Chapter 9. The Doctrine of Freedom of Contract

Table of Contents

Introduction
Some Reflections on the Doctrine of Freedom of Contract
The Recent Fair-Trading Debate in Australia

Thou shalt not take the name of the Lord thy God in vain; for the Lord will not hold him guiltless that taketh His name in vain.

— Exodus 20

But governments do not limit their concern with contracts to a simple enforcement. They take upon themselves to determine what contracts are fit to be enforced…There are promises by which it is not for the public good that persons should have the power of binding themselves.

— J. S. Mill[1]

Few who consider dispassionately the facts of social history will be disposed to deny that the exploitation of the weak by the powerful, organised for purposes of economic gain, buttressed by imposing systems of law, and screened by decorous draperies of virtuous sentiment and resounding rhetoric, has been a permanent feature in the life of most communities that the world has yet seen.

— R. H. Tawney[2]

Introduction

Contract law is one of the fundamental institutions that underpin the market system. It is not often understood that the religious and governmental regulations that underpin agreements have a very long history. Therefore, it is not often realised that the above quotation from the Ten Commandments refers not to the uttering of obscenities, but to the process of oath taking in ancient Israel, which—among other things—helped enforce contractual arrangements. A rigid view of contract law in the form of the doctrine of freedom of contract is a central element in economic fundamentalist rhetoric. It is desirable, therefore, for critics of economic fundamentalism to equip themselves with some understanding of the origins of this doctrine and how it emerged and then declined as part of the nineteenth-century view of social theory and laissez-faire economic doctrine. Our account now turns to an examination of the emergence of classical contract law towards the end of the nineteenth century in England and the United States. It will be shown that the doctrine has its origins in the breakdown of medieval ideas regulating social and economic life and the emergence of social contract ideas as a basis for explaining social order and for justifying the property rights of the elite. Natural law, the natural lawyers and the gradual secularising of that tradition also heavily influenced the growth of the doctrine. Consequently, my account parallels the earlier account of the rise of social contract ideas. As we saw then, many philosophers and economists used the concept of a contract as their fundamental explanatory device in explaining or justifying social order. The doctrine of freedom of contract is therefore central to the conceptual framework within which economists and, in particular, economic fundamentalists operate.

The development of common law and the associated growth of contract law in England and the United States parallel the rise of capitalist society and its adherence to social-contract theory.[3] That law was influenced heavily by the Enlightenment and by its natural-law outlook while English judgements and theorists continued to exercise considerable influence in the United States after the War of Independence.[4]

Chapter 4 pointed to the gradual breakdown in the medieval idea that people owed a wide range of social and religious duties. In that medieval world, relationships were largely customary, but law backed that custom. Indeed, law, custom and morality are not distinguished clearly. In particular, while there were some elements of bargaining and free choice in economic life, that freedom was constrained severely by ethical ideas, which ensured that economic relationships occurred in ways that were thought to be fair and just. The notions of a just price and a just wage were central to medieval economic thought.[5] Custom and law imposed a duty on those exercising authority to enforce those just prices and wages. Any bargain in which one party obviously gained more advantage than the other and used his power to the full was regarded as usurious. Similarly, no one doubted that everybody was entitled to subsistence. As a result, there were repeated attempts to impose price controls on staple items as well as to regulate wages. Until the end of the fifteenth century, all lending at interest was, in theory, prohibited. A sale in which there was a defect in either quantity or quality was sinful and was void. A seller was obliged to reveal a secret flaw in the product being sold. In this world, the doctrine of caveat emptor—the companion to the doctrine of freedom of contract—had no standing, while the possession of property involved temporary custodianship and carried duties as well as rights.[6]

The system of justice included the King’s tribunals and local and special courts in which administrative and judicial functions were blended. These functions included a wide range of regulations controlling trade and ensuring an open market, a fair price and good quality. These arrangements became even more formalised as market towns succeeded fairs. As ecclesiastical authority broke down, the secular realm—particularly the Crown—took a larger and larger role in maintaining these fair-trading regulations. By the end of the sixteenth century, the system of justice was shared between the common law, the courts of custom, the liberties of the towns and special tribunals. Importantly, customary law had not yet emerged as the common law.

