Chapter 7

The Parol Evidence Rule and Contract Interpretation

If you read the introduction to this book carefully (Chapter 1), you already know that the spelling of “parol” in the title to this chapter is not a typo and that you will advance your career by understanding this. To review, there is no “e” at the end of the word parol. “Parol” means “an oral statement or declaration.”1 The parol evidence rule serves as a filter that controls the evidence a party can introduce at trial to prove the terms of a contract, barring evidence of prior or contemporaneous oral agreements or promises that contradict or vary a term in a writing the parties intend to be complete with respect to that term.2 Despite the definition of parol, the rule also precludes evidence of prior written agreements that contradict the parties’ final written agreement.3 Part A of this chapter discusses the tricky parol evidence rule, which will make the above more understandable.

Once we understand what evidence courts can use to interpret a contract, we shall look in Part B of this chapter at the rules of contract interpretation, which are the rules contract law uses to ascertain the meaning of the words in a contract. Part B also examines the process by which courts fill gaps in incomplete contracts.


The illustration in Chapter 1 was pretty brilliant, so let’s repeat it here in order to introduce the parol evidence rule. You and your neighbor, Alice Franklin, enter a written contract for the sale of your piano. You include all of the pertinent terms, including a price of $500. However, at the time of performance, Alice refuses to pay more than $300 for the piano. She claims that, prior to signing the written contract, you orally agreed to accept $300 for the piano. She asserts that the contract says $500 only because you thought that your mother would be angry with you for selling the piano for so little. You sue Alice, and at trial she seeks to introduce evidence of your alleged oral agreement. The traditional parol evidence rule, defined in the introduction to this chapter, bars this evidence.4 Alice’s evidence is of a prior oral agreement that contradicts the written contract. Further, the contract is complete on its face with respect to the price of the piano.

The reason for the parol evidence rule should be clear from this example. The rule deters untruthful attacks on the terms of contracts. You can rest assured that you have a contract for the sale of your piano for $500, and that Alice cannot weasel her way to a lower price. Application of the parol evidence rule thus helps assure that contract law carries out the intentions of the parties.

Wait a minute, you say. My rendition of the facts does not make it clear whether you and Alice really did agree to $500 only to fool your mother. If she is telling the truth, the parol evidence rule subverts the parties’ intentions, it does not assist in enforcing them. It should not be surprising to learn, then, that the rule is full of exceptions, created because courts sometimes believe that the party who offers evidence that contradicts the writing is telling the truth. Let’s look at each of these exceptions. After we consider them, we’ll return to our hypo to see if any of the exceptions apply.5

1.Collateral Contract Exception

Let’s consider another problem to illustrate this exception. Suppose you agree to sell Alice your house. You and Alice further agree that the written sales contract is complete on the terms of the sale. (Contract law calls a writing the parties intend to be complete on all of the terms a “full integration” and calls a writing the parties intend to be complete on only some of the terms a “partial integration.” More on this shortly.6) Alice refuses to go through with the sale, claiming that, as part of the transaction, you had promised to remove an old tree on the property and you have not done so.7 You sue Alice for breach of the land-sale contract and she defends by seeking to introduce evidence of your alleged broken promise to remove the tree.

Under the traditional parol evidence rule, a court would admit evidence of the tree-removal agreement only if it did not contradict or vary the written contract or if the parties did not intend the writing to be complete on that issue. The written contract says nothing about tree removal, so, at first blush, you might think that Alice can introduce her evidence without a problem. However, courts have also wrestled with the issue of whether parol evidence contradicts or varies an implied term of the written contract and therefore should be inadmissible for that reason.8 For example, perhaps the parties’ silence about tree removal in the written contract implies that you do not have to remove any trees. This implication would arise if reasonable parties who had made an agreement for tree removal ordinarily would have put such an agreement in the land-sale contract.9 That, of course, depends on whether land-sale contracts generally include such agreements when made. If so, your contract with Alice would not require you to remove trees and Alice’s evidence would contradict the contract. Therefore, a court would not receive Alice’s evidence. But if land-sale contracts usually do not include agreements with respect to tree removal, the agreement for the tree-removal is called a “collateral contract” (a separate contract), and Alice’s evidence is admissible.10 Her evidence does not contradict the written contract, which is silent on tree removal.

Distinguishing between collateral contracts and agreements that parties would ordinarily include in the written contract is no easy task. Let’s look at our example again. On the one hand, we can say that your promise to remove the tree helped induce Alice to enter the land-sale contract, so we would expect that she would insist on putting the promise in the written contract. On the other hand, tree removal is a task unrelated to the actual sale of the property, and such sale contracts ordinarily deal only with the subject matter of the sale.

A leading parol evidence rule case, Mitchill v. Lath,11 contemplated just this problem (what a coincidence!). Prior to contracting, the sellers of land promised the prospective buyer to remove an ice house on adjacent land. When the sellers failed to keep their promise, the buyer sought specific performance. The court barred evidence of the promise on the theory that the promise, if made, would have been part of the written contract.12 A strong dissent thought that an agreement for removal of the ice house would constitute a collateral contract. After all, the typical land-sale contract focuses on the terms of conveyance and does not include personal-services agreements. The dissent was also motivated in part by its belief (mentioned more than once) that the parties really had made an agreement for removal of the ice house.13

Courts employ different techniques in applying the collateral-contract exception. One approach, favored by those who believe the parol evidence rule serves a useful role, requires the judge to determine the admissibility of parol evidence simply by reading the contract, without resort to extrinsic evidence (evidence outside of the actual agreement).14 Writers supporting this view reason that if courts admit extrinsic evidence, a party such as Alice, or the purchaser in Mitchill, could prove that the parties did not intend the writing to be complete on the subject at issue simply by introducing evidence of the additional oral agreement.15 If the evidence is credible, then the parties could not have intended the writing to be complete. For example, Alice’s evidence of the tree-removal agreement would show that the parties did not intend the written contract to be complete with respect to the promises that induced the contract. Here’s how Samuel Williston, one of the giants of contract law during the past century, described the problem and its solution:

Even if the oral agreement is repugnant to the writing, what was orally agreed would be of equal importance with what was written, since its existence would prove that there was no complete integration of the contract in regard to the matter to which it related. * * * It is generally held that the contract must appear on its face to be incomplete in order to permit parol evidence of additional terms.16

As a potential contract drafter, however, you should know that not all courts follow Williston by determining whether a writing is complete (fully integrated) without the aid of extrinsic evidence. In fact, the tide is turning against Williston.17 Arthur Corbin, another leading contract law figure of the twentieth century, and no fan of the parol evidence rule, disagreed with Williston.18 Corbin pointed out that the parol evidence rule operates only when the parties intended a writing to be complete with respect to the contested subject matter. Further, a court should not preclude any evidence in determining whether the parties so intended: “The ‘parol evidence rule’ does not itself purport to establish the fact of ‘integration’; and until that fact is established the ‘rule’ does not purport to have any legal operation.”19 The only logical conclusion, then, is that the parol evidence rule cannot preclude the admissibility of evidence of an oral agreement to show that the writing was not complete.20

If you are thinking that Corbin’s approach emasculates the parol evidence rule, I would have to agree. But here’s what you can do as a contract drafter to help protect your client who wants to be able to rely on her written contract and to fight off evidence of additional promises or agreements: Draft a term in the contract that provides that the writing is complete and is the only agreement between the parties. (If your client wants the writing to be complete on only certain subjects, you can make that clear as well.) Such a provision is often called a “full integration clause” (or “partial integration clause” if your client wants the writing to be complete only on certain subjects) because it demonstrates that the parties intend to “integrate” all of the terms of their agreement in their writing.21 Language such as “the parties intend this writing to be the full, complete, and only statement of the agreement between them” should do. Faced with such a clause, even courts otherwise inclined to follow Corbin’s reasoning may be hard-pressed to admit evidence on whether the contract is fully integrated.22 Of course, you should never be too content with your drafting prowess, and this area is no exception. Some courts resist the parol evidence rule even in the face of a full integration clause.23

2.Ambiguity Exception

The idea behind the ambiguity exception is that a court must admit parol evidence if a writing is unclear, even if the parties intended the writing to be complete.24 In case the meaning of “ambiguous” is itself ambiguous, let’s explain it: The ambiguity exception applies when the language in the contract is reasonably susceptible to more than one meaning.25

As you might expect, courts disagree about the appropriate process for deciding whether language is reasonably susceptible to more than one meaning. For example, many courts hold that the judge must determine the issue simply by reading the contract, without the aid of extrinsic evidence.26 Determining ambiguity without the aid of extrinsic evidence is, of course, consistent with Williston’s approach for determining whether the parties intended a writing to be complete.27 Not surprisingly, critics do not like this method of determining ambiguity any better than they liked Williston’s treatment of integration, and many courts have adopted a more expansive view.

Consider, for example, Pacific Gas and Electric Co. v. G. W. Thomas Drayage & Rigging Co.,28 decided by Justice Traynor, an influential judge during the middle of the last century. The parties disagreed over the meaning of the word “indemnify” in a contract calling for the defendant, Thomas Drayage & Rigging Co., to replace a portion of the plaintiff, PG & E’s, steam turbine. The clause in contention stated that defendant agreed to perform the work “at [its] own risk and expense” and to “indemnify [plaintiff] against all loss, damage, expense and liability resulting from injury to property, arising out of or in any way connected with the performance of this contract.”29 During the work, plaintiff’s turbine was damaged and plaintiff sought damages based on the indemnification provision. Defendant offered parol evidence, including PG & E’s admissions and the parties’ previous dealings, to prove that the parties intended the indemnification provision to cover only property owned by third parties, not the plaintiff’s property.

According to the traditional approach, a court should determine whether to admit defendant’s evidence of the meaning of “indemnify” simply by reading the clause and determining whether it is ambiguous on its face. In fact, Justice Traynor determined that the word “indemnify” was ambiguous on its face because people use the word, not only to refer to protection against third party liability, but also to describe protection against their own loss.30 But Justice Traynor then went further.

Justice Traynor hesitated to determine ambiguity without resort to contextual evidence. He reasoned that, because of the inherent imprecision of language, what appears clear to one judge might seem ambiguous to another.31 Justice Traynor’s objections, although long, are worth quoting directly:

A rule that would limit the determination of the meaning of a written instrument to its four-corners merely because it seems to the court to be clear and unambiguous, would either deny the relevance of the intention of the parties or presuppose a degree of verbal precision and stability our language has not attained.

* * *

* * * A court must ascertain and give effect to [the intention of the parties] by determining what the parties meant by the words they used. Accordingly, the exclusion of relevant, extrinsic evidence to explain the meaning of a written instrument could be justified only if it were feasible to determine the meaning the parties gave to the words from the instrument alone.

If words had absolute and constant referents, it might be possible to discover contractual intention in the words themselves and in the manner in which they were arranged. Words, however, do not have absolute and constant referents. “A word is a symbol of thought but has no arbitrary and fixed meaning like a symbol of algebra or chemistry * * *.” The meaning of particular words or groups of words varies with the “verbal context and surrounding circumstances and purposes in view of the linguistic education and experience of their users and their hearers or readers (not excluding judges). * * * A word has no meaning apart from these factors; much less does it have an objective meaning, one true meaning.” Accordingly, the meaning of a writing “can only be found by interpretation in the light of all the circumstances that reveal the sense in which the writer used the words. The exclusion of parol evidence regarding such circumstances merely because the words do not appear ambiguous to the reader can easily lead to the attribution to a written instrument of a meaning that was never intended. * * *.”

