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Contract Interpretation Preferences: A Textualist Approach in Commercial Contracts, Study notes of Law

Ho Chi Minh City University of Pedagogy (HCMUP)Law

The debate over contract interpretation rules, focusing on the preference of most contracting parties. An empirical study of 1,521 commercial contracts disclosed to the SEC reveals that a majority (75.28%) include a textualist 'merger clause,' which triggers textualist interpretation rules. The article discusses the theoretical arguments for both textualist and contextualist approaches and the lack of empirical literature on parties' actual preferences. The study also examines the dominance of New York choice-of-law clauses over California choice-of-law clauses and the reasons behind it.

What you will learn

  • What is the central question in the theoretical debate over contract interpretation?
  • Why do textualist scholars believe that parties to commercial contracts prefer textualist interpretation rules?
  • What percentage of commercial contracts include a textualist 'merger clause'?
  • What are the differences between New York and California contract interpretation laws?

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4 BENOLIEL 469-493 (DO NOT DELETE) 11/14/2017 8:31 PM
469
THE INTERPRETATION OF COMMERCIAL CONTRACTS: AN
EMPIRICAL STUDY
Uri Benoliel*
ABSTRACT .................................................................................................. 470
INTRODUCTION .......................................................................................... 470
I. THE THEORETICAL DEBATE: TEXT VS. CONTEXT ................................. 472
II. EXISTING EMPIRICAL EVIDENCE ........................................................... 477
III. THE EMPIRICAL TEST ........................................................................... 480
A. Merger Clause—A Brief Overview .......................................... 481
B. The Theoretical Hypotheses .................................................... 482
C. Data ......................................................................................... 485
D. Methodology ............................................................................ 488
E. Results...................................................................................... 489
IV. DISCUSSION AND NORMATIVE IMPLICATIONS ..................................... 491
CONCLUSION .............................................................................................. 493
* Faculty of Law, College of Law & Business. J.S.D. (UC Berkeley); LL.M (Columbia
University). I am grateful to Adi Ayal, Samuel Becher, Steven Burton, Hanoch Dagan, Omer Dekel,
Sinai Deutch, Christopher Drahozal, Charles Goetz, Alon Harel, Eyal Katvan, Rinat Kitai, Pablo
Lerner, Geoffrey Miller, Gideon Parchomovsky, Ariel Porat, Arie Reich, Boaz Sangero, and James
White for invaluable comments on earlier drafts of this Article. This Article is dedicated, with love, to
my father, Professor Ricardo Ben-Oliel.
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Download Contract Interpretation Preferences: A Textualist Approach in Commercial Contracts and more Study notes Law in PDF only on Docsity!

THE I NTERPRETATION OF COMMERCIAL C ONTRACTS : AN

EMPIRICAL S TUDY

Uri Benoliel

ABSTRACT .................................................................................................. 470

I NTRODUCTION .......................................................................................... 470

I. T HE T HEORETICAL DEBATE : T EXT VS. CONTEXT ................................. 472

II. E XISTING E MPIRICAL E VIDENCE ........................................................... 477

III. T HE E MPIRICAL T EST ........................................................................... 480

A. Merger Clause—A Brief Overview .......................................... 481

B. The Theoretical Hypotheses .................................................... 482

C. Data ......................................................................................... 485

D. Methodology ............................................................................ 488

E. Results...................................................................................... 489

IV. DISCUSSION AND NORMATIVE I MPLICATIONS ..................................... 491

CONCLUSION .............................................................................................. 493

  • Faculty of Law, College of Law & Business. J.S.D. (UC Berkeley); LL.M (Columbia University). I am grateful to Adi Ayal, Samuel Becher, Steven Burton, Hanoch Dagan, Omer Dekel, Sinai Deutch, Christopher Drahozal, Charles Goetz, Alon Harel, Eyal Katvan, Rinat Kitai, Pablo Lerner, Geoffrey Miller, Gideon Parchomovsky, Ariel Porat, Arie Reich, Boaz Sangero, and James White for invaluable comments on earlier drafts of this Article. This Article is dedicated, with love, to my father, Professor Ricardo Ben-Oliel.

470 Alabama Law Review [Vol. 69:2:

ABSTRACT

The theoretical debate over contract interpretation revolves around one

central question: what is the preference of most contracting parties for

contract interpretation rules? Textualist theorists believe that most parties

prefer textualist rules of interpretation, under which the contract

interpreter must normally consider only the contract’s written text. In

contrast, contextualist theorists believe that most parties prefer

contextualist rules of interpretation, under which the interpreter should

consider all relevant contextual evidence to interpret the contract, beyond

the written text.

Despite the widespread debate over contract interpretation, there has

been very little empirical research on this topic. This Article aims to fill

this research gap by empirically analyzing actual interpretation clauses of

commercial contracts. Examining 1,521 commercial contracts that have

been disclosed to the Securities and Exchange Commission, this Article

finds that a clear majority (75.28%) of contracts include a textualist

“merger clause,” which typically triggers a set of textualist rules of

contract interpretation. In addition, the results of this study indicate that

the merger clauses, included in the sample contracts, are not mere

arbitrary boilerplates which were randomly added to the contracts. More

specifically, the study found a significant statistical association between the

contractual existence of a variety of textualist contractual clauses, other

than a merger clause, and the existence of the textualist merger clause.

