Reconstructing Contracts

Douglas G. Baird

• Publisher: Harvard University Press
• Year: 2013
• Print ISBN: 9780674072480
• eBook ISBN: 9780674073586
• Topic: Law
• Subtopic: Business Law
• Index: Law

Every legal system must decide how to distinguish between agreements that are enforceable and those that are not. Formal bargains in the marketplace and casual promises in a social setting mark the two extremes, but many hard cases lie between. When gaps are left in a contract, how should courts fill them? What does it mean to say that an agreement is legally enforceable? If someone breaks a legally enforceable contract, what consequences follow?

For 150 years, legal scholars have debated whether a set of coherent principles provide answers to such basic questions. Oliver Wendell Holmes put forward the affirmative case, arguing that bargained-for consideration, expectation damages, and a handful of related ideas captured the essence of contract law. The work of the next several generations, culminating in Grant Gilmore's The Death of Contract in 1974, took a contrary view. The coherence Holmes had tried to bring to the field was illusory. It was more sensible to see contracts as merely a species of civil obligation and resist the temptation to impose rigid and artificial rules.

In Reconstructing Contracts, Douglas Baird takes stock of the current state of contract doctrine and in the process reinvigorates the classic framework of Anglo-American contract law. He shows that Holmes's principles are fundamentally sound. Even if they lack that talismanic quality formerly ascribed to them, properly understood they continue to provide the best guide to contracts for a new generation of students, practitioners, and judges.

1

Objective Intent

William Winter Raffles was a cotton broker in Liverpool in the middle of the nineteenth century.¹ His agents acquired cotton for him abroad, and he sold it in England, either to textile mills directly or to others who might hold it and try to resell it at a profit. In January 1863, Raffles was trying to sell 125 bales of cotton on a ship that had just left Bombay and would arrive in Liverpool in April. He found Daniel Wichelhaus, a cotton speculator. He agreed to give him 125 bales of cotton, roughly twenty-five tons, “to arrive ex ‘Peerless’ from Bombay,” and in return Wichelhaus agreed to pay 17¼d a pound.

The price for cotton was particularly volatile that January. Most southern ports in the United States were blockaded. The Union’s success at the Battle of Antietam and the resolve Lincoln showed in issuing the Emancipation Proclamation (and the House in affirming it) suggested that the war would continue for a long time, and the market for cotton would remain uncertain. The price fell somewhat and remained unstable. Cotton sold for 16¼d in February and then rose to 16¾d in April.

When the cotton arrived in April, Raffles demanded that Wichelhaus honor his promise to buy it, but Wichelhaus refused. He said there had been a misunderstanding. Raffles tendered Wichelhaus cotton from a ship called Peerless that had left Bombay in December, while Wichelhaus thought he was being offered cotton from a ship called Peerless that had left in October. Because each was thinking about cotton on different ships, Wichelhaus argued that they never had a deal with each other.

Raffles argued that it made no difference whether they had been thinking of different ships. Raffles produced the cotton in the amount and grade he promised and that was all that mattered. The identity of the ship was not relevant to the bargain they struck. “Peerless” was a common name for a ship during this period. In addition to the two involved in this case, there were seven other British sailing vessels registered under that name. That Wichelhaus had thought the cotton was on a different ship was neither here nor there. Raffles had cotton on only one of the ships called Peerless.

Raffles reduced the dispute to this point alone by demurring to Wichelhaus’s pleading. The contemporary equivalent under the Federal Rules of Civil Procedure is a motion for judgment on the pleadings. Today Raffles would be able to continue the litigation even if he lost a motion for judgment on the pleadings. At the time, however, a party that lost a demurrer lost the entire case. Raffles essentially was saying, “So what? Who cares?” Even if what Wichelhaus said was true, it did not make the slightest bit of difference. The bargain was over the cotton.

An example illustrates the essence of Raffles’s argument. You visit me and see both of the red Porsches that I own. I point to one and explain that it is my city Porsche. The other is my country Porsche, which I use mostly on weekends. You ask how I protect them against the weather, and I explain that I keep my city Porsche in the Michigan Street Garage, which is close to where I live during the week, and I keep my country Porsche in the California Street Garage, which is only a block from my country home. As it happens, there are two California Street Garages. One is in Naperville, which is the one I use. The other is in Libertyville. I do not live in Libertyville, and I do not park my Porsche in a garage there. Indeed, I have never been to Libertyville.

