The Limits of Contract

II. Three Types of Contract

To view the problem of obligation as resulting from the institution of contract, (i.e. the exchange of mutual promises) is to treat consent as foundational for the assignment of responsibility. To that extent, it seems to matter little whether the promises concern tangible resources, more abstract property rights, such as `good will', or even the commitments or forbearances which we call political obligations. At the heart of the matter, there always lies the notion that nothing more than the voluntary choices of the parties is involved in creating order among them.

But there are peculiar difficulties that arise and that are often not properly reflected upon when we examine the institution of contract in general and when we move from `spot' exchanges facilitated by the `meeting of the minds' to the problem of `implicit' indefinite, multi-person incomplete contracts. Examples of the latter are the `social contracts' of Hobbes, Locke and Rousseau.

It might be useful to examine systematically these complications as they emerge in the contractarian enterprise in both the domestic and the international arena. Let us therefore begin with the simplest type of contract, the one in which two actors agree on an on the spot exchange. Obviously such an analysis has to assume that the parties have something to exchange antecedent to their agreement, i.e. property rights must have been assigned. Similarly, the parties must know the rules which constitute the practice of contracting, such as e.g. the use of certain formulas like do ut des or signing certain forms. In addition, in order to insure the `voluntariness' of the exchange, rules must prevent the use of fraud, force and, depending on the case, impose a duty of disclosure of essential but not readily available information.<sup>6</sup> Finally, in case of non-performance, exogenous `enforcement' must be provided by the state. With the exception of the last point, ample analogies exist between domestic and international law. Not only do we have explicit rules for the acquisition and alienation of titles, but as Coplin⁷ reminds us, the rules of international law also authoritatively define who is an actor, and they determine the formalities which must be observed if the parties wish to attach validity to their acts (Vienna Convention on Treaties).

Beyond the obvious analogies, the above account of the spot contract provides several lessons. One is that even simple spot contracts are the result of the interaction of highly complex institutional arrangements. Their unproblematic character depends less on the simplicity and `naturalness' of such arrangements - Adam Smith's allegation of the natural tendency of men to `truck and barter notwithstanding' - than on the discipline of the actors which makes such exchanges routine. This highlights the second lesson of the example, i.e. the recognition that the `obligation' resulting from a contractual undertaking cannot simply be reduced to the `consent' of the parties. They may have committed a mistake of form, might not have foreseen some contingencies which make the contract either wholly or partially voidable, or have provided for grossly disparate benefits for the parties, so that their contract lacked (in common law terms) `consideration'.

Since I have dealt with these issues at great length elsewhere such cursory remarks might suffice here.⁸ However, what is important here is the realization that the institution of contract combines two related yet distinguishable ideals that suggest different bases for the obligatoriness of contractual obligations. As Michael Sandel points out:

One is the ideal of autonomy, which sees a contract as an act of will, whose morality consists in the voluntary character of the transaction. The other is the ideal of reciprocity which sees the contract as an instrument of mutual benefit ... contracts bind not because they are willingly incurred, but because (or in so far as) they tend to produce results that are fair.⁹

The last point becomes of particular importance when courts have to deal with unforeseen circumstances and when, therefore, there is no ascertainable `will' of the parties, or when losses or risks have to be allocated.

The third lesson is therefore, that `enforcement' problems cover a much wider field than the popular image of the public authority clubbing recalcitrant actors into submission. As a matter of fact, while exogenous claim enforcement figures prominently in our common sense view, as well as in the economics and law literature, `self-help measures' i.e. endogenous claim enforcement, are pervasive in private contracts. This is quite contrary to the conventional wisdom among international relations scholars, neoclassical economists and `pure theorists' of law who all, in one way or another, identify `self-help' with anarchy and consider the existence of either exogenous enforcement or of self-help as the main distinguishing characteristic of the domestic and the international arenas respectively. But not only is this dichotomy heuristically not very useful, as it makes the existence of order virtually a function of a particular kind of enforcement, it is also essentially misleading. If self-help is a rather pervasive phenomenon in both arenas, i.e. not limited to the exceptional circumstances of `self-defence', then self-help can neither be used as a defining property of international anarchy, nor can central enforcement institutions be exclusively credited for the existence of order or for the beneficial functioning of `markets'.