The theoretical and practical implications of these results are

discussed.

I NTRODUCTION

Contract interpretation—that is, the undertaking by an adjudicator to

identify the terms of the contract and give them a meaning

1

—plays a

significant role in American law.

2

It is one of the most common sources of

  1. Richard A. Posner, The Law and Economics of Contract Interpretation , 83 TEX. L. R EV. 1581, 1582 (2005) (“Contract interpretation is the undertaking by a judge or jury (or an arbitrator—more on arbitration later) to figure out what the terms of a contract are, or should be understood to be.”); see also Steven J. Burton, A Lesson on Some Limits of Economic Analysis: Schwartz and Scott on Contract Interpretation , 88 IND. L.J. 339, 341 (2013).
  2. STEVEN J. B URTON , E LEMENTS OF C ONTRACT I NTERPRETATION 1 (2009) (“Issues of contract interpretation are important in American law.”); Avery Wiener Katz, The Economics of Form and Substance in Contract Interpretation , 104 C OLUM. L. R EV. 496, 496 (2004) (“Under the modern American law of contracts, almost all applications of legal doctrine turn on questions of interpretation.... ”); Joshua M. Silverstein, Using the West Key Number System as a Data Collection and Coding Device for Empirical Legal Scholarship: Demonstrating the Method Via a Study of Contract Interpretation , 34 J.L. & C OM. 203, 204 (2016) (“Contract interpretation is one of the most significant areas of commercial law.”).

472 Alabama Law Review [Vol. 69:2:

included in commercial contracts between sophisticated parties.

12

This

study aims to fill this research gap.

Focusing on the preferences of sophisticated parties to commercial

contracts, this paper analyzes 1,521 commercial contracts that have been

disclosed to the Securities and Exchange Commission (SEC). The results of

the study reveal that the clear majority of contracts include a textualist

“merger clause,” which typically triggers a set of textualist interpretation

rules under current contract law.

13

The results also indicate that the merger

clauses, included in the contracts, are not mere boilerplates which are

randomly added to the contracts. Particularly, the study found a significant

statistical correlation between the existence of textualist contractual

clauses, other than a merger clause, such as a “no-oral-modification” or

“notices” clause, and the existence of a merger clause.

14

This Article will proceed as follows: Part I will provide context by

reviewing the theoretical debate over contract interpretation. Part II will

present the scant existing empirical research on the parties’ preferences for

contract interpretation rules and its limitations. Part III will present the

empirical test of this study. It will review the data and discuss the

methodology for empirically testing the frequency with which a textualist

merger clause is included in commercial contracts between sophisticated

parties. It will also examine the statistical association between central

textualist clauses, other than a merger clause, and a textualist merger

clause. Part IV will discuss the normative implications of the empirical

results.

I. T HE T HEORETICAL DEBATE : TEXT VS. CONTEXT

According to the textualist theory of contract interpretation, the

contract adjudicator must normally consider only the contract’s written text

when interpreting the contract.

15

Lacking a textual ambiguity, the

adjudicator should not consider extrinsic context that surrounds the

  1. Lisa Bernstein, Merchant Law in a Modern Economy 15 (Coase-Sandor Inst. for Law & Econ., Working Paper No. 639, 2013).
  2. See infra Part III.
  3. See infra Part III.
  4. Shawn Bayern, Contract Meta-Interpretation , 49 U.C. DAVIS L. R EV. 1097, 1099 (2016) (a textualist approach favors “a narrower... interpretive focus on the text of written contracts”); Ronald J. Gilson et al., Contract and Innovation: The Limited Role of Generalist Courts in the Evolution of Novel Contractual Forms , 88 N.Y.U. L. R EV. 170, 171 n.1 (2013) (“Textualist interpretation... looks to a contract’s formal language.... ”); Scott, supra note 4, at 1 (“Textualist theories look principally to the written agreement between the parties for the terms of the contract and... the meaning of those terms... .”); Robert E. Scott, The Death of Contract Law , 54 U. TORONTO L.J. 369, 376 n.18 (2004) (under a textualist approach, “the interpreter considers only a contract’s written text when deciding what the contract directed... .”).

2017] The Interpretation of Commercial Contracts 473

contract’s text.

16

The adjudicator must specifically exclude the following

major categories of contextual, nontextual, extrinsic evidence: (1) practice

between the parties under prior contracts; (2) practice between the parties

under the litigated contract; (3) precontractual oral statements or

understandings; and (4) industry custom.

17

According to the contextualist theory, the interpreter should consider

all relevant contextual evidence to interpret the contract, beyond the written

contractual text.

18

The interpreter must look at “events before contract

formation.”

19

The interpreter must also consider events that occurred after

contract formation.

20

The interpreter should consider contextual evidence,

even if it is oral or behavioral and nontextual.

21

The adjudicator should

determine “whether extrinsic evidence of the circumstances surrounding

the contract... improves understanding of what parties intended regardless

of the contractual text.”

22

The adjudicator should consider context, even if

the contract seems unambiguous.

