Choi, Gulati and Scott, ‘Contractual Arbitrage’

Contracts are inevitably incomplete. And standard-form or boilerplate commercial contracts are especially likely to be incomplete because they are approximations; they are not tailored to the needs of particular deals. Not only do these contracts contain gaps but, in an attempt to reduce incompleteness, they often contain clauses with vague or ambiguous terms. Terms with indeterminate meaning present opportunities for strategic behavior well after a contract has been concluded. This linguistic uncertainty in standard form commercial contracts creates an opportunity for ‘contractual arbitrage’: parties may argue, ex post, that the uncertainties in expression mean something that the contracting parties, ex ante, didn’t contemplate. We argue that the scope for contractual arbitrage is a direct function of the techniques that courts use to resolve ambiguities in boilerplate language. Using the infamous case of NML v Argentina, we show how traditional contract doctrine, which uses a model of interpretation that essentially treats all contracts as finely tailored, can produce a fertile setting for the growth of contractual arbitrage in standard form commercial contracting when courts give indeterminate terms idiosyncratic meaning. When this practice occurs in contexts where individual parties are reluctant due to collective action problems to revise boilerplate terms, the continued use of the terms can lead to a dramatic increase in social costs.

Choi, Stephen J and Gulati, G Mitu and Scott, Robert E, Contractual Arbitrage (June 13, 2016).

First posted 2016-06-14 06:04:36

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