Economic analysis of law as a guide to post-communist legal reforms: the case of Hungarian contract law

(2) Several contemporary journals are devoted to the topic, and most major law schools have allocated at least one full-time faculty position to a professional economist.(3) Interest in law and economics research is growing overseas as well. In a recent issue of the International Review of Law and Economics, scholars from seven Western European nations and Japan report an expanding influence of economic analysis of law in their respective countries.(4) Conspicuously absent from this symposium issue is any representative from the emerging democracies of East-Central Europe. Yet, it is in these emerging democracies that the insights of law and economics research are most needed. This article demonstrates that the economic approach to law can be particularly useful as East-Central Europeans seek to implement legal reforms.

Hungarian contract law provides the paradigm. A commission of legal experts has recently been impaneled to suggest reforms to the contract provisions of the Hungarian Civil Code. Although panel members agree on the ultimate goal of the reforms — a contract system attuned to a modern market economy — there is some debate on how this is best achieved. We advance this debate by providing an economic analysis of selected provisions of the Hungarian Civil Code. We argue that similar economic analyses would prove useful in other areas of Hungarian law and in other East-Central European nations as well.

Part I of this article provides a brief history of Hungarian contract law so as to place current reform issues in historical context. Part II identifies and discusses three fundamental tenets of contemporary economic analysis of law as it has developed in the United States. In Part III, we use these tenets to critique three provisions of the Hungarian Civil Code. We compare each Hungarian provision to analogous provisions in various Western nations and then provide an economic critique. These critiques illustrate the power of economic analysis to guide the legal reform process now underway throughout East-Central Europe. We conclude by raising and addressing four potential obstacles to the implementation of economic jurisprudence in the post-communist world.

TWENTIETH CENTURY EVOLUTION OF HUNGARIAN CONTRACT LAW

In the past fifty years Hungarians have transformed their economy from market capitalism to central planning to market socialism. With the advent of each economic regime, the rules of business, including contract law, changed. Once again, reform is in the offing. In this section, we place current contract reform issues in historical context.

Contract Law Under Central Planning: 1949-1968

Hungary emerged as an independent nation with the fall of the Hapsburg dynasty at the end of World War I.(5) During the interwar period much of Hungarian law was codified. Contract law was not.(6) Hungarians relied on their courts to develop a set of contract precedents reflecting market principles.(7) These precedents, often borrowed from German experience, established a contract law regime largely indistinguishable from regimes found in other market economies during the 1930’s.(8)

Communism was ushered in with the 1949 amendments to the Hungarian Constitution. The new economic orthodoxy argued that markets polarized wealth, underproduced public goods, overproduced externalities, and generally led to the exploitation of working people.(9) Central planning would be the answer to these social ills. To implement planning, property was divided into three types: social property held by state organs and cooperatives

Planning necessitated changes in contract law as well.(11) These changes, initially implemented through governmental decrees, were codified in the Hungarian Civil Code of 1959.(12) Under the new system, contract law was bifurcated.(13) Contracts involving personal or private property continued to be regulated under the traditional doctrines of the 1930’s. Hungarian interwar precedents were not erased, they were codified. Hence, in the area of petty trade, Hungarian courts, even at the height of central planning, continued to gain experience with traditional contract doctrines. Contracts involving social property, by contrast, were administered under special rules designed to support planning.(14) Of course, since most property was state owned, these so called “planned” contracts were dominant.

From a legalistic viewpoint, a planned contract looked much like any other.(15) There was an offer and acceptance, damages for breach, and other legal issues common to all contracts. The key distinction lay in the scope of the “free will” of the parties.(16) State enterprises entered into planned contracts pursuant to directive. Offers and acceptances were compulsory, not voluntary.(17) In the event of breach, the parties were compelled to sue so as to activate the jurisdiction of the Central Economic Arbitration Committee.(18) These arbiters had wide discretion to rework the contract to account for changing economic conditions.(19) The language of the parties, if relevant at all, was secondary to the needs of the plan.(20) In short, planned contracts were public matters, not private. There was no change of ownership because both parties to the contract were owned by the state. Planned contracts simply served as means of administering the state plan.

Contract Law Under Market Socialism: 1968-1989

By 1968 Hungarians had become disenchanted with the economic theory of central planning. Socialism had largely succeeded in evening the distribution of wealth and was not seen as the culprit. The problem was central planning. Planners simply did not have sufficient information to effectively coordinate a national economy.(21) Hungarians responded by turning to the theory of market socialism.(22) Coined the “New Economic Mechanism,” the new theory called for decentralizing the decision making process.(23) The government would continue to plan, but the plans would no longer be implemented through compulsory contracts.(24) National goals were to be achieved through indirect means: wage and price controls, subsidies, credits, taxes, and assorted regulations. The idea was to place the various state enterprises in a regulatory environment in which their independent contractual choices would implement the plan.(25) Whereas central planning had combined state property with state contracting, market socialism linked state property with the principle of freedom of contract.(26)

The contract provisions of the Civil Code were amended in 1978 to reflect the new economic system.(27) The chapter on planned contracts was repealed and the formal distinction between planned contracts and private contracts was abolished.(28) Henceforth, all contractual disputes would be resolved in the civil courts.(29) The provisions designed to support compulsory contracts remained on the books but fell into disuse. Enterprise autonomy and the primacy of contractual relations were formally recognized.(30) By 1978, the contract provisions of the Hungarian Civil Code looked distinctly western.(31)

Notwithstanding its theoretical virtues, the twenty year experiment with market socialism is now regarded as a dismal failure.(32) Empirical evidence suggests that Hungarian economic performance was actually worse under the New Economic Mechanism than it would have been under central planning.(33) Several explanations have been offered. Some argue that market socialism was never given a fair chance because interest groups forced the government to reverse many reforms.(34) Others argue that planners intervened so much in the decision making process that enterprise managers did not enjoy true autonomy.(35) Any market efficiency gains were drowned in a sea of wage and price controls, government regulations, subsidies, and credits.(36) At least one commentator has identified monopoly power as a central culprit.(37) Each of these criticisms could be answered with further reforms. Theoretically, Hungarians could retain market socialism and reform it by controlling interest groups, removing price controls, and providing effective antitrust enforcement.

The more radical criticisms come from those who resurrect the arguments of Hayek and Mises.(38) From an Austrian perspective, there is no room for mere reform

Current Issues in Hungarian Contract Law Reform

The Hungarian Civil Code divides into six parts.(41) Part Four arranges the rules of “obligation” under three titles.(42) Title One contains rules common to any type of contract. Here one finds rules of offer and acceptance,(43) modification,(44) performance,(45) breach,(46) assignment,(47) and the like. Title Three provides standard terms and regulations for about twenty-five specific types of transactions. For example, the Code provides rules on sale contracts,(48) delivery contracts,(49) leases,(50) bank loans,(51) and insurance contracts.(52)

The Hungarian reform commission is currently focusing on three issues. First, there is a general feeling that the rules contained in Title One may need to be updated. These rules initially codified the contract precedents of the 1930’s

These reform issues are not unique to Hungary. In fact, they are not even unique to post-communist societies. Similar contract issues are present in every market economy. For example, Professor Allan Farnsworth provides a list of ten contemporary American contract issues.(54) This list would provide a useful agenda for Hungarian reforms as well. What makes Hungary and other post-communist societies unique is the current reform atmosphere which encourages reconsideration of fundamental legal preconceptions.

ECONOMIC ANALYSIS OF CONTRACT LAW: THREE CENTRAL TENETS

Over the past twenty years Western scholars have produced an unprecedented array of contract theories. Some have seen contract in retreat from tort law with the growth of government crowding out the market.(55) Others have sought to denigrate traditional freedom of contract principles as outdated “neoclassicism” and to replace the doctrine with sociologically based relational concepts.(56) Others have sought to unify contract doctrine based on moral philosophy or cultural history.(57) Still others have found an underlying economic logic to contract law.(58) In this section, we identify and explore three central tenets associated with this economic approach to contract law: “deferring to individual autonomy

Tenet 1: Deferring to Individual Autonomy

The economic approach to contract law begins with the premise that private agreements should be enforced in accordance with their terms. A party does not agree to an exchange unless he or she believes it is in his or her interest to do so, and a voluntary exchange, duly consummated, makes both parties better off. This potential for mutual advantage through private contracting has been the principal lesson of economic theory since the time of Adam Smith.(60) Institutionalized in the principle of freedom of contract, this lesson continues to guide the economic approach to contract law.

A general regime of freedom of contract can be justified on either libertarian or utilitarian grounds.(61) Economic analysis of law tends to emphasize the utilitarian, or consequentialist, base.(62) In other words, freedom of contract is justified not as a moral right, but as a pragmatic institution designed to solve economic and social problems.

No one has been more articulate in explaining the economic consequences of a general regime of freedom of contract than the Austrian economist, Friedrich von Hayek.(63) Hayek was concerned with the inherent problems created by the dispersal of knowledge in society.(64) Human beings confront myriad ways of using physical resources, including their own labor. Knowledge of the uses to which resources may be put and of individual preferences is widely dispersed throughout society. Much of this knowledge is difficult, if not impossible, to communicate. To complicate matters, individual preferences change over time. For an economic system to operate efficiently, it must account for this dispersal of knowledge and for the temporal quality of individual preferences. Hayek saw two options — central planning or decentralized markets. For a centralized system to work, someone would have to (1) collect information on a grand scale, (2) process that information into a coherent plan, and (3) administer the plan by controlling and directing all relevant actions.(65) Information problems frustrate each step in this process. In this light, the failure of central planning derives not from the impossibility of central planning per se, but from the impossibility of using central controls to handle dispersed knowledge.

The principle of freedom of contract provides a means of addressing information problems. The principle encompasses two distinct subparts: freedom to contract and freedom from contract.(66) Freedom to contract means that parties are free to transfer their rights in any way they deem fit. This enables individuals to take advantage of their own idiosyncratic preferences and personal knowledge of closely held resources. Freedom from contract ensures that rights will not be transferred without prior consent. By insisting that each party secure the consent of the other, each must take into account the idiosyncratic information of the other. Such a requirement enables the evolution of a powerful institution that allows information to be “encoded” and communicated. In short, an unencumbered principle of freedom of contract generates resource prices. Both non-consensual transfers (e.g., required contract terms) and prohibited transfers (e.g., terms that are prohibited by public policy) short-circuit the price system and make it impossible for individuals to take the knowledge of others into account.(67)

In summary, the first tenet of economic jurisprudence dictates a strong presumption against governmental intervention into the substance of private contractual matters. Contractual language that reflects a subjective agreement between the parties should be summarily enforced.

Tenet 2: Reducing Transaction Costs

The second tenet of law and economics provides that the law should do more than passively enforce private transfers, it should be proactive, seeking to make transfers less costly for the parties. This tenet is embodied in the economist’s notion of “allocative efficiency.” Economists define an efficient allocation of resources as that allocation which would result, in the absence of transaction costs, from the exhaustion of all mutually advantageous exchanges.(68) Transaction costs include the costs of negotiating, performing, and enforcing the transfer of entitlements. High transaction costs frustrate private exchanges, impede the flow of resources, and distort prices. If contract law follows an economic logic, it should seek to reduce the costs of conducting private transfers.

