An Overview on the Theories of Contract Law

Common law textbooks on contract law typically define “contracts in terms of promise or agreement or of a combination of the two” (Cootes, 2010, p. 10). Within contemporary contract literature, it is often stated that “contractual obligations are voluntary” (Robertson, 2005, p. 180). Contemporary contract doctrines emerged during “the final quarter of the 19^th century” and represents the “legal system’s reasonable and practical compromise” between “conflicting values and interests” (Mason & Gageler, 1987, p. 1; Hillman, 1997, p. 2). Notwithstanding, a close examination of contract law as a social phenomenon has only recently emerged in academia.

Some claim that contract law’s complexity can be reduced to a “small number of basic moral principles” (Fried, 2015, ix). Others suggest that contract law is a balanced contradiction that intricately weaves together “conflicting set of rules, principles and policies” (Hilman, 1997, p. 2). Whereas some claim that the hybrid nature of contract law draws on a “diverse range of ideas and is shaped by a number of goals” (Robertson & Paterson, 2020, p. 4). Ultimately, whether there is an actual unifying structure of contract law, or whether contract law is absent of any justifiable universal principles that can properly explains its nature are questions that continue to be subject of debate in contemporary contract law.

In this article, we address the frequently asked questions on what contract law is, and its nature and role within contemporary society:

What are the Legal Elements to the Formation of a Contract?

In contract law, a contract is often defined “in terms of promise or agreement or of a combination of the two” that contain voluntarily assumed contractual obligations (Cootes, 2010, p. 10). As legally recognised constructs, contracts are also characterised by the principles of bargain and consideration that necessitate “reciprocity between the parties” (Cootes, 2010, p. 17).

In summary, the legal elements that form a common law contract are briefly described:

What are Unifying Theories in Contract Law?

With growing numbers of contract theories in contract literature, these contributions are viewed as being “filled with insights and ideas” that can deepen our understanding in the function of contract law (Hillman, 1987, p. 1). The theories are motivated to discover general categories and methods of classification that can join “insights that hold across those categories” (Bix, 2017, p. 391).

When evaluating contract theories, purposes and motivations may differ (Cootes, 2010). The purposes of contract theories may seek to justify the “legal recognition and enforcement of contracts”, show the connection in “the role of contracts in society”, or to provide prescriptive toolkits to predict any “given situation whether a contract will arise” (Cootes, 2010, p. 14).

Arguably, the value in contract theories is found in the search for theories which can “base contract on general concepts”, rather than fulfil just “technical requirements” (Cootes, 2010, p. 14). Ultimately, contract theories can be viewed as a way to help us to better understand the world in a prescriptive manner (Seddon & Bigwood, 2023).  

We briefly examine seven different theories of contract law: Classical Theory, Promissory Theory, Critical Legal Theory, Consent Theory, Economics Theory, Relational Contract Theory, and Contract Law as Regulation.

What is Classical Contract Theory?

The 19^th century is regarded as the “classical age of English contract law” that increasingly saw the “function of the law” as giving effect to a person’s intentions (Seddon & Bigwood 2023, para 27.20). During this period, there was substantial development in the “principles and structure of contract law” that separated itself from being “an adjunct to property law” (Seddon & Bigwood, 2023, para 27.20). This period is viewed as a historical attempt of bringing a unifying theory “to capture the essence of contract in a single idea” (Robertson & Patterson, 2020, p. 4).

Classical theory claims that a contract is as “an expression of the joint will of the parties” (Robertson & Paterson, 2020, p. 3). Others view this as the will theory of contract. Under will theory, contracts are a reflection of the “expressions of the human will” (Cootes, 2010, p. 15). It represents individual self-determination, and this expression of autonomy can be “traced back to at least to classical Greece and Rome” (Cootes, 2010, p. 15).  

This idea historically mirrors a societal position in England at the time, that viewed free choice as a principal goal to promote relationships that could be voluntarily entered, “permitted and respected” (Atiyah, 1985, p. 37). Contracts were voluntarily assumed by relevant parties to “facilitate the freedom of the parties to create their own private law” (Robertson & Paterson, 2020, p. 3). In support of this motivation, the function of the court was “to discover what the parties have agreed and give effect to it” (Seddon & Bigwood, 2023, para 27.23).