The above attitudes towards the regulation of economic activities were associated with a view of the law as a body of essentially fixed doctrine, derived from divine and natural law, and to be applied in order to achieve a fair result in particular cases.[7] As a consequence, judges in England, and later in the American states, conceived of their role as merely discovering and applying pre-existing legal rules. This brought with it a strict conception of precedent in which judicial innovation was not permissible. At the same time, statute was conceived of largely as an expression of custom.

With the gradual breakdown of these ideas, the lords and freeholders came to question to some extent the legitimacy and privileges of the Crown and of government more generally. They also began to see themselves as the owners of the land they occupied, while at the same time ideas about the ownership of property become more absolute. Similarly, ideas about freedom also became more absolute. The breakdown of central government during the Civil Wars (1642–51) also disorganised the system of market control, which had come to depend on national authority.[8] That authority to regulate economic life never completely recovered even though the supervision of an expanding trade and commerce was maintained with decreasing effectiveness until well past the Restoration (in 1660).

As recounted in Chapter 4, these changes made it easier for the propertied elite to see civil society as based on a social contract, rather than socially defined moral obligations backed by divine law. Unlike the traditional natural law, natural-rights theories were based on conflict between the individual and the State. As the basis of legal obligation was redefined in terms of popular sovereignty and contract, the natural-law foundations of common-law rules began to disintegrate.[9] By the eighteenth century, political theorists and men more generally thought of their relationships with each other, and the State, in contractual terms in which a key role was assigned to individual choice.

With this came a growing perception that judges did not merely discover law, they made it. Therefore, judges began to gradually feel free to disregard earlier precedent and to make law consistent with the prevailing contractual ideology. There developed, as a result, a close connection between liberal economic ideas and the rule of law as it came to be understood after 1688. In this regard, the idea that the law should be regular, certain and subject to interpretation by independent judges is not normatively neutral, but has a powerful value content—valuing individual freedom and free choice above some other values such as equity. Nor is the rule of law normatively neutral because by promoting procedural justice it enables the shrewd, the calculating and the wealthy to manipulate its forms to their advantage.[10]

English common law gained its supremacy over the prerogatives of the Crown largely through the efforts of Sir Edward Coke (1552–1634).[11] Coke was opposed to what he saw as the usurping of power by the King, and appealed to the common law as a traditional barrier to the interference by government with the economic and other freedoms of the individual.[12] In the process, Coke distorted and misinterpreted the past common-law tradition to make it seem more strongly favourable to economic liberalism than it was in fact. In particular, the doctrine of caveat emptor had no ancient ancestry. It was Coke who helped establish it by setting it down in his treatises on law.[13] Lord Mansfield, Chief Justice of the King’s Bench from 1756 to 1788, was another economic liberal, who did much to consolidate and develop commercial law. During his tenure, the overthrow of the traditional role of the courts in regulating the equity of agreements began in earnest.

Mansfield’s conception of a general jurisdiction of commercial law—which emphasised its claimed universal character and its supposed correspondence with natural reason—had an overwhelming influence in the United States. This involved a new stress on the functionality and rationality of the legal rules free from every local peculiarity, and brought with it a growing distinction between morality and the law. Horwitz,[14] in particular, notes the influence of a new utilitarianism in nineteenth-century US law in general and in the erosion of concern for the fairness of contracts in that country. What was involved was a change in the moral conception underlying contract in which the express contract became paramount. Horwitz also notes the influence of a new alliance between the mercantile classes and the legal profession—firstly in trying to subvert the influence of equity and of juries on commercial cases, and ultimately in moulding legal doctrine to accommodate commercial interests. This growth in commercial law also reflected the increasing complexity of economic transactions.

While there had never been an overt principle of fairness in the common law of contracts, lawyers of the seventeenth and eighteenth centuries were not indifferent to such concerns. There were signs of a broad principle of good faith emerging in the common law of contracts in the late eighteenth century—a development that ultimately came to naught. This could have been because jury control over damages rendered it unnecessary to strive for such a substantive doctrine. For Atiyah, it was the jury that bridged the gap between morality and the law.[15] In any event, grossly unfair contracts were liable to be upset in chancery, and it was in chancery that the greater part of contract litigation took place.