23

The written contractual language is

“treated merely as establishing prima facie terms,” which the adjudicator

can override by considering contextual, nontextual evidence if she believes

  1. Gilson et al., supra note 15, at 171 n.1 (“In a textualist regime, and absent ambiguity, generalist courts cannot choose to consider context... .”); see also Gilson et al., supra note 3, at 25; Darius Palia & Robert E. Scott, Ex Ante Choice of Jury Waiver Clauses in Mergers , 17 AM. L. & ECON. R EV. 566, 572 (2015) (“[T]he textualist approach bars context evidence... .”); Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law , 113 YALE L.J. 541, 572 n.61 (2003) (a court applying a textualist approach “will admit extrinsic evidence only when the contract’s language is vague or ambiguous on its face”).
  2. Alan Schwartz & Robert E. Scott, Contract Interpretation Redux , 119 YALE L.J. 926, 933 n.20 (2010); see also C ATHERINE MITCHELL , INTERPRETATION OF C ONTRACTS 123 (2007) (“Formalism may manifest itself in a desire for the documents to be taken as the primary evidence of what was agreed, without recourse to negotiations, trade customs, previous understandings or any other extrinsic material.”).
  3. Charles J. Goetz & Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Interactions Between Express and Implied Contract Terms , 73 C ALIF. L. R EV. 261, 308 (1985) (“[T]he contextualists have assumed that the purpose of interpretation is to uphold the expectations of the particular parties to the agreement by determining from an analysis of all relevant evidence what they ‘really meant.’”); Katz, supra note 2, at 498 (“A more ‘substantive’ approach to contract interpretation... would attempt to come to a more all-things-considered understanding, based on all of the materials reasonably available.”); Schwartz & Scott, supra note 16, at 572 (“[Contextualists’] theory lets courts consider all material evidence to resolve interpretive issues... .”).
  4. Melvin Aron Eisenberg, The Emergence of Dynamic Contract Law , 88 C ALIF. L. R EV. 1743, 1770 (2000).
  5. Id. ; see also Bayern, supra note 15, at 1100 (“[C]ontextualists consider post-formation information... .”).
  6. Scott, supra note 4, at 1 (“[C]ontextualist theories look beyond the writing, to... oral... evidence of what the parties intended.”).
  7. Gilson et al., supra note 3, at 27.
  8. Gilson et al., supra note 15, at 171 n.1 (“In a textualist regime, and absent ambiguity, generalist courts cannot choose to consider context; in a contextualist regime, these courts must consider it.”); Gilson et al., supra note 3, at 25–26.

2017] The Interpretation of Commercial Contracts 475

contextual evidence may generate a contract misinterpretation,

since the parties may actually have intended that their contract

text will serve as the only interpretive tool.

34

3. The textualist method, compared with the contextualist method,

increases the ability of the parties to predict “how contract terms

and language will be interpreted in [their] subsequent

transactions.”

35

By excluding contextual evidence when the

contract text is unambiguous, the textualist approach preserves

the linguistic clarity of existing unambiguous terms.

36

4. The textualist approach prevents opportunistic behavior that

might occur under a contextualist regime. Under the latter

regime, a contract party might strategically dispute the meaning

of a perfectly clear contract term, to which she freely agreed, in

an effort to escape a bad bargain.

37

The longer the contract, the

easier it will be to strategically create disputes regarding its

meaning.

38

5. The textualist approach prevents the adjudicator from imposing

his own set of beliefs on the contract by requiring him to follow

only the contract text. Conversely, under a contextualist regime,

“the interpreter necessarily imposes his own set of assumptions”

on the parties’ contract by “selecting certain bits of context” and

excluding others.

39

Scott, supra note 16, at 587 (“[A] disappointed party may plausibly claim that the parties’ course of dealing or their oral negotiations showed that, in the parties’ language, ‘all’ meant ‘some’... When such a claim is false but found to be true, the court necessarily will misinterpret the contract.”).

  1. Scott, Text Versus Context , supra note 4, at 16 n.40 (“But sometimes the parties may actually have intended that their clear language should be read in the standard (plain meaning) way despite the fact that the language itself conflicts with the prior practices and negotiations of the parties. In such a case, a court that relies too heavily on context risks misinterpreting the parties’ actual intentions.”).

35. Cf. Scott, supra note 15, at 376.

  1. Gilson et al., supra note 3, at 40–41; Scott, Text Versus Context , supra note 4, at 17 (“By insulating the standard meaning of terms from deviant interpretations, this strategy preserves a valuable collective good, namely a set of terms with a clear, unambiguous meaning that is already understood by the vast majority of commercial parties.”).
  2. MITCHELL, supra note 17, at 113 (“One may use the ‘context’ to seek an unbargained for advantage in imposing terms after the parties are in a contractual relationship, even in circumstances where the written terms appear relatively complete.”); Scott, supra note 15, at 377 n.18 (“Here the risk is that, unless the court privileges the written agreement by excluding the contextual evidence, parties... will be motivated to dispute the meaning of perfectly communicative contract terms as a strategic response to a now disfavoured contract.”).
  3. Schwartz & Scott, supra note 16, at 587 (“[T]he more complex the contract, the easier it will be to create disputes regarding what the contract says and what language it was written in.”).
  4. Goetz & Scott, supra note 18, at 308 n.125.

