dominates the latter. By using “apt and certain words,” parties can “effectuate a purpose that performance of every term shall be a condition of recovery.” But “the law will be slow to impute the purpose, in the silence of the parties, where the significance of the default is grievously out of proportion to the oppression of the forfeiture.” Justice, rather than intention, is the rule’s ultimate justification: from the proposition “that promises may not be treated as dependent to the extent of their uttermost minutiae without a sacrifice of justice, the progress is a short one to the conclusion that”—absent clear opt-out from law’s default rule—“they may not be so treated without a perversion of intention.”Footnote ³⁵

Indeed, as one of us has argued elsewhere, Jacob & Youngs is a milestone in the development of default rules regulating a party’s response to nonperformance of a contract.Footnote ³⁶ Over several centuries, the law shifted from treating promises as independent so nonperformance did not discharge a promise, to treating promises as wholly dependent so a party had a near absolute right to terminate a contract in response to nonperformance, to the nuanced approach in Jacob & Youngs, under which a response to nonperformance must be reasonable, balancing the loss resulting from nonperformance, the risk of forfeiture to the defaulter, and the defaulter’s bad faith. Each of these approaches probably seemed inevitable to many lawyers in their day. But these changes hardly could have seemed a matter of transactional necessity, much less something parties tacitly assumed “went without saying,” when the changes occurred.

3. Hypothetical Agreement?

The transactional necessity test is more demanding than the familiar hypothetical agreement (or bargain) test, which supplies a term by asking what the parties probably would have agreed to if the issue had been presented to them when they made the contract. As David Charny claims, a term explained in these terms requires further justification. The court must decide who the hypothetical bargainers are—these specific persons or persons like them generally—and what the mechanics of the hypothetical bargain are—a real-world bargain with constrained information and behavioral quirks or an idealized bargain with perfect information and a “greater degree of rationality.” The court must also decide the goal of the hypothetical bargain. Is the goal efficiency (i.e., minimize transaction costs and maximize the joint return)? Or is the goal to enhance people’s autonomy? Or is the goal something else like advancing solidarity or equality? And is the realization of whatever the goal may be assessed on an ex ante or ex post basis?Footnote ³⁷

The transactional necessity test implies a term only if the court is certain the parties would have agreed to the term if asked. The old officious bystander test nicely captures the level of certainty required. This level of certainty makes it unnecessary to resolve questions like those raised by Charny. But if a term could be supplied only if it met these demanding tests, it would prevent law from fulfilling its potential to proactively facilitate transactions. For example, a term will not satisfy the demanding transactional necessity and officious bystander tests if it involves a tradeoff between efficiency and autonomy, or a tradeoff between people’s present and future autonomy. Liberal contract theory resolves questions like those raised by Charny and so provides a principled basis for supplying terms that involve such tradeoffs.

4. The Importance of Truth in Labeling

So, we think Cardozo was right to abjure implication (i.e., resting the rule on “presumable intention”) in Jacob & Youngs and instead to ground the rule on what justice (we would say relational justice) requires in the situation. In addition to encouraging candor, this approach yields substantively better outcomes for it encourages lawmakers to look for and adopt the rule that best facilitates the parties’ joint plan when a term cannot be justified as a matter of tacit intent or transactional necessity.

The fact that—like Taylor v. Caldwell’s excuse-for-impossibility and Jacob & Youngs’ substantial performance rules—contract law’s default rules cannot be justified as a matter of tacit intent or transactional necessity is not a blemish; it does not mean that these cases are wrongly decided. Quite the contrary. In sharp contrast to the traditionalist position, liberal contract recognizes—indeed, celebrates—the critical proactive role of contract law in facilitating human interaction.

Efficiency-minded theorists would agree with everything we have said to this point. Indeed, they coined the concept of a “default rule” and undertook a project to explain contract law’s many default rules on efficiency grounds. Liberal contract insists instead that law’s defaults should be autonomy-enhancing when they have significant autonomy stakes and explains both Taylor v. Caldwell and Jacob & Youngs as safeguarding defaults that attend to contract’s potential autonomy-diminishing effects.Footnote ³⁸ Excuse rules, including Taylor v. Caldwell’s impossibility rule, ensure that contracts made today do not unnecessarily impinge on the autonomy of promisors’ future selves. Footnote ³⁹ Jacob & Youngs’ substantial performance rule guards against the relational injustice of a party exploiting their counterparty opportunistically.Footnote ⁴⁰

There is no need to expand on or defend these propositions here because the crucial point for this Article, which focuses on legal rules that try to excavate the parties’ agreement (i.e., the joint expression of their conscious choices), is more general. Terms supplied by law that do not meet the tests of tacit intent or transactional necessity are clearly part of their contractual obligations, but they are not part of their agreement. These rules are better described as supplied terms and not implied terms.Footnote ⁴¹ They do not necessarily follow the parties’ choices, and we should not mis-represent them as if they did.

Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp. Footnote ⁴² illustrates the importance of truth in labeling. The issue in the case was whether an arbitration clause that was silent on the point should be interpreted to permit class arbitration. The Supreme Court’s majority held “no,” and chastised an arbitration panel for answering “yes” based on policy reasons. The majority framed the question as whether “it is appropriate to presume that parties that enter into an arbitration agreement implicitly authorize” class arbitration. It answered “no” to this question “because class-action arbitration changes the nature of arbitration to such a degree that it cannot be presumed the parties consented to it by simply agreeing to submit their disputes to an arbitrator.”Footnote ⁴³ But this reasoning is disturbingly wrong. At best it arrogantly assumes the majority’s views about the nature of arbitration were shared by the parties. At worst it is using presumed intent as a fig-leaf to smuggle in the majority’s view that the law should not bother enforcing claims that are only worth enforcing in the aggregate. This answer wrongly prioritizes hoped-for savings from not litigating small claims over autonomy.

1. A Perplexing Challenge to Contract Theory

We turn from implied terms to implied-in-fact contracts. Contract traditionalists in common law systems have difficulty explaining implied-in-fact contracts because the parties “do not agree or promise or undertake to do anything. Rather they simply do something.”Footnote ⁴⁴ It is difficult to explain how and why a contract can follow from what people do if, like Williston, you equate contract law with the body of rules that instruct people how to make express promises and agreements legally binding. On its face, the objective standard solves this difficulty by suggesting that the reasonable meaning of their actions can supply the missing content. But the objective standard can do so on a value-neutral basis only if people generally think and communicate about the relevant term, or if the relevant term can be established as a matter of tacit intent or transactional necessity. Only then can it be said that a term flows from the parties’ choices.Footnote ⁴⁵

Legal theorists in civil law systems also have difficulty explaining implied-in-fact contracts because they are not based on a declaration of intent. As Ludwig Raiser explains, here “there is generally no doubt as to whether the parties’ behaviour was free and conscious”; rather, the issue for civilians is “whether a relationship created by the parties’ factual behaviour can be recognized by the legal order as a particular kind of legal relationship, or whether it should be ignored because the legal system’s requirements for validity have not been met.” Raiser rightly acknowledges that “[t]he problem can only be resolved by making a value judgment.”Footnote ⁴⁶

2. Facilitating Autonomy-enhancing Informal Contracting

Liberal contract theory, by contrast, has no difficulty accounting for implied-in-fact contracts because it has a broader vision of contract law. This vision is of a body of law that provides not only instructions on how to make binding promises and agreements but also a rich set of default rules to facilitate all types of voluntary joint plans that require legal backing. The two autonomy-based polestars of liberal contract law—proactively facilitating people’s joint plans and securing relational justice—instruct when the law may dispense with an expression of intent to undertake an obligation as a requirement for a legal obligation and the design of the resulting legal obligation.

On its face, these propositions suggest that the term implied-in-fact contract is a misnomer because the law defines when conduct is a basis for a legal obligation and the content of the resulting obligation. But it is not. The contract is implied (in the strict sense) since the basis for the parties’ obligations in all these cases is their shared choice to do something together that the law then facilitates by treating the interaction as contractual and by supplying terms. Law’s additional work—it specifies the types of joint plans that are treated as contractual, and it supplies terms to facilitate people’s choices—is not unique to these contracts. We began with the discussion of implication and implied terms to show that the law also supplies terms in express contracts.

We acknowledge that law’s contribution creates a risk of involuntariness, i.e., people being subjected to an obligation they did not and would not have chosen, which can be autonomy-reducing, especially regarding constitutive choices. As we argue elsewhere, this tension explains the significant role of formalities as contract law’s safeguards against the endemic risks of involuntariness.Footnote ⁴⁷ But the law’s failure to treat an interaction as contractual, and to supply terms, also can undermine people’s autonomy by creating unnecessary barriers to enlisting the law to back up a joint plan. Imagine what the world would be like if the law did not recognize even the most primitive implied-in-fact contracts, or if the law enforced promises given in exchange for each other only if the parties declared they intended the promises to be enforceable.

3. Primitive Implied-in-fact Contracts: Informal Bargain-exchanges

The inability of traditional contract theory to explain implied-in-fact contracts follows from its narrow focus on contract as promise, specifically an exchange of promises. The most primitive type of implied-in-fact contract predates contract law. Under the common law writ system, the action of debt was available to collect a debt based on a half-completed informal bargain-exchange.Footnote ⁴⁸ The market supplied the price, which was the only supplied term needed to protect the seller. No further formalities were necessary because performance and acceptance of performance “involves a kind of natural formality, which satisfies the evidentiary, cautionary, and channeling purposes of legal formalities.”Footnote ⁴⁹ Indeed, to require additional formality would reduce people’s autonomy by raising needless barriers to simple bargain-exchanges.

A taxicab ride is a 20th-century exemplar of this primitive type of implied-in-fact contract. A contract is formed when a passenger boards a cab that stops at a passenger’s signal (raising an arm or queuing at a cab stand). The only words that must pass between a passenger and a driver are the passenger’s destination. The precise fare is set by law. The driver’s duty of reasonable care and the passenger’s right to compensation if they are injured in an accident by a breach of this duty are also set by law. Other terms—the passenger will pay a fare, the driver will take the quickest or cheapest route, the passenger will not leave trash in the vehicle, &c.—are established by implication because they “go without saying.”