Contract law reduces transaction costs in three ways: (1) it encourages the performance of voluntary agreements by providing a sanction for breach

The first function of contract law is to determine which transfers will be enforced and which will not. Our first tenet, deference to individual autonomy, suggests that the courts should enforce every transfer that reflects the free will of the entitlement holder, and refuse to enforce all non-consensual transfers. Only subjectively understood transfers give true signals of individual preferences and knowledge. Given information problems, however, it is often difficult for parties to reach a true meeting-of-the-minds ex ante and for the courts to resolve subjective claims ex post.(70) If a party were free to argue that he or she did not subjectively understand the promise he or she made, a serious erosion in the security of contracting would ensue. Hence, the law, by necessity, must rely on objective evidence of subjective consent.(71)

Most contract doctrines serve this evidentiary function. For example, doctrines that require congruence between an offer and an acceptance, inquire into the reliance by the promisee, demand an exchange of consideration, require a writing, inquire into the presence of fraud or duress, or demand evidence of other bargaining formality all attend this evidentiary function. Each seeks to “objectify” an inherently subjective inquiry. The inevitable slippage in these evidentiary surrogates leads to problems of both over-enforcement and under-enforcement of contractual language. Under-enforcement results when subjectively intended exchanges are not legally recognized. Over-enforcement occurs when a court forces a transfer that was not subjectively assented to by the affected party. The second tenet of economic jurisprudence suggests that the courts should resolve evidentiary disputes with an eye toward minimizing the sum of over-enforcement and under-enforcement costs.(72)

Contract law also reduces costs by providing standard terms. Every contract involves both express and implied terms. It is not cost effective, or even possible, for parties to contemplate and account ex ante for every contingency that may arise in a contractual exchange. Contract law responds by providing standard terms, or “default rules,” that fill in the gaps left in express language.(73) Such rules reduce negotiation costs. Ideally, default rules reflect the terms the parties would have drafted for themselves. This is achieved by enacting default rules that reflect the customs associated with various transaction types. So long as both parties to a transaction are familiar with these customs, their failure to expressly modify the default term gives presumptive evidence of their consent to it.(74) Troubles arise when parties to a contract do not share similar conventions.(75) In such scenarios, judicial enforcement of the default term threatens to violate the first tenet of economic jurisprudence. In such a case, economic analysis suggests an enforcement of the default rule so as to provide an incentive for each party to master the language of the trade.(76)

Economic reasoning also provides insights into the substance of customary terms. Many customs involve the allocation of risk. For example, an implied warranty in the sale of goods assigns the risk of faulty workmanship to the seller rather than to the buyer. Liability for goods damaged during shipping is customarily assigned to the common carrier. The purchase of real property customarily involves an equitable conversion which shifts the risk of fire damage to the buyer upon the signing of a contingent land sales contract. In each case, it is in the interest of all parties that contractual risks be allocated to the party who can absorb them most efficiently.(77) Typically, the seller is in the best position to assure quality in the production process

Finally, contract law reduces transaction costs by assuring propriety in the contract negotiation process. Doctrines of fraud, undue influence, and unconscionability provide the paradigms. In a typical case, one party will assert that a contract reflects a voluntary agreement worthy of judicial enforcement, and the other party will seek to be excused from performing. The court must be alert to two forms of opportunism.(78) Perhaps the first party has misled the second into signing a contract the second did not fully understand. On the other hand, the second party may simply be trying to excuse itself from its own bad bargain. Either type of opportunism increases the costs of conducting exchanges. A court following an economic logic will decide such cases so as to minimize the potential for these two types of costly opportunism, and thereby provide an incentive structure that encourages future parties to bargain more effectively.(79)

In summary, the second tenet of law and economics provides a logic which unifies virtually all of the diverse doctrines that comprise contract law. It addresses the long-standing debate over whether the law requires an objective or subjective manifestation of intent, the substance of gap-filling terms, and the rules that discourage impropriety in contract negotiations. Every rule seeks to reduce the costs of conducting private exchanges.

Tenet 3: Providing Stability

Contract rules cannot have their instrumental effects unless they are communicated to the relevant actors and consistently and impartially enforced. In a well known passage, Lon Fuller identified potential miscarriages in any liberal system of justice:

[T]he attempt to create and maintain a system of legal rules may miscarry in at least eight ways

These caveats ring with added fervor in the transforming nations. The communist heritage was linked to an almost total disregard for respect for the rule of law.(81) The recent pace and scope of legal reforms continues to introduce uncertainty. Post-communist societies need to develop stable legal institutions which enable people to order their affairs.

In summary, strict adherence to the central tenets of economic theory provides a means of attaining legal stability. Taken collectively, the tenets have a central logic that unifies contract doctrine in a predictable and communicable fashion. The first and third tenets provide a jurisprudential tone or attitude. The first admonishes against governmental intervention into the substance of private contracts

AN ECONOMIC ANALYSIS OF THE HUNGARIAN CIVIL CODE

We now use the above tenets to analyze three selected provisions of the Hungarian Civil Code. The first provision, “socialist coexistence,” provides an opportunity to analyze the economic approach to contractual ethics. The second, the “battle of the forms,” applies an economic analysis to problems raised by the use of standardized form contracts. The final provision, “commercial impracticability,” raises the economic issues associated with contract performance. We compare each Hungarian provision with its Western counterparts and provide an economic critique. The three critiques illustrate the power of economic reasoning to provide a coherent and stable approach to civil law doctrine.

An Economic Analysis of Contractual Ethics: The “Norms of Socialist Coexistence”

Every nation has contract provisions that specifically address the ethics of contractual behavior.(82) In the West, the doctrines of good faith and unconscionability provide the paradigms.(83) Parties generally are free to seek self gain, but they are also expected to deal honestly with one another and to not take undue advantage of disparities in bargaining power. The 1959 version of the Hungarian Code did not use the word unconscionable, but it did employ an ethically charged concept — “the norms of socialist coexistence.” The Code provided: “A contract shall also be null and void if it evidently injures the interests of society or disregards the norms of socialist coexistence.”(84) The doctrine of socialist coexistence, like unconscionability, provided a flexible tool that could be used to instill an ethical baseline to private contractual activity.(85)

Hungarians have recently removed much of the socialistic rhetoric from their Civil Code. In 1991, the phrase “norms of socialist coexistence” was deleted in favor of the term “good morals.”(86) The question, of course, is what does good morals, or alternatively, “unconscionable conduct” mean in a capitalist setting. This is no simple matter. Unconscionability means different things in different Western nations, and its use in any given nation is a matter of some controversy.(87) In short, reinterpretation of the doctrine of socialist coexistence will require difficult policy choices.

The economic tenets developed in Part II provide a useful guide to the reform process. Taken collectively, the tenets address the notion of contractual “fair play” in a reasoned and coherent fashion. In other words, they provide a means of replacing the “norms of socialist coexistence” with the “norms of market capitalism.”

The notion of contractual “fairness” has two components. One may argue that the substance of a contract is overly one- sided and hence unfair. Or, one may argue that there is unfairness in the contract negotiations. Economic analysis finds a limited role for the substantive inquiry.(88) The first tenet of law and economics demands respect for individual autonomy.(89) Any contract that involves a voluntary meeting of the minds between competent individuals is presumptively fair. This is true even if contractual language appears to be very one-sided to an outside observer. The Hungarian Civil Code directly violates this economic tenet. It states: “If there is a remarkably great difference between the value of a service and that of the return service at the date of the conclusion of the contract, although neither of the parties has the intention of donation, the injured party shall be allowed to avoid the contract.”(90) This provision requires the Hungarian courts to measure every exchange with reference to criteria external to the wills of the contracting parties. By doing so it seems to draw upon a paternalistic ethic. Although the same requirement once guided American common law, it has long been discarded.(91) From an economic perspective, there simply is no external referent to fairness outside the will of the parties.(92)

Claims of contractual unfairness stand on an economic footing only when the complaining party can allege some sort of impropriety in the contract negotiations.(93) The doctrines of duress and misrepresentation are illustrative. We consider each in turn.

John R. Commons, a founding father of law and economics, provided an early economic critique of duress.(94) Defining duress as an abuse of bargaining power, he identified three types of power in contractual negotiations: political, personal, and economic.(95) Political power, held uniquely by the sovereign, is the right to compel by force. Personal power involves the use of superior mental faculties to persuade one’s trading partner. Economic power resides in the right to withhold property from others. Economic theory clearly condemns the threat of physical force in contractual negotiations

Contract negotiations always involve the exercise of economic power. If I agree to pay a dollar for a loaf of bread, I do so because the baker will withhold the bread if I do not. The baker is exercising his economic power over me. The question is whether contract law should recognize a moral duty on the part of the baker to share his bread. The first tenet of law and economic answers with an emphatic no.(97) Respect for individual autonomy encompasses both freedom to contract and freedom from contract.(98) Hence, the baker is free to seek his or her best price. this is true even if I am in great need of the bread and do not have a dollar.(99) It is also true if the baker somehow had a monopoly on the production of bread.(100)

The Hungarian Code seems to express a contrary norm. It states: “If a contracting party has stipulated a remarkably disproportionate advantage at the conclusion of the contract by making use of the situation of the other party, the contract shall be null and void.”(101) Not only does this provision again call for a substantive inquiry, it also introduces intractable problems of interpretation. Every contract involves “making use of the situation of the other party,” and it is difficult to see how the line between permissible and impermissible advantage taking is to be drawn.(102) In short, it violates the third tenet of economic analysis: the need for predictability.

Economic analysis is much more receptive to fairness claims based on misleading conduct.(103) An example may be found in a contract for the sale of a house. The house recently has been reappraised for tax purposes, and the house has a hidden defect — termites. The seller is aware of both facts

The Hungarian Civil Code addresses the parties’ respective duties to speak in paragraph 205(3). It provides: “The parties are obliged to co-operate at the conclusion of a contract and they shall observe each other’s rightful interests. They shall inform each other on all essential circumstances affecting the contract to be concluded even prior to the conclusion of the contract.”(108) Applying this language to the sale of the house, the seller would be expected to inform the buyer of both the termites and the appraisal. There is no reference to transaction costs. The Hungarian Code seems to once again call for greater degree of altruism and cooperation than that called for by economic theory.

An Economic Analysis of Standardized Form Contracts: The “Battle of the

Forms”

The doctrine of freedom of contract was born in an era in which most contracts were individually negotiated by the parties. Much of modern contracting is to the contrary. Industrialization, mass marketing, and the creation of large and sometimes market-dominating firms has led to prevalence of contracting through standardized forms. Standardized forms reduce transaction costs by relieving parties of the burden of individually negotiating and drafting contract provisions that regulate relatively routine exchanges. Standard forms also reduce agency costs by limiting the contractual discretion of subordinates within a corporate hierarchy, and facilitate centralized control by harmonizing contracts throughout a firm’s national or international business activities. Yet, standard forms also introduce problems. By deleting the necessity to negotiate, form contracting creates the possibility that the standardized language was not fully understood by the parties.(109) In such a scenario, the first economic tenet — deferring to individual autonomy — does not suffice to answer enforce-ability questions. It is simply unclear whether the contract represents a subjective meeting of the minds between the parties.(110) In such cases, the courts must turn to the second tenet and determine whether transaction costs will be reduced by strictly enforcing the express terms, or by refusing to enforce such language so as to encourage future parties to bargain more fully. Of course, our third tenet reminds us that any such judicial intervention must be done in a predictable and stable manner.