Motivated by a belief in economic liberalism, contracting parties were characterised as “self-interested individuals who created their own private law through agreement” and could freely enter into bargains with minimal interference from the court (Robertson & Paterson, 2020, p. 3). This reflected a historical context in England of a “society which largely ran itself”, and that “actual enforcement of laws was largely left to private initiative” (Atiyah, 1985, p. 102). Notwithstanding, throughout this period, a significant emphasis was placed on individual entrepreneurship (Atiyah, 1985).

What is Promissory Theory of Contract Law?

Promissory theory claims that contract law has an underlying, unifying structure that is grounded in moral principles (Robertson & Paterson, 2020, p. 11). Fried (2015) claims that promises “invokes trust in my future actions, not merely in my present sincerity,” and is a form of commitment to make it possible for “others to count on” future conduct (pp. 11, 13).

Others similarly share that a promise “is a commitment to some future action – a self-imposed limitation on future freedom of action” (Seddon & Bigwood, 2023, para 28.27). This reveals a normative position that promises are “special and must not be made lightly” (Seddon & Bigwood, 2023, para 28.27).

Promises also reflect a moral obligation by promoting the “institution of promising” as a way to bind the promisor and others to “expect a future performance” (Seddon & Bigwood, 2023, para 28.27). The “obligation to keep a promise is grounded not in arguments of utility, but in respect for individual autonomy and trust” (Fried, 2015, p. 15). The promisor becomes morally bound because the promise invokes a “convention whose function it is to give grounds – moral grounds – for another to expect the promised performance” (Fried, 2015, p. 16).

Therefore, underlying a contract is a moral position of it being “first of all a promise” and that a contract must be kept simply “because a promise must be kept” (Robertson & Paterson, 2020, p. 11).

What is Critical Legal Theory of Contract Law?

During the 1970s, a new movement known as Critical Legal Theory emerged as a “philosophical hybrid drawing on the theories” ranging from Marxism, Critical Theory, and Post-Structuralism (Drahos & Parker, 1990, p. 34). Critical Legal Theory is intended to be a critique of “law from a critical position, or through a critical lens” (Steward, 2020, pp. 121-122).

Therefore, it becomes an inquiry on how “the structure and doctrines of modern contract law” cannot be properly explained as “logical extensions of basic principles carefully designed to achieve particular social goals” but is rather a “false presentation of the law” (Feinman, 1983, p. 847; Seddon & Bigwood, 2023, para 28.24).

It is also critique on legal formalism, being a “notion of contract law as a set of value-free, abstract rules” (Robertson & Paterson, 2020, p. 22). Rather, contract law contains features that make it “essentially incoherent, and in practical application, indeterminate” (Seddon & Bigwood, 2023, para 28.26).

Critical legal theory also examines “the relationship between law and other elements of the social order” (Feinman, 1983, p. 847). That is, the inquiry of contract law is a study of “law as a legitimating ideology and as an expression of legal consciousness” (Feinman, 1983, p. 852). The perceived independence of law becomes a social examination of how judges understand the world, the application of “prior legal structures and concepts”, and a normative study of “underlying social relations” (Feinman, 1983, p. 856).

Under this lens, some claim that the existing model in contract law is intended to “support the existing economic and social order” (Robertson & Paterson, 2020, p. 22). Notwithstanding, the motivation of critical legal theory is to “expose the ideology of contract law and the contradictions within contract doctrine” (Robertson & Paterson, 2020, p. 22).

What is Consent Theory of Contract Law?

Consent theory views contractual obligations as being “dependent on an underlying system of legal entitlements” (Robertson & Paterson, 2020, p. 14). The function of a system based on entitlements defines the boundaries for individuals to “live, act and pursue happiness” free from “forcible interference” (Barnett, 1986, p. 291).

As part of that system, a transfer of entitlements requires the “consent of the right holders, that is, consent, to be legally obligated” (Robertson & Paterson, 2020, p. 15). It recognises that the concept of rights or entitlements is a social construct motivated by specifying “boundaries within which individuals may operate freely” (Barnett, 1986, p. 291). Furthermore, when boundaries are clearly defined, then this promotes an efficient allocation of “decision-making authority among individuals”, and rights “may be respected and disputes avoided” (Barnett, 1986, p. 302; Robertson & Patterson, 2020, p. 15)

In examining the moral justification of consent, the moral dimension of consent “mandates that others take the interests of the right holders into account” (Barnett, 1986, p. 298). It is the “consent of the rights holder to be legally obligated” that constitutes the moral component of an entitlement-based system and “validates the enforcement of certain commitments” (Barnett, 1986, p. 299). Therefore, consent represents the “heart of contract law” (Barnett, 1986, p. 299).