We meet later and you express an interest in buying one of my cars. I agree to sell you the one stored in the California Street Garage. I will deliver it to your house on Saturday. When I refer to the California Street Garage, you might think I am talking about the California Street Garage in Libertyville. After all, you do not know the location of my country home. But this makes no difference. We have a contract for a particular Porsche, and we both know which one it is. If I had red Porsches in each of the California Street Garages, you might have something to complain about. (You might have thought you were buying one Porsche, and I thought I was selling another.) But that is not the case here. “California Street Garage” uniquely identifies which of my Porsches we are talking about, no matter how many California Street Garages there are. The only work that “California Street Garage” is doing in the contract is distinguishing my country Porsche from my city Porsche. Otherwise, the garage in which the car is parked makes no difference. It is not material to our bargain.

I have to tender a particular Porsche; Raffles has to tender the specified cotton. I mention a garage; Raffles names a ship. It would matter that there were two California Street Garages if I had Porsches in both or that there were two ships called Peerless if Raffles had cotton on both. But I have only one Porsche in a garage on California Street, and it is in the garage in Napierville, and Raffles has cotton only on a ship called Peerless, and it is the December Peerless. We never need to talk about the garage in Libertyville or the second Peerless.

The court, however, did not buy the argument that the identity of the ship was immaterial. Indeed, the judges decided in favor of Wichelhaus after hearing only a few words of his lawyer’s argument. As Gilmore explained, Raffles lost because “the judges … believed that the identity of the carrying ship was important—a true condition of the contract.” In this, Gilmore had “no doubt” but that the judges were mistaken. Raffles’s understanding of the relevance of the name of the ship was the correct one. The contract term “to arrive ex Peerless”

meant only that “if the vessel is lost on the voyage, the contract is to be at an end” (that is, the seller would bear the loss but the buyer would have no claim for damages for non-delivery). In commercial understanding, that is exactly what the terms mean today and there is no reason to believe that they meant anything else a hundred years ago.²

As it happens, Gilmore was mistaken. A decade after Death of Contract, Brian Simpson took a close look at the nineteenth-century Liverpool cotton market and discovered that the name of the ship in such contracts “to arrive” served a distinct function over and above identifying goods in the event they were destroyed.

Today speculators like Wichelhaus can bet on the price of cotton by entering into a futures contract. The futures market for cotton did not exist in 1863. To speculate on the price of cotton, one had to buy and sell the physical commodity. It was possible to hold cotton, of course, but storing it was expensive. A better alternative was to buy or sell cotton that was en route. A ship took four months to sail from Bombay to Liverpool, but it took only a month for news of its departure from Bombay to reach Liverpool. While it was at sea, identifiable lots of cotton could be bought and sold. By entering into a “contract to arrive,” you could gamble on the future price of cotton without having to incur the expense of storing it. In a contract such as the one involved in Raffles, a one-penny change in the price of cotton represented a £200 gain or loss.

The exact date any particular ship would arrive in port was not clear in advance. Hence, the contracts referred to the ships rather than a specific time for delivery. A contract involving the October Peerless was as close as you could come to a futures contract for February cotton, and a contract involving the December Peerless was for April cotton. In promising in January to buy cotton “ex Peerless,” Wichelhaus believed he was buying cotton for delivery the next month, and in promising to sell cotton “ex Peerless,” Raffles believed he was selling cotton in three months.

Seen from this perspective, it makes a considerable difference which ship contained the cotton. Someone who wants cotton delivered in February is not necessarily interested in buying cotton that will arrive only in April. Such a buyer may himself have an obligation to deliver cotton to someone else in February. Cotton on the October Peerless hedges bets in a way that cotton on the December Peerless does not.

At the time Raffles and Wichelhaus entered into their contract, the futures price of February cotton and April cotton might have been about the same. Although there might be some differences because the market demand may be cyclical and storage is costly, in a market that is not well developed, the forward price for February and April cotton might be about the same as the spot price in January. But even if the price is the same, the contracts are not. An obligation to deliver cotton in February, when cotton sells at one price, is different from the obligation to deliver cotton in April, when it sells at a different price. Moreover, to beat back the demurrer, Wichelhaus needed to show only that the difference might matter—that one could not assume the differences were immaterial from the face of the pleadings alone.

As noted, the price of cotton declined significantly between the time of the contract and the time the first Peerless arrived in Liverpool. There was a full penny per pound difference between the contract price and the market price in February. Because Raffles failed to act at all when the first ship arrived, even though doing so would have profited him handsomely, he likely always intended to deliver cotton in April and had intended the December Peerless rather than the October Peerless. He would be unlikely to have cotton of the contract description on both ships.