A clear example of the problems posed by standard form contracting arises in the context of an offer and an acceptance of a sale of goods between businesses. The issue arises so commonly, it has been given a name — the “battle of forms.”(111) The extensive use of standardized forms in ordering and invoicing products gives rise to the problem. Typically the buyer will order goods from the seller using its own purchase order which has a number of provisions printed on it concerning such subjects as warranty requirements, jurisdiction, and so on. The seller will then acknowledge the order with its own form that may have additional terms such as limitations of liability and terms that may contradict the terms of the buyer’s purchase order. In most cases the goods are shipped, accepted, and paid for without difficulty and so the issue of contract formation does not arise. However, on occasion a problem arises with contractual performance or there is a significant change in market conditions that will lead one party to seek ways to escape any potential contract liability for non-performance. The question then arises as to whether a contract is concluded and if so, what are the terms of the contract.

The solutions to these questions vary depending upon what legal system is involved.(112) The more formalistic approach to contract formation, the so-called “mirror image” approach, is found in common law of countries such as Great Britain(113) and the United States,(114) as well as a number of civil law countries such as France.(115) Historically, centrally planned countries, including Hungary, took an approach similar to the “mirror image” rule.(116) The alternative “reliance” approach is exemplified by the Uniform Commercial Code of the United States and in the law of the Federal Republic of Germany. We will address each approach in turn.

Most nations follow the mirror image rule. The rule requires that there be no material variance in the acceptance when given in response to an offer.(117) If there is a material variance, then no contract is formed and the acceptance constitutes a counter offer terminating the offer.(118) The Hungarian Civil Code currently reflects this rule. Paragraph 213(2) states: “An acceptance deviating from the offer shall be considered a new offer.”(119) This language is not surprising considering that prior to break up of the Soviet bloc, the socialist countries took a rules oriented approach to the problem of acceptances that deviated from the offer. Because of the requirements of a planned economy the socialist legal systems took the strict view that a contract could not be concluded even if the acceptance deviates in unimportant ways from the offer.(120) According to Professor Eorsi, the reason for this approach to contracting is that in planned economies the “emphasis is on security without surprises — even at the expense of an otherwise desirable contract not coming into being.”(121)

In light of our economic tenets, the mirror image rule has clear virtues. It responds to the first economic tenet by providing a safeguard against court imposed contract terms. Deference to individual autonomy guarantees both freedom to contract and freedom from contract.(122) Since the parties have not reached a meeting of the minds ex ante, no contract is imposed upon them. In addition, the rule seems to constrain judicial discretion and hence lends a degree of legal stability and predictability — the third tenet. Unfortunately, these virtues are not without costs. In particular, the rule provides an incentive for business actors to carefully read and discuss all contract terms. Such an incentive may not be practical given the production-like contracting process that modern commerce demands.(123) Perhaps more importantly, the mirror image rule makes it too easy for one party to escape a contract when it is clear that a contract between the parties was intended. This, so called, “welsher” problem arises from opportunistic behavior and increases the costs of conducting exchanges.(124) Finally, declaring that no contract exists does not end the court’s involvement in the dispute. If there has been part performance, the court must still order restitution or fashion some sort or quasi-contractual adjustment. Hence, the gains to legal predictability may not be as great as would first appear.

Section 2-207 of the U.C.C. provides an interesting and much discussed alternative to the mirror image rule. In essence, the section states that in some circumstances in which a purported acceptance deviates from the offer, the court will still find that a contract was concluded.(125) So long as the deviation does not concern central issues such as price and quantity, a contract will arise and the court is to follow a precise, if somewhat complicated, set of rules to determine whether the terms contained in the offer or in the acceptance will control. While there has been a substantial amount of criticism of Section 2-207,(126) it represents one of the major attempts to reduce the costs created by the welsher problem, while simultaneously protecting the efficiency gains generated by form contracting.

When one examines the approach taken by the various legal systems to this problem, one is struck by the notion that few have taken a reliance approach similar to that of Section 2-207. Germany, through judicial interpretation of its Civil Code, appears to be an exception. Although the German Civil Code takes the position that a purported acceptance that deviates from the offer does not conclude a contract, judicial interpretation of the Code has resulted in an approach that is more reliance oriented.(127) Addressing German law, Professor Von Mehren writes:

Failure to agree on the form terms that will govern in the event of dissonant forms does not, however, render the contract as a whole ineffective. To the extent the parties’ terms are in agreement, these terms are accepted

Like Section 2-207 of the U.C.C., the German model would treat a conflicting form as generating a contract so long as the central terms provided by the parties are in agreement. The German model departs from the U.C.C., however, with reference to the treatment of the conflicting terms. In the U.S., either the terms reflected on the offeror’s form or on the acceptor’s form will control.(129) Under the German model, “business customs” will supply the contract terms when standardized forms conflict.

The international community has also recently addressed the battle of the forms during its negotiations concerning the adoption of the United Nations Convention on the International Sale of Goods (CISG).(130) At first blush, the final version of the CISG provision appears to be a compromise between Section 2-207 and the mirror image approach. Article 19 of the CISG states:

(2) [A] reply to an offer which purports to be an acceptance but contains additional or different terms which do not materially alter the terms of the offer constitutes an acceptance….

(3) Additional or different terms relating, among other things, to the price, payment, quality and quantity of the goods, place and time of delivery, extent of one party’s liability to the other or the settlement of disputes are considered to alter the terms of the offer materially.

A close reading of the latter subsection indicates that the drafters clearly rejected the flexible philosophy to contract formation exemplified by section 2-207 of the U.C.C. It defines “additional or different terms” so broadly, covering all of the essentials of any contract for the sale of goods, that it is hard to imagine a term that would not materially alter the terms of the offer with the result that the contract is not concluded. In essence, the CISG follows the mirror image rule.

Hungarian policy makers, like policy makers throughout the post-communist world, face an historic opportunity to implement fundamental legal reforms. One piece of the reform puzzle involves the legal treatment of standardized forms. Should Hungarians retain the mirror image rule, or should they modify their civil code to reflect a more reliance based approach? Although the mirror image rule has merit,(131) we believe that the more flexible approach to contract formation, particularly the German variant, is best suited to address economic concerns.

The battle of the forms arises in a context in which the parties initially believe that they have a contract. The buyer receives a non-conforming invoice, notices that the invoice matches the central terms contained in his or her purchase form, ignores the fine print, staples the two forms together, and then tosses both forms in a file cabinet. If the goods are shipped and received without incident, the forms remain uninspected. In the event that a problem arises, however, one party may seize upon the non-conforming forms as an excuse to renege on the agreement. The problem with the mirror image rule is that it creates two perverse incentives. First, it encourages parties to closely read their forms and to individually negotiate terms. This seriously erodes the cost savings associated with form contracts. Second, the mirror image rule rewards opportunistic behavior by allowing a party to repudiate a bona fide agreement that has turned sour.

The preferred approach is to find that a contract does indeed exist. The question, then, is to determine the terms of that contract. Two possibilities present themselves. Section 2-207 provides that in certain circumstances the terms in the offer will control, and in other circumstances the acceptance will control.(132) The German approach focuses on business customs, suggesting that customary terms should be followed when the parties’ forms conflict.(133) Of the two, the German variant appears to be more efficient. The problem with Section 2-207 is that it does not economize on transaction costs. Under Section 2-207, either party that ignores the fine print faces the possibility that the other party will introduce surprising and uncustomary terms into the exchange. Each ignores the fine print at his or her own peril. By contrast, under German law the parties can rely on court provided terms to at least assure that the ultimate contract will be customary and presumably not overly harsh or oppressive.

The German variant also provides the parties with a strong incentive to master business customs. The mastery of business customs is essential to all market economies, and is particularly important in the transforming nations. Shared customs facilitate communications, forestall misunderstandings between the parties, and generally promote contractual endeavors. In addition, most, if not all, business customs reflect an economic logic, assigning the various contractual duties and risks to the party who can address such concerns in the most efficient manner.(134)

In short, the German model best adheres to the dictates of our three economic tenets. Reflecting the first tenet — deference to autonomy — the model allows the parties to deviate from customary practices, if they wish to do so. The parties need only provide evidence to the court that a negotiation has occurred. If parties choose to not negotiate, then business custom guides the transaction in which the standard forms conflict. Party silence is taken as evidence of consent to customary language. Reflecting the second tenet — reducing transaction costs — the substance of these customary terms will be driven by an economic logic, allocating transactions costs in an efficient manner. Finally, the German approach should prove easy to administer. The court will simply follow custom when fine print conflicts. Ease of administration should lend stability and predictability to the law — the third tenet.

An Economic Analysis of Contractual Discharge: Excusing Performance on the Basis of Unforeseen Events

Parties do not enter contracts with perfect knowledge of the future. They make assumptions as to what events may or may not occur and attempt to account for these contingencies in the negotiation of the contract. But, lacking a crystal ball, the parties may find themselves subject to certain events that were not foreseen at the time the contract was formed. One issue to be resolved by any legal system concerns the circumstances under which a contract should be discharged based on the happening of an unforeseen event. Not surprisingly, the answer differs from one legal system to another,(135) and the search for the proper answer to this problem has been the subject of a substantial number of articles in the literature.(136)

To illustrate the issue, we offer three examples. In the first, a farmer contracts to sell his or her crop

The central question in all three examples is the same: should the courts excuse performance due to the unforeseen event? Two corollary questions are also present. First, if the court grants an excuse, should it simply rescind the contract, ordering restitution where appropriate, or should it rewrite the contract for the parties? And secondly, if the parties agree to modify their agreement, should the courts enforce that modification? This latter question is intertwined with the first

Question #1: When Should an Excuse Be Granted?

We turn first to the question of when an excuse should be granted. The first economic tenet, respect for individual autonomy, dictates that an excuse is not to be granted in cases in which the parties have expressly accounted for the contingency. In other words, if the parties addressed the event and allocated its risks ex ante, the courts should enforce that allocation. Of course, in the typical case the troublesome event has not been addressed ex ante. In such cases, the courts face the danger of forcing a party to perform a contract to which he or she never consented. For example, the builder will argue that he or she never agreed to clear away the unforeseen debris. This argument is a direct appeal to the first economic tenet — the right to be free from court imposed transfers, or freedom from contract. Yet, if the courts make it too easy to avoid contractual obligations, the cost allocation functions of contracting will erode, and transaction costs will rise. Hence, an economically minded court will strike a balance, allowing an excuse only in appropriate circumstances.(138)

In an often-cited article, Richard Posner and Andrew Rosenfield use law and economics insights to suggest a rational basis for determining when an excuse should be granted.(139) They argue that an excuse should be granted when the obligee is the “superior risk bearer” and denied when the obligor is the superior risk bearer.(140) According to Posner and Rosenfield, a party is a superior risk bearer if he or she is relatively more efficient in preventing the event from occurring or in insuring against the risk.(141) For example, in the builder case, the builder would presumptively be in a better position to prevent the construction problems ex ante. A reasonable core sample of the subsurface soil would likely have revealed the unforeseen debris. Such precautions are customary in building contexts, and failure to take such a precaution is tantamount to negligence.(142) By refusing to grant a contractual excuse in such cases, the courts provide an incentive for the relatively more efficient party to ferret out unforeseen, but foreseeable difficulties. In the long run, such an incentive reduces transaction costs — Tenet Two.