This most primitive type of contract is changing. Bargain-exchange transactions that used to be conducted on an informal basis increasingly involve one party presenting the other party with terms electronically through a cell phone or other electronic device.Footnote ⁵⁰ There is a danger here. Unless an electronically transmitted term figures in a party’s choice to engage in a transaction (e.g., the price quoted by an electronic platform to a passenger and a driver for a ride arranged through the platform), the law should not allow such a term to displace a term that would otherwise be set by law. The low cost of transmitting a form does not change the human reality that people appropriately give little thought to the terms of many types of transactions because little thought is warranted.Footnote ⁵¹

4. UCC § 2-207(3)

Our second example illustrates that the category of implied-in-fact contracts is not limited to half-completed exchanges and helps refine the formal properties of rules establishing a contract based on what people do. It is also ironic because the rule we focus on applies in cases where people try to make a contract by exchanging promises, but they fail to do so because the promises exchanged, while seemingly in the legally approved form of offer and acceptance, do not satisfy the law’s traditional requirement for making a contract because they have different terms.

Under the traditional common law rule, an acceptance must be the “mirror image” of an offer to make a contract. A response to an offer with an additional or different term is treated as a counteroffer even if the sender intends the response to be an acceptance, and the recipient (the original offeror) reasonably understands the response to be an acceptance.Footnote ⁵² This mirror-image rule gives both parties the right to withdraw from the agreement before performance. Under the traditional common law (so-called last shot) rule, if the original offeror performs or accepts performance, this is treated as an implied acceptance not just of a contract, but also of the terms of the counteroffer.Footnote ⁵³

UCC § 2-207(3) makes a small change and a big change in the law. The small change is to expand conduct that forms a contract beyond performance to include “[c]onduct by both parties which recognizes the existence of a contract.”Footnote ⁵⁴ Under this expanded rule, expected reliance by one party (such as incurring expenses to prepare to perform) can also give rise to a contract. The big change is that neither party’s conduct is treated as implied acceptance of the other party’s writing as an expression of contract terms (i.e., an “integrated agreement”). Instead, in keeping with modern law’s commitment to supply terms to facilitate contractual interactions, UCC § 2-207(3) creates a contract for the parties drawing on several sources.

The statute provides that “[i]n such cases the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under other provisions of this Act.”Footnote ⁵⁵ This, of course, incorporates statutory default rules, like the warranty of merchantabilityFootnote ⁵⁶ and standard remedies. Additional terms can be derived from course of performance, course of dealing, and trade usage.Footnote ⁵⁷ This regime is not, and it does not pretend to be, based on implication (it relies neither on the parties’ tacit intent nor on transactional necessity).Footnote ⁵⁸ But it is fully loyal to liberal contract’s autonomy-enhancing mission: it “ensure[s] that a party will not be held to terms that are directly contrary to the terms it has included in its own form”Footnote ⁵⁹; it verifies the parties’ choice to commit to an exchange by their actions; and it proudly embraces modern law’s empowering gap-filling apparatus.

UCC § 2-207(3) also illustrates the formal properties of a rule establishing an obligation based on what people do. The rule must define, first, the action giving rise to the obligation (here “conduct by both parties which recognizes the existence of a contract”), and second, the terms of the obligation (“terms on which the writings of the parties agree,” &c.). The rules governing primitive implied-in-fact contracts are in the same form. On the buyer’s side, the action is accepting performance in a bargain-exchange transaction and the resulting obligation is to pay the market price for the performance received. On the seller’s side in transaction involving a service, the action is undertaken to render a service to another person and the resulting obligation is to use reasonable care in rendering the service.

The obligations created by UCC § 2-207(3) are naturally described as contractual because they involve a bargain-exchange transaction and since the sources the law looks to for terms are familiar sources of contract terms in incomplete contracts. The happy innovation in § 2-207(3)—and this is no small thing—is to refuse to treat a party’s choice to proceed with a transaction as assent to the terms in the other party’s form, opting instead to apply default rules or terms derived from context.

Readers may resist describing our next example as an implied-in-fact contract because it does not involve a bargain-exchange transaction.Footnote ⁶⁰ But liberal contract theory rejects the position that contract law is all and only about bargain-exchange transactions.

5. Default Financial Obligations between Unmarried Cohabitants

Our third example involves implied financial obligations between unmarried cohabitants on dissolution of a relationship. Not too long ago, the law would not enforce an express agreement between unmarried cohabitants providing for a financial obligation on dissolution of a relationship. Happily, this is starting to change, as many courts are receptive to claims for a share of property accumulated during a relationship.Footnote ⁶¹ But U.S. courts generally have not been willing to prescribe an alimony-like obligation to equitably allocate financial losses on dissolution of a relationship.Footnote ⁶²

Liberal contract supports a 2002 proposal by the American Law Institute (“ALI”) to change the default rule on dissolution of a relationship between unmarried cohabitants to impose an alimony-like obligation when there is an imbalance of wealth (including earning capacity) between partners to reduce the economic impact on the poorer partner.Footnote ⁶³ Because of the diminishing utility of wealth, this default rule significantly enhances the autonomy and life-prospects of the poorer partner without unduly limiting the autonomy and life-prospects of the richer partner.Footnote ⁶⁴ For similar reasons, the default rule is required as a matter of relational justice.Footnote ⁶⁵ Tying the default rule to well-established rules in divorce law mitigates a major problem with regulating the disposition of household wealth with vague open-ended standards: that people will destroy household wealth in fighting over who gets it. Tying the default rule to the norm of relational justice may also lessen enmity bred by the rule. And this rule is unlikely to deter people from forming such relationships.