Although extrinsic evidence is not admissible to add to, detract from, or vary the terms of a written contract, these terms must first be determined before it can be decided whether or not extrinsic evidence is being offered for a prohibited purpose.32

Justice Traynor’s approach was bound to alarm proponents of the parol evidence rule, who saw in his language the implication that there should be no restrictions whatsoever on evidence offered to show that contract language was ambiguous.33 This approach, of course, would completely circumvent the parol evidence rule. For example, recall the example from the beginning of this chapter in which Alice wants to prove that $500 meant $300 in her purchase of your piano.34 Under Traynor’s reasoning, would Alice’s evidence be admissible? Some people thought so, and basically concluded that Traynor’s decision portended the end of the world (well, almost):

Pacific Gas casts a long shadow of uncertainty over all transactions * * *. It also chips away at the foundation of our legal system. By giving credence to the idea that words are inadequate to express concepts, Pacific Gas undermines the basic principle that language proves a meaningful constraint on public and private conduct.35

In actuality, Justice Traynor’s opinion is not too clear on how he would handle Alice’s offer of evidence, proving, I guess, his point about the limitations of language. (Maybe you’re saying the same thing right now about my prose.) On the one hand, he says that the parties’ intentions control and that courts cannot determine the meaning of language “from the instrument alone.”36 On the other hand, he says that the parol evidence must be relevant to prove a meaning to which the language of the instrument is “reasonably susceptible.”37 Further, he thinks courts should look preliminarily at all “credible evidence” to determine the parties’ intentions.38 Perhaps $500 is not “reasonably susceptible” to the meaning $300, or perhaps Alice’s evidence is not “credible.” But if Alice’s evidence is true, the parties’ intentions will not control.

One thing that is clear from Pacific Gas and Electric Co. is that Justice Traynor did not support a plain-meaning approach to the issue of ambiguity. Many courts have followed Traynor’s lead, and some have explicitly defined the kinds of evidence a party can offer to prove ambiguity. For example, one court allowed objective evidence, including course of performance, usage of trade, and course of dealing, at a formal preliminary hearing.39 We take up these kinds of evidence shortly.40 Suffice it to say here that course of performance, usage of trade, and course of dealing are reliable sources of contextual evidence involving respectively: earlier performances under the same contract, the customary meaning of terms within the same area or trade, and conduct of the same parties under earlier contracts or arrangements. Most important for now is that you understand that the court would not allow testimony of the parties’ private understanding of a term inconsistent with general usage (such as “we intended $500 to mean $300”).

3.Policy Implications

Analysts continue to debate the comparative merits of the traditional approach (also called the plain meaning or textual approach) and the contextual approach (the Justice Traynor approach).41 For example, traditionalists assert that judges and juries have difficulties understanding the relevance of extrinsic evidence and make too many mistakes when they apply it. Contextualists, parroting Traynor, however, believe words have no meaning absent context. In case you are wondering, I cast my vote with Traynor in part to avoid wrongly insulting judges and juries. I think they can do a better job in sorting out the relevance of extrinsic evidence than traditionalists assert (and it is also an open question whether judges and juries would be better equipped to find the meaning of a contract solely by looking at the language of the contract). In addition, extrinsic evidence helps reveal whether the parties intended to adhere rigidly to the written terms or, as they often do, opted for cooperation and flexibility notwithstanding the terms.

Traditionalists also contend that enforcement of contracts is less costly when courts apply the plain meaning rule because drafters, knowing that courts will not look beyond the written language, have the incentive to carefully draft relatively complete contracts. Because the contract takes care of all issues, the parties avoid the heavy costs of litigation. On the other hand, contextualists maintain that their approach reduces formation costs (the costs of planning, bargaining, and drafting) precisely because parties do not have to draft complete contracts. You can see that the better argument depends on which rule leads to an overall greater cost reduction. This is an empirical question, itself highly dependent on the type of contract and the particular circumstances. But the contextualists can point out that the costs of planning “are incurred with certainty and in the present while enforcement costs are incurred rarely and well into the future.”42

4.Proof of Fraud, Duress, or Mistake

Think back to Chapter 6 and the example in which Alice claims that she is selling you 5.5 acres of land when she knows the property contains only 3.5 acres.43 Assume further that she tells you to ignore the written contract, which lists the property as 3.5 acres. Can you introduce parol evidence of Alice’s fraudulent misrepresentation? Remember, the evidence is of a prior oral representation that contradicts the written contract.

Most courts allow you to introduce such evidence, so long as the misrepresentation is material, on the theory that the fraud preceding the contract induced you to make the deal.44 If the parol evidence is true, there is no enforceable contract and no role for the parol evidence rule. Thus, prior to considering the application of the parol evidence rule, courts admit evidence to prove the material misrepresentation. This approach should deter fraud. If the parol evidence rule barred evidence of fraud, victims would not be able to prove it, and nasty people would feel free to engage in it. For the same reason, evidence should be admissible to prove fraud notwithstanding the presence of a full integration clause in the alleged contract.45 Of course, just because a court will admit your evidence of Alice’s fraud, doesn’t mean you win the case. Recall that you must show reasonable reliance on her misrepresentation of the acreage. This may be difficult because the contract states that Alice is selling you 3.5 acres of land.46

All of what has been said about fraud also should apply to related policing defenses, such as duress and mistake. Chapters 6 and 9 contain discussions of the substantive grounds for these theories. The point here is that evidence of duress or mistake should be admissible notwithstanding the parol evidence rule. Although not all courts agree, as with fraud, if the grounds for these defenses exist, there is no enforceable contract and no role for the parol evidence rule.47

5.Parol Evidence and Promissory Estoppel

Can a party introduce parol evidence to establish a claim of promissory estoppel when a court has already barred the evidence for purposes of interpreting a contract? Think once again of your written agreement to sell Alice your piano for $500. She sues you for failing to deliver the piano. As you now are beginning to suspect, the parol evidence rule may preclude Alice from proving that the true purchase price was $300. Can she nonetheless proffer the evidence on the alternative ground of promissory estoppel?48

You may first ask, what is the detriment to Alice to support her promissory estoppel claim? You are forgetting that I am a law teacher and can make up hypos at the spur of the moment to help illustrate a point. So, assume that Alice is a piano teacher and, due to her reliance on you, she cannot get another piano for a few weeks and therefore loses profits from the time you should have delivered your piano until she receives a substitute. Can she succeed in showing that you broke your promise to deliver the piano for $300 even though the written contract says $500, and recover on a promissory estoppel claim?

Most courts would say no and would extend the parol evidence rule to promissory estoppel cases.49 Decisions that utilize the parol evidence rule in promissory estoppel cases worry that any other approach would circumvent the parol evidence rule and jeopardize people’s confidence in contract law. After all, if Alice collects lost profits based on a claim of promissory estoppel, you will find little solace in the fact that your written contract says $500 and that Alice could not prove otherwise in her breach of contract case.

People who are not enamored of the parol evidence rule can point out that the remedy for a successful promissory estoppel claim may be smaller than the remedy for breach of contract, and so the parol evidence rule, in barring the contract claim, would still play a role. In our example, Alice’s lost expectancy damages under a breach of contract claim (assuming she could prove the true contract price was $300) would be the market price-contract price differential, plus consequential damages (here, lost profits from teaching piano). If the market price of the piano is $500, Alice would recover $200, plus lost profits. Alice’s recovery for promissory estoppel, however, would not include the $200. She did not sustain the $200 loss by relying on your contract and forgoing a chance to buy a piano elsewhere, because she would have had to pay market value for an equivalent piano, namely $500.

6.UCC Section 2–202

Section 2–202 of the UCC sets forth the sale-of-goods parol evidence rule. The section provides that “confirmatory memoranda” or other writings intended by the parties to be the “final expression of their agreement with respect to such terms as are included therein,” cannot be contradicted by parol evidence. On the other hand, such agreements can be “explained or supplemented” by evidence of a course of dealing, usage of trade, or course of performance.50 Remember, we’ll get to these sources of evidence in detail soon.51 And we’ll also touch upon how to distinguish contradictory evidence from evidence that explains or supplements.52 For now, it is clear that, by allowing these evidentiary supplements, section 2–202 authorizes parties to introduce evidence of the commercial context, even without a finding that the contract language is ambiguous. Under section 2–202, a party can also introduce evidence of “consistent additional terms” unless the parties intended the entire writing to be a full integration.53

As at common law, the Code approach recognizes the possibility of a partially integrated contract, so that a court can find that the writing is complete on some subjects, but not others.54 The test for precluding contradictory evidence is similar to the collateral contract methodology of common law:55 “If the additional terms are such that, if agreed upon, they would certainly have been included in the document in the view of the court, then evidence of their alleged making must be kept from the trier of fact.”56 Section 2–202 does not speak to the controversy over whether courts should decide, without the benefit of extrinsic evidence, the parties’s intentions as to the completeness of a writing.57


Finally, let’s decide whether any of the exceptions discussed above apply to your piano sale.58 Remember, Alice wants to introduce evidence that you promised to sell your piano for $300, but the contract says $500. Certainly, the collateral contract exception is of little help. Reasonable parties who made an agreement for $300 would have put that in the contract. The price term also is not ambiguous. You have not committed fraud, and the problem is not one of a mistake. Alice’s best hope is to maintain that the court should follow Corbin and admit the evidence of the $300 deal to show the parties did not intend the writing to be complete. Alice can also argue along the lines of Justice Traynor that all “credible” evidence is admissible preliminarily and that the reason for the $300 oral deal (to fool your Mother) are credible.

But we can’t leave the parol evidence rule just yet. I believe that no matter how outlandish the issue, a good researcher can find a highly relevant case. Incredibly, there is a case in which a court admitted evidence that the parties intended the purchase price of $15,000 in a contract for the sale of a business to mean $50,000. The parties set forth the lower price in order to defraud the Small Business Administration into making the purchaser a loan. The court admitted the evidence, but came up with a rather unique way of dealing with the parol evidence rule. In short, the court required the seller to prove the oral agreement by clear and convincing evidence, a higher burden of proof than the normal preponderance of the evidence.59


In this part, we assume that any battles over the admissibility of evidence are over. One question for discussion here is how does contract law use admissible evidence to determine the meaning of contract language?60 In addition, how does contract law fill gaps in contracts. Unfortunately, complicating the matter, the quarrels of traditionalists and contextualists, discussed in Section 3 of Part A of this chapter, surface even after courts resolve issues on admissibility of evidence under the parol evidence rule.

1.Objective Contract Interpretation

How does a court determine the meaning of an agreement? Not surprisingly, the answer is consistent with the objective test of assent, discussed in Chapter 2.61 Courts generally determine the meaning of language by ascertaining what a reasonable person would believe the language means, not what either of the parties actually thought the language meant.62 One court put this in a rather flowery way: “[W]e give words their ‘ordinary meaning,’ viewing the subject of the contract ‘as the mass of mankind would view it.’ ”63 Perhaps a more useful way of thinking about the objective approach to interpretation (and, for that matter, to contract formation) is that it measures a party’s language and conduct against the test of reasonableness and sanctions careless, reckless, or purposeful misleading language by finding an obligation even if the promisor did not intend one.

Suppose, for example, an advertisement at a gasoline station says “Buy 10 gallons of fuel, get a voucher for a free [ski] lift ticket!” You purchase the 10 gallons and receive a voucher. Wait, don’t get happy yet (and I’m not making this up).64 The voucher is for a two-for-one lift ticket, meaning you have to purchase one at full price to get the “free” one. You are a reasonable person, right? And you thought you’d get a free lift ticket simply by purchasing the 10 gallons. With these facts, a court agreed with you and applied the objective test: “Plaintiff, as the recipient of the advertisement ‘reasonably might have concluded that by acting in accordance with the request a contract would be formed.’ ”65

Of course, we will see that if both parties intended a particular meaning, contract law enforces that meaning, even if it is inconsistent with the reasonable person test.66 However, relatively few judicial decisions reflect this observation. In most cases, courts enforce apparent, not necessarily real, intentions.67 Judge Learned Hand’s famous observation makes the point succinctly:

A contract has, strictly speaking, nothing to do with the personal, or individual, intent of the parties. * * * If * * * it were proved by twenty bishops that either party, when he used the words, intended something else than the usual meaning which the law imposes on them, he would still be held, unless there were some mutual mistake, or something else of the sort.68

So don’t be fooled by language you find in numerous judicial decisions that refers to the parties’ intentions.69 We have learned that one of contract law’s important goals is to facilitate freely-made private agreements.70 It is therefore not surprising to find language in opinions that is consistent with this goal, even when courts are giving lip service to the idea when interpreting language.