In most cases neither party can prevent the unforeseen event. If prevention is not feasible, Posner and Rosenfield would ask whether one of the two parties is more efficient in insuring against the unforeseen, but foreseeable, contingency.(143) Here, the relevant costs include the costs of risk-appraisal and the transaction costs of taking insurance. This factor lends insights in the farmer case. The commercial buyer of grain can insure against natural disasters by diversifying its porfolio of grain contracts, contracting to buy grain from geographically dispersed farms. To the commercial buyer, failure of any one crop is not a disaster. By contrast, the farmer enjoys no such ability to diversify. Since the obligor farmer cannot prevent the flood nor efficiently insure against its effects, the farmer’s performance should be excused.

Of course, in some cases neither of the above two criteria will provide a guide. For example, in the hotel case, neither party could prevent the parade from being canceled, nor could either party effectively insure against the event. Neither party was at fault. In addition, since the parties did not address the contingency in their contract, it was presumptively outside the scope of their agreement. In such cases, the first economic tenet, avoidance of court imposed transfers, would dictate in favor of discharge.

Turning to the Hungarian Civil Code, one finds several provisions addressing excuse for unforeseen events.(144) Of particular relevance is paragraph 312. It provides:

(1) If fulfillment has become impossible out of a reason for which neither of the parties shall be liable, the contract shall be terminated….

(2) If fulfillment has become impossible out of a reason for which the obligor is liable, the obligee may claim indemnification for failure of fulfillment.

(3) If fulfillment has become impossible out of a reason for which the obligee is liable, the obligor shall be relieved from his obligation and may claim compensation for his damages.(145)

This language provides an excellent foundation upon which to build an economically sound approach to contractual excuse based on unforeseen events. It avoids semantic distinctions such as the difference between “unforeseen” and “unforeseeable” events, and focuses on fault. If the event was no one’s fault or the fault rests on the obligee, then excuse is granted. If fault lies with the obligor, then no excuse is permitted. Of course, the courts must determine the inquiries appropriate in determining fault.(146) Economic theory suggests that such an inquiry focus on efficiency in risk bearing. If the obligor could have prevented or insured against the contingency in an efficient manner, then discharge should not be forthcoming. On the other hand, if the obligor was not at fault and there is no contractual language or strong business custom to the contrary, then excuse is appropriate.

Question #2: What is the Appropriate Remedy?

Once the court has decided to excuse performance, it must determine the appropriate remedy. Most nations favor rescission and restitution, allowing no judicial authority to modify contractual language.(147) Other nations grant their courts the discretion to reform the contract.(148) Both the U.C.C. and the Restatement of Contracts are in the former camp. One commentator has noted: “The remedy contemplated by the U.C.C. and the Restatement clearly is the traditional remedy of Anglo-American law for impossibility of performance — discharge of both parties from any duty of further performance with restitution, if needed, of any performance already rendered.”(149) Section 2-615 of the U.C.C. liberalizes the common law in some ways by allowing the seller to delay delivery when unforeseen circumstances render timely delivery “impracticable,” provided that the seller complies with subsections (b) and (c) of 2-615 regarding allocation and notification to the buyer. However, the provisions do not give the court the power to fashion an independent remedy.(150)

German law is perhaps the best example of a system that allows the courts to revise a contract based upon impossibility of performance of the existing contract.(151) The origins of the current willingness of the German courts to revise contracts for the parties are found in the economic dislocation caused by World War I and the tremendous inflation that resulted. Initially, the contract revisions were limited to situations in which parties were simply unable to perform their monetary obligations because of the inflation in the German currency. Based upon the German concept of “good faith” found in the civil code(152) and examination of gerschaftsgrundlage, “foundation of the transaction,” German law has evolved today to the point where courts now will revise many types of contracts.(153) Today, the standard doctrine of the German courts is to revise by court order those contracts “whose foundations have been destroyed by unexpected events or discoveries” rather than to rescind them.(154)

The German approach has been widely criticized, at least as a model that would be applied to law in the United States. It is not necessary to examine these criticisms in detail, but the central ideas are that judges have insufficient knowledge of contractual subject matter to fashion intelligent revisions, and that judicial willingness to reform contracts introduces too much uncertainty.(155) In essence, the third economic tenet — the need for predictability — is the guide.

Turning to the Hungarian Code, one finds two paragraphs addressing remedies. Paragraph 312 applies in cases in which performance has become literally impossible.(156) An example would be the farmer case

Paragraph 241 seems to allow for more judicial discretion. It provides: “A court may modify a contract if the contract injures an essential legal interest of one of the parties as a result of a condition that occurs in the permanent legal relationship of the parties following the conclusion of the contract.”(158) Apparently this section of the Code has been interpreted to apply to a broad set of circumstances in which performance is not literally impossible, but has somehow changed in character, like the parade case, or has become commercially impractical, like the building case.(159)

Judicial efforts to redraft contract terms on the basis of unforeseen events should be resisted on three grounds. First, redrafting of contractual terms threatens to violate the principle of respect for private autonomy. Redrafting subjects the parties to contractual terms to which they did not consent. Secondly, if either strict enforcement of contractual language or excuse coupled with rescission and restitution does not suit the parties’ needs, the parties themselves can agree to redraft the contract along equitable grounds. In fact, party redrafting, or settlement, is the preferred solution. It allows for the parties to use idiosyncratic information not available to the courts. It also saves administration costs. In a perverse way, judicial willingness to redraft may introduce uncertainties into the private negotiations of the parties, making it more difficult for them to settle. This would increase transaction costs — violating Tenet Two. Finally, a proclivity for judicial redrafting will muddle the law, violating the third economic tenet, the need for predictability.

Question #3: Should Private Agreements to Modify Be Enforced?

Facing an unforeseen event, the parties may attempt to modify their contract. As discussed above, there are good reasons to encourage them to do so. Party settlement saves transaction costs and economizes on idiosyncratic knowledge. But party modifications can also be fraught with difficulties.

Two situations presenting modifications may occur. In the first, an excuse based on the doctrines of “impossibility” or “frustration” is in the offing, and if the parties do not modify their contract, the courts will order rescission and restitution.(160) Preferring the modification to rescission, the parties fashion a settlement. There is an exchange of consideration, both parties having agreed to something they were not required to do, and both parties are made better off.

The second type of modification occurs in a setting in which the courts will not grant an excuse, the obligor’s duties being strictly enforceable. Nonetheless, the obligor refuses to perform, and seeks to negotiate a settlement. If the obligee cannot afford to wait for a court order enforcing the obligor’s original commitment, the obligee may consent to the modification. Here, the settlement is one-sided

The common law requirement of consideration addresses the above distinction. Modifications of the first type are mutually supported by consideration and are enforced. Those of the latter type are not enforced.(162) The rule of consideration allows some modifications, while simultaneously providing a safeguard against opportunism.(163)

The Uniform Commercial Code seeks the same goal, but employs different means. First, Section 2-209 eliminates the requirement of consideration with regard to the modifications of contracts for the sale of goods.(164) The purpose of this provision, according to the drafters, is to make enforceable “all necessary and desirable modifications of sales contracts without regard to the technicalities which hamper such adjustments [under the common law].”(165) The U.C.C. approach is a blanket one, not relying on whether the unforeseen event would allow for an excuse or not. If the parties agree to the modification then it is enforceable without consideration.

By eliminating the consideration requirement, however, the Code threatens to encourage costly opportunism.(166) As noted above, there are those who would take advantage of circumstances that would allow them to extort modifications from other parties to the contract. The Code answers this concern with reference to the concept of “good faith.” The comments to Section 2-209 suggest a good faith limitation to contractual modifications.(167) Its application presumably would result in modifications being unenforceable when they are obtained through costly opportunism.

The 2-209 references to good faith, however, are troublesome.(168) If a contract is made for the purchase of a product by a wholesaler and the market price for the product begins to decline substantially, the wholesale purchaser determines that it will not be able to resell the product at cost and thus demands a reduced price from the seller. The seller agrees to the modification because he cannot sell the goods elsewhere. In effect the buyer has extorted the modification from the seller. Such behavior, however, is beyond the reach of the Code’s good faith limitation. Comment 2 to Section 2-209 specifically states that modifications in response to a “market shift” are presumptively done in good faith.(169) This is true even if the market shift was fully anticipated by the parties, and the risk of a changing market allocated ex ante. Put another way, there is no requirement that the shift in market conditions be of the character that the parties would have assumed would not occur. This seems to be unusually broad safe harbor for opportunistic behavior.(170)

The Hungarian Code addresses agreements to modify in paragraph 240. It provides:

(1) Unless otherwise provided by statute, the parties may modify the content of a contract by consent….

(2) The part of a contract with a changed content or legal title which was not affected by modification shall remain unchanged….

(3) A contract may be modified by agreement. In the case of an agreement the parties settle disputed or uncertain questions originating from the contract by consent, making mutual concessions.(171)

The Hungarian approach is similar to that found in the U.C.C. No consideration is required, but agreements to modify are subject to a good faith limitation.(172) Again this calls for judicial interpretations informed by economic reasoning.

In summary, the Hungarian Code provides an efficient framework for addressing excuses based on unforeseen events. Paragraph 312 correctly focuses on the fault of the parties, enabling the courts to develop excuse doctrines with reference to the transaction-costs faced by the parties.(173) Obligors who can prevent or insure against an unforeseen event would not be excused. Although paragraph 241 grants the courts the power to redraft contracts for the parties, the tendency in the courts has been to use the power sparingly.(174) Paragraph 240 respects the parties’ rights to modify their agreements.(175) Efficiency reasoning suggests that this right be subject to a good faith limitation on opportunism. Here, as elsewhere, the process of judicial interpretation will play a critical role. Awareness of economic principles will aid that process.

CONCLUSION

The above applications demonstrate the power of economic reasoning to guide Hungarian contract law reforms. Similar analyses could be used to reform other areas of Hungarian law and to reform the laws of other post-communist societies. Of course, for economic analysis of law to have an impact, its central ideas must first be disseminated among policy makers and these policy makers must see value in the approach. We conclude our analysis by raising and addressing four potential obstacles to the implementation of economic jurisprudence in the post-communist world.

First, some policy makers may associate economic analysis with a common law tradition. Economic analysis of law originated in the United States and is generally perceived to be an American product.(176) Reflecting a common law orientation, American analysts tend to emphasize the role of the courts, with relatively less attention paid to legislation.(177) Hungary, like all East-Central European nations, works within a civil law tradition that tends to view judging as an administrative function, with little room for judicial discretion. Under a centralized civil law model, judges are seen as quasi-administrators following the dictates of parliament.(178) Given the policy orientation of the economic approach, one may wonder whether the insights can be transferred to a civil law culture.