The 2021 Uniform Cohabitants’ Economic Remedies Act (“UCERA”), which provides that “[a] cohabitants’ agreement may be oral, in a record, express, or implied-in-fact,”Footnote ⁶⁶ is a step in the wrong direction. The history of the Act suggests that “implied-in-fact” here was intended to invite an inquiry into the parties’ intent (i.e., what their plans were with respect to dividing assets on dissolution of the relationship), and requiring intent be established by “clear and convincing” evidence.Footnote ⁶⁷ This heightened standard was justifiably rejected because it “would be a step backward in most states.”Footnote ⁶⁸

But the problem is deeper. Tying the content of this implied-in-fact contract to people’s intent is an error. An obligation based on people’s actions, and not their express commitments, must be in the form of the ALI’s proposal. The law must define the action giving rise to the obligation and the obligation that arises. In addition, the triggering action should clearly demonstrate a commitment to an interaction that justifies the resulting obligation the law imposes. The ALI’s proposal is thus correct to treat the parties’ cohabitation—the action they both clearly voluntarily undertake that justifies the resulting obligation—as the triggering action. It is also right to set an alimony-like obligation as the default rule, given its support of the parties’ voluntary joint plan (to cohabit) and compliance with relational justice. Contract law can require no more when a contract is implied in fact because while people surely have in mind the action giving rise to the obligation, they are unlikely to have in mind the resulting obligation.

We concede that this default rule cannot be justified as a matter of tacit intent or transactional necessity. Like many other default rules (recall Taylor v. Caldwell and Jacob & Youngs), it expresses what the background rule should be for cohabitants in an autonomy-based contract law. The risk of involuntariness—people being subjected to an obligation they would not have agreed to undertake, if they had been asked in advance—is mitigated by allowing people to disclaim the obligation.

Contract traditionalists will resist describing this obligation as contractual. Not only is the obligation based on people’s actions, and not their express promises, but the interaction that is the basis for the obligation is not a bargain-exchange transaction.Footnote ⁶⁹ But modern contract law does not confine its ambition to facilitating “this-for-that” interactions, nor should it.Footnote ⁷⁰ To be sure, contract law should recognize that in some non-bargain contexts law’s involvement is unnecessary and even potentially detrimental (this is the case where legally imposed obligation tends to crowd out internal motivations) and that some impositions on people’s autonomy—think an intimate touching—require actual or apparent consent. But we think the ALI’s proposal will facilitate the relationships it covers, and that it will enhance people’s autonomy and secure relational justice when a relationship ends.

Contract traditionalists may also object to describing the alimony-like obligation on dissolution of a relationship of unmarried cohabitation as contractual because it is patently created by law. But so too long ago was the primitive implied-in-fact contract to pay for performance obtained in a bargain-exchange transaction. If the primitive implied-in-fact contract seems natural and not a legal creature, it is only because it was recognized long ago.Footnote ⁷¹ The alimony-like obligation is appropriately described as contractual because it arises from people’s choice to enter a mutually beneficial relationship. And the obligation’s purpose is to facilitate this choice, and to prevent relational injustice on dissolution of the relationship.

1. The Textualist/Contextualist Debate

There are various formulations of the warring positions that judges and commentators occupy under what is often referred to as the textualist/contextualist debate. For our purposes, it is enough to present one version of each: the U.C.C., which codifies the position taken by the Restatement Second, can represent the modern/California contextualist approach; the Restatement First can stand for the classical textualist position (which approximates New York and Texas law).

The U.C.C. rejects the plain meaning rule. It prescribes that to reach the parties’ “true understanding” of their agreement, even an unambiguous writing “may be explained or supplemented by course of dealing or usage of trade … or by course of performance.” The premise is that these “were taken for granted when the document was phrased,” and are the best indication of what the parties intended the writing to mean.Footnote ⁷² The U.C.C. also takes the position that the goal is to determine the parties’ agreement in fact, which may not be reflected by a writing they adopt as an expression of their agreement.Footnote ⁷³

The Restatement First takes the position that when a writing the parties adopt as an expression of their agreement speaks unambiguously to an issue, interpretation begins and ends with the writing. This position is embodied in the plain meaning rule. The Restatement First does not employ the strictest version of the plain meaning rule,Footnote ⁷⁴ for it allows a court to “stretch” the meaning of terms as needed to interpret a writing purposively so that it makes sense in the context of the agreed exchangeFootnote ⁷⁵; and it also allows courts to consider evidence of “surrounding circumstances,” including trade usage or local practice, even when a writing is unambiguous.Footnote ⁷⁶ But it does not allow courts to consider evidence of course of performance or course of dealing, for this goes to the parties’ actual intent which is irrelevant when a writing is unambiguous.

