March 2006 Vol. 104 No. 5 THE REVIEW

The Return of Bargain: An Economic Theory of How Standard-Form Contracts Enable Cooperative Negotiation between Businesses and Consumers

Jason Scott Johnston

Among attorneys, judges, and legal academics, there is virtual consensus that the widespread use by business firms of standard-form contracts in their dealings with consumers has completely eliminated bargaining in consumer contracts. I believe that this perception is false, that rather than precluding bargaining and negotiation, standard-form contracts in fact facilitate bargaining and are a crucial instrument in the establishment and maintenance of cooperative relationships between firms and their customers. On this view, which I elaborate below, firms use clear and unconditional standard-form contract terms not because they will insist upon those terms, but because they have given their managerial employees the discretion to grant exceptions from the standard-form terms on a case-by-case basis. In practice, acting through its agents, a firm will often provide benefits to consumers who complain beyond those that its standard form obligates it to provide, and it will forgive consumer breach of standard-form terms. Firms do this because they have an interest in building and maintaining cooperative, value-enhancing relationships with their customers. Were firms legally required to extend such benefits or forgiveness—as would result either from judicial invalidation of the tough standard-form performance terms or legislatively mandated generous standard-form performance terms—then both firms and their customers would be worse off.

Most of my analysis here is concerned with standard-form terms of performance: contract terms that set out, for example, the amounts and repayment dates on a consumer loan, or an airline passenger’s rights to be upgraded to a first-class seat. While my main concern is with such standard-form performance terms, I also discuss what may be called standard-form breakdown terms—terms that determine where and how an “endgame” dispute over breach of the performance terms will be resolved. Unlike performance terms, which firms intend to forgive or expand upon when so doing is consistent with building and maintaining valuable customer relationships, breakdown terms are not meant to be varied, since breakdown signals that no mutually beneficial customer relationship exists. Moreover, the optimal breakdown terms are those that maximize the firm’s incentives to pursue discretionary, cooperative tailoring of its customer relationships. By systematically overcompensating consumers with large claims against business firms, and undercompensating those who have relatively small claims against such firms, the civil justice system blunts or eliminates such incentives. By offering a more predictable and more uniform schedule of damages, private arbitration can offer a form of endgame dispute resolution that allows firms to focus more on business value and less on litigation risk in negotiating the terms of their ongoing consumer relationships.

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