Contract law’s objective approach to interpretation (the reasonable person test) is a logical extension of its objective test of contract formation.71 Both processes protect a party’s reasonable reliance on the other party’s manifestation of intent.72 If you promise in writing to sell your piano to Alice for $500, contract law will enforce what a reasonable person would believe the terms mean, namely the sale of your piano for $500. It doesn’t matter if you unreasonably thought that “piano” meant your toy electric keyboard or that $500 meant $300 (unless, as we will see, Alice knew what you thought73).

Under the objective approach, contract law commonly incorporates multiple sources of contextual evidence. This should be no surprise in light of the overall goal of determining what a reasonable person would believe the language means under the circumstances.74 (I used to say “surrounding circumstances,” but a student told me that’s redundant). The circumstances include “all writings, oral statements, and other conduct by which the parties manifested their assent, together with any prior negotiations between them and any applicable course of dealing, course of performance, or usage.”75 In addition, the nature of the exchange itself is evidence of the meaning of the contract. For example, suppose you hire Alice to build a barn. You and Alice argue over when payment is due because the contract is unclear. In construction contracts of this nature, payment is not due until the contractor has substantially performed. Congratulations, you won’t have to pay until Alice has substantially built the barn. (We study substantial performance in Chapter 8.) Now let’s consider the most important sources of evidence in more detail.

a.Purposive Interpretation

Evidence of the parties’ purpose in making the contract is probative of a reasonable person’s understanding of language.76 For example, suppose an installment sales contract sets forth a schedule for the delivery of 7500 humidifiers and then provides that “the above release schedule [is] to be reviewed quarterly.”77 After accepting a number of humidifiers, the purchaser refuses to accept any more and claims that the provision requiring review allowed it to cancel after any quarter. Evidence of preliminary negotiations, drafts, and other conversations show that the purpose of the clause was to allow the parties to change the delivery schedule, not to give the purchaser the right to cancel after each quarter. A court therefore should have little trouble interpreting the language in this way and finding the purchaser in breach.78

Evidence of purpose may be inconclusive, of course. Suppose a seller and purchaser of a commercial lot include a satisfaction clause in Article 4.1 of their contract. The clause sets forth an inspection period so that the purchaser can investigate various factors, such as permits, licenses, and government requirements pertaining to the purchaser’s intended use of the property. Clause 4.1 also states that at the end of the inspection period the earnest money the purchaser paid becomes non-refundable. Now suppose Article 4.3 of the contract authorizes the purchaser “in its sole and absolute discretion” to terminate the contract if the property “is not suitable for Buyer’s intended use.” Under the same Article, the purchaser must notify the seller in writing “on or before the last day of the Inspection Period.”

The purchaser seeks to terminate the contract because it has lost a prospective tenant. You may have guessed that my imagination is not so fertile, and that this is a real case. You are correct.79 The majority and dissent could not agree on whether the purpose of Article 4.3 was to release the purchaser for losing the tenant or whether the Article was limited to reasons related to Article 4.1. The majority held that the contract was ambiguous on this issue and remanded the case for a trial.

b.Usage of Trade, Course of Dealing, and Course of Performance

A second source of evidence is any applicable usage of trade (also called a “trade custom”), course of dealing, or course of performance. I have grouped these sources together because they are equally important tools for finding the meaning of contract terms (notwithstanding the cry of textualists), and because most lawyers usually think of them as a group. All of them constitute objective evidence of the meaning of words because they go beyond the parties’ own claims about their intentions. Usage of trade shows what other similarly situated parties mean when they use the language, while course of dealing and course of performance rely on the parties’ prior conduct to show the meaning of their language.

The UCC defines each of these sources of evidence, and I will use the UCC definitions for purpose of discussion. But you should understand that courts utilize this evidence in a wide variety of cases outside sales of goods.80

According to the UCC, “[a] usage of trade is any practice or method of dealing having such a regularity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question.”81 Notice that the definition is broad enough to allow for the possibility that a party will be bound to a usage of trade even though she is not a member of the trade, if she should reasonably expect the trade meaning to apply because it is regularly observed in the place she is doing business.82 Further, a usage of trade does not have to be “ancient or immemorial,” or practiced by literally everyone in the trade, but only “regularly observed” over a reasonable period of time by “the great majority of decent dealers.”83

A footnote in Pacific Gas and Electric Co. v. G.W. Thomas Drayage & Rigging Co. supplies lots of examples of trade usage:

Extrinsic evidence of trade usage or custom has been admitted to show that the term “United Kingdom” in a motion picture distribution contract included Ireland (Ermolieff v. R.K.O. Radio Pictures (1942) 19 Cal.2d 543, 549–552, 122 P.2d 3); that the word “ton” in a lease meant a long ton or 2,240 pounds and not the statutory ton of 2,000 pounds (Higgins v. Cal. Petroleum, etc., Co. (1898) 120 Cal. 629, 630–632, 52 P. 1080); that the word “stubble” in a lease included not only stumps left in the ground but everything “left on the ground after the harvest time” (Callahan v. Stanley (1881) 57 Cal. 476, 477–479); that the term “north” in a contract dividing mining claims indicated a boundary line running along the “magnetic and not the true meridian” (Jenny Lind Co. v. Bower & Co. (1858) 11 Cal. 194, 197–99) and that a form contract for purchase and sale was actually an agency contract (Body-Steffner Co. v. Flotill Prods. (1944) 63 Cal.App.2d 555, 558–62, 147 P.2d 84).84

You can see from these examples that evidence of trade usage may trump any different dictionary definition in ascertaining the meaning of contract language. This is appropriate when a party reasonably should expect the trade meaning to control: “[O]ne cannot understand accurately the language of * * * trades without knowing the peculiar meaning attached to the words which they use.”85

The UCC also defines a course of dealing: It is a “sequence of previous conduct between the parties to a particular transaction which is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct.”86 Suppose in previous contracts for the delivery of a “ton” of coal, the seller has always delivered a long ton of 2,240 pounds and not a statutory ton of 2,000 pounds. This “course of dealing” evidence would be relevant to show that the purchaser reasonably expected the seller to deliver 2,240 pounds under the present contract.

Finally, a course of performance involves “repeated occasions for performance by either party” where the other party has “knowledge of the nature of the performance and opportunity for objection to it * * *.”87 If the other party does not object, the course of performance is “relevant to determine the meaning of the agreement.”88 The main difference between a course of dealing and a course of performance lies in when the conduct takes place. If the conduct occurred as part of a particular contract it is called a course of performance. If the conduct occurred prior to the contract at issue it is called a course of dealing.

Course of performance evidence is relevant in at least two ways. First, the evidence may help prove a contract modification or waiver of express terms. If you agree to mow Alice’s lawn every Saturday during the summer, but during the month of July you actually mowed every Sunday without Alice’s objection, you can persuasively argue that your course of performance establishes a modification agreement allowing Sunday mowing (there are no peaceful days in my neighborhood either). Second, course of performance evidence may help determine what a reasonable person would believe an ambiguous agreement means. If your contract to mow Alice’s lawn says only that mowing shall take place at a reasonable time and you show up repeatedly without Alice’s objection on Sundays at 9 a.m., a court likely will find that this time is reasonable.

Some analysts object to use of course of performance as an interpretive tool. They claim that incorporating parties’ previous conduct as a mode of interpretation has the perverse effect of making the parties more inflexible and uncooperative.89 Critics argue that parties who act cooperatively lose the right in the future to insist on performance according to the express contract. For example, when Alice lets you mow her lawn on a few successive Sundays, although the contract calls for mowing on Saturdays, she may lose the right to insist that you mow on Saturdays.90 Therefore, to avoid losing her rights, she must rigidly insist on Saturday performance at all times. If contract law did not consider course of performance evidence, obviously Alice would not have this concern about losing contract rights, and she could afford to be more flexible.

What these critics miss, however, is that Alice can preserve her contract rights at a very low cost.91 Remember, to establish a course of performance, you must prove that there have been “repeated occasions for performance,” that Alice has actual “knowledge of the nature” of those performances, and that she has had an opportunity to object.92 With such stringent standards, Alice does not have to expend resources monitoring (checking up on) your performance for fear of losing rights. Further, under UCC section 2–208(1), a course of performance must be “accepted or acquiesced in without objection * * *.”93 Therefore, Alice can accept performance on Sunday, but reserve her right to performance on Saturdays in the future,94 and a verbal reservation should suffice.95 With these ground rules, a party should not have to worry too much about inadvertently losing contract rights.

Courts have had little trouble determining when the parties have established a course of performance and whether a party has reserved rights.96 Many cases finding a course of performance require repeated performances without any form of protest at all. For example, in Margolin v. Franklin,97 purchasers of a car agreed to pay in installments. The seller accepted payment at least eight days late for seven months and then repossessed the car the following month.98 Although the seller claimed to have sent “reminder notices,” the court accepted one of the purchaser’s testimony that the seller sent only one notice and then told the purchaser it sent the notice by mistake. The court found that “the testimony and exhibits indicate a pattern of conduct on the part of [the seller] to accept payments from the [purchasers] on or before the 27th day of each month.”99 In Oregon Bank v. Nautilus Crane & Equipment Corp.,100 the seller of equipment authorized certain repair work and promised to credit the buyer’s account for the cost of the repairs, despite a warranty disclaimer in the contract. Further, the seller met with the buyer “on the average of three times per week” for over a year without mentioning the warranty disclaimer.101 The court therefore denied seller’s motion for summary judgment to determine whether the course of performance overrode the warranty disclaimer.

Before we leave trade usage, course of dealing, and course of performance, you may be wondering what happens if these sources of evidence contradict each other or contradict express terms in the contract. Both the second Restatement of Contracts and the UCC establish the same hierarchy for resolving such matters. Specifically, express terms trump the other sources of evidence.102 Course of performance prevails over course of dealing and trade usage, and course of dealing defeats trade usage.103 Contract law bases this hierarchy on the degree of likelihood that each kind of evidence reveals the parties’ real intentions (with express terms being the most likely).

Recall that the UCC’s parol evidence rule allows evidence of a course of dealing, usage of trade, or course of performance to explain or supplement express terms, but not to contradict them.104 This, of course, is consistent with the UCC’s preference for express terms discussed here. Courts have not been consistent, however, differentiating between evidence that explains or supplements and evidence that contradicts.105 As with other issues involving the parol evidence rule, the trend here seems towards admissibility of evidence, with courts increasingly finding that the evidence “explains or supplements,” even when it seems otherwise.106

c.Other Rules of Interpretation

Courts often set forth many additional aids for interpreting contracts. For example, one common rule is that courts construe ambiguous language against the drafter.107 Suppose a nine-hole golf course holds a tournament in which each player is to play eighteen holes (two times around the course). The golf course promises $1000 to anyone who makes a hole-in-one on the eighth hole. Taylor Plantations scores a hole-in-one on the eighth hole, but the second time around so that it is his seventeenth hole of the tournament. Should he win the $1000? Many courts would find for Taylor because the golf course created an ambiguity about whether it required a hole-in-one on the eighth hole of the tournament or the eighth hole of the golf course.108 But as a general matter, the drafter should be let off the hook if two sophisticated businesses painstakingly negotiate a contract that one of them memorializes in a writing.109

Here are some additional rules of interpretation that almost speak for themselves. Parties intend to incorporate the common meaning of language, not an unusual definition.110 Specific language trumps general language.111 Courts favor an interpretation that upholds a contract instead of defeats it.112 An interpretation that furthers the public interest trumps a different interpretation.113 Terms should be interpreted with the meaning of the whole contract in mind.114 Maybe you think I’m not spending enough time on these rules. But the rules are of limited importance. The problem with these and other rules of interpretation of this nature is that courts often trot them out to support a decision that they have made on other grounds and ignore them when they don’t serve the court’s purpose.115 In fact, these rules may have little clout at all, except as after-the-fact rationalizations of results.116

2.Exceptions to the Objective Interpretation of Contracts

Several rules of interpretation constitute exceptions to the objective interpretation of contract language. We take them up here.

a.Restatement (Second) Section 201

If both parties intend a particular meaning, contract law enforces that meaning, even if it contradicts the objective interpretation of the language.117 Recall that Alice offered evidence that you and she meant $300, not $500, in your contract for the sale of your piano.118 If that evidence survives the parol evidence rule, contract law will interpret the language in the manner you both intended, even though to us reasonable people $500 means $500.119 This rule should be no surprise. It is consistent with freedom of contract and supports all of the “intentions of the parties” and “meeting of the mind” flag waving in the opinions. The problem is that courts rarely receive cases where they can enforce parties’ mutual, but unreasonable, interpretations of language. In the usual litigated case, each party is trying to prove that her interpretation of the language is the reasonable one. You can comfortably think of the “both parties intend the same unusual meaning” rule as an exception to the objective interpretation of language.