476 Alabama Law Review [Vol. 69:2:

A central theoretical argument that underlies the contextualist approach

is that given the benefits of this approach, most parties probably prefer this

approach over the textualist approach.

40

The central benefits that possibly

underlie the parties’ preference for contextualism are the following:

1. The contextualist approach allows the adjudicator to expose the

actual subjective intention of the parties by considering all

relevant contextual evidence.

41

If the adjudicator excludes

contextual evidence during the contract interpretation process,

such as the parties’ prior negotiations or practices, she may

interpret the contract contrary to the parties’ actual intentions.

42

Contextualists argue, therefore, that the textualist approach,

which excludes contextual evidence, deprives the adjudicator of

essential information relevant to determining the true intention

of the parties.

43

2. From a philosophy-of-language perspective, the contract text

alone has no meaning.

44

The contract words are “mere

symbols... [and] [t]heir meaning is a joint product not only of

the word[s] selected, but also of the context” in which the

parties used the words.

45

Accordingly, the contractual context

allows the adjudicator to understand the parties’ contractual text.

  1. James W. Bowers, Murphy’s Law and the Elementary Theory of Contract Interpretation: A Response to Schwartz and Scott , 57 R UTGERS L. R EV. 587, 601 (2005) (“[F]irms might in fact prefer Corbin style contextualist contract interpretation rules... .”); Scott, Text Versus Context , supra note 4, at 3 (“This contextualist regime of contract interpretation rests on the powerful intuition that most parties... would prefer courts to take advantage of hindsight in assisting the parties to achieve their contractual objectives.”).
  2. Scott, supra note 15, at 375–76 (“[F]ollowing the lead of Arthur Corbin, courts interpreting the new contract law were advised to use context evidence... so as to ascertain the subjective meaning

of the parties agreement.”).

  1. Scott, Text Versus Context , supra note 4, at 16 (“Excluding evidence of these parties’ prior negotiations or practices under their contract risks interpreting the contracts in opposition to the parties’ actual intentions.”).
  2. Gilson et al., supra note 3, at 36 (“Contextualists argue, therefore, that formal interpretive rules that exclude certain categories of extrinsic evidence deprive the factfinder of indispensible information relevant to deciding the case and thus can distort the court’s assessment of what the parties meant by their agreement.”).
  3. R OBERT E. S COTT & J ODY S. KRAUS, C ONTRACT L AW AND T HEORY 544 (4th ed. 2007) (“Proponents of a more liberal approach to interpretation have argued that meaning is necessarily contextual.”); Gilson et al., supra note 15, at 172 n.1 (“Contextualist courts, on the other hand, reject the notion that words in a contract can have a plain or unambiguous—contextfree—meaning at all.”); Goetz & Scott, supra note 18, at 307 n.121 (“Without context, the argument goes, the search for meaning must necessarily fail, since a text has no objective or unitary meaning apart from the peculiar referents.”).
  4. Bowers, supra note 40, at 590; see also MITCHELL, supra note 17, at 94 (“[C]lear words are only clear because everyone understands the context in which they are operating.”); id. at 593 (“Having the phrase ‘Keep off the grass’ on a sign next to a newly germinating lawn means something

478 Alabama Law Review [Vol. 69:2:

run private commercial law systems.

51

In the first empirical research,

Bernstein presents “a case study of the private legal system created by the

National Grain and Feed Association (NGFA) to resolve contract disputes

among its members.”

52

The study shows that “NGFA arbitrators take a

formalistic approach to adjudication.”

53

They do not allow trade usage,

course of dealing, and course of performance “to vary either trade rules or

written contractual provisions.”

54

In another study, Bernstein presents “a

detailed case study of contractual relations in the cotton industry.”

55

According to the study, most such relations are subject to arbitration in one

of several cotton tribunals.

56

The study furthermore shows that cotton

arbitrators “use a relatively formalistic adjudicative approach that gives

little explicit weight to elements of the contracting context.”

57

The reliance of textualist scholars on Bernstein’s case studies suffers

from one central limitation. The grain, feed, and cotton industries,

empirically examined by Bernstein, may not be representative of other

dominant commercial industries, such as health, construction, energy, and

IT. Therefore, the results of Bernstein’s case studies do not allow

generalizations about the interpretation preferences of parties to

commercial contracts.

58

Textualist scholars further base their theoretical assumption that parties

to commercial contracts prefer a textualist approach on Professors

Theodore Eisenberg and Geoffrey Miller’s quantitative empirical study on,

inter alia , choice-of-law clauses.