Consider in this context a second type of spot contract, i.e. one which entails sequential performance. This is Hobbes' classical description of Prisoners' Dilemma situations. Aware of the dangers of being played for a sucker, the parties might not want to rely on costly ex post litigation but devise measures which alleviate the dangers of being exploited: they can agree on payment schedules, escrow arrangements, or resort to limited acts of retaliation such as notifying the Better Business Bureau, or ruining the delinquent party's credit.

It is probably no exaggeration to consider the credit reporting system as the most important disciplining force in our society in which credit cards and, in general, access to credit (given the low savings rate) have become a virtual necessity. The horror stories which appear periodically in the papers dealing with the consequences of erroneous credit reports make it clear that it is the effects of these private means of enforcement rather than the club of the state that keeps most of us in line. In cases in which neither the loss of reputation nor actual denial of access to future credit serves as a sufficient motivating force to honour one's obligation, resort to more stringent means of private enforcement is sometimes a viable option. Repossession by private agents acting as enforcers of the authoritative decisions of public authorities show an interesting symbiotic relationship of public and private elements in some areas of domestic `self-help'.

Internationally, we possess similar remedies such as e.g. publicity - a measure in which Jeremy Bentham put considerable trust, despite its dubious efficacy in all but a few extreme cases of shunning and branding states as `pariahs' - unilateral countermeasures, such as the suspension of treaties, freezing of assets, the enforcement of arbitral awards through domestic institutions, and various other unfriendly acts falling into the categories of retorsion or reprisals.¹⁰ Similar to domestic contract law, however, self-help measures have been limited since the inception of the Charter regime and the ICJ Corfu Channel¹¹ decision, to measures not involving the use of force. Self-defence and action authorized by the Security Council are the obvious exceptions.¹² The only other exception is perhaps intervention in case of the rescue of one's own nationals in instances of a credible threat to their safety and the inability of the foreign government to provide for minimum conditions of civil order.¹³

Whether such strict limitation of the role of force in international politics, as outlined above - prohibiting it even in defence of violation of rights - is a sensible solution is, of course another matter. In the absence of a well institutionalized political process presiding over peaceful change, of even the presumption of compulsory judicial settlement, and in the face of the weakness of exogenous claim enforcement, the temptation to resort to forceful reprisals might indeed become overwhelming. Such a course of action might even appear to be morally justifiable, especially after a fruitless exhaustion of other remedies.

Further complications arise when we examine `long-term' iterated transactions. If, as is likely, not all contingencies can be exhaustively listed and dealt with, the contract will have to include catch-all concepts and quite non-specific, higher order `principles'. Again the problem of endogenous enforcement arises, precisely because both the attempts to stipulate contingencies and their enforcement through the courts become costly, as Llewellyn has pointed out in his famous `What price Contract?' article.<sup>14</sup> Instead of a direct quid pro quo the parties face two interrelated problems: the commitment to keep the contractual relationship going which, in turn, frames the distributive bargaining problem at each iteration. It is clear that the parties will be able to maintain such a relationship only if they agree to dispute settlement `in a businesslike' or `amicable fashion'. But beyond such an agreement in principle they must share fairly concrete common understandings as to what these principles mean in certain `typical situations'. Here precedent, customary ways, salience, etc. are all important in particularizing the higher order principles.