Now suppose you know or have reason to know that Alice believes the meaning of $500 is $300, and she does not know nor have reason to know that you believe she must pay you $500. Alice’s meaning prevails.120 The Restatement (Second) states the rule, which is easier to understand if we plug in our heroes:

Where the parties have attached different meanings to a promise or agreement or a term thereof, it is interpreted in accordance with the meaning attached by one of them [Alice] if at the time the agreement was made

(a)that party [Alice] did not know of any different meaning attached by the other [you], and the other [you] knew the meaning attached by the first party [Alice]; or

(b)that party [Alice] had no reason to know of any different meaning attached by the other [you], and the other [you] had reason to know the meaning attached by the first party [Alice].121


What approach if the contractual language is ambiguous and the parties have assigned different meanings to the language? This problem first came up in the wonderful case of Raffles v. Wichelhaus,122 which appears in virtually every contracts casebook.

In Raffles, the contract called for the plaintiff to sell cotton scheduled to arrive on a ship called the “Peerless.” The buyers refused to take the cotton, claiming that the cotton arrived on a ship called the Peerless that sailed from Bombay in December and that the buyers had intended to buy cotton arriving on another ship called the Peerless that sailed from Bombay in October. The seller tested the legal sufficiency of the buyers’ defense by demurring. The issue before the English Court of Exchequer, therefore, was whether to excuse the buyers, assuming there was more than one ship called “Peerless” and the seller and buyers were thinking of different ships.

The report of the case consists of interchanges between the lawyers and judges during the oral argument of the case, to the endless entertainment of law students trying to figure out what is going on. In fact, the actual decision consists of one line from the judges declaring per curiam that the buyers’ defense was legally sufficient. The court issued this decision after the buyers’ lawyer argued that the existence of two ships named Peerless created latent ambiguity and that the court should admit evidence to show that the seller and buyers were thinking of different ships.

From this case we can glean the law of misunderstanding. A misunderstanding exists when (1) the parties’ contract is ambiguous, meaning that it is reasonably susceptible to more than one meaning; (2) the parties actually had in mind different interpretations of the language; and (3) the misunderstanding is material (or important). When all of these elements are satisfied, the contract is unenforceable.123 Contract law declines to enforce the contract because “[i]f neither party can be assigned the greater blame for the misunderstanding, there is no nonarbitrary basis for deciding which party’s understanding to enforce, so the parties are allowed to abandon the contract without liability.”124

In Raffles (where we can assume the facts most favorable to the buyers for purpose of the seller’s demurrer), the contract was ambiguous because two ships sailed under the name Peerless. A reasonable person reading the contract would not have known which Peerless was the subject matter of the contract. Further, the parties actually were thinking of different ships. (You have just learned that if the buyers actually knew that the seller was thinking of the December Peerless, the seller’s meaning would prevail.125) Finally, the misunderstanding was material (important) because one Peerless sailed in October and one in December.

Suppose there was only one Peerless and the contract called for delivery on that ship. But for reasons that are hard to explain (just go with the hypo), the seller believes he is supposed to deliver the cotton on a ship called the Intrepid and the buyers believe they are supposed to purchase cotton from a ship called the Inferno. According to the rules of objective interpretation, the parties are bound to buy and sell using the Peerless even though neither party intended that result. Contract law can’t be this obtuse, and I doubt that a court would use objective interpretation, but a comment in the first Restatement suggests otherwise.126

3.Rules of Gap Filling

If contracting parties leave a gap with respect to an essential term, or leave so many gaps that a court simply doesn’t know what to enforce, the court will declare the contract unenforceable for indefiniteness.127 Well, I’m only one sentence into this subsection and I already have to mention two exceptions to the indefiniteness rule. Courts sometimes (but sparingly) fill essential gaps by supplying a term if it supports the parties’ purposes for making the contract.128 Courts also fill a gap if the gap arose because the parties reasonably could not have foreseen supervening (post contract) circumstances.129 In fact, it may be fair to say that, despite the general rule of indefiniteness, courts want to fill gaps for the parties, rather than give up on their contract.130

Parties may leave gaps for many reasons. A problem may be unforeseeable at the time they contract, or, at least, may have been unforeseen by them. You agree to mow Alice’s lawn on Saturdays, but you and Alice do not foresee that it would rain every Saturday in June and July. Do you have to mow on an another day? Which day? Alternatively, parties may understand the existence of an issue, but choose not to deal with it in their contract because they believe they cannot resolve it.

For an example of drafters strategically leaving a gap, consider the recent U.S. Supreme Court case, M&G Polymers USA, L.L.C. v. Tackett, where the issue was whether retired employees were entitled to lifetime healthcare benefits under a collective bargaining agreement that never clearly reached the issue.131 At oral argument, Justices Alito and Scalia were a bit incredulous that the parties left this gap. Justice Alito asked directly why the parties left this gap. Justice Scalia remarked that “this thing [the duration issue] is obviously an important feature. Both sides knew it was left unaddressed, so you know, whoever loses deserves to lose for casting this upon us when it could have been said very clearly in the contract. Such an important feature.”132 But the drafters may have left the gap strategically. They may have been willing to live with uncertainty because raising the issue during bargaining might have led to an unsatisfactory outcome for one side or the other.133

Drafters also leave gaps because they believe the issue is too remote to worry about. Let’s leave the heady Supreme Court discussion above and return to you and Alice and the rain-on-Saturday issue. You both understand the unpredictability of weather, but c’mon, what are the chances it is going to rain every Saturday? (Unfortunately, the chances are high in Ithaca, N.Y., where I live.)

Determining exactly when a court is filling a gap or simply interpreting a contract sometimes challenges lawyers. Suppose that in previous summers, you always mowed on the next clear day if it rained on Saturday. A court may find that this year’s contract requires you to mow on the next clear day. But is the court supplying a term for the parties or interpreting contractual language and the circumstances to determine the term the parties intended for themselves?

Bear in mind also that the objective-interpretation strategy of courts is similar to gap filling because the court enforces what a reasonable person would believe a contract means, not necessarily what the parties actually intended. Notwithstanding the ambiguous line between interpretation and gap filling, the following discussion focuses on judicial solutions after the court concludes that the parties failed to include an important term, meaning that they have left a gap in their contract.

We now look at several “sources of gap filling,” which constitute the various justifications for the terms courts supply to fill gaps in agreements. For example, a court may fill a gap in a certain way, believing that the parties would have contracted that way had they thought about the matter. Alternatively, a court may decide that a particular gap filler creates appropriate incentives for future parties. Or a court may fill a gap in a manner that the court believes is fair to the contracting parties or that protects third parties. And so on. This subsection takes up the most common judicial gap-filling approaches.

a.What the Parties Would Have Done

Courts that fill gaps based on what the parties would have done had they contracted on the issue can support their decision by invoking freedom of contract.134 By asking what you and Alice would have done about the miserable Saturday weather had you thought about the issue, a court reasons that it is simply facilitating the parties’ own contractual arrangements. Of course, this is largely a fiction, especially to the extent that it is difficult to determine what you would have done.

This strategy of gap filling also appeals to analysts who apply economic reasoning to legal problems. We already have discussed the economic perspective on gap filling in Hadley v. Baxendale.135 Recall that a contract between the miller and carrier for the carrier to transport the miller’s broken crank shaft said nothing about what happens if the carrier delays and the miller suffers lost profits as a result. How should contract law fill the gap? One answer is with the term the parties would have wanted.136 Why? Because this strategy serves economic efficiency. Private exchange is efficient because each party gains more than the party gives up. Carriage of the crankshaft was worth more to the miller than the price of carriage and the price was worth more to the carrier than its cost of carriage. The miller-carrier contract therefore moves resources to “higher valued uses.”137 Contract law’s goal should be to reduce the costs of transactions, such as the cost of bargaining to reach an agreement, because this will increase the gains from contracting. By filling gaps with the terms the parties would have wanted, future parties do not have to invest resources bargaining over terms, such as whether carriers are liable for lost profits if they delay.138

But what term would the parties have wanted in Hadley? We have learned that economic analysts reason that the parties would have allocated the risk of lost profits to the party who can deal with the problem most inexpensively. This is either the “superior risk bearer,” the party better able to accept the risk, such as by purchasing insurance, or the “superior risk avoider,” the party who can better prevent the loss from occurring in the first place.139 Such reasoning is consistent with the idea that the goal of the parties is to maximize their gains from the transaction. In Hadley, for example, the superior risk bearer may be the miller, who can insure most cheaply against the risk of a broken crank shaft. The miller therefore should bear the risk of the carrier’s delay.

We have already pointed out the shortcomings of this analysis.140 One can argue that the carrier should be liable for the lost profits because it can take precautions to ensure delivery of the crank shaft on time more cheaply than the miller can insure against the risk of a broken shaft.141 On the other hand, the miller can avoid the problem by owning a spare crank shaft, which should not be very expensive. But all of this is pretty speculative in most cases and, ultimately, not a very convincing method of filling gaps.142

b.Creating Incentives

A court filling a gap may feel free to try to create incentives for future contracting parties. We have already discussed what may be the best example of this process, and again Hadley served as our illustration.143 We saw that commentators treat Hadley as an example of a “penalty default,” which penalizes the miller for failing to reveal the ramifications of tardy delivery (the loss of profits). The miller’s penalty is that it cannot recover the lost profits.144 Further, were it not for the Hadley rule, the miller would have an incentive not to disclose. The information would lead the carrier to raise its price of carriage because it would be taking a greater risk (assuming that most millers do not suffer lost profits due to a carrier delay).145 In sum, penalty-default theorists assert that Hadley creates incentives for the miller to reveal information and for the carrier to select the appropriate level of precaution.146

We also saw that the “penalty default” gap-filling strategy is controversial. Specifically, the cost of revealing information may outweigh the gain even for the miller.147 Still, courts may find very alluring the idea of crafting substantive gap-filling provisions for the purpose of creating positive incentives to disclose information.

c.Fairness Concerns

Courts also fill gaps based on their view of what is fair in the circumstances. For example, a court may consider a particular gap filler’s effect on the potential gains and losses of each party.148 Let’s revisit our lawn-mowing contract. What are the ramifications of requiring you to mow Alice’s lawn on the first dry day if it rains on Saturday? Perhaps you have counted on working only on Saturdays and took another job on other days. A court may consider whether filling the gap by requiring you to work on the next dry day would cause you considerable harm. On the other hand, perhaps Alice has relied on you to mow as soon as possible after a rainy Saturday because she is trying to sell her house and wants the yard to look presentable. You can see that the potential gains and losses analysis only helps a court select the appropriate gap filler if one party’s needs greatly outweighs the other’s.

Now let’s look at an example from the business context. Suppose a domestic oil supplier seeks relief from a fixed-price, long-term supply contract with an electric utility after an international disruption in oil supply causes the price of oil to skyrocket. The supplier claims that the parties did not contract about performance in the face of a catastrophic disruption and that, if forced to perform, it will go bankrupt. We will see in Chapter 9 that some courts will entertain such an argument even though the supply contract contains an unconditional promise by the supplier to perform.149 The usual explanation is that the court believes the parties reasonably failed to foresee a disruption of such proportions and, hence, left a gap with respect to it. If the supplier will go bankrupt by performing, and the utility can raise the price it charges customers (me and you), a court may fill the gap by placing the risk of the international disruption on the utility (which means excusing the supplier). In doing so, the court averts disproportional harm to the supplier, without harming the utility. We consumers bear the loss, but remember, we are only going to pay fair market value for our electricity; it’s just that the market value takes into account world events.