Wichelhaus’s silence after Raffles’s failure to deliver may reflect his reluctance to acknowledge a losing deal. If, as he claimed, Wichelhaus had wanted cotton in February and had therefore intended the October Peerless, he would have expected Raffles to call and tender delivery of cotton from the ship that docked in February. But Wichelhaus had no reason to encourage Raffles to perform under a contract when it no longer benefited him. He was entitled to remain silent. When the second ship Peerless arrived in April and Raffles demanded payment, Wichelhaus, if he had always expected cotton on the February ship and had known nothing of the April ship, would likely have behaved much as he did. He had a losing contract for February cotton, but Raffles had never claimed his rights under that contract. And by April, Raffles was too late. One cannot meet a futures contract for February delivery with April delivery.

It is possible that Wichelhaus knew about the two ships by February and was trying to have it both ways. If the price of cotton remained below the contract price, he could, as he did, use the ambiguity in the contract to let himself off the hook. And if the price rose again above the contract price by April, he could have insisted that he had wanted cotton on the December Peerless all along and hold Raffles to what would now be for him a winning contract. It seems likely, however, that Wichelhaus at the outset had thought he was buying cotton that was to arrive in February. If he had not, Raffles would not have allowed the case to turn on the legal question of whether an enforceable contract had been formed.

Of course, not all ambiguities matter, as our example with the Porsche suggests. But to the extent that the name of the ship is a proxy for the delivery date, the difference between two different types of futures contracts is not something that can be glossed over.

The court found that the ambiguity of which Peerless was intended was dispositive. Although the court did not issue an opinion, it seemed to hold that in order for a contract to come into being, the minds of the parties must meet, at least with respect to all the material elements of the bargain. There has to be consent for a contract to be formed. There could be no contract in Raffles because, in the words of Wichelhaus’s lawyer, there was no “consensus ad idem.” Because each was thinking of a different ship and the identity of the ship mattered, there was no deal.

The debate that emerged out of this case was whether a subjective meeting of the minds on all material points was necessary for a contract to be formed at common law. At the time Raffles was decided, the theoretical foundations of contract law were unclear. Blackstone’s Commentaries was the first book in every American lawyer’s library in the eighteenth century. Blackstone tried to make the common law of England coherent, but he provided little help when it came to identifying the central principles of contract law.

No one ever accused Blackstone of being a deep thinker. He glorified the common law, but he had no philosophical intuitions and little historical sense. More to the point, the Industrial Revolution was only just beginning, and the law merchant had not been completely integrated into the common law. He was worried about the problems that arise in a largely land-based economy. He had little to say about contracts or indeed, about commercial law.

Contract law was not recognized as a separate subject until well into the nineteenth century. When people started to think seriously about the law of contracts, the rules of pleading were on their way out, and they no longer provided the conceptual framework for thinking about contracts. In seeking a framework, those in England first looked to thinkers on the Continent such as Savigny, who were steeped in Roman law and the civil law tradition.

One of the central ideas of Savigny’s theory of contracts was that a subjective meeting of the minds was essential. In his discussion of Roman law, Savigny noted that there were some kinds of obligations that arose simply because the parties had engaged in a particular legal ritual. There were other obligations, however, that were enforced simply by virtue of consent. It was the existence of the meeting of the minds of the two parties itself that made the obligation enforceable. The legal obligation could arise only from “a union of several wills to a single, whole, and undivided will.”³ Savigny was understood to make this into a normative as well as a positive proposition. A contractual obligation should not exist if both parties did not will it. Before a contract became legally enforceable, the minds of the two parties had to meet. Unless they were in subjective agreement on all the issues that mattered, there could be no enforceable contract.

To the extent that Holmes had an agenda, it was to separate the study of the common law from the intellectual superstructure imposed by European thinkers like Savigny. A way to do this was to insist that it was independent of Roman law. In particular, Holmes sought to show that the contractual obligations at common law were not based on the will of the parties. Contracts are formed according to objective criteria, rather than the subjective intent of the parties. A binding contract on a given set of terms might exist even if one of the parties did not subjectively intend to enter such a contract.

The Young Astronomer, of course, cannot describe the stars as he wishes them to be. Holmes was heavily imbued with the spirit of pragmatism that pervaded his intellectual circle in Boston. He was attempting an account of t...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Dedication
• Contents
• Preface
• Introduction: The Young Astronomer
• 1. Objective Intent
• 2. The Bargained-for Exchange
• 3. Holmes’s Bad Man
• 4. The Expectation Damages Principle and Its Limits
• 5. Terms of Engagement
• 6. Mistake, Excuse, and Implicit Terms
• 7. Duress and the Availability of the Legal Remedy
• 8. Fine Print: Contracts in Mass Markets
• Epilogue: The Boundaries of Contract
• Notes
• Index