Our analysis demonstrates that the differences between common and civil law systems are less important than may first appear.(179) Common law countries increasingly employ statutes and codes, and civil law countries rely on judicial interpretation to implement legislation. More importantly, the economics tenets prove equally adept at critiquing legislation as judicial decisions. For example, our discussion of the “battle of the forms” focussed on a provision of the Uniform Commercial Code that has displaced the common law of contracts for the sale of goods. The analysis essentially compared American, German, and Hungarian codes, with a policy recommendation for legislative drafting and judicial interpretation. Such an approach applies equally in all legal systems.

The second potential obstacle centers on legal philosophy. The economic approach to law is unabashedly instrumental and pragmatic.(180) It is instrumental in the sense that legislation and judicial opinions are critiqued on the basis of the incentives they create for future business actions. Judges are encouraged to formulate decisions with references to comparative costs, openly admitting a policy orientation. Economic analysis is pragmatic in the sense that it recognizes the need for law to evolve in accord with changes in technology and business customs. Legal rules are tested in the crucible of experience

Law used to be viewed as a tool to oppress people and an instrument to control people against their will, especially before World War II. Arguments based on the assumption that law is one of the instruments for social control have a strong association with the pre-war era among liberals. Accordingly, law & economics receives a strong negative reaction from the liberals.(184)

A similar observation is made by Professor Christian Kirchner.(185) Kirchner argues that legal instrumentalism has been discredited in the Federal Republic of Germany by the Nazi experience, and that German courts insist upon formalistic reasoning, never citing policy.(186) Arguing that “legal reasoning matters” he suggests that jurisprudential disputes are significantly retarding the influx of law and economics insights in Germany.(187)

One may wonder whether a similar cultural impediment may present itself in Hungary and other post-communist societies. These nations, too, have had a long experience with totalitarianism and the consequent disrespect for the rule of law. The third economic tenet–providing stability–is designed to allay these concerns. Law and economics scholars implicitly assume the need for legal predictability.(188) In a post-communist context, this tenet needs to be explicit. Due respect for the rule of law is essential to economic efficiency, and should not be taken for granted.

Perhaps more to the point, Hungarians cannot afford to ignore the pragmatic consequences of legal reform. They need legal change, and sensible change requires policy analysis. Insistence on legal formalism is really not an option.

Even if one accepts the need for a policy orientation to direct legal change, one may still challenge whether economic analysis of law provides the appropriate tools. This challenge presents a third obstacle to the influx of law and economics: the perception in many circles that the economic approach is fundamentally flawed either in its method or in the goals it seeks to attain.(189) We briefly address each concern.

According to orthodox (neoclassical) economic theory, people are rational, self-interested, and calculative.(190) Differing legal institutions provide differing incentives, and legal change is assessed in terms of the incentives it creates. But what if people are not rational? And do not people follow altruistic impulses? In short, if one does not accept the economic assumptions regarding human behavior, how can one accept the policy prescriptions that flow from that analysis?(191) The answer to these questions is that assumptions of hyper-rationality are not central to economic theory

The economic approach to law is best conceived as a heuristic device. It directs the analyst to consider the impact that legal change will have on human behavior and insists upon a comparative cost perspective. These two directives define the approach as economic and provide a central core that facilitates the collaborative advancement of theory. Yet, within the two directives there is room for intellectual diversity.(196) Alternative behavioral assumptions are possible

A related objection focuses less on the method of economic analysis, than on the goals it is designed to achieve. To some, economics analysis is hopelessly tainted with a conservative political bias.(197) The trouble lies in the economic vision of “allocative efficiency.” As discussed earlier, economists define an efficient allocation of resources as that allocation which would result, in the absence of transaction costs, from the exhaustion of all mutually advantageous exchanges.(198) The second economic tenet — reducing transaction costs — seeks to promote this goal. Yet, this notion of efficiency is a function of the initial distribution of societal wealth. Different initial distributions will generate different exchanges, hence, will result in different “efficient allocations.”(199) This suggests that efficiency is somewhat limited as a moral precept

We find little merit in the above argument. First, there are areas of the law in which distributional concerns legitimately play no role. Contract law provides the most obvious example. Liberal democracies have elected to address distributional issues through general tax and transfer legislation, not through contract law.(200) A contract between a millionaire and a pauper raises the same issues as a contract between people of equal economic status. Second, and more fundamentally, economic analysis can be used to promote progressive policies, including the redistribution of wealth. In fact, the first great movement in law and economics arose in support of President Roosevelt’s New Deal legislation.(201) The economic principle of “diminishing marginal utility” suggests that the marginal utility of a last dollar earned by a person is less than the marginal utility of the first dollar earned.(202) Thus, if one permits interpersonal utility comparisons,(203) progressive taxation coupled with wealth transfers is well within the purview of economic analysis.(204) Adopting a law and economics perspective does not preclude establishing a meaningful social safety net.(205) In fact, the perspective supports it.

In summary, we find that the first three obstacles to law and economics are largely based on perceptions, rather than substance. Law and economics insights apply equally well in civil law and common law countries

The fourth obstacle, however, is more substantive. For law and economics scholarship to have an impact in post-communist societies, its central tenets and insights must first be disseminated among the relevant policy-makers. Evidence suggests that advances are being made in the European Community. Faculty and student exchange programs are playing a role

(2)By economic analysis of law we refer to that body of work usually traced to Ronald Coase’s seminal essay and currently expounded by Judge Richard A. Posner. See generally Ronald Coase, The Problem of Social Cost, 3 J.L. & ECON. 1 (1960)

(3)See generally William M. Landes and Richard A. Posner, The Influence of Economics on Law: A Quantitative Study, 36 J.L. & ECON. 385 (1993) (chronicling the growing influence of law & economics in legal citations)

(4)Symposium, Economic Analysis in Civil Law Countries: Past, Present, Future, 11 INT’L REV. L. & ECON 261 (1991).

(5)See generally Istvan Kovacs, Hungary, 1 INT’L ENCYCLOPEDIA COMP. L. 13 (1978) (chronicling the early twentieth century history of Hungarian law).

(6)See Endre Lontai, Codification of the Law of Contracts, in QUESTIONS OF CIVIL LAW CODIFICATION 111, 111-17 (Attila Harmathy & Agnes Nemeth eds., 1990).

(7)Id. at 113.

(8)Kovacs, supra note 5, at 15.

(9)See generally Abram Bergson, Socialist Economics, in 1 A SURVEY OF CONTEMPORARY ECONOMICS 412 (Howard Ellis, ed., 1948) (summarizing the debate between market advocates and leading socialist economists).

(10)This property scheme was reflected in Act XX of 1949 on the Amendment to the Hungarian Constitution and codified in the Hungarian Civil Code of 1959 [hereinafter PTK. (1959)].

(11)For a general discussion of contract law under central planning see 1 E. ALLAN FARNSWORTH & VIKTOR P. MOZOLIN, CONTRACT LAW IN THE U.S.S.R. (1987).

(12)An English translation of the Hungarian Civil Code of 1959 complete with amendments was published by the Hungarian Chamber of Commerce in 1990. This translation is particularly useful because it collects the original 1959 language in bold face type and presents amendments in standard typeface. A copy can be obtained from the Hungarian Embassy in Washington, D.C. Hereinafter, references to the Hungarian Code rely on that translation.

(13)This bifurcation between contracts involving personal or private property and contracts involving state property was common to all socialist countries. See generally George G. Clos, The Czechoslovak Civil Code of 1964 and Its 1982 Amendment Within the Framework of Czechoslovak Civil Law, 6 N.Y.L. SCH. J. INT’L & COMP. L. 215 (1986) (identifying the same dichotomy in Czechoslovak contract law)

(14)The distinctively socialistic elements of Hungarian contract law appeared most notably in a chapter on “planned contracts.” That chapter was repealed in 1978.

(15)For a fuller development of this argument see Daniel T. Ostas, Institutional Reform in East-Central Europe: Hungarian and Polish Contract Law, 26 J. ECON. ISSUES 513 (1992).

(16)See generally Gyula Eorsi, Contracts in Socialist Economy, 7 INT’L ENCYCLOPEDIA COMP. L. 3 (1981) (providing a similar observation).

(17)See, e.g., PTK., supra note 10 at [paragraph] 206 (1959) (compulsory contracts).

(18)See, e.g., PTK., supra note 10 at [paragraph] [paragraph] 316, 318 (1959) (compulsory law suit). The Central Economic Arbitration Committee was formally abolished in 1972.

(19)Eorsi, supra note 16, at 5.

(20)Id.

(21) The most severe criticisms of central planning came from Austrian economists. See generally Ludwig von Mises, Economic Calculation in Socialism (1922), reprinted in MORRIS BORNSTEIN, COMPARATIVE ECONOMIC SYSTEMS: MODELS AND CASES (1969) (complexities of modern economies doom planning to failure)

(22)The theory of market socialism was initially designed to answer the criticisms of Hayek and Mises. See generally A. P. LEARNER, THE ECONOMICS OF CONTROL (1944) (the first formal model of decentralized socialism)

(23)See generally Hubert Izdebski, Legal Aspects of Economic Reform in Socialist Countries, 37 AM. J. COMP. L. 455 (1989) (comparing the Hungarian experiment with market socialism to similar efforts in other centrally planned economies).

(24)Direct planning officially ended with Act VIII of 1972 on Economic Planning (plan from above not binding on state enterprises).

(25)The legal foundations of the New Economic Mechanism were reflected in the Hungarian Constitution as amended by Act I of 1972 amending Act XX of 1949. These essential points were: (1) social ownership of the means of production

(26)Additional legislation provided a host of institutions designed to support market activity: joint venture law (1980)

(27)See Jeno Szilbereky, The Civil Code Amended and Restated, 20 ACTA JURIDICA HUNGARICA 5 (1978) (discussing the key 1978 amendments).

(28)See Gyula Eorsi, Contracts in Hungary after the Economic Reform, 11 ACTA JURIDICA HUNGARICA 25 (1969) (analyzing the changes in contract law needed to implement market socialism).

(29)Act IV of 1972 abolished the Central Economic Arbitration Committee.

(30)Autonomy is recognized in PTK., supra note 10 at [paragraph] [paragraph] 57-61 and [paragraph] [paragraph] 170-71. The primacy of contractual relations is codified in PTK., supra note 10 at [paragraph] [paragraph] 31-36 and [paragraph] [paragraph] 43-56.

(31)Of course, there are some differences from contemporary American contract law. For example, reflecting a civil law tradition, the Hungarian Code does not require an exchange of consideration. Promises to give gifts are fully enforceable. PTK., supra note 10 at [paragraph] [paragraph] 579-82 (1959). Reflecting a shortage economy, there is also a presumption in favor of specific performance over damages. PTK., supra note 10 at [paragraph] [paragraph] 295-311 (1959).

