Plate iii in print

The Gap

Ayres and Gertner; the incomplete contract, and the default rules by which the law fills the silence the parties left.

Because no agreement can speak to every turn the world may take, the law must supply the terms the parties left unsaid — and the deepest question of contract is which terms it should supply, and when.

— the argument of this plate, after Ian Ayres and Robert Gertner, 1989

If the sword can enforce only what the contract says, and the contract can never say everything, then every contract arrives at the court — and at life — full of holes. The builder's contract did not say who bears the loss if the river floods the site; the supply agreement did not say what happens if the factory burns. When such an unforeseen case arrives and the parties fall to disputing, someone must decide what the silent contract requires. The first and most formal answer to this — the law's answer — is the subject of this plate: the default rule, the term the law supplies when the parties have supplied none.

Begin by seeing that the gaps are not a defect of careless drafting but a necessity of the human condition. To write a complete contract — one specifying each party's duty in every possible state of the world — the parties would have to foresee every contingency, however remote, agree on what to do in each, and write it all down; and this is impossible, for the contingencies are endless, most are unforeseeable, and even the foreseeable ones would cost more to enumerate than the contract is worth. So every real contract is radically incomplete: a few terms for the likely cases, and silence on the vast remainder. The parties know this when they sign; they deliberately leave most of the future unaddressed, trusting that the unaddressed cases will either not arise or be sorted out when they do. The gap is built into the contract from the start — and the law, faced with a dispute over an unaddressed case, cannot throw up its hands, but must decide what the silent contract means.1

1. Contracts are necessarily incomplete: a complete contract — specifying every duty in every state of the world — would require foreseeing all contingencies (most unforeseeable) and enumerating them (prohibitively costly). So every contract is mostly silence, deliberately leaving the future unaddressed. The incomplete-contracts insight (Hart; met in The Owner from the side of ownership) here concerns the contract itself. The law must still resolve disputes over unaddressed cases.

The law's instrument for the gaps is the default rule: a term the law reads into the contract unless the parties have agreed otherwise. When a contract is silent on who bears a risk, the law of contracts does not leave the question open; it supplies an answer — a default, drawn from statute, precedent, or the general duty of good faith — that governs unless the parties expressly contracted around it. Default rules are the law's vast store of off-the-shelf terms, filling the silence of every contract with a presumed agreement the parties never actually reached. And they are defaults, not commands: the parties remain free to displace them by saying so, writing their own term where they wish and falling back on the law's only where they were silent. So a contract is really two layers — the express terms the parties wrote, and beneath them the default terms the law supplies for everything they did not — and most of what governs a contract, in the cases that actually go wrong, is the second layer, the law's defaults, not the first.2

2. A default rule is a term the law reads into a contract unless the parties contract around it — supplied by statute, precedent, or the duty of good faith. Defaults fill the silence of every contract with presumed terms, governing unaddressed cases. They are defaults, not mandates: parties may displace them by express agreement. A contract is thus two layers — express terms plus the law's defaults beneath — and the defaults govern most cases that go wrong.
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The deep question Ayres and Gertner pressed is which default the law should supply — for the choice is far from obvious, and shapes every contract silently. The natural first answer is the majoritarian default: supply the term that most parties, in this kind of contract, would have wanted had they addressed the matter — the term they would have written, so that the law, by reading it in, saves them the trouble and matches what they would have agreed anyway. On this view, default rules are a public convenience, sparing parties the cost of specifying what is usually wanted; the law guesses the common intent and supplies it, and most parties, getting what they would have asked for, never need to contract around it. This is efficient as far as it goes: it minimizes the cost of contracting by writing, for free, the terms most parties want. But Ayres and Gertner saw that the majoritarian default is not always the right one — that sometimes the law should deliberately supply a term most parties do not want, for a subtler reason.3

3. The majoritarian default supplies the term most parties to such a contract would have wanted — sparing them the cost of specifying the usual, matching likely intent (so few contract around it), and minimizing contracting costs. Ayres and Gertner (1989) argued this is not always optimal — that the law should sometimes set a default most parties do not want, for strategic reasons (the penalty default).