A well-known skirmish between Judges Roger Traynor and Alex Kozinski illustrates these different positions. In Pacific Gas v. Thomas Drayage & Rigging, Traynor (writing for the California Supreme Court)—proudly adopting the modern approach—held that “a court must ascertain and give effect” to the intentions of the parties by “determining what the parties meant by the words they used.” Traynor argued the nature of language makes it impossible to ascertain intent from a writing itself, decrying this view as “a remnant of a primitive faith in the inherent potency and inherent meaning of words.” Courts must not “presuppose a degree of verbal precision and stability our language has not attained,” and therefore should consider “all credible evidence offered to prove the intention of the parties.”Footnote ⁷⁷

In Trident Ctr. v. Conn. Gen. Life Ins., the district court rejected the plaintiff’s claim that the agreement was something other than what their written contract plainly said, while refusing to look at the plaintiff’s evidence supporting the claim. The court added a sanction for making a frivolous legal claim for good measure. Kozinski (writing for a panel of the 9th Circuit) held California law did not permit this, even though the case involved a “lengthy and detailed” multi-million-dollar commercial loan between “highly sophisticated business people” negotiated “at arm’s length from position of roughly equal bargaining strength.” The agreement, moreover, “squarely address[ed] the precise issue that is the subject of this dispute,” leading Kozinksi to observe “[i]t is difficult to imagine language that more clearly or unambiguously expresses” the parties’ prescription for the contingency at hand. While following Pacific Gas, the Trident court questioned the wisdom of a rule that opened the door to “costly and protracted litigation.”Footnote ⁷⁸

2. Why the Textualist Position Should Govern Commercial Transactions

Insofar as commercial transactions between sophisticated firms are concerned, we think Judge Kozinski has the upper hand both conceptually and substantively. Conceptually, contract law values, and not (or not only) the nature of language, govern the design of rules of contract interpretation. Substantively, the textualist position is indeed appropriate for commercial transactions like that in Trident. But, as we shall argue later, the California contextualist approach is appropriate for many other types of transactions.

The conceptual point is helpfully elucidated by Gregory Klass. Meaning, as Klass explains, “is a social fact, one whose existence depends on the relevant social interpretive practices.” This means that “there are multiple, sometimes overlapping social interpretive practices,” and thus also “multiple, sometimes overlapping types of meaning.” It is conceptually fallacious to think (as friends of the California approach often suppose) that “[t]he enriched pragmatic meaning that often anchors the parties’ understanding of their agreement is [] the only meaning the law might look to.” Deciding “[w]hich interpretive practice we deploy in given situation—that is, what type of meaning we care about”--necessarily “depends on the goal of the inquiry.” This is a matter of contract law values, or, as Klass puts it, “considerations of principle, policy, and practicality.”Footnote ⁷⁹

The substantive reason builds on, but reframes, the economic theory advanced by Alan Schwartz and Robert Scott for why the interpretation of transactions between legally sophisticated wealth-maximizing firms (like the parties in both Pacific Gas and Trident) should be interpreted based on limited, mostly textual, evidence.

Schwartz’s and Scott’s account rests on the proposition that because “any theory ‘on the ground’ must trade off the gains from increased accuracy in interpretation against the costs,” choosing the proper rules of interpretation necessarily requires “trading off accuracy against contract writing and adjudication cost.”Footnote ⁸⁰

Schwartz and Scott observe that risk-neutral business parties will commonly prefer judicial interpretations to be made on a limited evidentiary base, the most important element of which is the writing itself. The reason is simple. Being aware of both writing and litigation costs, but particularly concerned with the latter, sophisticated commercial parties are expected to “write contracts that are sufficiently detailed to ensure that the most likely interpretations of their contracts are correct when courts interpret those contracts using the minimum evidentiary base we specify.” Because parties “know better than courts how best to trade off these front-end and back-end contracting costs,” courts should follow this presumed (second order) preference of commercial parties.Footnote ⁸¹

The key point is that while the task of interpretation may seem to be about recovering the parties’ intentions, the design of interpretive rules necessarily involves a value assessment, specifically a tradeoff between accuracy and cost. Schwartz and Scott present a compelling case for the proper (defaultFootnote ⁸²) rule in the commercial setting on which they focus,Footnote ⁸³ at least (and this is an important qualification) where no externalities are at stake. It is compelling because of the low autonomy stakes in transactions between legally sophisticated wealth-maximizing firms.Footnote ⁸⁴ In this important category of contractual interactions, the (legitimate) name of the game is maximizing expected contractual surplus with default rules (including rules of interpretation) that “reflect majoritarian party preferences.”Footnote ⁸⁵

3. More (Inevitably) Normative Choices

Before we can get to our own sketch of an autonomy-based theory of contract interpretation, we need to mention another contribution of Klass, this time regarding the questions lawmakers must answer when designing rules of interpretation. The current debate misleadingly suggests that the choice between textualism and contextualism is the only pertinent one. Not so, says Klass. There are in fact three critical questions: “Whose meaning governs? What type of meaning governs? And what facts determine that meaning?”Footnote ⁸⁶

The third question (what facts determine meaning) roughly corresponds to the textualist/contextualist divide,Footnote ⁸⁷ and the first (whose meaning) seems trivial in the commercial context (where the answer is clearly “both parties”), though (as discussed below) it is crucial in transactions involving people (on one or both sides) with significant, asymmetric autonomy stakes. The second question (what type of meaning) involves the choice between authorial, pragmatic, and semantic meaning.Footnote ⁸⁸ We put semantic meaning off the table. As noted, even courts (such as the New York Court of Appeals) and scholars (such as Williston) who take a highly textualist approach do not limit themselves to the literal (semantic) meaning of the parties’ words, but rather read them purposively.Footnote ⁸⁹ This consensus is hardly surprising: unlike the textualist/contextualist divide which (as we explain) raises a tradeoff in terms of autonomy and efficiency, it is hard to think of any autonomy or efficiency-based case for relying exclusively on the semantic meaning of a writing regarding any type of contract.Footnote ⁹⁰

Liberal contract provides an answer to a question that is anterior to these three questions. Klass claims that the answers to these three questions turn on “considerations of principle, policy, and practicality”Footnote ⁹¹ that vary across different domains of law. This vague proposition invites the anterior question, namely: what values should bear on the design of rules of contract interpretation? What values determine which considerations should count (or count more) regarding each contract type?