Chancery was the second of two different traditions in English legal practice. Equity consisted originally of a body of rules and procedures that grew up separately from the common law and were administered in different courts. From the time of Edward II or earlier, the chancellor and his officials—later the Court of Chancery—as ‘keeper of the King’s conscience’, could give equitable relief where the common-law courts might provide no remedy. The chancellors until the appointment of Sir Thomas Moore in 1529 were churchmen. With the rationalisation of legal practice, the common law and equity are now merged and administered by a single set of courts almost everywhere. While the merger of law and equity is usually portrayed as a rationalisation of civil procedure, for Horwitz, it represents the final and complete emasculation of equity as an independent source of legal standards.[16]

As the law moved increasingly to recognise the generality of the binding nature of contracts, they began to be seen as being about promises, wills and intentions and not about particular relationships and particular transactions. The rationalisation of the common law was influenced by a new legal literature looking for legal principles based on rational first principles. Further, there was a particularly close relationship between law, economics and the social sciences in the first 40 years of the nineteenth century. The economic ideas that influenced the development of the common law were those of the classical economists between 1776 and 1870. While they assumed that the law must provide for the enforcement of contract, they gave little thought to why the enforcement of contracts was not itself a form of government intervention.[17]

Laissez-faire principles might well have had more influence on judges—and judge-made law—than on the other organs of the State. Atiyah makes much of the emphasis on principle in Victorian life and on its tendency to become more absolute.[18] The rise of formalism in the law, particularly in the United States, played a role in this attitude. This formalism—the attempt to place the law under the rubric of science—was a further development of the rationalism noted earlier. It involved a belief that all law was based on abstract legal doctrines and principles, which could be deduced from precedents, and that there was only one correct way of deciding a case. The formalists aspired to create formal general theories that would provide uniformity, certainty and predicability in legal arrangements and which would distinguish sharply between law and morals.[19]

This formalism served to reinforce the recently developed law of contract by giving the impression that the principles of the law of contract were inexorable deductions drawn from neutral principles. Within this framework, it was the market that supplied the so-called neutral principles, free from all political influence. This attempt to separate law from politics has been a central aspiration of the American legal profession in particular.[20] It served the interests of the legal profession to represent the law as an objective, neutral, apolitical and scientific system. This encouraged a search for fixed principles that would govern a large number of cases without too close an inquiry into the facts. As a consequence, every law not fitting the pattern of the free market was defined simply as being outside the law of contract, as some other exceptional body of rules: company law, factory legislation, building laws, sanitary laws and so on. Such statutes were excluded from the emerging conceptual scheme of a general law of contract based on free-market principles—the classical theory of contract. Nevertheless, Atiyah cautions that legal writers, in commenting on the influence of caveat emptor and laissez-faire, attribute a much greater significance to particular legal cases than is warranted by the practice of the courts more generally. Nevertheless, the effect of these changes in values was to reshape the legal system to the benefit of business and to the detriment of less powerful groups. The selection of ‘leading cases’ and the dismissal of the ‘anomalous’ were clearly influenced by the ideological commitments of the system builders.

Ironically, while the nineteenth century was the very heyday of sanctity of contract and of laissez-faire, it was also the period when Britain was creating its modern machinery of government. Despite the widespread support for free markets, the role of government and of government regulation expanded greatly. Atiyah comments that one of the main inhibitors of such government regulation had been ignorance of the social evils associated with rapid population growth, industrialisation and urbanisation, and of how to deal with them.[21] The growth of a professional bureaucracy—and the activities of royal commissioners and parliamentary select committees—overcame this ignorance and led to much legislative and regulatory activity. Many of the participants—who started as disciples of Smith and Ricardo, and as firm believers in individualism and self-reliance—were converted by their inquiries into zealous public servants demanding more legislation, better enforcement and more administrative staff.

This enormous change in the character and quantity of legislation had a profound impact on the very idea of a contract-based society. With the growth in increasingly sophisticated legislative activity, the courts abandoned overt law-making activity. Atiyah argues, therefore, that by 1870, the influence of individualism had largely broken down, and had been replaced by a different order in which control, regulation, licensing and institutional arrangements had become the dominant mode of social organisation.