Courts also fill gaps to try to assure that each party enjoys the fruits of her contract.150 Obviously, this does not mean that contract law assures each party of making a profit on every contract. Circumstances change and one party may be disappointed with how the exchange turns out. Nevertheless, courts avoid using gap fillers that would be catastrophic to one party and a windfall for the other. Instead they prefer solutions that would roughly preserve the benefit of the bargain for each party.

OK, you are thirsting for an example of this point too. Suppose Alice promises to supply water to your rural vacation home through a well on her nearby property. You promise to pay her $10 on Monday of each week. After months of successful performance on both sides, you show up to pay on a Tuesday instead of Monday. Alice claims you have materially breached the contract and she is relieved of her duty to supply any water in the future. The contract says nothing about what happens if you are a day late in tendering payment. You cannot get another water supply for your home.

This problem involves the law of implied conditions and material breach, subjects we treat in Chapter 8.151 For our purposes here, all we have to know is that the court has a choice of filling the gap in your contract by finding that Alice can cancel the contract because you are late, or by finding that Alice must perform notwithstanding your broken promise to pay on Mondays. You are probably not surprised to learn that courts likely will choose the latter provision (and force you to pay Alice any damages she sustains because of the delay in payment).

Fairness also takes into account the reasonableness of the parties actions.152 Courts tend to select gap filling terms that favor a party who acts reasonably. Conversely, of course, courts frown on unreasonable behavior in selecting gap fillers. Determining what is reasonable involves comparing a contracting party’s conduct with that of similarly situated parties or with community standards.153

Suppose, for example, a supplier of molasses to a manufacturer promises to deliver approximately “1,500,000 wine gallons * * * of the usual run from the National Sugar Refinery.”154 The supplier does not contract with National Sugar for the molasses, but assumes that the latter will produce a sufficient quantity. The refinery produces only about 344,000 gallons for the supplier, which it delivers to the manufacturer. The manufacturer sues the supplier for breach of contract. The supplier claims that the contract says nothing about what happens if National Sugar does not produce enough molasses. However, if similarly situated suppliers would have contracted with National Sugar to assure that it produced the necessary amount of molasses, and our supplier failed to do so, it is unlikely that a court would excuse the supplier. In fact, a court considering almost identical facts held that the supplier acted unreasonably in failing to secure a contract with National Sugar.155

4.Good-Faith Performance

You have already encountered the obligation of good faith. For example, we saw that UCC section 2–209 authorizes courts to strike a contract modification agreement made in bad faith.156 The concept of good faith purchase, beyond the scope of this book, is another use of the good-faith principle.157 Courts also impose an obligation of good faith performance, which is the subject matter for discussion here. Actually, we have already discussed good faith performance in Chapter 2, in the context of the mutuality-of-obligation problem.158 We now look further at the question of what it takes for a party to be in good faith or bad faith. We study the subject here because courts decide the question through the processes of interpretation and gap filling.

The best way to understand good faith performance is to think of the principle as excluding various forms of bad faith performance.159 Restatement (Second) section 205 uses this model:

[t]he phrase ‘good faith’ is used in a variety of contexts, and its meaning varies somewhat with the context. Good faith performance or enforcement of a contract * * * excludes a variety of types of conduct characterized as involving ‘bad faith’ because they violate community standards of decency, fairness or reasonableness.160

But how do courts determine the kinds of conduct that “violate community standards” in the context before them? To find out, we now take up two examples of conduct that courts have ruled out, namely asserting an overreaching interpretation of contract language and failing to cooperate.

a.Overreaching Interpretation

Suppose a written employment contract grants a salesperson commissions on sales in excess of certain minimum sales requirements. The contract also grants the employer the right to raise the sales quota retroactively without prior notice or reason in the employer’s “sole discretion” and therefore to reduce the employee’s commissions. The employer raises the sales quota. The employee claims the employer did so in bad faith, solely to deprive the employee of earned compensation.161 To determine whether the employer’s actions were in bad faith, the court must interpret the contract to determine whether the employer had the right to raise the quota in order to diminish the employee’s compensation. If through interpretation or gap filling, the court concludes that the employer did not have such a right, then the court would find bad faith, assuming, of course, that the employee proved that the employer’s motive was solely to reduce the employee’s compensation.

At first blush, it looks like the employer simply exercised an express contract right and so motives are irrelevant. Remember, the contract expressly says that the employer has the right to raise the sales quota retroactively without prior notice or reason. How can an employer’s conduct constitute bad faith when the contract seems to expressly authorize the employer’s actions?162 We have learned that courts find the meaning of contract terms by looking at the circumstances in which the parties used them. Further, courts interpret language objectively, meaning according to a reasonable party’s understanding of the words. So, the question in the sales-quota scenario is whether, under all of the facts, the employee should reasonably have understood the contract to allow the employer retroactively to increase the sales quota solely to reduce the employee’s compensation.

Courts have recognized that terms that appear to allow a party sole discretion do not necessarily allow the party to exercise the discretion in an “arbitrary or unreasonable” manner.163 In Tymshare, Inc. v. Covell, a case involving a sales quotas very similar to our hypothetical, then Judge Scalia described the concept:

[A]greeing to such a provision would require a degree of folly on the part of these sales representatives we are not inclined to posit where another plausible interpretation of the language is available. It seems to us that the ‘sole discretion’ intended was discretion to determine the existence or nonexistence of the various factors that would reasonably justify alteration of the sales quota. Those factors would include * * * an unanticipated volume of business from a particular customer unconnected with the extra sales efforts of the employee assigned to that account; and * * * a poor overall sales year for the company, leaving less gross income to be expended on commissions * * *. But the language need not (and therefore can not reasonably) be read to confer discretion to [increase] the quota for any reason whatever—including * * * a simple desire to deprive an employee of the fairly agreed benefit of his labors.164

This reasoning is typical in cases involving good faith performance and shows that the source of good faith lies on the border between contract interpretation and gap filling. Judge Scalia thought that the parties probably did not intend to allow the employer to reduce the employee’s compensation retroactively and arbitrarily because a reasonable employee would not agree to such an arrangement and a reasonable employer would not seek it.165 Reasonable parties, in other words, intend to incorporate the meaning of terms society would find fair and just.

Suppose the quota provision expressly permitted the employer to change the sales quota at any time “for the sole purpose of reducing or eliminating the employee’s earned commissions?” Such a term would leave little room for the kind of argument made by Justice Scalia that the language of the agreement does not bar relying on the spirit of the agreement. In short, the employer would not be asserting an overreaching interpretation of contract language and use of the term would not be bad faith, at least in courts that take seriously the language of the written contract.166 Recall, however, that such a provision might be unconscionable under the tests we developed in Chapter 6.167

b.Failing to Cooperate

Contracting parties often know each other, having dealt with each other repeatedly during the performance of a long-term contract or over a series of contracts.168 Parties to such contracts should not expect their counterparts to act as fiduciaries (meaning to place the interests of the other party above their own), but they do reasonably expect cooperation and flexibility.169 In light of these expectations, good faith performance may rule out uncooperative conduct even when the express contract terms do not.

The issue comes up, for example, when one party fails to share important information with the other party. Suppose a landlord has been sending notices to a tenant reminding her of her obligations, such as paying taxes or utility bills. The landlord knows that the time for exercising an option to renew the lease will expire in three days and that the tenant is not aware of this. The landlord wants to deter the tenant from exercising the option to renew because the landlord can charge a higher rent on the open market. Despite notifying the tenant about other legal duties, the landlord does not alert the tenant about the option to renew.

The landlord does not have a fiduciary duty here and the parties’ lease does not expressly require the landlord to send a notice about the option to renew. The tenant only has rights if the landlord had a good-faith performance obligation to notify the tenant.

In circumstances similar to these, Judge Posner found a good-faith obligation to cooperate, which he characterized as “halfway between a fiduciary duty * * * and the duty merely to refrain from active fraud.”170 Posner justified his findings not based on fairness or justice, but by considering what the parties would have intended had they contracted with respect to the issue: Good faith performance “is a stab at approximating the terms the parties would have negotiated had they foreseen the circumstances that have given rise to their dispute.”171 Posner concluded that the parties would have agreed to cooperate, and would not have allowed the landlord to lull the tenant into losing her right to renew the lease.

Posner’s effort to define good-faith performance by finding “what the parties would have intended” should not surprise you. We have seen that his general formula for filling gaps follows this approach. In his view, good-faith performance is simply what the parties would have wanted. In fact, Posner has gone as far as to say that good faith is an unnecessary diversion.172 For example, in the context of a seller who refused to perform without a price increase where the buyer had no choice but to accede to the seller’s demand, Posner comments:

Courts might describe the seller’s conduct * * * as coercive, extortionate, or in bad faith, but all they would mean by these highly charged words * * * would be that an implicit term of every contract (unless disclaimed) is that neither party shall take advantage of a temporary monopoly, conferred by the contract * * *. One can if one wants denounce the temporary monopolists’s conduct as wrongful, but the adjective adds nothing to the analysis.173

Of course, the phrase “tak[ing] advantage” in Posner’s definition is also “highly charged” and requires an investigation of the fault-based motives of the seller and the circumstances of the buyer. For example, we have seen that a seller who believes that changed circumstances entitle the seller to more consideration would not necessarily be “taking advantage” of a promisee that has no market alternatives.174 And a buyer with ample substitute opportunities would not be the victim of advantage-taking even if the seller’s motive was to extract extra-contractual gains.175 “Temporary monopoly” is also a technical term meaning roughly that the buyer has no reasonable alternatives. Determining what constitutes reasonable alternatives in various contexts will also tax the courts. Posner simply may want to substitute one set of abstract concepts for another, which may not clarify issues or reduce litigation costs at all.

c.Good Faith’s Additional Functions

As with other legal categories (for example, larceny, fraud, duress, duty), good faith helps clarify the law by linking or grouping common kinds of conduct and the manner in which the law relates to this conduct.176 By denominating the issue one of “good faith modification,” for example, a court entertaining the buyer’s claim signals that the issue involves whether the seller seeks to extract additional gains by taking advantage of the buyer’s exigent position.177 Further, by denominating conduct as good or bad faith, contract law increases the incentive of contracting parties such as the seller to abide by the spirit of the contract in order to create or maintain a good reputation and good will.

1Black’s Law Dictionary 1149 (8th ed. 2004).

2See, e.g., 1 James J. White, Robert S. Summers & Robert A. Hillman, Uniform Commercial Code 124 (6th ed. 2012).

3See, e.g., 3 Arthur Linton Corbin, Corbin on Contracts 357 (1960). But see Johnson Regional Medical Center v. Halterman, 867 F.3d 1013, 1017 (8th Cir. 2017) (“ ‘When two instruments are executed contemporaneously, by the same parties in the course of the same transaction, they should be considered as one contract for purposes of interpretation, in the absence of a contrary intention.’ ”) (quoting Stokes v. Roberts, 289 Ark. 319, 711 S.W.2d 757, 759 (1986)).

4See supra note 2, and accompanying text.

5See infra notes 58–59, and accompanying text.

6See infra notes 20–23, and accompanying text.

7See Mitchill v. Lath, 160 N.E. 646 (N.Y. 1928).

8Id. at 647 (“Is it also implied that the defendants are not to do anything unexpressed in the writing?”).

9Id. (“Were such an agreement made it would seem most natural that the inquirer should find it in the contract.”).

10Marinelli v. Unisa Holdings, Inc., 655 N.Y.S.2d 495, 496 (App. Div. 1997) (“[T]he standard for the introduction of an oral promise was satisfied here. The * * * agreements are collateral, they do not conflict with the [written] agreement and they would not reasonably be expected to be found there.”).

11160 N.E. 646 (N.Y. 1928).

12Id. at 647.

13Id. at 649 (Lehman, J. dissenting) (“The plaintiff’s assertion of a parol agreement by the defendants to remove the ice house was completely established by the great weight of evidence.”).

144 S. Williston and W. Jaeger, A Treatise on the Law of Contracts 1014 (Richard A. Lord ed., 4th ed. 1990).

15Id. at 1015–16 (“ ‘If we may go outside of the instrument to prove that there was a stipulation not contained in it, and so that only part of the contract was put in writing, and, because of that fact, enforce the oral stipulation, there will be little of value left in the rule itself.’ ”) (citation omitted).

