Midstream Contract Interpretation

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Alan Schwartz* & Simone M. Sepe**

This Article makes two original contributions to the contract interpretation and renegotiation literatures.  First, we introduce an underexplored cause of renegotiation failure: party uncertainty regarding the type of court that will interpret their contract.  Parties may predict differently how the applicable court will weigh facts, apply legal rules, or interpret contracts.  When parties disagree regarding the court’s interpretive practices, they will assess their expected litigation payoffs differently.  This could cause parties to litigate transactions rather than complete them, even when the parties agree on the economic parameters.  Litigators know that differing predictions about what a court will do can impede settlement.  We add that party uncertainty over court types can prevent parties from making efficient deals and continuing those deals to completion.  Neither scholars nor courts have analyzed how the consequences of uncertainty over court types affects the parties’ behavior.

 Our second contribution is to suggest a novel interpretive procedure that responds to uncertainty about both party and court types.  Parties should be able to obtain a “midstream contract interpretation”: a judicial interpretation of their contract at the renegotiation stage rather than after a breach occurs.  A midstream interpretation, in the form of a declaratory judgment or a new reformation remedy, would permit parties to learn about the applicable court and each other.  As a result, parties would be more likely to continue an arrangement they would otherwise inefficiently terminate, or efficiently terminate a relationship without bearing unnecessary performance or litigation costs.

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© 2023 Alan Schwartz & Simone M. Sepe.  Individuals and nonprofit institutions may reproduce and distribute copies of this Article in any format at or below cost, for educational purposes, so long as each copy identifies the authors, provides a citation to the Notre Dame Law Review, and includes this provision in the copyright notice.

* Sterling Professor of Law and Professor of Management, Yale Law School.

** Chester H. Smith Professor of Law and Finance, University of Arizona James E. Rogers College of Law; The University of Arizona Center for the Philosophy of Freedom; ECGI.  We are grateful for suggestions we received at the 2022 SIOE Conference, the American Law and Economics Association 2022 Meeting, a Chicago Law School contracts workshop, and a law and economics workshop held at Droit & Croissance in Paris.  Henry Bauer, Lisa Bernstein, Sam Bray, Tom Christiano, Daniel Markovits, Joshua Macey, Saura Masconale, Kish Parella, Brad Peterson, Robert E. Scott, Andrew Verstein, and Joel Watson also made helpful comments.