59

This important empirical study

  1. For textualist scholars who rely on Prof. Bernstein’s empirical research, see, for example, Jody S. Kraus & Robert E. Scott, Contract Design and the Structure of Contractual Intent , 84 N.Y.U. L. R EV. 1023, 1102 (2009); Geoffrey P. Miller, Bargains Bicoastal: New Light on Contract Theory , 31 C ARDOZO L. R EV. 1475, 1477 (2010); Schwartz & Scott, supra note 17, at 956; Schwartz & Scott, supra note 16, at 576 n.66 (referring to Lisa Bernstein’s empirical scholarship, Professors Schwartz and Scott argue that “[t]here is considerable evidence that firms prefer a formalist adjudicatory style”); Scott, supra note 15, at 378 & n.21; Silverstein, supra note 2, at 278–79 (“Textualism is frequently defended on the ground that businesses prefer that method of construction. This view finds support in the work of Lisa Bernstein.”).
  2. Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms , 144 U. P A. L. R EV. 1765, 1769 (1996).
  3. Id. at 1769–70.
  4. Id.
  5. Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms and Institutions , 99 MICH. L. R EV. 1724, 1725 (2001).
  6. Id. at 1724 (“[M]ost such contracts are concluded under one of several privately drafted sets of contract default rules and are subject to arbitration in one of several merchant tribunals.”).
  7. Id. at 1735.
  8. Burton, supra note 1, at 347 n.64 (arguing that Bernstein’s “two case studies of arbitration practices in two commodities markets... cannot be easily generalized... .”).
  9. For textualist scholars who rely on Professors Theodore Eisenberg and Geoffrey Miller’s empirical scholarship see, for example, Lisa Bernstein, Custom in the Courts , 110 NW. U. L. R EV. 63, 109 (2015); Kraus & Scott, supra note 51, at 1102–03; Miller, supra note 51, at 1477–78; Schwartz & Scott, supra note 17, at 956–57; Bernstein, supra note 12, at 15–16.

2017] The Interpretation of Commercial Contracts 479

examines, among other things, choice-of-law clauses in a data set of

“contracts contained as exhibits in Form 8-K filings by reporting

corporations over [a] six month period in 2002 for twelve types of contracts

and a seven month period in 2002 for merger contracts.”

60

The results of

the study show that the parties examined in the study chose New York law

in approximately 46% of the contracts,

61

while California was chosen for

its law in less than 8% of the contracts.

62

Since New York’s contract-

interpretation law is inclined towards textualism,

63

while California’s

contract-interpretation law is inclined towards contextualism,

64

textualist

scholars believe that Eisenberg and Miller’s results indicate that parties to

commercial contracts prefer the textualist approach of contract

interpretation.

65

The reliance of textualist scholars on Eisenberg and Miller’s empirical

study suffers from one central limitation. There are many legal differences

between New York law and California law, besides the differences in the

rules of contract interpretation.

66

Just within the realm of contract law, the

differences between New York and California concern the application of

many important noninterpretation doctrines, such as promissory estoppel,

consideration, duress, unconscionability, public policy, and mistake.

67

Hence, the dominance of New York choice-of-law clauses over California

choice-of-law clauses—as witnessed in Eisenberg and Miller’s study—

does not necessarily result from the parties’ preference for New York’s

textualist interpretation rules.

68

Generally put, the scant existing empirical literature assessing parties’

preferences of contract interpretation rules focuses on indirect indicators,

  1. Theodore Eisenberg & Geoffrey P. Miller, The Flight to New York: An Empirical Study of Choice of Law and Choice of Forum Clauses in Publicly-Held Companies’ Contracts , 30 C ARDOZO L. R EV. 1475, 1475 (2009).
  2. Id. at 1489.
  3. Id. at 1490.
  4. Miller, supra note 51, at 1478; Schwartz & Scott, supra note 17, at 956; Bernstein, supra note 12, at 15.
  5. Miller, supra note 51, at 1478; Schwartz & Scott, supra note 17, at 956; Bernstein, supra note 12, at 15.
  6. Miller, supra note 51, at 1478; Schwartz & Scott, supra note 17, at 956; Bernstein, supra note 12, at 15–16.
  7. See , e.g. , Miller, supra note 51, at 1479–1522.
  8. Id. at 1482–84, 1485–1502, 1504–06.
  9. Bayern, supra note 15, at 1122 (“[T]here are many provisions of substantive New York law that public firms might favor; an inference that they are specifically choosing textualism is unfounded.”); Burton, supra note 1, at 347 n.64 (arguing that “firms’ frequent use of choice-of-law clauses to select New York law... could be made for any of a variety of reasons” other than a preference for textualist contract interpretation rules); Silverstein, supra note 2, at 280 n.417 (“But Miller’s article identified roughly seventeen doctrinal differences between New York and California, only one of which was contract interpretation. Thus, it is far from clear that differences in interpretive regimes played an important role in the choice of law and forum decision-making that Eisenberg and Miller studied.” (citation omitted)).

2017] The Interpretation of Commercial Contracts 481

A. Merger Clause—A Brief Overview

A merger clause, known also as an “integration” or “entire agreement”

clause,

74

merges all pre-contractual negotiations between the parties into

the written contract.

75

“A [typical] merger clause reads: ‘This writing

contains the entire agreement of the parties and there are no promises,

understandings, or agreements of any kind pertaining to this contract other

than stated herein.’”

76

The typical legal effect of a merger clause is “to exclude any

[contextual] claims based on precontractual negotiations or understandings

between the parties.”

77

More specifically, a merger clause usually triggers,

inter alia , three textualist interpretation rules: First, prior oral and written

statements between the parties cannot add to the contract text.

78

Second,

prior oral and written statements cannot modify the contract text.