16Id. at 1014.

17See, e.g., E. Allan Farnsworth, Contracts 422 (4th ed. 2004).

18See John D. Calamari & Joseph M. Perillo, A Plea for a Uniform Parol Evidence Rule and Principles of Contract Interpretation, 42 Ind. L.J. 333, 341 (1967).

193 Corbin, supra note 3, at 442.

20“[I]t can never be determined by mere interpretation of the words of a writing whether it is an ‘integration’ of anything * * *.” Id. at 441.

21See, e.g., Tangren Family Trust v. Tangren, 182 P.3d 326 (Utah 2008).

22See Harrison v. Fred S. James, P.A., Inc., 558 F. Supp. 438, 442 (E.D. Pa. 1983) (“[W]hen a writing contains an integration clause which expressly provides that the written instrument contains the entire agreement of the parties, it is conclusively presumed to do so * * *.”); see also Christy v. Travelers Indem. Co. of Am., 810 F.3d 1220, 1227 (10th Cir. 2016) (“A standard integration clause * * * merges any prior or contemporaneous agreements into the final written contract, and it limits the parties’ agreement to the final written contract”).

23See, e.g., Farnsworth, supra note 17, at 424 & n.37 (citing cases); see also Andy Mohr Truck Center, Inc. v. Volvo Trucks N.A., 869 F.3d 598, 608 (7th Cir. 2017) (“[M]ere existence of an integration clause * * * does not control whether a writing was intended to be completely integrated.”).

24See, e.g., Jacked Up, L.L.C. v. Sara Lee Corp., 854 F.3d 797, 805 (5th Cir. 2017) (“ ‘[I]f the contract is ambiguous, ‘its construction is then a question of fact, and parol evidence is admissible to explain and ascertain what the parties intended.’ ”) (quoting Farm Credit Bank of St. Louis v. Whitlock, 581 N.E.2d 664, 667 (1991)); Gold Kist, Inc. v. Carr, 886 S.W.2d 425, 429 (Tex. App. 1994).

25See, e.g., General Refractories Co. v. First State Ins. Co., 855 F.3d 152, 159 (3d Cir. 2017); Uncle Henry’s Inc. v. Plaut Consulting Co., 399 F.3d 33, 47 (1st Cir. 2005); Coker v. Coker, 650 S.W.2d 391, 393 (Tex. 1983).

26See Gold Kist, Inc., 886 S.W.2d at 429; see also Gateway Customer Solutions, LLC v. GC Serv. Lim. Partnership, 825 F.3d 502 (8th Cir. 2016) (plain meaning applies when contract is not ambiguous); Prochazka v. Bee-Three Devel., LLC, 466 S.W.3d 448 (Ark. Ct. App. 2015) (same); Grand Wireless, Inc. v. Verizon Wireless, Inc., 748 F.3d 1 (1st Cir. 2014) (New York applies the plain meaning rule).

27See supra notes 16–17, and accompanying text.

28442 P.2d 641 (Cal. 1968).

29Id. at 642.

30Id. at 646 n.8.

31Id. at 644.

32Id. at 644–45.

33See, e.g., Trident Ctr. v. Connecticut Gen. Life Ins. Co., 847 F.2d 564, 569 (9th Cir. 1988).

34See supra note 4, and accompanying text.


36Pac. Gas & Elec. Co., 442 P.2d at 644.

37Id. (emphasis supplied); see also Kunkel v. C.I.R., 821 F.3d 908, 910 (7th Cir. 2016) (“When considering parol evidence a court looks to documents, and sometimes to oral exchanges, but never considers either side’s private thoughts and hopes.”).

38Id. at 645 (emphasis supplied).

39Eskimo Pie Corp. v. Whitelawn Dairies, Inc., 284 F. Supp. 987 (S.D.N.Y. 1968).

40See infra notes 80–106, and accompanying text.

41The case reports overflow with decisions that invoke the plain meaning rule. See, e.g., Samaan v. General Dynamics Land Systems, Inc., 835 F.3d 593 (6th Cir. 2016); Gateway Customer Solutions, LLC v. GC Services Limited Partnership, 825 F.3d 502 (8th Cir. 2016). An excellent discussion of the arguments in this subsection and of additional related issues appears in Joshua M. Silverstein, Using the West Key Number System as a Data collection and Coding Device for Empirical Legal Scholarship: Demonstrating the Method via a Study of Contract Interpretation, 34 J.L. & Com. 203, 253–284 (2016); see also Robert A. Hillman, Article 2 of the UCC: Some Thoughts on Success or Failure in the Twenty-First Century, 23 Barry L. Rev. 165, 171–172 (2018) (symposium in honor of Robert S. Summers and James J. White); William C. Whitford, Jean Braucher’s Contracts World View, 58 Ariz. L. Rev. 13, 28 (2016).

42Id. at 281.

43See Chapter 6, Section (B)(1)(c).

44See, e.g., Riverisland Cold Storage, Inc. v. Fresno-Madera Prod. Credit Assoc., 291 P.3d 316 (Cal. 2013) (reversing rule that barred parol evidence to prove fraud); Culbreth v. Simone, 511 F. Supp. 906, 915 (E.D. Pa. 1981) (“Exceptions to the parol evidence rule exist to explain essential written terms in instances of fraud * * *.”).

45Farnsworth, supra note 17, at 430; but see Newburgh/Six Mile Ltd. P’ship II v. Adlabs Films USA, Inc., 724 F. Supp. 2d 740, 755 (E.D. Mich. 2010) (“[W]hen a contract contains a merger clause releasing all antecedent claims, only a certain type of fraud can vitiate the contract: fraud that invalidates the merger clause itself, i.e., fraud relating to the merger clause or fraud that vitiates the entire contract, including any merger clause.”).

46See Chapter 6, Section (B)(1)(c); see also Harrison v. Fred S. James, P.A., Inc., 558 F. Supp. 438 (E.D. Pa. 1983).

47See Ravenswood Constr., LLC v. F.L. Merritt, Inc., 936 A.2d 679, 685–86 (Conn. App. Ct. 2007) (“Professor Corbin has instructed that there is no parol evidence rule to be applied when determining any one or more of the following issues: (1) whether the parties have made a contract; (2) whether the contract is void or voidable because of illegality, mistake, fraud or some other reason, or (3) whether the parties assented to a particular writing as the complete and accurate integration of a contract. No relevant evidence, whether parol or otherwise, is excluded on these issues.”) (citation omitted); Krossa v. All Alaskan Seafoods, Inc., 37 P.3d 411, 417 (Alaska 2001) (“The parol evidence rule does not apply where a contract has been formed as a result of misrepresentation or mutual mistake.”). But see Harrison v. Fred S. James, P.A., Inc., 558 F. Supp. 438 (E.D. Pa.1983) (“In order for evidence of the prior negotiations to be admissible, plaintiff must first prove mistake.”).

48For a discussion of promissory estoppel, see Chapter 3, Section (A).

49E.g., Addicks Services, Inc. v. GGP-Bridgeland, LP, 596 F.3d 286, 301 n. 20 (5th Cir. 2010); Kinn v. Coast Catamaran Corp., 582 F. Supp. 682 (E.D. Wis. 1984); see also Farnsworth, supra note 17, at 425.

50UCC § 2–202(a).

51See infra notes 80–106, and accompanying text.

52See infra notes 105–106, and accompanying text.

53UCC § 2–202 (b).

54UCC § 2–202, cmt. 1.

55See supra notes 6–23, and accompanying text.

56UCC § 2–202, cmt. 3.

57See supra notes 14–23, and accompanying text.

58See supra notes 4–5, and accompanying text.

59Hield v. Thyberg, 347 N.W.2d 503 (Minn. 1984).

60“What is interpretation? It is the process of endeavoring to ascertain the meaning or meanings of symbolic expressions used by the parties to a contract * * *.” Edwin W. Patterson, The Interpretation and Construction of Contracts, 64 Colum. L. Rev. 833, 833 (1964).

61See Chapter 2, Section (B)(1).

62See, e.g., Gateway Customer Solutions, LLC v. GC Serv. Lim. Partnership, 825 F.3d 502 (8th Cir. 2016) (reasonable person test); Kearney v. Equilon Enterprises, LLC, 65 F. Supp.3d 1033 (D. Or. 2014); Zell v. American Seating Co., 138 F.2d 641, 647 (2d Cir. l943) (Frank, J.), rev’d, 322 U.S. 709 (1944) (per curiam) (“We ask judges or juries to discover that ‘objective viewpoint’—through their own subjective processes.”); see also Robert A. Hillman, Contract Lore, 27 J. Corp. L. 505, 510–12 (2002).

63All-Ways Logistics, Inc. v. USA Truck, Inc., 583 F.3d 511, 516 (8th Cir. 2009) (quoting Coleman v. Regions Bank, 216 S.W.3d 569, 574 (2005)).

64Kearney v. Equilon Enterprises, LLC, 65 F. Supp.3d 1033 (D. Or. 2014).

65Kearney, 65 F. Supp.3d at 1039 (quoting Sateriale v. R.J. Reynolds Tobacco Co., 697 F.3d 777, 787 (9th Cir. 2012).

66Restatement (Second) of Contracts § 201(1) (1981). See infra notes 117–119, and accompanying text.

67Farnsworth, supra note 17, at 114–15.

68Hotchkiss v. Nat’l City Bank of N.Y., 200 F. 287, 293 (S.D.N.Y. (1911).

69See, e.g., Life Plans, Inc. v. Security Life of Denver Ins. Co., 800 F.3d 343, 349 (7th Cir. 2015) (“The role of a court in interpreting a contract is to give effect to the intention of the parties as expressed in the agreed terms.”); Haber v. St. Paul Guardian Ins. Co., 137 F.3d 691, 702 (2d Cir. 1998) (Parker, J., dissenting) (“[I]t is the intent of the parties which controls the interpretation of contracts.”); Philadelphia Eagles Football Club, Inc. v. City of Philadelphia, 823 A.2d 108, 125 n.25 (Pa. 2003) (“A fundamental rule in construing a contract is to ascertain and give effect to the intent of the contracting parties”).

Even the U.S. Supreme Court makes this mistake. See Robert A. Hillman, The Supreme Court’s Application of “Ordinary Contract Principles” to the Issue of the Duration of Retiree Healthcare Benefits: Perpetuating the Interpretation/Gap-Filling Quagmire, 32 ABA Journal of Labor & Employment Law 299 (2017).

70See Chapter 2, Section (A)(5).

71See Chapter 2, Section (B)(1).

72See Hillman, supra note 62, at 511–12; McDonald v. Mobil Coal Producing, Inc., 820 P.2d 986, 990 (Wyo. 1991) (“Under the ‘objective theory’ of contract formation, contractual obligation is imposed not on the basis of the subjective intent of the parties, but rather upon the outward manifestations of a party’s assent sufficient to create reasonable reliance by the other party.”).

73See infra notes 120–121, and accompanying text.

74Farnsworth, supra note 17, at 453–54.

75Id. at 453; see also Gosiger, Inc. v. Elliott Aviation, Inc., 823 F.3d 497, 502 (8th Cir. 2016) (setting forth admissible extrinsic evidence).

76See Farnsworth, supra note 17, at 454–55; Restatement (Second) of Contracts § 202(1).

77Leslie v. Pennco, Inc., 470 A.2d 110, 112 (Pa. Super. Ct. 1983).

78Id. at 114; Keating v. Stadium Mgmt. Corp., 508 N.E.2d 121, 124–25 (Mass. App. Ct. 1987) (“[T]he construction which * * * we approve, ‘is the one which appears to be in accord with justice and common sense and the probable intention of the parties. It [interprets the Agreement] as a business transaction entered into by practical men to accomplish an honest and straightforward end * * *.’ ”) (quoting Clark v. State St. Trust Co., 169 N.E. 897, 903 (Mass 1930)).

79Prochazka v. Bee-Three Devel., LLC, 466 S.W.3d 448 (Ark. Ct. App. 2015).