(32)Eastern Europeans who once championed market socialism are now completely disillusioned with the theory. See, e.g., Wlodzimerz Brus, The Eastern European Reforms: What Happened to Them?, 31 SOVIET STUD. 257 (1979)

(33)See XAVIER RICHET, THE HUNGARIAN MODEL: MARKETS AND PLANNING IN A SOCIALIST ECONOMY (1985)

(34)See, e.g., I.T. Berend, The Crisis of Hungarian Reform in the 1970’s, 40 ACTA OECONOMICA 105 (1989)

(35)See, e.g., Kornai, supra note 32.

(36)See Richard Ericson, The Classical Soviet Type Economy: Nature of the System and Implications for Reform, 5 J. ECON. PERSP. 11 (1991) (market socialism failures due to price controls).

(37)See Paul G. Hare, From Central Planning to Marker Economy: Some Microeconomic Issues, 100 ECON. J. 581 (1990).

(38)See supra notes 21-22 and accompanying text.

(39)The inefficiencies associated with market socialism derive from two primary factors. First, state ownership generates a host of “agency costs.” No single individual or group of individuals bears the risk of loss or has claim to residual profits of enterprise activity. Without a residual owner, there is no one to restrain enterprise managers from using the firm’s assets for their own purposes or to control managerial shirking. See Andras Sajo, Diffuse Rights in Search of an Agent: A Property Rights Analysis of the Firm in the Socialist Market Economy, 10 INT’L REV. L. & ECON. 41 (1990). The second inefficiency derives from imperfect information. The success or failure of a state enterprise is determined with reference to the state plan. The problem, of course, is that planners must rely on information supplied by enterprise managers. This creates an incentive to supply false information. See generally JANOS KORNAI, ECONOMICS OF SHORTAGE (1980). Even assuming that planners had true information and that planners were loyal fiduciaries to state interests, one would still be left with the insurmountable problems of coordinating a national economy See generally Hayek, supra note 21

(40)During the current transition, changes in property law and issues involving the distribution of property rights must take center stage. The vast majority of Hungarian wealth is still in state hands and transferring this wealth to private owners is no small task. Western scholars have responded with a virtual avalanche of advice on how to privatize state assets. For a sampling of this literature see Richard Daniels & Robert Howse, Reforming the Reform Process: A Critique of Proposals for Privatization in Central and Eastern Europe, 25 N.Y.U. J. INT’L L. & POL. 27 (1992)

(41)The six parts are: (I) Introduction

(42)The three titles are: Contracts, Torts, and Individual Contracts. PTK., supra note 10 at (1959).

(43)PTK., supra note 10 at [paragraph] [paragraph] 205-18 (1959).

(44)Id. [paragraph] [paragraph] 240-46 (1959).

(45)Id. [paragraph] [paragraph] 277-97 (1959).

(46)Id. [paragraph] [paragraph] 298-318 (1959).

(47)Id. [paragraph][paragraph] 328-33 (1959).

(48)Id. [paragraph] [paragraph] 365-78 (1959).

(49)Id. [paragraph] [paragraph] 379-88 (1959).

(50)Id. [paragraph] [paragraph] 423-51 (1959).

(51)Id. [paragraph] [paragraph] 522-35 (1959).

(52)Id. [paragraph] [paragraph] 536-67 (1959).

(53)This is no easy matter

(54)E. Allan Farnsworth, Developments in Contract Law During the 1980’s: The Top Ten, 41 CASE W. RES. L. REV. 203 (1990). The list includes: (1) “bad faith breath” and the role of punitive damages in contract law

(55)See, e.g., P. S. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT (1979) (waning of contract a direct result of government growth)

(56)See, e.g., Ian R. Macneil, Contracts: Adjustment of Long-Term Economic Relations Under Classical, Neoclassical, and Relational Contract Law, 72 NW. U. L. REV. 854 (1978). For an even more biting critique of free contracting see ROBERTO M. UNGER, THE CRITICAL LEGAL STUDIES MOVEMENT (1983) (market systems based on oppression).

(57)See, e.g., CHARLES FRIED, CONTRACT AS PROMISE (1981) (contract law best understood with reference to libertarian moral philosophy)

(58)See, e.g., ANTHONY T. KRONMAN & RICHARD A. POSNER, THE ECONOMICS OF CONTRACT LAW (1979)

(59)Economic analysis of law can be either positive, demonstrating that the law has an internal economic logic, or normative, proposing that law should conform to external economic criteria. Both forms of analysis have their supporters and critics. See RICHARD A. POSNER, THE PROBLEMS OF JURISPRUDENCE 353-92 (1990) (discussing the normative/positive dichotomy and identifying the chief criticisms and central virtues of each approach). Since we argue that Hungarian law should respond to economic criteria, our analysis is distinctively normative.

(60)See generally JAMES BUCHANAN, ECONOMICS: BETWEEN PREDICTIVE SCIENCE AND MORAL PHILOSOPHY 26-29 (1987) (arguing that the potential gains from voluntary exchange is virtually the sole lesson of economic theory)

(61)See Richard A. Epstein, Unconscionability: A Critical Reappraisal, 18 J.L. & ECON. 293, 293-95 (1975). The libertarian approach places contracting within a broader scheme of moral entitlements that specifies how resources may be acquired (property law), used (tort law), and transferred (contract law). See Richard A. Epstein, The Static Conception of the Common Law, 9 J. LEGAL STUD. 253, 255 (1980). In a liberal conception of justice, property rights carve out zones of individual authority with which others may not interfere. For property rights to have meaning, the parties must be free to transfer their entitlements as they see fit and free from non-voluntary confiscation of their rights by others. See generally ROBERT NOZICK, ANARCHY STATE AND UTOPLA (1974) (specifying the moral underpinnings of a libertarian entitlement theory).

(62)See POSNER, supra note 59, at 353-92 (linking economic jurisprudence to a mature form of pragmatism).

(63)See supra notes 21-22 and accompanying text. See also FRIEDRICH A. HAYEK, INDIVIDUALISM AND ECONOMIC ORDER (1948).

(64)See Friedrich A. Hayek, The Use of Knowledge in Society, 35 AM. ECON. REV. 519 (1945).

(65)Hierarchies exist outside of centrally planned economies. The bureaucratic organization of corporate life also involves hierarchical control and is consequently plagued with informational problems. Hierarchies introduce agency costs as those in control seek self gain at the cost of the collective. They also introduce incentive problems because each participant suffers the full costs of his or her inputs, but shares the benefits of the collective output. Hence, each has an incentive to shirk his or her duties. See generally OLIVER E. WILLIAMSON, MARKETS AND HIERARCHIES (1975) (analyzing the systematic inefficiencies found in large organizations).

(66)See generally Richard E. Speidel, The New Spirit of Contract, 2 J.L. & COM. 193 (1982) (employing the same dichotomy).

(67)Not every resource is alienable. For example, public policies in most Western nations prohibit child labor contracts. Slavery has been abolished virtually worldwide, and most nations either prohibit or strictly regulate prostitution. Properly conceived, such limitations are not matters of contract law, but reside more deeply within a general theory of entitlements. See Anthony Kronman, Paternalism and the Law of Contracts, 92 YALE L.J. 763 (1983) (discussing the contract law implications of the distinction between alienable and inalienable rights).

(68)POSNER, supra note 2, at 11-15.

(69)KRONMAN & POSNER, supra note 58, at 4-5.

(70)See Randy E. Barnett, A Consent Theory of Contract, 86 COLUM. L. REV. 269, 272-274 (1986). “It has long been recognized that a system of contractual enforcement would be unworkable if it adhered to will theory requiring a subjective inquiry into the putative promisor’s intent.” Id. at 272 (emphasis added). See also Felix Cohen, The Basis of Contract, 46 HARV. L. REV. 533 (1933) (discussing the interplay between objective and subjective inquiries into contractual consent).

(71)Anthony Kronman and Richard Posner address the old dispute in contract law over whether the basis of contractual enforcement is objective or subjective. They write:

Only a contract that involves an actual meeting of minds satisfies the economist’s definition of a value-maximizing exchange

KRONMAN & POSNER, supra note 58, at 5.

(72)For an application of this principle see Daniel T. Ostas, Predicting Unconscionability Decisions: An Economic Model and an Empirical Test, 29 AM. BUS. L.J. 535 (providing evidence that American courts follow an economic logic in deciding unconscionability controversies).

(73)For an thorough and provocative analysis of the gap-filling function of contract law see Randy E. Barnett, The Sound of Silence: Default Rules and Contractual Consent, 78 VA. L. REV. 821 (1992).

(74)Id. at 885-97.

(75)Id.

(76)See POSNER, supra note 2, at 84.

(77)Id.

(78)See Ostas, supra note 72, at 550.

(79)Id. at 551-52.

(80)LON L. FULLER, THE MORALITY OF LAW 38-39 (rev. ed. 1969).

(81)For an often cited analysis of the rule of law under communist regimes, see JOHN N. HAZARD, COMMUNISTS AND THEIR LAW (1969).

(82)Contracting occurs within a context of social customs and shared ethical norms. Although these customs and norms ultimately derive from the individuals who make up a society, the law can play a role in reinforcing and promoting ethical conduct. See generally IAN R. MACNEIL, THE NEW SOCIAL CONTRACT (1980) (analyzing the social norms that support contractual behavior). Perhaps the most fundamental problem facing all post-communist societies is the lack of social consensus regarding the norms that support modern capitalism. The institutionalization of ethical norms takes time.

(83)Although every rule of contract law can been seen as resting on an ethical base, the notions of good faith and unconscionability are phrased in ethical terms. Section 2-103(1)(b) of the Uniform Commercial Code defines good faith as “honesty in fact and the observance of reasonable commercial standards of fair dealing.” The Legislative Comments to [sections] 2-302 of the Uniform Commercial Code refer to unconscionable conduct as an “abuse of bargaining power.”

(84)PTK., supra note 10 at [paragraph] 200(2) (1959).

(85)The doctrine of socialist coexistence was (is) common to all East-Central European civil codes. See generally Adam Zielinski, Civil Law, in GENERAL PRINCIPLES OF LAW OF THE POLISH PEOPLE’S REPUBLIC 161, 171 (Leon Kurowski ed., 1984) (citing the use of socialist coexistence to protect long-term tenants from the harshness of eviction and to shield debtors against the demands to pay interest accumulated over long periods of time).

(86)The term socialist coexistence appeared in two other paragraphs of the Hungarian Civil Code. Paragraph 206(4) provided: “If the agreement of the parties does not extend to some unessential question,…the contract may be supplemented by the court–with attention paid to the aim and contents of the contract–on the basis of standard customs and of the norms of socialist coexistence.” PTK., supra note 10 at [paragraph] 206(4) (1959) (emphasis added). Paragraph 237(4) stated that “the court may award to the State the service that would have to be returned to the party who has concluded a forbidden contract or one violating the interests of society or offending against the norms of socialist coexistence.” Id. [paragraph] 237(4) (1959) (emphasis added). References to socialist norms were deleted from the Code in 1991.