Atiyah also qualified his account of the dominance of the doctrine of freedom of contract by suggesting that English judges were stronger in doing justice in a pragmatic fashion than in providing theoretical justifications for their decisions. In addition, the weight of earlier tradition was influential in particular cases. As a result, laissez-faire and the doctrine of freedom of contract had a much greater influence on contract law in the United States than in England. Gilmore attributes this to the influence of ‘the great systems-builders’ seeking to develop self-contained and logically consistent systems of rules and doctrines.[22] Gilmore also speculates that the Puritan ethic was somehow involved, noting the moral fervour with which judges insisted on the performance of contractual obligations. For Horwitz,[23] nineteenth-century US judges professed a contractual ideology that was instrumental in promoting economic development and laissez-faire, in being hostile to legislative or administrative regulation. Moreover, the idea of property as a pre-political Lockean natural right—not created by law—remained at the centre of American legal thought.[24]

Under this influence, the US Supreme Court in 1905[25] elevated the principle of freedom of contract to the level of a sacred constitutional principle. In the common law in England, however, the tide was about to turn. Even in the United States, the dominance of the doctrine of freedom of contract was short-lived. The US Supreme Court decision of 1905 provoked a progressive reaction and fundamental attacks on this form of legal thought. With these attacks came a breakdown in these absolute concepts of property and contract.

In England, the idea of caveat emptor did not long survive the growth in consumption of manufactured goods and the reality that people did rely on their suppliers when it came to the quality of the goods they supplied. For example, in Piggott v. Stratton in 1859, Lord Campbell and the Lords Justice of Appeal ruled that ‘the business of life could not be conducted if it were required that men should anticipate and expressly guard against the wily devices to which the deceitful may resort’.[26]

From the 1860s onwards, the English courts started to limit the application of the principle of caveat emptor. Consequently, some inquiry by the courts into the facts was needed from this date onwards. In 1884, in Foakes v. Beer, the House of Lords started to move back towards the idea of fairness in an exchange and away from the idea that a bare agreement was always binding. At the same time, the idea of freedom of contract was itself subject to increasing political challenge, particularly with the expansion in franchise. This involved a significant shift in political thinking—a shift that occurred in England and the United States. For example, in the 1880s, George Bernard Shaw opposed the appeal to free contract, free competition, free trade and laissez-faire against the regulatory activities of the State.[27]

Similarly, philosopher T. H. Green set out to challenge the primacy of freedom of contract in his Liberal Legislation and Freedom of Contract: ‘To uphold the sanctity of contracts is doubtless a prime business of government, but it is no less its business to provide against contracts being made, which from the helplessness of one of the parties to them, instead of being a security for freedom becomes an instrument of disguised oppression.’[28]

Joseph Chamberlain in 1885 also criticised the faith that had been placed in freedom of contract for the best part of the nineteenth century:

The great problem of our civilisation is still unresolved. We have to account for and to grapple with the mass of misery and destitution in our midst, co-existent as it is with the evidence of abundant wealth and teeming prosperity. It is a problem which some men would set aside by reference to the eternal laws of supply and demand, to the necessity of freedom of contract, and to the sanctity of every private right of property. But gentlemen, these phrases are the convenient cant of selfish wealth.[29]

Increasingly, the common law and legislation interfered with that freedom of contract and with the principle of caveat emptor. The effect was to narrow significantly the field of activity over which freedom of contract and contract law held sway. This change is perhaps marked most clearly by the passage in England in 1893 of the Sale of Goods Act, dealing with such matters as title, quiet possession, freedom from encumbrances, correspondence with description, merchantable quality, fitness for purpose and sales by sample. This legislation was adopted virtually unchanged by every Australian state and territory.[30]

It is clear, therefore, that the idea of freedom of contract as an absolute ideal gained credibility and influence in the nineteenth century but was eclipsed by the end of the century as the practical consequences of reliance on this principle began to be realised and began to offend the sense of justice of the bulk of the population.

Surely it is now clear that property and contract are not natural rights but social and legal artefacts, or even ‘techniques’. Atiyah argues that there is much about the modern world that suggests an affinity with some of the older traditions and suggests that, at least in England, the law is returning to these traditions. This is a theme that arose in Chapter 4 with Toulmin’s suggestion that there is a need to return to the humanism characterised by Erasmus and away from the dogmatism of the Enlightenment.[31]