80See, e.g., Restatement (Second) of Contracts § 202(4).

81UCC § 1–205(2) (now 1–303(c)); see also Restatement (Second) of Contracts § 222.

82Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772, 791 (9th Cir. 1981) (“[A] usage need not necessarily be one practiced by members of the party’s own trade or vocation to be binding if it is so commonly practiced in a locality that a party should be aware of it.”) (emphasis added). See also M&G Polymers USA, LLC v. Tackett, 135 S.Ct. 926 (2015) (trade custom must apply to the contract).

83UCC § 1–205, cmt. 5 (now 1–303, cmt. 4), quoted in Nanakuli Paving & Rock Co., 664 F.2d at 792; see also AstenJohnson, Inc. v. Columbia Cas. Co., 562 F.3d 213, 222 (3d Cir. 2009) (“[T]rade usage evidence need not demonstrate that a particular term always carries a particular meaning or that the particular meaning claimed cannot be otherwise stated.”).

84442 P.2d at 645 n.6.

85Hurst v. W. J. Lake & Co., 16 P.2d 627, 629 (Or. 1932).

86UCC § 1–205(1) (now 1–303(b)); see also Restatement (Second) of Contracts § 223.

87UCC § 2–208(1); see also Restatement (Second) of Contracts § 202(4); Jobim v. Songs of Universal, Inc., 732 F. Supp.2d 407, 416 (S.D.N.Y. 2010) (“course of performance over an extensive period”).


89See Omri Ben-Shahar, The Tentative Case Against Flexibility in Commercial Law, 66 U. Chi. L. Rev. 781, 784 (1999); Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms, 144 U. Pa. L. Rev. 1765, 1812–13 (1996).

90Precision Fitness Equip., Inc. v. Nautilus, Inc., 2011 WL 378761 (D. Colo. 2011) (“The inclusion of [a term renouncing course of dealing and usage of trade evidence] demonstrates the parties’ ex ante intent that extrinsic evidence of course of dealing and usage of trade would be inadmissible for the purpose of proving the meaning of a term in the Agreement. The Court finds that this intent should be respected.”); Dixie Aluminum Prods. Co. v. Mitsubishi Int’l Corp., 785 F. Supp. 157, 160 (N.D. Ga. 1992) (“Where, as here, there are repeated opportunities for performance by either party and repeated opportunities for objection, and where no objection is made, that course of dealing is relevant to the meaning and terms of the written agreement * * *.”); Bernstein, supra note 89, at 1812 (“The Code’s course of performance provision * * * increases the cost of agreeing to forgiving adjustments. It creates a significant risk that a series of such adjustments will be found to constitute a course of performance * * *.”).

91Schulze & Burch Biscuit Co. v. Tree Top, Inc., 831 F.2d 709, 715 (7th Cir. 1987) (“[Defendant] had sent a confirmation form containing the same arbitration provision to [plaintiff] in each of the previous nine transactions he brokered between the two parties * * *. To prevent the clause from becoming part of the contract, [plaintiff] needed only to give notice of objection within a reasonable time.”).

92See supra notes 87–88, and accompanying text.

93UCC section 2–208(1) (emphasis added).

94See Schulze & Burch Biscuit Co., 831 F.2d at 715. See also UCC § 1–207.

95Ben-Shahar, supra note 89, at 808. (“[T]he cost of verbal objections—may often be trivial.”). But see Bernstein, supra note 89, at 1813 (It will be “difficult” for parties to “negate the influence” of their conduct on how courts interpret contracts).

96See Lancaster Glass Corp. v. Philips ECG, Inc., 835 F.2d 652, 659–60 (6th Cir. 1987); Ben-Shahar, supra note 89, at 808 (“Courts have * * * consistently held that rights are waived only when the breached-against party did not protest the violation.”). But see Jason Scott Johnston, Should the Law Ignore Commercial Norms? A Comment on the Bernstein Conjecture and Its Relevance for Contract Law Theory and Reform, 99 Mich. L. Rev. 1791, 1803 (2001) (“[T]here is much too high a probability that courts will err in determining what the parties have actually done or said in their prior dealings.”).

97270 N.E.2d 140 (Ill. App. Ct. 1971).

98Id. at 142.


100683 P.2d 95 (Or. Ct. App. 1984).

101Id. at 102.

102Restatement (Second) of Contracts § 203(b); UCC §§ 2–208(2), 1–303(e). For a criticism of this hierarchy, see Eyal Zamir, The Inverted Hierarchy of Contract Interpretation and Supplementation, 97 Colum. L. Rev. 1710 (1997).

103Restatement (Second) of Contracts § 203(b); UCC §§ 2–208(2), 1–303(e).

104UCC § 2–202(a); see supra notes 50–53, and accompanying text.

105Farnsworth, supra note 17, at 473–76.

106See, e.g., Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772, 805 (9th Cir. 1981) (evidence admitted that “all suppliers to the asphaltic paving trade price protected customers” even though the express contract set “the price at seller’s posted price, with no mention of price protection * * *”); Columbia Nitrogen Corp. v. Royster Co., 451 F.2d 3 (4th Cir. 1971).

107Pauma Band of Luiseno Mission Indians v. California, 813 F.3d 1155, 1166 (9th Cir. 2015) (ambiguity interpreted against the party that caused the ambiguity); State of Or. ex rel. Dept. of Transp. v. Delta Inn, Inc., 3 P.3d 180, 186 (Or. Ct. App. 2000) (“In resolving that ambiguity, we resort, necessarily, to the ‘construe against the drafter’ principle.”). But see Joyner v. Adams, 361 S.E.2d 902, 905–06 (N.C. Ct. App. 1987) (“[The] rule [of construction against the drafter] is usually applied in cases involving an adhesion contract or where one party is in a stronger bargaining position * * *. In this case, where the parties were at arms length and were equally sophisticated, we believe the rule was improvidently invoked.”).

108See, e.g., Morrison v. Prime Tech., LLC, 2009 WL 455254, at *5 (D. Conn. 2009) (“Connecticut courts endorse this widely accepted principle of interpretation: ‘[w]here the language is ambiguous * * * we must construe those ambiguities against the drafter.’ ”) (quoting Ramirez v. Health Net of Ne., Inc., 938 A.2d 576, 586 (Conn. 2008)).

109See, e.g., Mitchell Co. v. Campus, 2009 WL 532246, at *6 (S.D. Ala. 2009) (“The exception to this general rule is that ‘[w]here both parties to a contract are sophisticated business persons advised by counsel and the contract is a product of negotiations at arm’s length between the parties, we find no reason to automatically construe ambiguities in the contract against the drafter.’ ”) (quoting Western Sling & Cable Co. v. Hamilton, 545 So.2d 29, 32 (Ala. 1989)).

110Southgate Recreation & Park Dist. v. California Ass’n for Park & Recreation Ins., 130 Cal. Rptr. 2d 728, 730 (Ct. App. 2003) (“The basic rule of contract interpretation is to effectuate the parties’ intent as expressed in the contract’s terms, which are given their common meaning.”); see also Restatement (Second) of Contracts § 202(3)(a).

111Jerry’s Enterprises, Inc. v. U.S. Specialty Ins. Co., 845 F.3d 883, 890 (8th Cir. 2017) (specific language controls over general is a basic principle); Genunzio v. Genunzio, 598 So.2d 129, 132 (Fla. Dist. Ct. App. 1992) (“[G]eneral language of a contract must yield to specific language which deals with the matter at issue * * *.”).

112See, e.g., In re Energy Future Holdings Corp., 842 F.3d 247, 256 (3d Cir. 2016) (interpret contracts to give meaning to all of the terms); Torncello v. United States, 681 F.2d 756, 761 (Ct. Cl. 1982) (“[W]e assume that the parties intended that a binding contract be formed. Thus, any choice of alternative interpretations, with one interpretation saving the contract and the other voiding it, should be resolved in favor of the interpretation that saves the contract.”).

113Beck Park Apartments v. United States Dept. of Hous. and Urban Dev., 695 F.2d 366, 370 (9th Cir. 1982) (“Where, as here, a public interest is involved, ‘an interpretation is preferred which favors the public.’ ”) (quoting Restatement (First) of Contracts § 236(f) (1932)); Patterson, supra note 60, at 855.

114United Postal Serv. v. Ester, 836 F.3d 1189, 1195 (9th Cir. 2016) (“A written contract must be read as a whole and every part interpreted with reference to the whole, with preference given to reasonable interpretations.”) (quoting Klamath Water Users Protective Ass’n v. Patterson, 204 F.3d 1206, 1210 (9th Cir. 1999); Samaan v. General Dyn. Land Sys., 835 F.3d 593 (6th Cir. 2016) (contract should be read as a whole); Prochazka v. Bee-Three Devel., LLC, 466 S.W.3d 448 (Ark. Ct. App. 2015) (same); Portell v. AmeriCold Logistics, LLC, 571 F.3d 822, 824 (8th Cir. 2009) (“ ‘The cardinal principle of contract interpretation is to ascertain the intention of the parties and to give effect to that intent.’ We read the contract as a whole and give the terms their ‘plain, ordinary, and usual meaning.’ ”) (quoting Dunn Indus. Group, Inc. v. City of Sugar Creek, 112 S.W.3d 421, 428 (Mo. 2003) (per curiam)).

115Patterson, supra note 60, at 852.

116Id. at 853.

117Restatement (Second) of Contracts § 201(1).

118See supra note 4, and accompanying text.

119Berke Moore Co. v. Phoenix Bridge Co., 98 A.2d 150, 156 (N.H. 1953) (“[W]hen it appears that the understanding of one is the understanding of both, no violation of the rule results from determination of the mutual understanding according to that of one alone.”).

120Restatement (Second) of Contracts 201(2); Joyner v. Adams, 361 S.E.2d 902, 905 (N.C. Ct. App. 1987) (“[W]here one party knows or has reason to know what the other party means by certain language and the other party does not know or have reason to know of the meaning attached to the disputed language by the first party, the court will enforce the contract in accordance with the innocent party’s meaning.”).

121Restatement (Second) of Contracts 201(2); see, e.g., The SCO Group, Inc. v. Novell, Inc., 2010 WL 2426018 (D. Utah 2010).

122159 Eng. Rep. 375 (Ex. 1864).

123Id.; see also First United Leasing Corp. v. Campagnie Nationale Air France, 1995 WL 560918, at *5 (N.D. Ill. 1995) (“When parties attach different meanings to a contract term, a situation best understood as a ‘misunderstanding’ or a ‘mistake,’ there is * * * technically no meeting of the minds and, consequently, no contract.”).

124Colfax Envelope Corp. v. Local No. 458–3M, 20 F.3d 750, 753 (7th Cir. 1994) (Posner, J.).

125Restatement (Second) of Contracts, § 201(2)(a); see also Trinidad v. King, 1998 WL 823653, at *6 (S.D.N.Y. 1998) (“If the ‘parties had conflicting understandings as to the meaning of a material term, there is contract based on the meaning of the party who is unaware of the ambiguity if the other party knows or has reason to know of the ambiguity.’ ”) (quoting John D. Calamari & Joseph M. Perillo, The Law of Contracts 169 (3d ed. 1987)).

126See Restatement (First) of Contracts, § 230, cmt. b and illustration 1 (“In an integrated agreement A promises to sell, and B promises to buy certain patents. A intends to sell only English patents on a certain invention. B understands that A promises to sell the English, French, and American patents on the invention. If a reasonably intelligent person at the time when the integration is made and at the place as of which the standard of interpretation is applicable, under the circumstances accompanying its making, would understand the agreement to state a promise to sell the English and American patents, but not the French patents, there is a contract and A and B are bound by that meaning.”).

127Reyes v. Lincoln Automotive Financial Services, 861 F.3d 51, 58 (2d Cir. 2017) (“ ‘If essential terms of an agreement are omitted or are phrased in too indefinite a manner, no legally enforceable contract will result’ ”) (quoting Brookhaven Hous. Coal. v. Solomon, 583 F.2d 584, 593 (2d Cir. 1978)); Champaign Nat’l Bank v. Landers Seed Co., 519 N.E.2d 957, 959–60 (Ill. App. Ct. 1988) (“The terms of a contract must be reasonably certain. Some terms may be missing or left to be agreed upon, but if the essential term or terms are so uncertain that there is no basis for deciding whether the agreement has been kept or broken, there is no contract.”).

