The collapse of contracts

Philip Slayton
Contracts are sacrosanct. This principle has been pounded into law students’ heads since legal education began. Professors pontificate as follows: provided certain formalities are met, and public policy is not offended, individuals (including juridical persons, corporations being the most important of these) are free to create private law between themselves. If necessary, courts will enforce this private law. Our freedom, our economy — gosh, our very way of life — depend upon this being so. (Full disclosure: I taught the law of contracts over many years in several law schools, and always toed this traditional line.)

Until fairly recently, law graduates have reverently carried the principle of pacta sunt servanda into the practice of law. Clients beyond count have been told that the terms of a contract are mighty important. Sign nothing, they have been instructed, until you have read and agreed with every word. Once you have agreed, you will be bound to do what you have promised; you’ll be punished if you don’t. In my two decades of legal practice, I always dutifully said all of this. After all, we advocates intoned dolefully, respect for contracts is the rock upon which our society is built. It was only after I left the law that I decided the whole contract thing was overrated, and was prepared to sign just about anything if I liked and trusted the person on the other side. But that’s another story. . . .


Now, we are suffering a sea change. Prompted by the corrosive effect of the current economic climate, traditional ethical precepts about the law of contract are being tossed out the window. The New York Times lately published an article with the headline, “Contracts now seen as being rewritable.” The article began, “Contracts everywhere are under assault.” Employment contracts are thought to be particularly vulnerable, but other types of agreements may also be in doubt. For example, U.S. Treasury Secretary Timothy Geitner is apparently working on an initiative to give the federal government wide power to modify the contracts of financial institutions it takes over.

The flashpoint for the collapse of contracts seems to have been the controversy over $165 million in bonuses for senior executives of AIG, the insurance giant that was run into the ground by the very same executives who collected the bonus money. The AIG collapse famously almost took down the world financial system, and the company had to be rescued by the American government to the tune of $170 billion. President Barack Obama said the employment contracts in question should be torn up. “This isn’t just a matter of dollars and cents,” the president said. “It’s about our fundamental values.”

The battle lines were quickly drawn following Obama’s angry comment. Andrew Ross Sorkin, mergers and acquisitions columnist for the New York Times, wrote that Wall Street types agreed with the president that fundamental values had to be respected, “but from their point of view, the ‘fundamental value’ in question here is the sanctity of contract.” Professor Lawrence Cunningham of George Washington University Law School opined in the same newspaper, “moral outrage and public rebuke do not provide legal grounds for backing out of a contract.”


But Cunningham, apparently a stealth anti-contract operative, then went on to list all the perfectly acceptable legal reasons for repudiating the terms of an agreement. “Our legal and business system,” he wrote, “recognizes plenty of valid excuses from contractual duty and even justification for breaching.” These excuses include aggressive and creative interpretation of the contract itself, misconduct or fraud by the other side, the effect of unforeseeable or uncontrollable circumstances (so-called force majeure), and the possibility of a fraudulent conveyance. And, as any practising lawyer knows, often just the allegation of these things roils the waters enough to make an inconvenient contract go away, particularly if you’re Goliath to somebody else’s David.

Bankruptcy protection is the ultimate contract buster for a company in trouble. In Canada, this protection is generally obtained by filing under the federal Companies’ Creditors Arrangement Act. Such a filing produces a court order giving the company pretty much blanket immunity, for a time, from its creditors, which includes suppliers and employees. Major companies — for instance, Nortel and AbitibiBowater — have filed for CCAA protection, and others are expected to do so soon. When this happens, folks, tear up those contracts you were relying on! Now they’re just words on a piece of paper, signifying nothing.

And so, the old-fashioned view that, as an ethical matter, lawyers should not advise clients to break contracts, and shouldn’t figure out good ways for them to ignore commitments presumed binding, is just that — an old-fashioned view, no longer relevant, out of tune with the times. Now, a contract may or may not be respected and performed by the parties — it all depends. That’s the correct legal advice. This is another example of morally neutral lawyering, the belief that lawyers are there to serve clients and it’s not their business to protect society or promote particular values at a client’s expense. (I have recently argued in this column that a lawyer’s moral neutrality, desirable as it may be in some ways, doesn’t mean that he is free to subvert the values of his society, or be blind to its best interests. Even law society rules make this clear. Not everyone agrees.)

Back to those pontificating law professors. I think the time has come for them to rejig the basic law of contract course, taught everywhere in first year. Students should now be told that a contract is just one tentative way of organizing your affairs. You may think you have enforceable private law rights, but don’t count on it; they can disappear as do the snows of winter (except a lot faster). And, if you’re on the other side, don’t worry too much about obligations that have become burdensome; there are plenty of ways out.

As for lawyers? We’re here to help.

Philip Slayton has been dean of a law school and senior partner of a major Canadian law firm. Visit him online at

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