Some Reflections on the Doctrine of Freedom of Contract

As indicated above, the doctrine of freedom of contract was the central doctrine of the classical contract law that came to full development in the last half of the nineteenth century. The very idea of a general law of contract is part and parcel of the same positivist era. This law was the creation of judges and thesis writers influenced by social-contract ideas dating back to Locke, by classical economic thought and the associated ideology of voluntariness. Among legal theorists of the late nineteenth century, the law of contract was the archetypical branch of what was conceived of as legal ‘science’. This involved an attempt to systematise the various doctrines and decisions of the courts to do with contract issues into a consistent and logical theory in which the legal rules were to be deduced from general concepts such as property.

The classical view of contract involved a process of abstraction, generalisation and systemisation in an attempt to create a unitary theory that was thought to be free of moral valuations and could therefore be described appropriately as a science. This development formed part of the more general attempt to substitute scientific discourse for moral discourse at a time when the traditional religious underpinnings of moral values were coming under increasing attack with the decline in formal, traditional religious belief. There was, therefore, an attempt to distinguish between what was conceived of as public law and contract or private law—law that individuals legislated for themselves. This distinction between public and private law was part of the Enlightenment’s attempt to separate the public from the private realm in political and legal theory. Central to this conception of contract was the idea that contract obligations arose from the wills of the individuals concerned, and not as a result of a socially and historically constructed legal institution. It has much in common with the Lockean idea of property as a pre-social natural right. Indeed, the obligation to fulfil promises—central to classical contract law—was at its heart a Lockean natural law, but a natural law increasingly bereft of its metaphysical foundations.

In retrospect, this development could be seen as a process of reification—a manifestation of an excessively legalistic mentality in which legal rules and universal abstractions acquired sanctified status and became absolutes. What was also involved was an attempt to claim that the rule of law provided norms independently of politics. There is a close connection between this ideal of a rule of law and not of men and laissez-faire ideas. It was assumed that rules fixed and known beforehand would make it possible for economic actors to foresee how the courts would use their coercive powers and would allow those economic actors to plan their activities effectively. Hayek made much of these ideas in his defence of the market system.[32] They involve an underlying assumption that predictability is associated with generality. It is also a view that conceives of courts as enforcers of rules rather than as settlers of disputes. This is a view that also conceives of judges as rulers on the truth—a view that encourages the adversarial approach of common-law courts. From this rule-based point of view, any movement away from the strict enforcement of rules towards multi-dimensional standards such as fairness is to be deplored. Herein lies the source of the conflict between equity as it had been developed in earlier times and classical contract law. The nineteenth-century desire for uniformity, certainty and predictability could not be reconciled with the discretionary element implicit in equity. Herein also lies the source of the reluctance to inquire too closely into the particularities of the subject matter of an agreement, the circumstances of its making, the expectations of the parties and especially of the outcomes realised. In practice, what came to be important in contracts was the written document as interpreted by the courts in a highly literalist manner, independent of any substantive inquiry of the parties (the parole evidence rule precluded such inquiry into the circumstances surrounding written contracts). All of this involved a commitment to a rigid and mechanical decision rule, to be implemented in a mechanical manner—a replica of the determinism of Newtonian physics.

This view of contract law has increasingly foundered on the evidence of experience. Too rigid an enforcement of contracts on the basis of freedom of contract led to what were recognised clearly as unjust outcomes. Legislatures and, over time, the courts themselves did not tolerate these. As a matter of practical politics, legislatures everywhere moved to legislate and regulate to remove the grosser abuses of the contract system. These measures have not been confined to simply addressing issues associated with contract formation but have been concerned increasingly with the substantive outcomes of contractual arrangements. Therefore, contract law came to be robbed systematically by legislatures of much of its subject matter. As a consequence, pure contract law has ceased to occupy so central a position in the economic system.

Among legal theorists, it was recognised increasingly that the refusal to inquire into the circumstances surrounding a contract was obviously inconsistent with the will theory on which classical contract theory rested.[33] This in turn led to the replacement of the will theory with the development of the objective theory of contract—a theory that acknowledged openly that contracts were enforced for reasons of public policy. It has come to be recognised—particularly in the work of the theorists of the American realist school—that classical contract theory is neither neutral nor natural; it is instead a historically contingent social and legal construct.[34]

In consequence, the very idea of contract law as a neutral system has had to be abandoned. Rather, all valuations at law are moral choices. Contract law—and decisions in particular cases—involves a balancing of conflicting social values, not a deduction from consistent scientific principles. This realisation has posed an overwhelming challenge to deductive legal reasoning, as it is impossible to reason down from very general principles to particular decisions. Furthermore, this viewpoint leads directly to a good deal of scepticism about the practicality of general rules of the kind Hayek advocated.[35] It also became clear that classical contract law conferred a privileged position on the status quo, the intelligent and the powerful.