(87)See Symposium, Unconscionability Around the World, 14 LOY. L.A. INT’L & COMP. L.J. 455 (1992) (comparing the role played by unconscionability in Germany, France, England, United States, Italy, and South Africa). For an economic analyses of unconscionability see Michael J. Trebilcock, An Economic Approach to the Doctrine of Unconscionability, in STUDIES IN CONTRACT LAW 381 (Barry J. Reiter & John Swan eds., 1980).

(88)See Richard A. Epstein, Unconscionability: A Critical Reappraisal, 18 J.L. & ECON. 293 (1975) (analyzing unconscionability with reference to its substantive and procedural components and suggesting abandonment of the substantive inquiry).

(89)Supra notes 60-67 and accompanying text.

(90)PTK., supra note 10 at #201(2) (1959).

(91)The reference here is to the common law doctrine of laesio enormous which was largely abandoned in the early nineteenth century. See MORTON J. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW: 1780-1860 at 160-80 (1978).

(92)The notion of economic efficiency can be used to fill in the gaps in contractual language. The law assumes that the parties would have agreed to assign the contractual risks in an efficient manner. Thus, efficiency can be seen as an external referent to fairness. See supra text accompanying note 77. However, if the parties expressly agree to vary from these efficient terms, the express language controls.

(93)Here we are speaking of unfairness at the time of contractual agreement. Fairness issues also arise at the time of performance. We analyze performance issues later in the article. See infra notes 135-72 and accompanying text.

(94)JOHN R. COMMONS, LEGAL FOUNDATIONS OF CAPITALISM 34-59 (1924).

(95)Id. at 34, 56-58.

(96)Commons wrote: “[I]t is perfectly lawful…to exercise either superior economic power or superior mental and managerial faculties over others, provided advantage is not taken of recognized special personal relations of confidence, trust, dependence, or the like, which are deemed peculiarly liable to abuse.” Id. at 59. The equitable doctrine of undue influence guards against abuses of personal persuasion in fiduciary settings. For an economic analysis of fiduciary relationships see Frank H. Easterbrook & Daniel R. Fischel, Contract and Fiduciary Duty, 36 J.L. & ECON. 385 (1993).

(97)Economic analysis does suggest one exception. Sometimes called economic duress, it involves situations in which the necessitous condition of the complaining party was initially caused by the wrongful act of the stronger. In such situations the stronger party would have no right to withhold his or her property. See, e.g., Thompson Crane & Trucking Co. v. Eyman, 267 P.2d 1043 (Cal. App. 1954) (a classic case illustrating the doctrine of economic duress).

(98)See supra notes 66-67 and accompanying text.

(99)See generally William M. Landes & Richard A. Posner, Salvors, Finders, Good Samaritans, and Other Rescuers: An Economic Study of Law and Altruism, 7 J. LEGAL STUD. 83 (1978) (finding that the necessitous condition of the aggrieved party does not per se generate an affirmative duty of altruism).

(100)See Ostas, supra note 72, at 581-83 (arguing that monopoly power is largely irrelevant to issues of duress).

(101)PTK., supra note 10 at [paragraph] 202 (1959) (emphasis added).

(102)In a private correspondence Professor Harmathy pointed out that in court practice and in the general understanding of Hungarian lawyers paragraph 202 only addresses usury contracts. Such an understanding would provide a much needed prophylatic to the breadth of the provision. (Letter on file with the authors).

(103)See generally George J. Stigler, The Economics of Information, 69 J. POL. ECON. 213 (1961) (a seminal work on the economics of information asymmetries).

(104)For a useful introduction to the economic analysis of fraud see POSNER, supra note 2, at 96-101.

(105)See supra text accompanying notes 68-79.

(106)”[L]iability for nondisclosure should turn on which of the parties to the transaction, seller or consumer, can produce or obtain information at lower cost. If the relevant characteristic is one that the purchaser can determine by casual inspection…then it would be redundant to require the seller to disclose.” POSNER, supra note 2, at 99.

(107)A similar analysis can be used to address surprising and uncustomary provisions found in consumer contracts. If it would be too costly for the consumer to ferret out such provisions ex ante, the courts may require the seller to take affirmative steps to inform the buyer of the surprising language. See Barnett, supra note 73, at 888-90.

(108)PTK., supra note 10 at [paragraph] 205(3) (1959).

(109)To complicate matters, the terms contained in these forms typically are slanted to favor the drafting party, restricting, if not removing, the rights granted by other areas of the law to the non-drafting party. For example, a standard form may restrict a warranty, excuse the seller for liability caused by its own negligence, provide for a penalty, or alter the burden of proof rules. Such clauses become troublesome in consumer contracts where the consumer may be unaware of the presence and effect of such clauses. See generally Friedrich Kessler, Contracts of Adhesion–Some Thoughts About Freedom of Contract, 43 COLUM. L. REV. 629 (1943) (discussing the use of standardized forms to surprise unwary consumers with uncustomary terms)

(110)See generally Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 AM. SOC. REV. 55 (1963) (providing evidence that most business people do not known the contents of their own form contracts, never reading the fine print).

(111)See, e.g., Douglas C. Baird & Robert Weisberg, Rules, Standards, and the Battle of Forms: A Reassessment of 2-207, 68 VA. L. REV. 1217 (1982)

(112)The fact that there is no uniform method for resolving these questions complicates the matter when international sales are involved. See generally JOHN HONNOLD, UNIFORM LAW FOR INTERNATIONAL SALES UNDER THE 1980 UNITED NATIONS CONVENTION 165 (1982).

(113)Vergne, supra note 111, at 241.

(114)RESTATEMENT (SECOND) OF CONTRACTS (1981). Section 57 states: “Where notification is essential to acceptance by promise, the offeror is not bound by an acceptance in equivocal terms unless he reasonably understands it as an acceptance.” Section 59 provides: “A reply to an offer which purports to accept it but is conditional on the offeror’s assent to terms additional to or different from those offered is not an acceptance but is a counter-offer.”

(115)Vergne, supra note 111, at 247.

(116)Hungary joined other Eastern Bloc nations in forming the Council for Mutual Economic Assistance (CMEA). The organization adopted a mandatory set of rules called the “General Conditions for the Delivery of Goods” that regulated contracts between individuals of differing member nations. Chapter 1, Section 1(2) provided: “If the offeror receives a notification of acceptance that is other than unconditional acceptance… The notification shall be considered to be a counteroffer.” The CMEA has been dissolved, and the CMEA General Conditions are no longer in force.

(117)Some have also called this the “rule” approach. See Baird & Weisberg, supra note 111, at 1228 (defining a rule as “a very specifically framed guide to conduct that is detailed in its normative content and that the lawmaker believes will directly implement his social or economic goals”).

(118)Recently, the mirror image rule has been relaxed somewhat. An example can be found in French law. If the variance is on an essential element of the contract, then no contract is concluded. See Vergne, supra note 111, at 249. But a contract may be concluded if the variance concerns a matter that is subsidiary to the contract. Id. Under French law the essential elements of a contract concern price and subject matter, and some variation in the acceptance is permitted so long as it does not concern the essential elements of price and subject matter. Id. (citing the French Code Civil, Article 1583). This trend toward relaxation of the inflexible application of the rule can also be found in the court decisions under the common law in both England and the United States. However, in all these countries, if the acceptance varies from the offer in any material way, a contract is not concluded.

(119)PTK., supra note 10 at [paragraph] 213(2) (1959).

(120)See Gyula Eorsi, A Propos the 1980 Vienna Convention on Contracts for the International Sale of Goods, 31 AM J. OF COMP L. 333, 341-42 (1983).

(121)Id. at 342.

(122)See supra note 66 and accompanying text.

(123)See, e.g., Mehren, supra note 111, at 270.

(124)Id.

(125)U.C.C. [sections] 2-207 provides:

(1) A definite and seasonable expression of acceptance or a written conformation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms.

(2) The additional terms are to be construed as proposals for addition to the contract. Between merchants such terms become part of the contract unless:

(a) The offer expressly limits acceptance to the terms of the offer

(b) They materially alter it

(c) Notification of objection to them has already been given or is given within a reasonable time after notice of them is received.

(3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In such a case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act.

(126)See, e.g., JAMES J. WHITE & ROBERT S. SUMMERS, UNIFORM COMMERCIAL CODE 28-49 (3d ed. 1988) (observing that the section was originally drafted to deal with the “welsher” problem, but has been inappropriately applied to determine the terms of the contract)

(127)See Mehren, supra note 111, at 290.

(128)Id. (citations omitted).

(129)See supra note 125.

(130)See generally Burt A. Leete, Contract Formation Under the United Nations Convention on Contracts for the International Sale of Goods and the Uniform Commercial Code: Pitfalls for the Unwary, 6 TEMP. INT’L AND COMP. L.J. 193 (1992).

(131)Most of the parties that Hungarians contract with internationally operate under a legal system that employs the mirror image rule. This is particularly true of contracts covered under the CISG. In addition, the Hungarian system historically has taken a strict formalistic approach to the question

(132)See supra note 125.

(133)See supra notes 127-128 and accompanying text.

(134)See supra note 77 and accompanying text.

(135)For a brief, but useful, comparative law perspective see Denis Tallon, Imprevision Revisited: Some Remarks on the Consequences of a Change of Circumstances on Contracts, in BINDING FORCE OF CONTRACT 107-112 (Attila Harmathy ed., 1991).

(136)E.g., Beth A. Eisler, Modification of Sales Contracts Under the Uniform Commerical Code: Section 2-209 Reconsidered, 57 TENN. L. REV. 401 (1990)

(137)In all three hypotheticals, the obligor seeks a discharge due to the occurrence of an unforeseen event. Although the central issue is similar in all three cases, a common law court probably would address the three cases under different rubrics. The farmer case raises the issue of “impossibility of performance

(138)More particularly, the courts face three options: (1) they could routinely grant an excuse based on unforeseen events

(139)Posner & Rosenfield, supra note 136.

(140)Id. at 90.

(141)For a critical view of this approach, see Aivazian et. al., supra note 138.

(142)Brian Constr. & Dev. Co. v. Brighteni, 405 A.2d 72 (Conn. 1978) (customary for excavators to run test borings).

(143)Posner & Rosenfield, supra note 136, at 93-94.

(144)Paragraph 226 addresses the need for contractual modification due to unforeseen changes in the state’s central economic plan. PTK., supra note 10 at [paragraph] 226 (1959). Due to economic reforms, this section is of reduced importance today. See Attila Harmathy, The Binding Force of Contract in Hungarian Law, in BINDING FORCE OF CONTRACT 35 (Attila Harmathy ed., 1991). More generally, [paragraph] 227(2) provides: “A contract aimed at an impossible performance shall be null and void.” PTK., supra note 10 at [paragraph] 227(2) (1959).

(145)PTK., supra note 10 at [paragraph] 312 (1959).

(146)Although many Hungarian statutes and codes have been translated to English, the same is not true of Hungarian judicial opinions. Fortunately, Professor Harmathy has provided a very useful analysis of Hungarian court opinions on contractual modifications for unforeseen events. See Harmathy, supra note 144. His analysis indicates that Hungarian judicial opinion is largely in accord with the efficiency analysis suggested here.

(147)Denis Tallon cites France, Poland and Czechoslovakia as examples. See Tallon, supra note 135, at 108.