128See, e.g., John Hancock Life Ins. Co. v. Abbott Laboratories, 863 F.3d 23, 25 (1st Cir. 2017) (“ ‘[A]lthough a court can declare an implied covenant to exist, that is only where there is in the express contract . . . a satisfactory basis which makes it necessary to imply certain duties and obligations in order to effect the [parties’] purposes’ ”) (quoting Mid-West Energy Cons., Inc. v. Covenant Home, Inc., 815 N.E.2d 911, 916 (Ill. App. 2004)).


130Zielinski v. Pabst Brewing Co., 463 F.3d 615, 619–20 (7th Cir. 2006) (“Filling gaps is a standard activity of courts in contract cases * * *. As we explained in Haslund v. Simon Property Group, Inc., 378 F.3d 653, 655 (7th Cir. 2004), ‘If contracting parties had to provide for every contingency that might arise, contract negotiations would be interminable. Contracts can be shorter and simpler and cheaper when courts stand ready to fill gaps and resolve ambiguities in the minority of contracts that get drawn into litigation.’ ”).

131M&G Polymers USA, L.L.C. v. Tackett, 135 S.Ct. 926 (2015).

132Transcript of oral argument at 18, M & G, 135 S.Ct. 926 (No. 13–1010).

133See Robert A. Hillman, The Supreme Court’s Application of “Ordinary Contract Principles” to the Issue of the Duration of Retiree Healthcare Benefits: Perpetuating the Interpretation/Gap-Filling Quagmire, 32 ABA Journal of Labor & Employment Law 299, 317 (2017).

134See Richard A. Posner, Economic Analysis of Law 96–98 (7th ed. 2007); National Distillers & Chem. Corp. v. First Nat’l Bank of Highland Park, 804 F.2d 978, 982 (7th Cir. 1986) (“Ambiguities and gaps in contracts should be resolved by finding what the parties would have bargained for had they addressed the matter explicitly at the time.”); Scottsdale Ins. Co. v. Market Finders Ins. Corp., 2008 WL 4217679, at *4 (D. Ariz. 2008) (“The Restatement of Contracts states that in cases where parties omit essential terms of the contract out of lack of foresight, the court may supply the omitted term if they have substantial evidence that ‘the parties would have agreed to [it] if the question had been brought to their attention.’ ”) (quoting Restatement (Second) of Contracts § 204, cmt. d (1981)).

135156 Eng. Rep. 145 (Ex. 1854). See Chapter 5, Section (A)(4)(b).

136See, e.g., In re Hilling Lumber Co., 355 B.R. 566, 573 (Bankr. N.D.W. Va. 2006) (“In supplying a term, the court should supply one that is reasonable in light of the purpose of the contract, considering what term the parties would have agreed to if the questions had been brought to their attention, and impose a term that ‘comports with community standards of fairness and policy * * *.’ ”) (quoting Restatement (Second) of Contracts § 204 (1981)); Binder v. Aetna Life Ins. Co., 89 Cal. Rptr. 2d 540, 553 (Ct. App. 1999) (“ ‘Sometimes it is said that the search [for an omitted term or omitted meaning] is for the term the parties would have agreed to if the question had been brought to their attention.’ ”) (quoting Restatement (Second) of Contracts § 204, cmts. a, b & d.); Richard A. Posner & Andrew M. Rosenfield, Impossibility and Related Doctrines in Contract Law: An Economic Analysis, 6 J. Legal Stud. 83, 88–90 (1977).

137See, e.g., Farnsworth, supra note 17, at 735–36.

138Posner, supra, note 134, at 96–99; see also United States v. Westlands Water Dist., 134 F. Supp. 2d 1111, 1137 (E.D. Cal. 2001) (“[I]f no other method can adequately interpret the contractual provision in question, the court allocates the risk of the unforeseeable loss to the more efficient risk bearer.”).

139See Chapter 5, Section (A)(4)(b).

140See id.

141See Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 Yale L.J. 87, 101 (1989).

142See Dalton v. Robert Jahn Corp., 146 P.3d 399, 410 (Or. Ct. App. 2006) (“While a court may allow exceptions for ‘subordinate details of performance,’ it cannot ‘under the guise of ‘filling gaps’ make the contract which it thinks the parties would have agreed to.’ ”) (quoting Booras v. Uyeda, 666 P.2d 791 (Or. 1983)); but see Great Am. Ins. Co. v. Honeywll Int’l Inc., 2009 WL 5064478 (W.D. Pa. 2009) (“The letter agreements contemplated that Honeywell would be compensated for any work it performed as a result of a CPS default. This court cannot construe the Letter Agreements to mean Honeywell was to complete CPS’s subcontract for free because to do so the court would create an absurd result.”).

143See Chapter 5, Section (A)(4)(b).

144See id.

145See Jason Scott Johnston, Strategic Bargaining and the Economic Theory of Contract Default Rules, 100 Yale L.J. 615, 622 (1990).

146Ayres & Gertner, supra note 141, at 104.

147See Chapter 5, Section (A)(4)(b).

148See Robert A. Hillman, An Analysis of the Cessation of Contractual Relations, 68 Cornell L. Rev. 617, 629–34 (1983); see also Dato v. Mascarello, 557 N.E.2d 181, 184 (Ill. App. Ct. 1989) (“[I]t was proper for the trial court to supply terms which it determined to be reasonable, either by construing the expressed terms together with the circumstances surrounding and occurring subsequent to the formation of the contract, or on the basis of fundamental principles of fairness, or both.”).

149See Chapter 9, Section (C).

150Hillman, supra note 148, at 638–39.

151See Chapter 8, Section (C)(2)(b).

152Hillman, supra note 148, at 637; see also Marshall Constr. Co. v. Forsyth, 57 A.2d 902 (Pa. 1948) (holding that a reasonable time should be implied where no time was specified in the contract, and that the exercise of an option three months after contract date was reasonable and timely performance).

153Hillman, supra note 148, at 637; see also Howell v. United States, 51 Fed. Cl. 516, 523 (Fed. Cl. 2002) (“[W]here parties to a binding agreement have not agreed to an essential term, ‘a term which is reasonable in the circumstances’ may be supplied by the court. In supplying a term, [Restatement] comment d of § 204 says that ‘the court should supply a term which comports with community standards of fairness and policy rather than analyze a hypothetical model of the bargaining process.’ ”) (quoting Restatement (Second) of Contracts § 204, and cmt. d).

154Canadian Indus. Alcohol Co. v. Dunbar Molasses Co., 179 N.E. 383, 384 (N.Y. 1932).

155Id. at 384–85.

156See Chapter 2, Section (A)(8); Chapter 6, Section (A).

157See, e.g., UCC § 2–403.

158See Chapter 2, Section (A)(7).

159Mahan v. Avera St. Luke’s, 621 N.W.2d 150, 159 (S.D. 2001) (“The term ‘good faith’ generally indicates an absence of bad faith on behalf of a party to a contract.”); see Robert S. Summers, “Good Faith” in General Contract Law and the Sales Provisions of the Uniform Commercial Code, 54 Va. L. Rev. 195 (1968).

160Restatement (Second) of Contracts, § 205, cmt. a; see also Life Plans, Inc. v. Security Life of Denver Ins. Co., 800 F.3d 343, 347 (7th Cir. 2015) (purpose of good faith is to “compel[ ] fairness”); Mahan, 621 N.W.2d at 159–60 (“Examples of bad faith performance include depriving the other party of a negotiated right under the contract, preventing the aggrieved party from receiving the benefits of the bargain, or interfering in the other party’s performance of the contract.”).

161See Tymshare, Inc. v. Covell, 727 F.2d 1145 (D.C. Cir. 1984) (employer contracted for right to modify or terminate employee’s compensation plan in its “sole discretion”); see also Walsh v. Zurich American Ins. Co., 853 F.3d 1 (1st Cir. 2017) (discretion subject to good faith obligation); Kamco Indus. Sales, Inc. v. Lovejoy, Inc., 779 F. Supp. 2d 416 (E.D. Pa. 2011) (discretion would not be used to deprive party of benefits).

162Carma Developers, Inc. v. Marathon Dev. Cal., Inc., 826 P.2d 710, 728 (Cal. 1992) (“We are aware of no reported case in which a court has held the covenant of good faith may be read to prohibit a party from doing that which is expressly permitted by an agreement.”); Storek & Storek, Inc. v. Citicorp Real Estate, Inc., 122 Cal. Rptr. 2d 267, 277 n.10 (Cal. Ct. App. 2002) (“[T]he implied covenant of good faith and fair dealing does not impose an affirmative duty on a party to forbear from enforcing rights expressly given under the contract.”).

163Tymshare, Inc., 727 F.2d at 1154 (holding “sole discretion” is not equivalent of “for any reason whatsoever, no matter how arbitrary or unreasonable”); see also Eldridge v. Gordon Bros. Group, LLC, 863 F.3d 66, 82 (1st Cir. 2017) (good faith forbids arbitrary and unreasonable conduct in order to protect the other party’s “fruits” of the contract); Robert A. Hillman, Drafting Chapter 2 of the ALI’s Employment Law Restatement in the Shadow of Contract Law: An Assessment of the Challenges and Results, 100 Cornell L. Rev. 1341 (2015); Restatement (Second) of Contracts § 212(1) and cmt. b.

164Tymshare, Inc., 727 F.2d at 1154.

165Id.; see also Betco Corp., Ltd. v. Peacock, 876 F.3d 306 (7th Cir. 2017) (good faith requires honoring the spirit of the agreement); Fortune v. National Cash Register Co., 364 N.E.2d 1251 (Mass. 1977) (employer’s bad faith termination resulted in employee losing percentage of commission).

166See, e.g., CitiMortgage, Inc. v. Chicago Bancorp, Inc., 808 F.3d 747, 751 (8th Cir. 2015) (“[T]here can be no breach of the implied . . . covenant . . . where the contract expressly permits the actions being challenged, and the defendant acts in accordance with the express terms of the contract”) (quoting The Arbors at Sugar Creek Homeowners Ass’n v. Jefferson Bank & Trust Co., 464 S.W.3d 177, 183 (Mo. 2015).

167See Chapter 6, Section (D).

168See Robert A. Hillman, Court Adjustment of Long-Term Contracts: An Analysis Under Modern Contract Law, 1987 Duke L.J. 1, 4–6.

169Benefit Mgmt. of Me., Inc. v. Allstate Life Ins. Co., 993 F.2d 1530, 1993 WL 177120, at *8 (1st Cir. 1993) (“ ‘[B]ad faith’ has been described as ‘opportunistic advantage-taking or lack of cooperation depriving the other contracting party of his reasonable expectations’ * * *.”) (quoting Hentze v. Unverfehrt, 604 N.E.2d 536, 538 (Ill. App. Ct. 1992)); Best v. United States Nat’l Bank of Or., 739 P.2d 554, 558 (Or. 1987) (“[D]iscretion had to be exercised within the confines of the reasonable expectations of the depositors.”).

170Market St. Assocs. Ltd. P’ship v. Frey, 941 F.2d 588, 595 (7th Cir. 1991).


172Richard A. Posner, Let Us Never Blame a Contract Breaker, 107 Mich. L. Rev. 1349, 1359 (2009) (“There is a legally enforceable contract duty of ‘good faith,’ but it is just a duty to avoid exploiting the temporary monopoly position that a contracting party will sometimes obtain during the course of performance.”).


174See, e.g., Chapter 6, Section (A); Angel v. Murray, 113 R.I. 482 (1974) (trash collector granted an increase in the contract price for unexpected additional costs.).

175See Robert A. Hillman, Policing Contract Modifications Under the UCC: Good Faith and the Doctrine of Economic Duress, 64 Iowa L. Rev. 849, 852 n.14 (1979).

176See Robert S. Summers, “Good Faith” in General Contract Law and the Sales Provisions of the Uniform Commercial Code, 54 Va. L. Rev. 195 (1968).

177Hillman, Policing, supra note 175.

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