If situations cannot be typified, if they are not recurrent enough to develop settled ways of dealing with them, the contract becomes more and more a framework for continuous negotiation rather than a historic document which freezes the `meeting of the wills' of the parties at a given time. An example for this latter type of `long-term contract' in the international arena was SALT II. First, `enforcement' had to be entirely endogenous (national means of verification!) and compliance was based virtually entirely on `discovery' rather than on measures we traditionally associate with `enforcement'. Second, since facts seldom speak for themselves but need interpretation particularly if `intent' is at issue (was it a `mistake' or a `deception'?), some method of arriving at a shared understanding becomes necessary. Third, since most of these situations could not readily be typified because they concerned technological innovations or unprecedented events (such as the building of the Krasnoyarsk radar stations), (re)negotiation of the terms of the contract became a characteristic of this particular arms control regime.¹⁵ Commentators have not only correctly pointed to the essential part played by the Standing Group in Geneva¹⁶ dealing with complaints about alleged violations, but have also suggested that a distinction existed between SALT as a treaty and SALT as a process. The last point was vividly brought home by the fact that SALT continued to provide the operative framework even after the `treaty' had expired.

Another interesting case in point is GATT which serves as the basis for the continued post-war multilateral trading order. Its viability and actual resiliency over the years is hardly conceivable without both the various negotiating `rounds' creating new specific norms on the basis of the general principles of the initial `incomplete contract', and the crucial role of its dispute settling mechanisms.¹⁷ While these chambers have certainly not `enforced' anything, they have created a large body of `standard solutions' for dealing with trade disputes.¹⁸ Indeed, one can argue that over the years a certain `evolution' has taken place in which the chambers have moved increasingly from consensual (mediational) procedures to the more principled application of `norms' and standard solutions to a controversy.

Given the difficulties that arise for endogenous enforcement of incomplete contracts, in particular when the participants face a highly volatile environment, the development of customary practices is difficult; or when asymmetries of information create incentives for actors to act with guile, a radically new `contractual' solution can be tried. Consider in this context the `complex incomplete contract'. Instead of iterated rounds of bargains providing for re-negotiation and dispute settlement, this type of contract is based on an exchange of promises of the parties which explicitly changes the quality of their relationship.

A good example of this type of contract is the wage contract. On the surface it is an exchange (labour for money), but it is also an incomplete contract that involves a `long-term' relationship with all the attendant difficulties of endogenous enforcement. After all, hiring people and paying them a salary or wage instead of relying on contracts for procuring the needed goods and services creates a `firm'. This means that the employer not only acquires the labour power of the employee, but obtains the right of directing it. Labour has not only its price like any other commodity - a point crucial for Marxists - but, more importantly, for our purposes, the wage contract amounts to an exchange of money for the employer's authority. The parties cease to enjoy equal status precisely because the contract entails explicit inequality in decision-making power. Employees have to defer to the authoritative directives of their `boss'; they can no longer object to specific commands, or bargain over them because in the incomplete contract which exchanged `work' for a wage, broad areas of discretion were left to the employer to determine what `work' entails.

This authority though is not unlimited; it is circumscribed in a variety of ways. First, there is the limitation of `time' stipulated by the `working' hours. Second, there are substantive limits of discretion, such as those that the govern the ability of an employer to ask his secretary to type a letter or even perhaps to make coffee, but they prohibit a solicitation of personal favours even if these demands fall within the time period covered by the employment contract. Third, limits are created to regulate hazardous activities, and there are health codes, injunctions against child labour, etc. Finally, there are normative definitions of what constitutes the scope of `managerial' (owner) directive power, and less formally articulated, but nevertheless important understandings of `how things are done'. The latter rest on both experiential and/or technical knowledge and on customary conceptions of what can be expected from a worker. Thus, bosses have only limited opportunities to `pull rank' before their commands engender resistance, and if their directives do not make sense in terms of customary trade practices they will not be followed even if they are innovative or efficient. Indeed, the work force has to be `brought around' by persuasion and inducements.

In other words, since a principal/agent problem exists in the complex incomplete contract, the de facto terms of the `exchange' result largely from the sanctions, surveillance and a variety of other self-help measures which cannot be transferred to exogenous enforcement. While the employer can exchange money for work he cannot `make' the employee work, or `sue' or fire him for not giving his best. Rather, employers have to rely on surveillance (quotas), incentives (bonuses), threats (probationary period, contract renewal) and/or stipulation of work rules (particularly important in organizations operating in non-market environments, i.e. bureaucracies).