What is Economic Theory of Contract Law?

An economic analysis of contract law observes legal rules “against the criterion of economic efficiency” to promote efficient outcomes (Seddon & Bigwood, 2023, para 28.11). Whilst there are conflicting opinions as a field of study, the economic approach adopts the “tools and methods of economics” as a way of understanding human activity (Katz, 2014, p. 171). At the forefront of this discourse, the economics approach places the “costs and benefits of alternative choices” as “relevant considerations when resources are limited” (Veljanovski, 1980, p. 175).

An economic analysis involves the application of positive economics and normative economics as tools that contain the attributes of being “predictive, descriptive and prescriptive” (Seddon & Bigwood, 2023, para 28.12). It can also be a method to explain the “underlying basis of, or flaw in, a particular rule” (Seddon & Bigwood, 2023, para 28.12). This rationale arises from a belief that the theory of choice can also be applicable to “all human and institutional behaviour” (Veljanovski, 1980, p. 162). Therefore, a market-based approach is adopted and applied to hypothetical market settings, with the assumptions of “maximising behaviour (utility maximisation), stable preferences and opportunity costs” (Veljanovski, 1980, p. 162).

However, the economic approach has been criticised as reducing the application of law through “simplistic” lens, and overextending “positive and normative claims” through the vehicle of economic doctrines (Veljanovski, 1980, p. 195).

What is Relational Contract Theory?

Relational Contract Theory describes contracts as a “social relationship between transacting parties” that should be examined within its broader “social matrix” (Robertson & Paterson, 2020, pp. 27, 30). It represents a relationship of exchanges between people, and that “complex patterns of human interaction” inform the direction of legal and social development (MacNeil, 1985, p.483).

For example, in most situations, a contract is generally not required. Rather, normative standards guide the conduct between parties, namely, that commitments should be honoured, and a person should be able to produce a “good product and stand behind it” (Macaulay, 1963, p. 63).

Further, in every contract, there are also four ideas that arise. Every transaction is social and is “embedded in complex relations” between people, understanding a transaction requires a contextual understanding of “all essential elements of its enveloping relations”, an analysis of a transaction requires a recognition of those relations and essential terms, and a contextual analysis of a transaction is more productive than a non-contextual analysis (MacNeil, 2000, p. 881).

Ultimately, a contract represents a social device for the conduct of exchanges and the creation of exchange relationships (Macaulay, 1963).

What is Contract Law as Regulation?

In viewing contract’s role as regulatory, a contract is claimed to regulate markets and exchanges (Robertson & Paterson, 2020). People commit to contractual relations not because of trust between parties as strangers, but rather a reliance on an “extensive system of sanctions that can be imposed against those who breach the rules of the game” (Collins, 1999, p. 4). Therefore, as a social construct, a contract is a “societal institution that sets the limits within which parties may exercise some degree of control…” (Jean, 1990, p. 699).

Contract law becomes a “regulation of contractual behaviour” and the “state provides the systems of rules and sanctions” that permits commercial exchange to take place between strangers (Collins, 1999, p. 4). There are three dimensions to the regulatory nature of contract law. Legal decision-makers determine the validity and limits of consent for enforcement (Jean, 1990). The interpretation of contracts is shaped by legal decisions that carve obligations “along socially desired lines” (Jean, 1990, p. 701). Further, the application of the law is also required to “supply a great deal of content of contractual obligation” such as gap-filling, validity and interpretation (Jean, 1990, p. 701).

However, the regulation of contractual behaviour is viewed as facilitating economic, prosperity, social order and “complex division of labour” (Collins, 1999, p. 3).

Bibliography

Related Entries

Implied Terms | Enforceable Contract | Frustration | Legally Binding Agreement | Termination | Express Terms | Consideration | Intention to Create Legal Relations | Offer and Acceptance | Certainty | Repudiation | Privity of Contract | Classification of Terms | Causation | Remoteness | Damages | Liquidated Damages and Penalties |

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Authored by:
Ben Franklin, Managing Partner (LIV Accredited Specialist – Property Law), & Matthew Tran, Lawyer.