(148)Examples include the Federal Republic of Germany, Italy, Greece, and Algeria. Id. at 109.

(149)John P. Dawson, Judicial Revision of Frustrated Contracts: The United States, 64 B.U. L. REV. 1, 3 (1984).

(150)The case of Aluminum Co. of Am. v. Essex Group, 499 F.Supp. 53 (W.D.Pa. 1980) is a well known exception. It has been subjected to heavy criticism. For example, Professor Dawson observes that the case is “the only instance in which an American judge has tried to dictate entirely different substantive terms in a contract that was stil being actively performed.” Id. at 35. Professors White and Summers are equally critical. They write: “It is one thing for the court to say the parties should be freed from the contract, or that there should be allocation under 2-615 and 2-616

(151)For a discussion of the experience of the German courts with court ordered adjustment or revision of contracts in which unforeseen events destroyed the purpose or balance of the contract see John P. Dawson, Judicial Revision of Frustrated Contracts: Germany, 63 B.U. L. REV. 1039 (1983).

(152)BGB [sections] 242.

(153)The German concept of gerschaftsgrundlage is akin to the English word used in the doctrine of “frustration of purpose” but has a much broader meaning. It would include the concepts of impossibility and impracticality as well as mistake. See Dawson, supra note 151, at 1040.

(154)Id. at 1087.

(155)See Dawson, supra note 149, at 37.

(156)See supra text accompanying note 145.

(157)Harmathy, supra note 146, at 39.

(158)PTK., supra note 10 at [paragraph] 241 (1959) (emphasis added).

(159)Harmathy, supra note 146, at 35. Professor Harmathy notes that although the courts have discretion to redraft contract provisions, the tendency in the courts is to resist such actions. Id. at 35-38. More particularly, he writes: “The only published decision, I found, modifying the contract because of price changes concerned a contract having a public utility service character.” Id. at 36.

(160)In the United States the term “impracticability of performance” is often used. Thus the Restatement (Second) of Contracts [sections] 261 (1981) provides:

Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.

(161)Professor Halson defines “opportunism” as “the practice of bilateral monopolists, i.e. parties who have no practical alternative but to deal with each other, of using that strategic position to their advantage.” Halson, supra note 136, at 650. See generally Timothy J. Muris, Opportunistic Behavior and the Law of Contracts, 65 MINN. L. REV. 521 (1981).

(162)RESTATEMENT (SECOND) OF CONTRACTS [sections] 89 (1981) states with regard to executory contracts:

A promise modifying a duty under a contract not fully performed on either side is binding

(a) if the modification is fair and equitable in view of circumstances not anticipated by the parties when the contract was made

(b) to the extent provided by statute

(c) to the extent that justice requires enforcement in view of material change of position in reliance on the promise.

(163)The safeguard provided by considerationis not air tight. For example, an opportunistic obligor could insist that a nominal consideration be added to the exchange, rendering the agreement mutual under the common law, and enforceable. Traditionally, consideration provides a symbolic function evidencing the consent of the parties and providing a warning to each party that their agreement has legal effect, rather than serving as a safeguard against opportunism. See generally Lon E. Fuller, Consideration and Form, 41 COLUM. L. REV. 799, 820 (1941) (justifying nominal consideration as an indicator of consent).

(164)U.C.C. [sections] 2-209 provides, in relevant part:

(1) An agreement modifying a contract within this Article needs no consideration to be binding.

(2) A signed agreement which excludes modification or recision except by a signed writing cannot be otherwise modified or rescinded, but except as between merchants such a requirement on a form supplied by the merchant must be separately signed by the other party.

(3) The requirements of the statute of frauds section of this Article … must be satisfied if the contract as modified is within its provisions.

(165)U.C.C. 2-209, comment 1.

(166)Halson, supra note 136 (making the same argument).

(167)U.C.C. [sections] 2-209, comment 2 states, in part:

However, modifications made thereunder must meet the test of good faith imposed by this Act. The effective use of bad faith to escape performance on the original contract terms is barred, and the extortion of a “modification” without legitimate commercial reason is ineffective as a violation of the duty of good faith. Nor can a mere technical consideration support a modification made in bad faith.

The test of “good faith” between merchants or as against merchants includes “observance of reasonable commercial standards of fair dealing in the trade” ([sections] 2-103), and may in some situations require an objectively demonstrable reason for seeking a modification. But such matters as a market shift which makes performance come to involve a loss may provide such a reason even though there is no such unforeseen difficulty as would make out a legal excuse from performance under [sections] [sections] 2-615 and 2-616.

(168)For a thorough discussion of this problem see Eisler, supra note 136, at 410.

(169)See supra note 167.

(170)See generally Robert A. Hillman, Policing Contract Modifications Under the UCC: Good Faith and the Doctrine of Economic Duress, 64 IOWA L. REV. 849 (1979) (offering a similar criticism)

(171)PTK., supra note 10 at [paragraph] 240 (1959).

(172)Although the Hungarian Code does not contain a general provision requiring good faith, it does require party respect for the “norms of socialist coexistence,” an analogous concept. See supra notes 82-106 and accompanying text.

(173)See supra notes 145-46 and accompanying text.

(174)See supra note 159.

(175)See supra note 171 and accompanying text.

(176)The origins of modern economic analysis of law is generally traced to scholars at the University of Chicago. For a discussion of the early Chicago movement see Ronald Coase, Law and Economics at Chicago, 36 J.L. & ECON. 239 (1993).

(177)A survey of leading American texts on law and economics reveals that common law topics of contracts, tort, and property predominate. See, e.g., POSNER, supra note 2 (the seminal text)

(178)Early scholarship in modern comparative law tended to emphasize the distinctions between civil and common law systems. See, e.g., R. DAVID & J. BRIERLEY, MAJOR LEGAL SYSTEMS IN THE WORLD TODAY (2d ed. 1978)

(179)Modern comparative law scholars are beginning to emphasize the similarities between legal systems. See Uto Mattei & Robert Pardolesi, Law and Economics in Comparative Law Countries: A Comparative Approach, 11 INT’L REV. L. & ECON. 265, 266-67 (1991). See, e.g., A. WATSON, LEGAL TRANSPLANTS: AN APPROACH TO COMPARATIVE LAW (1974).

(180)See POSNER, supra note 59, at 353-93 (linking economic analysis of law to a mature form of instrumental pragmatism).

(181)For an excellent discussion of the instrumental pragmatism see WENDELL GORDON & JOHN ADAMS, ECONOMICS AS SOCIAL SCIENCE: AN EVOLUTIONARY APPROACH 72-77, 83 (1989) (identifying the historical roots of legal instrumentalism in the works of the American pragmatic philosophers, Charles Sanders Peirce, William James, and John Dewey).

(182)See HAZARD, supra note 81.

(183)Shozo Ota, Law & Economics in Japan: Hatching Stage, 11 INT’L REV. L. & ECON. 301 (1991).

(184)Id. at 306.

(185)Christian Kirchner, The Difficult Reception of Law & Economics in Germany, 11 INT’L J.L. & ECON. 277 (1991).

(186)Id. at 281-86. Notwithstanding the observations offered by Professor Kirchner, our discussions of the German approach to both the “battle of the forms” and the excuse doctrines for unforeseen events suggest that the German courts enjoy a marked degree of discretion.

(187)Id. at 285.

(188)We have found no explicit references to the need for “legal stability” in the law and economics literature. The principle, however, is implicit in all such work.

(189)In the United States, an entire school of critical thought has arisen in direct response and opposition to the law and economics movement. See generally MARK KELMAN, A GUIDE TO THE CRITICAL LEGAL STUDIES MOVEMENT 114-185 (1987) (linking “legal economics” to “conservative preferences”)

(190)See GARY S. BECKER, THE ECONOMIC APPROACH TO HUMAN BEHAVIOR 3-14 (1976) (defining any question that can be stated as a choice between rational alternatives as an “economic” question).

(191)In a well known essay, Noble Laureate Milton Friedman argued that realistic assumptions are not necessary to scientific inquiry. According to Friedman, the value of an assumption depends solely on its ability to generate testable hypotheses. MILTON FRIEDMAN, ESSAYS IN POSITIVE ECONOMICS (1953).

(192)The hyper-rationality assumption of neoclassical theory becomes more realistic as one introduces the concepts of imperfect information and uncertainty. See generally FRANK H. KNIGHT, RISK, UNCERTAINTY, AND PROFIT (1921) (the pioneering work on uncertainty from a neoclassical perspective)

(193)See Herbert A. Simon, Theories of Bounded Rationality, in DECISION AND ORGANIZATION 161-76 (C. B. McGuire & Roy Radner eds., 1972) (bounded rationality results from a person’s inability to assemble and use all available information)

(194)See OLIVER E. WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM 43-52 (1985) (defining opportunism as “self-interest with guile”).

(195)See, e.g., THORSTEIN VEBLEN, THE THEORY OF BUSINESS ENTERPRISE (1904) (providing an anthropological perspective on business decision making).

(196)See H. H. Liebhafsky, Law and Economics from Different Perspectives, 21 J. ECON. ISSUES 1809 (1987)

(197)For example, Goran Skogh argues that many Swedes resist economic analysis of law because they perceive it to be tainted with a “right wing political bias.” See Goran Skogh, Law and Economics in Sweden, 11 INT’L REV. L. & ECON. 319, 322 (1991). Wolfgang Weigel reports a similar perception among Austrian policy makers. Wolfgang Weigel, Prospects for Law and Economics in Civil Law Countries: Austria, 11 INT’L REV. L. & ECON. 325, 327 (1991). The same objection motivates many who write within the Critical Legal Studies tradition in the United States. See supra note 189.

(198)See supra note 68 and accompanying text.

(199)See Warren J. Samuels, Interrelations Between Legal and Economic Processes, 14 J.L. & ECON. 435 (1971) (offering the same observation in an applied context).

(200)See Anthony T. Kronman, Contract Law and Distributive Justice, 89 YALE L.J. 472, 473-474 (1980) (finding a consensus among American scholars of all political leanings that distributive issues should play no role in contract law adjudication).

(201)See Herbert Hovenkamp, The First Great Law & Economics Movement, 42 STAN. L. REV. 993 (1990).

(202)Id. at 1002-09.

(203)Some, but not all, economists argue that interpersonal utility comparisons are illegitimate. Id.

(204)Economic analysis also points to “market failures” as a justification for government actions in the name of public welfare. Examples include: active antitrust policy to correct for monopoly power

(205)Interestingly, Santos Pastor reports that there has been relatively little resistance to law and economics scholarship in Spain, governed currently by a socialist government. He writes: “[D]espite the rule of a socialist party, most policies tend to be pro-market and pro-competition. In the government’s understanding, this is far from being contradictory, especially when redistribution policies are taken into account.” Santos Pastor, Law and Economics in Spain, 11 INT’L J.L. & ECON. 309, 309 (1991).

(206)See Gerard Hertig, Switzerland, 11 INT’L J. L. & ECON. 293 (law and economics influencing Swiss policy through study abroad).

(207)See Mattei & Pardolesi, supra note 179, at 274-75 (providing an extensive bibliography of law and economics scholarship either translated to or originally produced in Italian)