79

Third, if

  1. 2 E. ALLAN F ARNSWORTH , F ARNSWORTH ON C ONTRACTS § 7.3 (3d ed. 2004).
  2. Id. ; LON L. F ULLER & MELVIN ARON EISENBERG , B ASIC C ONTRACT LAW 602 (8th ed. 2006) (“These provisions are known as ‘merger’ or ‘integration’ clauses because they say, in effect, that all agreements between the parties have been merged or integrated into the writing.”); 11 SAMUEL WILLISTON & R ICHARD A. LORD , WILLISTON ON C ONTRACTS § 33:23 (4th ed. 2012) (“Recitations to the effect that a written contract is integrated, that all conditions, promises, or representations are contained in the writing, and that the parties are not to be bound except by the writing are commonly known as merger or integration clauses.”); Miller, supra note 51, at 1507 n.254 (“Merger clauses provide that all prior agreements and understandings between the parties related to the transaction are merged into the final contract.”); Schwartz & Scott, supra note 17, at 932 n.16 (“A merger or integration clause recites that all prior party understandings are merged into the final written agreement.”).
  3. F ARNSWORTH , supra note 74, at § 7.6a; see also Helen Hadjiyannakis, The Parol Evidence Rule and Implied Terms: The Sounds of Silence , 54 F ORDHAM L. R EV. 35, 51 n.91 (1985) (“A merger or integration clause is a provision that states that the writing ‘contains the entire agreement of the parties.’” (quoting J OHN D. C ALAMARI & J OSEPH M. P ERILLO, THE LAW OF C ONTRACTS § 3-3 (2d ed. 1977))).
  4. Miller, supra note 51, at 1507 n.254; see also HOWARD O. HUNTER, MODERN LAW OF C ONTRACTS § 7:8 (2017 ed.), Westlaw (database updated March 2017) (“If a written agreement contains an express merger clause, then the presumption is that it is an integrated document and only under extraordinary circumstances... is parol evidence admissible.”); E RIC A. P OSNER, C ONTRACT LAW AND THEORY 147 (2011) (a merger clause “implicitly invokes the parol evidence rule, instructing the court that because the writing is complete, the court should resist the temptation to examine extrinsic evidence”). Notably, some “courts... hold that a merger clause creates a... conclusive presumption that the parties intend courts not to rely on extrinsic evidence.” Eric A. Posner, The Parol Evidence Rule, The Plain Meaning Rule, and the Principles of Contractual Interpretation , 146 U. P A. L. R EV. 533, 552 (1998) [hereinafter Posner, The Parol Evidence Rule ]. Other “[c]ourts... generally hold that a merger clause creates a rebuttable presumption that the parties intend courts not to rely on extrinsic evidence.” Id. ; see also WILLISTON & L ORD , supra note 75, at § 33:23.
  5. Farnsworth, supra note 73 (“According to the parol evidence rule, if a contract is completely integrated in a writing... prior oral... statements cannot be used to add to... the writing.... [T]he draftsman can make sure that the contract is completely integrated simply by saying so in what is commonly called in international transactions an ‘entire agreement’ clause and in American parlance a ‘merger’ or ‘integration’ clause.”); see also F ARNSWORTH , supra note 74, at § 7.3.
  6. F ARNSWORTH , supra note 74, at § 7.3; Farnsworth, supra note 73; see also Norman Bobrow & Co. v. Loft Realty Co., 577 N.Y.S.2d 36, 36 (App. Div. 1991) (“Parol evidence is not admissible to vary the terms of a written contract containing a merger clause.” (citation omitted)).

482 Alabama Law Review [Vol. 69:2:

the contract text is seemingly unambiguous, extrinsic evidence cannot be

considered for the purpose of giving meaning to the contract text.

80

Through a merger clause, therefore, the parties signal to the adjudicator

that they prefer a textualist approach of contract interpretation which

excludes any contextual claim based on precontractual negotiations or

understandings between the parties.

81

Parties that fear a contextual method

of interpretation, under which courts consider evidence of precontractual

negotiations, are likely to include a merger clause in their contract.

82

B. The Theoretical Hypotheses

This paper hypothesizes that most parties to commercial contracts

between sophisticated parties will include a merger clause in their contract.

This is for the following central reasons. To begin with, the probability of

judicial error in evaluating contextual, precontractual evidence is likely to

be high in commercial contracts. First, since commercial contracts are

normally complex and have a large number of oral and written statements

and understandings made during preliminary negotiations, erroneous

judicial enforcement of some of these statements and understandings is

likely.

83

Second, commercial contracts are normally sophisticated,

unconventional, and unknown for nonbusiness people, such as judges.

84

Consequently, courts are likely to err in evaluating the precontractual

contexts of transactions that they have not seen before.