A conventional answer to this question sets the preeminent goal of “freedom of and freedom from contract,” which is qualified by subsidiary goals like “security of transactions,” “predictability,” and “formulating legal rules that are administrable.” On this account, “[f]ar less important in contract interpretation is a group of possible values involving general fairness, equality, and justice.”Footnote ⁹² Liberal contract instead answers that the values that should bear (and to some extent already do bear) on the design of rules of contract interpretation are enhancing autonomy and securing relational justice.Footnote ⁹³

1. A Broad Coverage Attending a Diverse Inventory of Contract Types

Liberal contract theory happily endorses the economic case for adopting the classical approach to contract interpretation for commercial transactions between sophisticated wealth-maximizing firms. It also embraces Schwartz’s and Scott’s suggestion that when commercial parties prefer that their agreement be interpreted using a broader evidentiary basis, they should be able to opt out of the classical approach with minimal difficulty.Footnote ⁹⁴

Our interest is in designing rules of interpretation for other contractual settings. These include the vast domain of voluntary joint planning that pervades our lives—in the spheres of work, consumption, housing, and intimacy. In none of these spheres does the practice of contracting resemble the model that justifies the textualist approach, and Schwartz and Scott are indeed properly cautious not to suggest otherwise.Footnote ⁹⁵

Liberal contract’s starting point should be obvious by now. Interpretive rules—like all other rules of contract law—should serve contract’s autonomy-enhancing mission. This goal implies that contract law must not apply a uniform set of interpretive rules across all contract spheres. The reason for this should also be clear. While the differences among contract spheres do not affect the choice between pragmatic and semantic meaning, as autonomy always favors either authorial or pragmatic meaning over semantic meaning, these differences are critical to the other questions.

As the following pages demonstrate, liberal contract generates answers to these three questions for all types of contracts. Beginning with the first question (whose meaning), liberal contract insists that where the writing is not (or not really) co-authored, the perspective of a voiceless natural person should be particularly emphasized. Turning to the second question (what meaning), when a party is an individual, and not a large company with a legal office, interpretation often begins with an inquiry into authorial meaning and ends with an inquiry into pragmatic meaning, which takes us back to implication and implied terms. This is because people’s choices tend to be general and not fine grained. Inevitably, if the law is to effectuate people’s general choices, the law must take a proactive approach to supply and regulate terms. Finally, on the third question (what facts determine legal meaning), liberal contract generally requires the law to honor the choices people (that is, natural persons) actually make when they enter into contracts. It thus requires courts to consider all helpful evidence to get this crucial fact right, though there are exceptions to this. We now turn to elaborate and demonstrate these significant takeaways, beginning with the “whose meaning” question.

2. Liberal Contract’s Answer to the “Whose Meaning” Question

Some rules of interpretation wear their values on their sleeves by stating an explicit preference for a substantive outcome. Under modern contract law, these preferred terms often serve liberal values—specifically, relational justice—by favoring the meaning of the weaker or more vulnerable party. Eyal Zamir gives examples (including rules disfavoring exculpatory terms, forfeiture, and warranty disclaimers), and concludes “[i]n all these and other instances, the courts interpret the contract so as to implement social and moral values of fairness, reasonableness, efficiency, helping the weaker party, and even protecting people from their own shortsightedness.”Footnote ⁹⁶

The modern form of the venerable contra proferentem rule also tilts in favor of the weaker party.Footnote ⁹⁷ The rule requires courts to “adopt the meaning that is less favorable in its legal effect” to the drafter,Footnote ⁹⁸ and “is often invoked in cases of standardized contracts where the drafting party has superior bargaining position,”Footnote ⁹⁹ to avoid “unfairness to a party in a weaker bargaining position.”Footnote ¹⁰⁰ Under California law, the party in a superior bargaining position is not even permitted to introduce extrinsic evidence that the parties intended the meaning favorable to it.Footnote ¹⁰¹

Lamp Plus Inc. v. Varela Footnote ¹⁰² illustrates the imbalance-reducing potential of the rule. A hacker obtained the tax information of about 1,300 Lamp Plus employees. The company’s employment contract included a mandatory arbitration term. The issue in the case was whether class arbitration was available. The district court and the Ninth Circuit held it was because the contract was ambiguous, applying California’s contra proferentem rule. Relational justice requires no less. Indeed, liberal contract requires vindicating workers’ interests in privacy and access to justice because it is critical to their ability to interact with others as self-determining agents.Footnote ¹⁰³

This story ends badly for reasons that underscore the general point that rules of interpretation often are designed to serve substantive values. The Supreme Court reversed in a five-four decision. The majority resolved the ambiguity in the company’s favor by applying decidedly illiberal values. The majority got one thing right. It correctly characterized the contra proferentem rule as being based primarily on “considerations about the parties’ relative bargaining strength,” and as seeking “ends other than the intent of the parties.”Footnote ¹⁰⁴ Following its Stolt-Nielsen decision we criticized above, the majority resolved the ambiguity in the company’s favor by applying a substantive rule of interpretation of its own making that prohibits an agreement to participate in class arbitration being inferred from silence or ambiguity.Footnote ¹⁰⁵

The majority justified this substantive rule of interpretation by citing a “first principle that underscores all of our arbitration decisions,” which is that “[a]rbitration is strictly a matter of consent.”Footnote ¹⁰⁶ This is bitterly ironic, for it is unlikely that the company’s employees read the employment agreement and knew that it contained an arbitration term. This is typical because often when people make contracts they only think about a few salient terms. The next Section explains how liberal contract steps in to effectuate people’s general choices.

