How Contract Law Affects Behavior by Shaping Reputations 

By | May 2, 2023

Private and commercial law affects behavior not just directly, by ordering damages, but also indirectly, by providing information on how the parties to the dispute behaved. Information from litigation can then help third parties decide whether to do business with or avoid the disputants going forward. In other words, the law affects behavior by shaping reputations and facilitating market discipline. Indeed, interviews with litigants and their attorneys, and content analysis of media coverage reveal just how significant the reputational impact of litigation can be. 

Recognizing these information-production effects of litigation carries important lessons for academics, judges, and regulators. For one, it allows us to explore how different doctrines and branches of the law affect the quantity and quality of information produced. To illustrate, the information-production perspective clarifies an efficiency-based justification for the stark divide between contract liability (strict liability) and tort liability (negligence). A negligence regime comes with higher administrative costs relative to strict liability, but also with the promise of more granular information on how the parties behaved. In torts, the informational benefits of negligence over strict liability are pronounced and often justify its higher administrative costs. In contracts, by contrast, strict liability often comes with distinct informational benefits of its own. 

In contracts, the most reputation-relevant piece of information is a person’s propensity to keep her promises. Outside observers who choose among potential contractual partners would like to learn about the ability and intentions of each potential party to deliver the precise quality of goods specified on time. Contract litigation under strict liability implicates this question precisely: the gap between what the defendant promised and what she delivered. To be sure, the exact reputational ramifications vary from case to case. Some litigation reveals the defendant’s capacity to calculate realistically, implicating her due diligence skills. Other cases reveal that the defendant opportunistically reneged on her promises, implicating her integrity. But the upshot remains the same: contract litigation under strict liability often produces information on the defendant’s propensity to keep promises. To the extent that such information becomes publicly available, it facilitates a more robust market (reputational) discipline. 

Contrast this basic contract law scenario with a scenario of medical malpractice. Say that the patient suffers a severe injury during complex surgery and sues in court. For outside observers, knowing that the surgery caused harm does not help decide whether they want to be treated by the surgeon. After all, it is the nature of complex procedures that bad things may inevitably happen, perhaps due to background or inherent risks. The critical piece of information for potential patients (or employers of surgeons) is not whether harm occurred but rather whether other surgeons could have avoided the harm. Medical malpractice litigation under a negligence rule tends to provide answers to this question, by focusing on whether the surgeon adhered to “common practice” or performed below it. Medical malpractice litigation under strict liability would not. In other words, whereas the sales-of-good litigation focuses on the defendant’s “faulty” behavior in setting up standards for how she should behave, the professional-malpractice litigation focuses on the defendant’s faulty behavior in living up to existing standards. 

There exist surprisingly common contractual contexts where strict liability produces more reputation-relevant information than negligence, as well as contractual contexts where the informational benefits of negligence are too marginal to justify its higher administrative costs. Still, in many real-world scenarios, learning that the promisor overpromised in the past is not necessarily indicative of the likelihood that she will overpromise in the future. 

For example, unusual contingencies may arise after the parties have made legally binding promises. In such circumstances, knowing what happened – namely, that dire circumstances interfered and the defendant failed to deliver – is not very helpful for outside observers. Instead, outside observers will need to learn why and how things happened: was the promisor prepared and flexible enough to deal with the unexpected, or did she opportunistically manipulate the events to invoke excuses? In other words, the relevant information in such contexts is not about the outcome (did the defendant deliver?), but rather about the process (did the defendant exercise due care? What was her level of investment in quality controls?). To provide such granular information, contract litigation must introduce negligence-based investigations. 

And indeed, various contract law doctrines employ fault in ways that resemble a negligence regime. Doctrines of interpretation, excuses, and remedies often produce granular details on things such as the technological know-how or preparedness of the parties, thereby affecting the parties’ reputation. Looking at these doctrines from a reputational perspective allows us to revisit time-honored puzzles, such as the “inverted hierarchy” of contract interpretation, the intractability of excuse doctrines, judicial hostility toward liquidated damages clauses, and the courts’ tendency to interpret best efforts clauses objectively. In other words, the information-production perspective explains contract law’s baseline of fault-free liability and highlights the functionality of veering away from this baseline under certain conditions and creating “islands of fault.” 

The information-production perspective also generates concrete policy implications, such as regarding the openness of proceedings or recent calls to personalize the law. Recognizing that litigation subsidizes the production, certification, and diffusion of information carries essential lessons for regulators, such as when to allow mandatory arbitration provisions; for judges, such as when to grant protective orders or rights of action for nominal damages; and for academics, such as how to assess the optimality of private ordering. Many scholars have observed that contractual parties rely heavily on reputational mechanisms and have gone on to presume that private ordering works just fine without law. But in reality, private ordering is often made possible only through contract law. Contract litigation produces credible information that facilitates the proper functioning of reputational enforcement. Acknowledging that law and reputation complement each other necessitates rethinking one’s priors regarding the design of default rules. 

Finally, the information-production perspective puts a thumb on the scale against calls to personalize contract law. Recently, notable contract scholars started calling to customize contract law by utilizing big data and predictive analytics. The idea behind these recent calls is that today’s big data and predictive analytics technologies allow us to easily boost the efficiency of contract law by tailoring different default rules to different parties and by deciding whether the defendant breached, or what remedy to award, to the plaintiff based on the parties’ unique skills and preferences. The reputational framework exposes a major flaw in this line of argument: personalizing contract law would take away the information-production, “benchmarking” benefits that the law provides in its current, impersonal form. Personalization may therefore end up hurting the efficiency of our contract system. 


Assaf Jacob is a Professor of Law at Reichman University.  

Yotam Kaplan is Associate Professor at Bar-Ilan University. 

Roy Shapira is Visiting Professor at Berkeley Law, a Professor of Law at Reichman University, and a Research Member at ECGI.  

This post is based on their paper, “An Information-Production Theory of Contract Law,” available on SSRN 

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