Against these measures, passive resistance, `yesing' the boss to death, reporting to `upstairs' what they want to hear, and - particularly in the case of bureaucracies - `working by the book'(slow-downs) are quite effective means to counter such enforcement measures. Thus, while the reliance of hierarchy on command rather than exchange certainly creates `efficiencies' in some respects, it also often generates a perverse incentive system explained by the research on organizational pathologies.¹⁹ These range from misreporting and non-compliance with directives to the extreme case of outright sabotage. Firms and bureaucracies have therefore found it necessary to inculcate feelings of `loyalty' into the employees, and rely on appeals to a `corporate culture'.²⁰

Finally, particular difficulties arise in assessing the efficiency of non-market organizations. They share with firms not only the endogenous enforcement problem of the incomplete wage contract, but have to face, in addition, problems resulting from the absence of a market `discipline'. Since the output of the organization is not directly related to the satisfaction of the consumers (who create through their `purchases' the resources (inputs) for the firm), the funding of the bureaucratic organization depends to a large extent on its ability to mobilize resources from groups which are not their clients. Heads of agencies know that ties to congressional leaders are more important than customer satisfaction. In public interest or `third sector' organizations, resource mobilization depends upon the ability of the leadership to tap into latent sympathies in the environment of the organization. They have to persuade people or groups to contribute to various `causes' with virtually no control of the donors over the organization's `product', i.e. its performance. While the `agency' problem, i.e. endogenous enforcement of the wage contract, is lessened if most employees are highly motivated individuals dedicated to the `cause', managing according to a `chain of command' template is virtually impossible in these organizations. In case of conflict over priorities and programs which operationalize and implement the organizational `goals', disagreements become immediately `political'. Various leaders and factions will try to rally support, start intrigues, personalize the `fight', etc.; in short, they will attempt to outflank hierarchical decision control. If there is a solution, it will usually involve `exit' of one of the factions, a `sacrifice' of one of its leaders, or the establishment of a new consensus by often laborious negotiations.

These considerations have particular importance for the functioning of international organizations. First, a `contract' among states establishes, in the `charter', the organization's `domain', within which the organization is supposed to exercise its `powers'. Second, this delineation is not only dependent upon the consensus among the sponsors but on the availability of technical knowledge which defines `functionally' the specific tasks. For example, Peter Cowhey has shown that the operation of the traditional telecommunications regime `implemented' by the International Telecommunications Union (ITU) was crucially dependent upon the accepted view of natural monopolies (which served as the underpinning in the creation of national Postal- and Telecommunications authorities), and the resulting `technical problems' of linking national telecommunications networks through compatible switches. The establishment of the ITU in l932 resulted in an organization in which engineers debated the technical rules and standards for the functioning of the existing networks and their linkage. At most they speculated about the adequacy of the allocation system for radio frequencies and orbital satellite slots. Although, technically speaking, the resulting `standards' were recommendations only and not `directives', the three expert bodies charged with these duties could largely proceed with technical and bureaucratic modes of decision-making, until well into the l970's.

Change came from two sources: one from the increasingly eroding consensus that telecommunications indeed represented natural monopolies, a doubt powerfully reinforced by the emerging notion that `services' should be treated like `goods'; and two, from the new technologies of satellite and digital transmission that made it possible to bypass the switches linking national networks.²¹ Both elements ushered in the end of the old telecommunications regime and upset the merely `technical' mission of the ITU. It became a forum for debates rather than a functional organization in which authoritative decision-making is legitimized by `knowledge' of the relevant technology.