3. Liberal Contract’s Answer to the “What Meaning” Question and Its Crucial Role in Effectuating People’s General Choices

Interpretation cannot really be about recovering people’s intent when the issue is something people do not think about in making a contract. This frequently occurs in contracts made by people (rather than companies with a legal department) because people’s choices tend to be of a general type, like taking a cab in pre-app days (or cohabiting). A genuinely liberal contract law appropriately steps in proactively to facilitate people’s general choices.

To demonstrate this proposition, we use three examples.Footnote ¹⁰⁷ We begin with personal insurance contracts, which also raise the issue of the legal effect to be given to unread terms in form contracts. We then consider employment and prenuptials. In all these cases, the law adheres to its commitment to relational justice: it designs its interpretive rules so as to vindicate the autonomy of the weaker or more vulnerable party while effectuating the parties’ general choice; and it appropriately treats these interpretive rules as mandatory, rather than defaults, since allowing people to opt out of an interpretive rule only makes sense if people know of the default rule and that it is being altered, which is rarely the case when people make contracts without legal counsel.

a. Personal insurance contracts. Robert Keeton’s early discussion of personal insurance contracts demonstrates that courts used the contra proferentem rule and other doctrines to ensure that personal insurance agreements conform with “the larger goals of insurance policy regardless of the clarity of the contractual language.”Footnote ¹⁰⁸ Keeton sought to rationalize this practice in terms of “reasonable expectations,” conceived not as people’s actual expectations, but rather as what people reasonably could expect a policy to cover. Thus, courts should not enforce an unambiguous term denying coverage on an event that in fact did not materially increase the pertinent risk of loss. The term is not enforced because it is inconsistent with the purpose of insurance (as taken from the perspective of the insured, of course).Footnote ¹⁰⁹

This is surely not interpretation in the sense of trying to recover the meaning people attach to policy terms when they purchase an insurance policy. Nor is this what efficiency would dictate, given the deadweight cost of resolving such “unreasonable as applied” claims.Footnote ¹¹⁰ But it does make perfect sense on our account. Law should set a rule that is best for people as a general matter, given a choice we know they intended to make, namely: to purchase insurance, while typically neither thinking nor even reading all other terms. The rule is justified because it is crucial to autonomy. Loss of insurance coverage can have momentous negative effects on people’s lives, whereas paying a few dollars more for coverage does not.

Keeton is therefore right to applaud courts that allow recovery of benefits in these cases when a policy exclusion is facially reasonable but unreasonable as applied.Footnote ¹¹¹ He is also correct in treating this interpretive rule as mandatory, rather than a default, since allowing people to opt out of a rule only makes sense if people know of the default rule and of its corresponding altering rule.

b. Employment contracts. Employment contracts law offers another example of the law’s crucial role in facilitating people’s general choices when there are significant autonomy stakes. Liberal contract embraces the modern rule that an informal indefinite promise of job security by an employer, like a promise of “permanent employment,” should be interpreted as a promise that an employee will be terminated only for cause.Footnote ¹¹² The old rule was that an informal indefinite promise of job security was not sufficient to overcome the presumption of at-will employment. The modern rule is better because people’s interest in job security outweighs a company’s interest in having largely unfettered power to terminate employees. Indeed, liberal contract would go further than U.S. law to eliminate the presumption of at-will employment and impose stiff formal requirements (akin to those for disclaiming an express warranty) to alter the default rule of job security to ensure people know and understand what they are getting into when they take a position without job security.

Interpretation of a promise of job security begins with an inquiry into the meaning the recipient attached to the promise, but it quickly becomes an inquiry into pragmatic meaning (dare we say “reasonable expectations”). This is because the recipient of a promise of job security will have a general understanding of what job security means, but they will not have thought about the details. The law supplies the details. Some details are a matter of implication because they are based on tacit intent or transactional necessity (e.g., an employee can be fired for theft). But many other details are worked out by lawmakers with an eye to balancing the interest of an employee in job security and the interest of an employer. On this point, U.S. law is less protective of employees than the law in most wealthy societies by allowing an employer to terminate an employee when a significant change in the business means it no longer needs an employee.Footnote ¹¹³

c. Prenuptial agreements. Our final example shows that sometimes interpretation involves a deep inquiry into an individual’s understanding of a choice they made. The context is a challenge to the enforcement of a prenuptial agreement on the ground a change in circumstances makes it unfair to enforce the agreement. A leading case explains, “prenuptial agreements will be enforced in their explicit terms only to the extent that circumstances at the end of the marriage are roughly what the parties foresaw at the time they entered into the prenuptial agreement.”Footnote ¹¹⁴ More precisely, the question is whether the party challenging the prenuptial agreement roughly foresaw the circumstances they would be in at the end of marriage. Liberal contract supports this rule because of the enormity of the autonomy stakes to the challenger. The challenger’s present self can make a choice that significantly impairs the autonomy of their future self but only if they roughly understand the gravity of the implications for their future self.