85

In addition, the

  1. Farnsworth, supra note 74, at 276 (a merger clause “will make it clear that the contract is completely integrated so that a plain meaning rule applies so that extrinsic evidence will only be considered for the purpose of interpreting language if the language is ambiguous”); see also Tempo Shain Corp. v. Bertek, Inc., 120 F.3d 16, 21 (2d Cir. 1997) (“Ordinarily, a merger clause provision indicates that the subject agreement is completely integrated, and parol evidence is precluded from altering or interpreting the agreement.”); L.D.S., LLC v. S. Cross Food, Ltd., 954 N.E.2d 696, 705 (Ill. App. Ct. 2011) (“[I]n interpreting the contract [which contains a merger clause], the court examines the language of the contract alone, without considering extrinsic evidence of prior negotiations.”).
  2. George M. Cohen, Implied Terms and Interpretation in Contract Law , in 3 ENCYCLOPEDIA OF LAW AND ECONOMICS : THE R EGULATION OF C ONTRACTS 78, 96 (Boudewijn Bouckaert & Gerrit De Geest eds., 2000) (“The contracting parties may prefer textualism and express that preference through... merger clauses.”).
  3. Karen Eggleston, Eric A. Posner & Richard Zeckhauser, The Design and Interpretation of Contracts: Why Complexity Matters , 95 NW. U. L. R EV. 91, 131 n.113 (2000) (“Parties that fear liberal interpretation can... include a merger clause, which directs courts not to rely on evidence of precontractual negotiations when interpreting contracts... .”).
  4. Michael B. Metzger, The Parol Evidence Rule: Promissory Estoppel’s Next Conquest? , 36 VAND. L. R EV. 1383, 1387–88 (1983) (“Jurors also may lack the sophistication needed to deal effectively with complex commercial transactions involving numerous alleged oral and written contract terms.”); Posner, The Parol Evidence Rule , supra note 77, at 556.
  5. Cf. Posner, The Parol Evidence Rule , supra note 77, at 553.
  6. MITCHELL, supra note 17, at 115 (“The contextual approach arguably increases the chances for error by increasing the amount of information deemed relevant to the interpretation exercise. Judges may have to deal with a significant amount of contextual material, some of it connected to particular

484 Alabama Law Review [Vol. 69:2:

commercial contracts, as opposed to unsophisticated parties, can draw upon

their experience in order to easily move relevant contextual evidence into

the written contract in anticipation of the likelihood of judicial error.

95

In

addition, parties to commercial contracts are often repeat players and

therefore may be encouraged to bear the increased costs of moving

contextual evidence into the written contract.

96

By incurring these costs

only once, commercial companies are able to use their written contracts

repeatedly.

97

Because parties to commercial contracts are able to embed the

contractual context in a written contract, they “are more likely to resent

than to welcome a court’s efforts to supplement or circumvent their”

contract text by contextual evidence.

98

Hence, most sophisticated parties to

commercial contracts are expected to include a textualist merger clause in

their contract.

99

Thus, this paper proposes:

H1: A merger clause is more likely than not to appear in

commercial contracts between sophisticated parties

In addition, this paper hypothesizes that contracts that include

“textualist clauses” other than a merger clause are more likely to include a

merger clause than contracts without textualist clauses. Textualist clauses ,

as defined in this paper, are contractual clauses that aim to prevent courts

from considering contextual evidence that was not embedded formally in a

written text, such as post- and pre-contractual oral statements or notices.

Textualist clauses, as suggested in this paper, can be divided into two

major categories: direct and indirect. Direct textualist clauses explicitly

require courts to consider only written text, thereby ignoring nontextual

contextual evidence. Relatively common examples of direct textualist

clauses are: (1) a no-oral-modification clause, which states that the contract

may be modified or amended only in writing ;

100

and (2) a notices clause,

which states that all notices under the agreement shall be in writing.

101

Indirect textualist clauses aim to limit courts from considering the

infinite set of contextual evidence during the litigation process. These

clauses embed relevant context, aiming to specify precisely the contextual

“evidentiary base that will be made available to a court” during the

litigation.

102

Relatively common examples of indirect textualist clauses are:

  1. Posner, The Parol Evidence Rule , supra note 77, at 553–54.
  2. MITCHELL, supra note 17, at 110.
  3. Id.
  4. Gilson et al., supra note 3, at 26.
  5. Id.
  6. F ARNSWORTH , supra note 74, at § 7.6a; Farnsworth, supra note 73, at 274.
  7. See, e.g. , Philip Morris USA, Inc. v. Appalachian Fuels, LLC, No. 3:08–CV–527, 2009 WL 1011650, at *6 (E.D. Va. Apr. 15, 2009).
  8. Scott, supra note 3, at 23; see also Schwartz & Scott, supra note 17, at 961.

2017] The Interpretation of Commercial Contracts 485

(1) a “whereas clause,” also known as “recitals clause,” which includes “[a]

preliminary statement in a contract... explaining... the [contextual]

background of the transaction[s],”

103

the reasons upon which the contract

was formed,

104

or the existence of particular contextual facts that surround

the contract;

105

and (2) a “definitions clause,” which normally “ascribe[s

contextual] meanings to words and terms that may vary from their plain

meaning.”

106

Given their characteristics, textualist clauses, either direct or indirect,

reflect the preferences of parties to a transaction for a textualist approach of

interpretation, namely that the terms they write in text are enforced as

written in the text.