Even the ideology of voluntariness has come under attack. The first point to be made in this regard is that methodological individualism in economic and moral theorising does not necessarily lead to any justification for a policy of self-reliance, however much the two are confused in practice. Secondly, it is obvious that individuals are frequently not the best judges of their own interests. In any event, individual interests are often subordinated to social and political goals, including in the law of contracts. It has been pointed out also that markets are to some extent coercive. Consequently, the problem is to decide what forms of coercion are to be regarded as legitimate.

The ideology of voluntariness has been seen to provide the more powerful party to a contract a freedom of manipulation and motivation, a freedom from any onus of articulation and a freedom from any other legal duties that cannot be fitted under the rubric of contract as promise.[36] Consequently, there has been a growing reluctance to concede to big business the right to dictate contract terms to less powerful parties—particularly consumers—through standard-form contracts. Equally, there is a problem of deciding to what extent deception and concealment of information in contractual negotiations are also to be regarded as legitimate.

More generally, having acknowledged that contracts are enforced for reasons of public policy, and that contracts involve a balancing of conflicting value choices, the idea that contracts should always be enforced is open to question. This is what has happened as a result of legislative action and as a consequence of judicial enlargement of the law of contract and various equitable doctrines. Adding to the confusion has been the realisation that the grounds for equitable intervention in the enforcement of contracts cannot be fitted under a unified doctrine or theory. The law is not in fact static. Judges are required frequently to rule on novel situations requiring departure from precedent. In such cases, even perfect knowledge of precedent and other case law applying to the situation will not protect the subject of litigation. In these cases, the judge retrospectively rules certain conduct to be contrary to law—that law being the decision just made. In practice, one can conduct oneself in accordance with the law only to find out some time later that when a judge considers that conduct it is ruled to be contrary to the law. Only at that point does the conduct become, retrospectively, contrary to law. No degree of knowledge or foresight can prepare someone for a judgement such as this.

As Joseph Schumpeter pointed out, it is inevitable that the creative destruction inherent in capitalism will create new situations. The destructive and creative impulses of capitalism create novel situations requiring novel judicial treatments. If judges were not free to create novel legal pronouncements, commercial activity would move progressively beyond the influence of law. While precedent binds judges, if they were not free to rule creatively in novel situations the law would ossify.

Equity is always available as a remedy in a court of law, even though equity is distinct from law. Being governed by vague maxims rather than strict rules—and gifted with great flexibility with regard to remedies—equity has been criticised by many legal scholars and practising jurists as too unpredictable to be relied on to produce the proper result. Nonetheless, all lawyers within the common-law tradition are examined in equity during their training, and equitable arguments are always available to litigants. It is the reputation of equity as soft, vague and unpredictable that prevents it from occupying a similar place of renown as the law proper. Only a brave barrister will resort to an equitable argument in place of a legal one, despite vast quantities of case law recording successful equitable arguments.

All of these influences have led to a period of confusion in contract theory. Here in Australia there has been a growing acceptance of the objective theory of contract at the very time that theorists in the United States detect a process of doctrinal disintegration. There, it has been perceived increasingly that contract law—as modified by the various equitable doctrines—involves a complex of diffused principles.[37] Even the idea of—and a need for—a general law of contracts as a uniform body of rules has been questioned.[38]

Some theorists such as Gilmore predict the death of contract and its collapse into the law of torts.[39] While it might be going too far to suggest that a uniform law of civil obligations might emerge, there is certainly an increasing recognition of an obligation of good faith and a development in the direction of a duty of care in contractual arrangements. The former is not as radical as some of its opponents might like to suggest. For example, the German civil code has had such an obligation for more than a century and a doctrine of good faith is now firmly entrenched in the US Uniform Commercial Code and in the Restatement of Contract. More generally, contract theorists such as Atiyah[40] and Ian Macneil[41] have questioned whether contracts should be seen as a legal mechanism for establishing long-term business relationships, rather than the risk-allocation mechanisms that economists have conceived them to be. This point of view emphasises the relational element involved in any commercial arrangement that is not a simple one-off exchange transaction. Atiyah,[42] for example, sees contractual obligations arising primarily from the reliance one party places on another, while Macneil stresses the fact that all longer-term contracts are incomplete. It is simply not possible, in practice, to anticipate all the possible eventualities and risks involved in a continuing commercial relationship. Macneil sees the solution to this incompleteness as involving the development of intermediate contract norms to govern the continuing relationship. This is consistent with empirical evidence of real commercial behaviour, particularly between large companies where the existence of a valued long-term relationship induces companies to resolve difficulties that occur in the relationship without reference to the written agreements between them, and without reference to the courts.