The last point brings to the fore the importance of consensual knowledge and the role of epistemic communities in institutionalizing such a consensus in organizational structures and routines. These factors have been investigated by Ernst and Peter Haas.²² It also shows that in an arena in which a domain consensus is either non-existent, or is fragmented by constitutional provisions, formal organizations will have to internalize the formation of such a consensus by providing for an appropriate forum. Ann-Marie Burley has shown that the organizational design of some of the functional organizations of the UN not only differs from the old international union model, but that its templates were the regulatory agencies of the New Deal.²³ These agencies had been designed to overcome the constitutionally mandated fragmentation of an issue area by combining legislative and executive functions in the new domain of the regulatory agency. The curious design of traditional IGOs which combines an assembly (for debate and consensus) with a council (giving shape to the `mission' of the organization) and the `staff' (secretariat) charged with the support of the council and the administration (implementation) of some policies, is an attempt to satisfy these conflicting demands. But since bolting together different organizational designs is not the same as finding a truly integrative solution for decision-making, we should not be surprised that these different organizational forms often work at cross purposes.

Most obvious are the problems in the case of the multipurpose universal membership organizations such as the League and the United Nations.²⁴ There is first the General Assembly as an organ to debate and provide for the collective legitimization of issues.²⁵ The Security Council represents, in a way, the directors setting policy to be implemented by personnel assigned to the organization, either through earmarking troops and subjecting them to the machinery of chapter VII, or to the more administrative personnel hired by the Secretary-General. It is not surprising that the former has never been tried and that the increase of direct managerial control by e.g. the Secretary-General of UNESCO has been cited as an instance of the `politicization' of the organization.²⁶

However, most of the time, politicization charges indicate a disagreement about the priorities of the United Nations. This is amply demonstrated by the challenge for developing nations to make the organization serve their goal of development by redesigning the international economic order²⁷ rather than addressing only, or primarily, `peace and security' issues. In the case of more specialized agencies, `politicization' concerned largely the issue of a vanishing domain consensus. For example, the quest for a New Information Order raised the fundamental issue whether information should be treated as a good supplied by private individuals and market mechanisms or as one which is subject to state regulation.²⁸ Similarly, addressing issues outside the original organizational domain was held to exceed the bounds of legitimacy. Under such circumstances, sponsors of the organization have the option to resort to voice (including the withholding of funds) or to loyalty (holding exit at bay and activating voice) as means for establishing domain consensus, but both of these options are strengthened by the threat of a credible `exit'.²⁹

Another set of problems concerns the issue of coordination. Proposals for organizational reform have a long history in the UN system with the Bertrand report serving as only one of the most recent examples. However, given the complex parameters of this organization, opportunities for actual reorganization are here, even more so than in domestic politics, severely limited.³⁰ Furthermore, by arguing for `reform' of the organizational structures implementing the regime, one makes a subtle but important shift by implying the permanence of the regime which, so to speak, provides the `constitutional frame' for the organizations within it. This raises the question: can constitutional frames still be understood through the contractual metaphor, or does the rapid increase of theoretical inconsistencies critically undermine the consent argument as the basic template to understand social order? It is the task of the next section to address these issues.

6 For a discussion of these problems see, for example, the works of P. Atiyah, The Rise and Fall of Freedom of Contract (1979); G. Gilmore, The Death of Contract (1974); C. Fried, Contract as Promise (1981); M. Horowitz, The Transformation of American Law (1977) especially Chapter 6.

7 Coplin, `International Law and Assumption about the State System', 17 World Politics (1965).

8 See my Rules, Norms, and Decisions (1989) Chapter 4.

9 M. Sandel, Liberalism and the Limits of Justice (1982) 106 and 107.

10 For a good discussion of unilateral countermeasures in international law see E. Zoller, Peacetime Unilateral Remedies (1984).

11 United Kingdom v. Albania (1949) ICJ 4. (a.k.a. Corfu Channel Case). See also Nicaragua v. U.S. (1985) ICJ 169.

12 For a general discussion see O. Schachter, International Law in Theory and Practice (1985) especially Chapter 7: `The Prohibition of Force'. Additionally, see A. Verdross and B. Simma, Universelles Völkerrecht: Theorie und Praxis (3rd ed., 1984) especially Chapter 12: `Die Erlaubte Selbsthilfe'. See also Waldock, `The Regulation of the Use of Force by Individual States', 81 RdC (1952-II) 451-517.