That subtler reason is the penalty default — a default deliberately set against what a party wants, so as to force that party to speak. Suppose one side to a contract knows something the other does not: knows, say, that its needs are unusual, or its risks higher than they appear. A majoritarian default, supplying the usual term, would let the knowing party stay silent and enjoy a term priced for the usual case, hiding its unusual situation to the other's cost. A penalty default reverses the incentive: the law sets the silent-case term unfavorably to the knowing party, so that to get a better term it must reveal its information — must speak up about its unusual needs or risks — and so the very setting of the default forces a disclosure the majoritarian rule would have let the party conceal. The penalty default thus turns the gap-filling rule into an instrument against the asymmetry of information the volume on the asymmetry studied: by punishing silence, it induces the informed to inform, and so improves the contract the parties finally write. The choice of default, Ayres and Gertner showed, is not merely a convenience but a lever — a way for the law to shape what the parties disclose, and so what they agree.4

4. A penalty default deliberately sets the silent-case term against the party with private information, forcing that party to reveal it (to bargain for a better term) rather than stay silent and exploit a majoritarian default priced for the usual case. By penalizing silence it induces disclosure — turning gap-filling into an instrument against information asymmetry (cf. screening in The Screen). The choice of default is a lever shaping what parties reveal, not merely a convenience.

Behind the default rules stand a few mandatory ones, and the distinction marks the limit of the parties' freedom and of this plate's fix. Most contract terms are defaults — the law supplies them, but the parties may contract around them, for the law presumes that competent parties know their own interests best. But some terms are mandatory: the law imposes them and forbids contracting around them, however much both parties might wish to — the rules against enforcing a contract of bondage, against the unconscionable bargain, against terms the law deems intolerable whatever the parties agreed. These mark the outer limit of freedom of contract, the bargains the law will not enforce though both sides freely struck them, and they are the subject of a later plate. But note, for now, the limit of the whole legal apparatus of gap-filling: default rules and mandatory rules together can fill or forbid the gaps the law is asked to resolve — but most gaps never reach the law at all. The flooded site, the burned factory, the unforeseen turn: far more often than not, the parties sort these out themselves, by negotiation, by custom, by the relationship — never troubling a court, never invoking a default. The law's gap-fillers govern the gaps that come to law; but most gaps are filled elsewhere, by hands the law never sees.5

5. Default rules (which parties may contract around) are distinguished from mandatory rules (which they cannot — e.g., bars on enforcing bondage or unconscionable bargains), the latter marking the limit of freedom of contract (see The Limit). The deeper limit: the law's gap-fillers govern only gaps that reach a court. Most gaps are resolved privately — by negotiation, custom, and relationship — without any default invoked, pointing to the non-legal gap-fillers (The Handshake) and the flagship.

The gap, then, is the hole in every contract — the unforeseen case the parties did not address, which the silence of the document cannot resolve. The law's answer is the default rule: the term it reads into the contract for the cases the parties left open, drawn from common intent, or set as a penalty to force the informed to speak — a vast hidden layer of law beneath every agreement, governing the cases that go wrong. Ayres and Gertner showed that the choice of default is no mere convenience but a lever, shaping disclosure and so the bargain itself; and the distinction between default and mandatory rules marks the limit of the parties' freedom. But the law's defaults reach only the gaps that reach the law, and most do not: the everyday gap, the ordinary surprise, is filled not by a court reading in a term but by the parties themselves, falling back on understanding and relationship. What fills the gaps the law never sees — and how a contract works when no clause and no default speaks — is the matter of the plates to come. The next plate turns from the gaps to the terms the parties do write with care: the terms designed to make a self-interested partner behave, when his conduct cannot be watched.