Legal Theory Blog: Legal Theory Lexicon: Default Rules and Completeness

Introduction

At some point in the introductory class in contract law, students are likely to encounter a very powerful idea--the distinction between "default rules" and "mandatory rules." The basic distinction is easy to grasp. Some rules of contract law supply default terms that are subject to contractual override; other rules of contract law are mandatory--they can't be modified by the contract. Lurking in the background of this distinction is a theoretical construct--the complete contract, an idealized contract that would include explicit terms covering every possible contingency. Once you understand the distinction between default rules and mandatory rules, additional questions arise: as a matter of normative contract theory, which rules should be default rules and which rules should be mandatory? And what normative principles should guide the design of default rules?

As always, this post in the "Legal Theory Lexicon" series is aimed at law students--especially first year law students--with an interest in legal theory.

Default Rules and Mandatory Rules

Let's start with the "takeaway" point. In contract law, we can sort the rules into two sorts, "default rules" and "mandatory rules."

Here's an example. The Uniform Commercial Code (or UCC, the codified law of contract that applies to contracts between businesses as a matter of state law in the United States) creates a duty to act in good faith--this is a mandatory rule, because this duty cannot be disclaimed by a contractual provision. The UCC also includes an implied "warranty of merchantability," that attaches to contracts, but can be waived by agreement--this is a default rule.

Grasping this distinction is important for at least two reasons. First, unless you know whether a given rule of contract law is a default rule or a mandatory rule, you don't really know the law. And it isn't always clear whether a given rule is one or the other: the usual tipoff is language like, "unless the contract provides otherwise" or "absent an agreement to the contrary." Second, the distinction between default rules and mandatory rules is fundamental to the normative structure of contract law. Learning contract is more than a matter of mastering the rules; mastering the arguments of principle and policy that can be used to argue for and against the rules is equally important. But the arguments for default rules and the arguments for mandatory rules must be different--because these two kinds of rules have different functions.

Generalizing the Idea of a "Default Rule"

Although the notion of a "default rule" is usually introduced to law students in the context of contract law, the idea is more general. For example, we could think of the law of wills and intestate succession through this theoretical lens. Rules of intestate succession are "default rules" that can be overridden by a will. Much of the law of wills consists of default rules, and we can imagine a "complete will" that covered every possible contingency.

Similarly, we can imagine a "complete code" that covers every possible action or inaction and specifies what legal consequences follow. Given that actual codes are incomplete, we can look at the law of statutory interpretation as including a collection of "default rules" that allow courts to fill in the gaps. Another example is provided by corporations law--once again, some of the rules are mandatory and others are merely defaults.

You get the idea--default rules can be applied to any authoritative legal text that is "incomplete."

Normative Theories of Default Rules

Once we understand the distinction between default rules and mandatory rules, we can then ask the question, "What normative principles should guide the design of default rules?" For example, we might decide that lawmakers (legislators or common-law judges) should attempt to devise the default rules that are most likely to be the rules that the parties would have adopted had they contracted on the issue. Or we might want "efficient" default rules. Or default rules that maximize utility. All of these approaches are associated with normative law and economics. But there are other approaches as well. For example, we might try to design default rules so that they maximize the autonomy or liberty of the parties to the contract--imposing the fewest possible restrictions that have not actually be agreed to by the parties. Or we might impose default rules that will serve some other goal such as distributive justice or economic equality.

Default Rules as Public Goods

Another interesting question is why the law provides default rules at all. Why don't we force the parties to reach complete agreements? Immediately, of course, we realize that this would be very costly. Drafting a complete contract would almost always (perhaps always) cost more than the contract is worth. And there is another problem as well. Most contract provisions are not protectable as intellectual property; in general, you can't copyright or patent a nifty contractual provision. (You may be able to copyright the specific language, but that doesn't preclude someone else from expressing the idea in different language.)

This suggests an interesting perspective on the economics of default rules. We might see the default rule provisions of contract law as a "public good." That is, consumption of default rules is "nonrivalrous"--because my use of a given provision doesn't interfere with your ability to use the same provision. And consumption of default rules is "nonexcludable"--assuming that there is no intellectual property protection available for "form contracts" or "form contract provisions." If this is correct (and it may not be), then there is a classic economic justification for government to provide for the "public good." For more on the idea of a public good, see Legal Theory Lexicon 029: Public and Private Goods.

Complete Contracts

Now that we have the basic distinction between default and mandatory rules in mind, let's discuss the related idea of a complete contract. Once again, the core intuitive idea is relatively simple--a complete contract has provisions that cover "every contingency." In other words, a complete contract has no gaps.

Why did I put "every contingency" in scare quotes? Because "every contingency" is an ambiguous way of formulating a fairly complex idea. We need some special terminology here. Economists tend to use the phrase "states of affairs" to express the idea of a contingency. A "state of affairs" is simply a way that the world can be--a complete specification of the way things are. Philosophers use different jargon--the phrase "possible world" expresses the same idea as "state of affairs."

So a truly "complete" contract would be a contract that specified the duties and rights of the parties for all the future states of the world--or all the possible worlds that share the history of the actual world up to the point the contract is formed. Once you think about it, it becomes clear that no actual contract could be complete. There are infinitely many possible future states of the world--and a contract that covered all of them would have an infinite number of provisions, and hence the drafting of such a contract would never be complete--it would still be unfinished when the universe reached a state of complete entropy.

So the notion of a complete contract is an idealization--not a practical option. And once we see this point, another point becomes obvious. Contract law cannot provide default rules to cover every possible contingency either. Of course, as a practical matter, contract law doesn't have to cover all the contingencies. Some possible future states of the world are so remote or far-fetched that they can safely be disregarded--Martian invasions and/or the discovery of a true universal fabrication machine (3D printers are not even close) are not contingencies about which we need worry.

The General Idea of Completeness

Just as the idea of a default rule can be generalized beyond contract law, so can the idea of completeness. So we can imagine "complete wills," "complete corporate charters," "complete trusts," and so forth. One particularly important idealization is the idea of a "complete code"--a legal code that itself has provisions that cover every possible contingency. The complete code will have default rules or mandatory rules that for every possible future state of affairs.

Conclusion

Well, as is usually the case, we've barely scratched the surface. Nonetheless, I hope this Lexicon entry has given you a basic framework for understanding the ideas of a complete contract and the distinction between default rules and mandatory rules. Once you have this ideas in your conceptual toolkit, you are likely to start noticing them in all kinds of contexts, not just in contract law, but in every legal subject you encounter. When you do, you might ask yourself, "Why is this a default rule rather than a mandatory rule?," or vice versa. And, "What normative legal theory or principle supports this choice?"

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(This entry was last updated on December 2, 2023.)