13 For a discussion of rescue mission vs. a broader right of `humanitarian intervention' see the discussion of Schachter, `Self-help in International Law: US Action in the Iranian Hostages Crisis', 37 Journal of International Affairs (1984) 231-46; Donnelly, `Human Rights, Humanitarian Intervention and American Foreign Policy: Law, Morality and Politics', 37 Journal of International Affairs (1984) 311-28; and my `Sovereignty as Dominium: Is there a Right to Humanitarian Intervention', in G. Lyons (ed.), After Westphalia (1994 forthcoming).

14 Llewellyn, `What Price Contract: An Essay in Perspective', 40 Yale Law Journal (1931) 704-751.

15 For a further exploration of the relation between contracting and regimes see my `Contract and Regimes: Do Issue-specifity and Variations of Formality Mattter?', in V. Rittberger (ed.), Regime Theory and International Relations (1993) Chapter 4.

16 On the Standing Consultative Commission, see S. Talbott, Deadly Gambits (1985) 228-232, 319-321. See also S. Talbott, Endgame: The Inside Story of Salt II (1979).

17 For a good discussion of the results of the Tokyo Round of Gatt and its various conventions see J. Grieco, Cooperation Among Nations: Europe, America, and Non-tariff Barriers to Trade (1990).

18 See J.H. Jackson, Restructuring the GATT System (1990) Part II.

19 The locus classicus for this argument is O. Williamson, Markets and Hierarchies (1975).

20 For an excellent discussion of this point see Kreps, `Corporate Culture and Economic Theory', in J. Alt, K. Shepsle (eds), Rational Perspectives on Positive Political Economy (1990) 90-143.

21 See Cowhey, `The International Communications Regime: The Political Roots of Regimes for High Technology', 44 International Organization (1990) 169-99.

22 See, e.g., E. Haas, `Is there a Hole in the Whole?', 29 International Organization (1975) 827-876; and E. Haas, `Why Collaborate?: Issue Linkage and International Regimes', 32 World Politics (1980) 357-405; and P.M. Haas, `Do Regimes Matter? Epistemic Communities and Mediterranean Pollution Control', 43 International Organization (1989) 377-404.

23 Burley, `Regulating the World: Multilateralism, International Law and the Projection of the New Deal Regulatory State', in J.G. Ruggie (ed.), Multilateralism Matters: The Theory and Praxis of an Institutional Form (1993) Chapter 4.

24 The history of the underlying ideas for the universal organization is well-elaborated in Kennedy, `The Move to Institutions', 8 Cardozo Law Review (1987) 841-988.

25 On the importance of collective legitimization by the UN see Claude, `Collective Legitimization as a Function of the UN', 20 International Organization (1966) 267-279.

26 See M. Imber, The USA, ILO, UNESCO and IAEA: Politicization and Withdrawal in the Specialized Agencies (1989).

27 See Bhagwati, `Rethinking Global Negotiations', and Ruggie, `Another Round - Another Requiem? Prospects for the Global Negotiations', both in J. Bhagwati and J.G. Ruggie (eds), Power, Passion and Purpose: Prospects for North-South Negotiations (1984).

28 For a comprehensive discussion of these problems see Drake, Nikolaides, `Ideas, Interests and Institutionalization: Trade in Services and the Uruguay Round', 44 International Organization (1992) 37-100.

29 For the fundamental discussion of these strategies see A. Hirschman, Exit, Voice and Loyalty (1970).

30 For a survey of the issues dealing with the political rhetoric and reality of reforming the United Nations, see Taylor, `The United Nations System Under Stress: Financial Pressures and their Consequences', 17 Review of International Studies (1991) 365-382.

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