107

This paper assumes that if the parties indicate their

preference for textualism by utilizing textualist clauses, they are more

likely to utilize a merger clause in their contract. This is because a merger

clause, given its legal textualist implications,

108

supports the parties’

existing textualist preferences, as reflected in the textualist clauses. Thus,

this paper proposes:

H2: Contracts that include a no-oral-modification clause are more

likely to include a merger clause than contracts without a no-oral-

modification clause

H3: Contracts that include a notices clause are more likely to

include a merger clause than contracts without a notices clause

H4: Contracts that include a whereas clause are more likely to

include a merger clause than contracts without a whereas clause

H5: Contracts that include a definitions clause are more likely to

include a merger clause than contracts without a definitions clause

C. Data

The sample of this empirical study is based on commercial contracts

contained as exhibits to Form 8-K filings with the SEC.

109

Form 8-K

  1. Recital , B LACK ’S LAW D ICTIONARY (10th ed. 2014); see also Edwards v. Doe, 331 F. App’x 563, 572 n.15 (10th Cir. 2009).
  2. Blackstone Consulting, Inc. v. United States, 65 Fed. Cl. 463, 470 (2005); see Recital , B LACK ’S LAW DICTIONARY (10th ed. 2014).
  3. Edwards , 331 F. App’x at 572 n.15; see also Recital , B LACK ’S LAW DICTIONARY (10th ed. 2014).
  4. Gilson et al., supra note 3, at 59; see also Gilson et al., supra note 15, at 184; Scott, supra note 3, at 23–24.
  5. Cf. Bernstein, supra note 12, at 13–14.
  6. See supra notes 78–80 and accompanying text.
  7. For the same methodological approach of analyzing contracts contained as exhibits to Form 8-K filings with the SEC, see Theodore Eisenberg, Geoffrey P. Miller & Emily Sherwin, Arbitration’s Summer Soldiers: An Empirical Study of Arbitration Clauses in Consumer and Nonconsumer Contracts , 41 U. MICH. J.L. R EFORM 871, 880 (2008); Theodore Eisenberg & Geoffrey P. Miller,

2017] The Interpretation of Commercial Contracts 487

major types of contracts, as reflected in the contracts’ titles, are shown in

table 1.

Table 1. Contract type

Type Number Percentage Type Number Percentage

Distribution 183 12.

Terminal

Services

Consulting or

Advisory

Transportation

Services

Agency 123 8.

Exporter

Services

Management

Services

117 7.69 Supply 26 1.

Cooperation 105 6.90 Purchase 23 1.

Marketing 73 4.

Administrative

Services

Independent

Contractor

69 4.54 Storage 16 1.

Licensing 63 4.14 Research 13 0.

Financing 51 3.

Pipeline

Services

Manufacturing 43 2.83 Advertising 7 0.

Development 46 3.02 Assignment 5 0.

Civil Marriage , 27 C ARDOZO L. R EV. 1161, 1198 (2006) (“Consumer contracts differ from commercial contracts between businesses.”); see also Silverstein, supra note 2, at 261.

488 Alabama Law Review [Vol. 69:2:

The industries of the companies, which filed to the SEC the contracts

of this study, are also very heterogeneous, including, for example: banking,

education, electricity, agriculture, pharmaceutical, management and

consulting, natural gas, hotels and motels, patents, personal services,

telephone communication, television broadcasting services, motor vehicle

parts and accessories, computer programming, retail, wholesale, tobacco,

business services, and industrial organic chemicals.

117

D. Methodology

In order to locate contracts with a merger clause, I took the following

central steps: First, I conducted an in-depth review of the full text of 100

random commercial contracts in the sample. The purpose of this review

was to identify the terms commonly associated with a merger clause.

Second, based on my in-depth review, I conducted a computerized search,

via Westlaw’s terms-and-connectors search engine, for contracts that

include the terms commonly associated with a merger clause.

118

This search

included the following terms: “entire agreement!”; “entire contract!”;

“entire understanding!”; or (supersede! /s prior /s agreement!). The “!”

symbol was used to search for words with multiple endings, and the “/s”

symbol was used to search terms in the same sentence.

119

Contracts with a

merger clause were coded “1.” Finally, in order to verify that the search

results for terms commonly associated with a merger clause were not

overinclusive, I performed a human-coded audit of 100 random contracts

which were coded “1.” The audit was successful.

120

In order to locate contracts with textualist clauses, I took the following

two steps for each textualist clause: First, I conducted an in-depth review of

the full text of 100 random commercial contracts in the sample in order to

identify the terms commonly associated with the textualist clause. Second,

based on this review, I conducted a computerized search via Westlaw’s

terms-and-connectors search engine for contracts that include the terms

commonly associated with the textualist clause. For example, to determine

whether a contract included a no-oral-modification clause, which states that

the contract may be modified or amended only in writing, I searched via

Westlaw’s terms-and-connectors search engine for terms such as “amend! /

  1. The companies industries were located via the EDGAR company search engine. See EDGAR: Company Filings , U.S. S EC. & EXCH. C OMM ’N , https://www.sec.gov/edgar/searchedgar/ companysearch.html (last visited Sept. 6, 2017).
  2. For a similar methodological approach applied on a “specific performance” clause, see Eisenberg & Miller, Damages Versus Specific Performance , supra note 109, at 44.
  3. Terms and Connectors Searches , supra note 114.
  4. Out of 100 results, no result was overinclusive.