4. Back to the Textualist/Contextualist Divide

Thus far, we have addressed liberal contract’s instructions for the “whose meaning” and “what meaning” questions and, more particularly, for interpreting and supplementing contract types that involve general choices made by people with significant autonomy implications.Footnote ¹¹⁵ We turn now to the question of what facts determine meaning.Footnote ¹¹⁶

a. From corporations to real people. Liberal contract’s endorsement of the textualist approach for contracts between legally sophisticated wealth-maximizing firms generally does not extend to contracts made by people. This is because liberal contract attaches significant value to honoring people’s choices, and often people cannot be expected to ensure that a writing corresponds with their intentions. The former reason is particularly heavy when a choice implicates people’s lives in fundamental ways that cannot (or should not) be reduced to the cost-benefit analysis that guides Schwartz’s and Scott’s account.Footnote ¹¹⁷ Indeed, the further the contract type at hand is from the strictly instrumental pole—the more it tends to play a constitutive role in one or both parties’ lives—the more important accuracy is, and thus the less acceptable it is to trade it off against the costs of contract writing and of adjudication.

Steuart v. McChesney Footnote ¹¹⁸ illustrates how the plain meaning rule violates people’s autonomy by ignoring their intent. The case involves the interpretation of an agreement between the Steuarts and the McChesneys giving the latter a right of first refusal on a parcel of farmland during the Steuart’s lifetime. The right was triggered if the Steuarts “obtain a Bona Fide Purchaser for Value,” and gave the McChesneys the right to purchase the land “at a value equivalent to the market value of the premises according to the assessment roles” for real estate taxes. After her husband died, widow Steuart got two bona fide offers of $35,000 and $30,000, both below the land’s appraised value of $50,000. The McChesneys sought to exercise their right and tendered $7,820, which was twice the land’s value on the assessment rolls. The trial court rejected this claim and ruled that the McChesneys would have to match the price of the first offer ($35,000). The appellate courts reversed applying the plain meaning rule.

Melvin Eisenberg shows that this result was unnecessary, even under the plain meaning rule, because the court could easily have found an ambiguity in the writing.Footnote ¹¹⁹ We suspect the appellate courts sacrificed widow Steuart on the altar of the plain meaning rule to demonstrate their commitment to the rule. But this violated the Steuarts’ autonomy by ignoring their intent. The extrinsic evidence (including the testimony of the draftsman, an attorney employed by the McChesneys) made it clear that the parties intended the value of the assessment rolls to be a protective minimum price. Apparently, the Steuarts were not legally sophisticated and can hardly be faulted for not realizing the writing said something else. The fault lies with the McChesneys, who demanded the writing be interpreted literally when they knew this was not what the Steuarts intended.

When people (again: natural persons) do make a choice about an aspect of a contract, liberal contract endorses the simple principle that the law should honor that choice, since autonomy does not lend itself to the radical commensurability that governs commerce.Footnote ¹²⁰ In other words, the cost-savings analysis, which (properly) guides an account like Schwartz’s and Scott’s that focuses on the economic bottom line of contracts between sophisticated wealth-maximizing companies, cannot usually justify bypassing people’s actual choices.Footnote ¹²¹ There are exceptions to this that we momentarily address, but outside these exceptions, autonomy requires respecting people’s choices, which implies that courts should consider all helpful evidence to get this crucial fact right. This is especially true when a contract involves people’s identitarian features like work and home.

Happily, the new Restatement of Consumer Contracts (“RCC”) achieves this goal through a tailored parol evidence rule (PER) in which “a standard term that contradicts, unreasonably limits, or fails to give the effect reasonably expected by a consumer to a prior affirmation of fact or promise by a business does not constitute a final expression of the agreement regarding the subject matter of that term,” and thus does not discharge “obligations that would otherwise arise as a result of the prior affirmation of fact or promise.”Footnote ¹²²

The RCC also properly clarifies that this rule means the “four corners rule” of interpretation does not apply in consumer contract law. Furthermore, even though businesses often include “merger clauses” in their standard forms, these clauses “do not preclude a finding that the standard contract terms do not constitute the parties’ final expression of a particular matter.”Footnote ¹²³ Because RCC’s answer to the “whose meaning” question is “the consumer’s,”Footnote ¹²⁴ it properly instructs courts to recover what the business should have reasonably understood the consumer intended, and not to effectuate intent expressed in an unread writing.

b. An exception. Hyper-textualist rules of interpretation are appropriate when it comes to formal wills. Courts often say the rules of interpretation are the same for wills and contracts.Footnote ¹²⁵ Of course (and happily), this is not true. In California, for example, the law is clear that when courts interpret wills their task is to determine the testator’s intent based on what the will says.Footnote ¹²⁶ This is appropriate because of the nature of a will. Generally, the relevant autonomy interests are those of the testator.Footnote ¹²⁷ In addition, given the nature of a will (testators know that when the time comes to implement a will the document must speak for them) and the formalities surrounding its execution, it is sufficiently likely that a will reflects a testator’s intent. Therefore, it is sensible to not give people the opportunity to establish an intent not expressed in the will itself.