Friday, April 24, 2009



Nobody likes to default. It is a dirty word. It means that you failed to uphold your promises. But few people worry about staining their honor when they default. Rather, they worry about the massively stressful legal process that will soon befall them. Soon, they will receive harassing telephone calls, summonses, judgments, late payment assessments, lien notices and garnishment orders. They will experience firsthand the whole legal arsenal with which the law arms creditors. Worse, their creditors will call them “irresponsible people who do not consider the rights of others,” adding a wholly unnecessary moral dimension to purely legal questions. All for what? Because they ran out of money. Life threw them a curve; they couldn’t afford the payments anymore.

Contract law fascinates me because it allows private parties to create private law. Contrary to popular belief, private contracts do not directly implicate the State; the State only steps in to enforce them when deals go awry. In large part, however, contracts represent quintessentially private ordering. They allow private individuals to make their own, compulsory rules in order to obtain some material benefit from others. In theory, parties to a contract are equal. One party possesses something the other wants; each side gains exactly as much as the other loses, and vice versa. Yet this “equality” in bargaining power only exists in law textbooks. In modern commerce, most transactions involve gross disparities in power. One party (usually a corporation) has something others desperately need, leaving them to accept difficult terms in order to get it. Often, these difficult terms include high prices and an agreement to waive a jury trial if something goes wrong. More often, these difficult terms impose crushing penalties, fees and other procedural handicaps that make it hard—if not impossible—for the party to prevail if there is a dispute. In practice, contract law allows powerful parties to impose their will on those who wish to acquire things they possess—and it is all legal.

There is nothing surprising about this. When human beings deal privately with one another, they always attempt to secure maximum advantages for themselves while assuming minimum risk. If one party has something the other needs, he can leverage that need to his advantage by negotiating extremely favorable terms. Of course, the same party could not secure extremely favorable terms if the buyer could go to a different seller. But in many commercial settings, individual buyers must obtain their goods through much more powerful sellers. When they do not have enough money to buy things outright, they must seek financing; and debt places them at a consummate disadvantage. In our society, very few people have enough money to buy all the things they need. They are stretched to the limit. In many cases, even “honest, hard-working people” have no choice but to take out loans for necessary items. In so doing, they expose themselves to creditors’ virtually unbridled legal power. Debtors are glorified beggars; and creditors have immense power over them. In debt relationships, contract law gets even uglier than usual. Yet debt is unavoidable for most people. In that sense, most people find themselves in an extremely unfavorable legal position. They sign contracts that subject them to brutal sanctions if they miss payments. They need the money. They take their chances that their income stream will remain intact to make their payments.

Many debtors make their payments. But life is not so kind to others. Perhaps a breadwinner dies or suffers an injury that forecloses him from work. Perhaps a debtor loses his job. Perhaps a debtor moves and bills get lost in the mail. Perhaps intervening expenses arise that wipe out a debtor’s savings, making it impossible to repay existing obligations. Perhaps a debtor has children who drain his income more than he could have imagined when he took out the loan. In America, most people cling desperately to financial stability. Their money is generally spoken for the moment they make it: rent; mortgage; taxes; clothing; food; car note; gas; tuition; student loan; credit card bill; utilities; medical expenses; dental expenses; the list goes on until the last penny is gone. They calculate their expenses to match their income stream. If there is an interruption, the entire financial structure unravels. And when a creditor does not receive a bargained-for, contractually-mandated payment from the unfortunate debtor, the creditor’s legal arsenal grinds into action. At these moments, contract law shows its true, pitiless colors. When creditors assert rights, somebody starts suffering.

I always found it perversely entertaining when creditors informed me that I owed “late fees” and “interest payments” if I failed to make a scheduled payment. This is standard contractual stuff. Loan contracts say that you must pay so-and-so amount on so-and-so date every month, plus interest (which may be raised at will and added to the principal). Then they say you must pay a special “extra fee” if you miss a payment. Why do creditors do this? If a person fails to make a payment, doesn’t that lead a reasonable person to conclude that he did not have the money to pay it? If that is true, how can a creditor expect a person to pay the payment he could not afford and extra fees? If a person does not have $400, he cannot pay $400 plus $250 in fees. In my view, this is sadism. It is like kicking people when they are down. Still, the law squarely favors the creditor in this situation. In the law’s view, you bargained for all the terms in the contract, no matter how counterintuitive or cruel. When you default, you entitle the creditor to apply all those terms against you, no matter how apparently unfair or oppressive. If the contract says the creditor can charge late fees and interest on your late payment, he can. It does not matter that you are broke. It does matter that you have children to feed. It is the creditor’s right. And the law enforces private contractual rights. It does not query whether they are oppressive or even ludicrous in practical effect. In short, contract law allows superior parties to exercise their rights over those who default, no matter how shameless it may be to do so. Those rights include the right to charge all the fees they defined in the contract, as well as obtaining a judgment for the full loan amount now. Once they obtain the judgment, they can legally seize all your cash and property to “satisfy” it, the same way a zookeeper “satisfies” a hungry lion with raw meat.

From a legal perspective, this all makes perfect sense: The debtor defaulted; he owes the amount; the debtor must pay. Yet from a practical and humanitarian perspective, this result is perverse. If a debtor cannot pay a monthly payment, how can a creditor reasonably believe that he can pay the entire loan amount now? If a person does not have money to pay $400, he obviously does not have money to pay $125,000, plus interest, fees and attorney’s costs. It defies imagination to think that the creditor could reasonably make these demands. But they do—all the time. Why? In my view, it is because the law gives creditors a smug feeling of total entitlement. Creditors believe that, because the law supports their position, they can do whatever the contract says they can. No matter how absurd the demand, the law permits it; thus the creditor feels he can make the demand in good conscience. It may be utterly impossible to wring $125,000 from a penniless debtor, but it makes the creditor feel good to crush him with legal process simply because he has the right to crush him. When people have commercial rights, they exercise them to the fullest. After all, rights are about power; when a person has power, he will exercise it. There is something distinctly human about rights. When people feel entitled to do something, they feel much better about doing it than they would if there were no such official imprimatur. The law gives exactly such an official imprimatur to the exercise of private commercial power. To answer the question “why” a creditor charges late fees on a debtor who obviously has no money to pay them, we must simply cite the smugness that flows from legal rights: “They do it because they can.”

Some may call this cynical nonsense. But I challenge anyone to provide me an example of a creditor who chooses not to exercise power over a debtor when the law permits. Do banks show mercy? Do commercial actors forgive? Here, we see that forgiveness and mercy necessarily involve rights. Specifically, to forgive someone, you must first have the right to punish him. Those who forgive have the right to visit hardship and pain on those who aggrieve them. Yet they forgo exercising their right because they pity their debtors, or at least understand that it would serve no purpose to punish them. Such values are entirely inconsistent both with the values of modern commerce and human nature. In commerce, people want to win profits. If exercising commercial rights allows them to win profits, they will not “forgive” those from whom they could rightfully obtain money or property. And human beings like to exercise power over their fellow men. It is in their nature to dominate others. If rights make it easier to tyrannize and dominate others, human beings will not forgo the great satisfaction they experience when they exercise their rights. That is just the way we are.

Christ may have admonished us to “forgive our trespassers.” But Christ never lent money. Nor did he write finance contracts with capitalized interest clauses. In fact, we can reasonably posit that Christ hated debt relationships and commerce in general because he overturned the moneylenders’ tables and "cast them out." Matthew 21:12-14.

In sum, debt relationships bring out the worst in both people and the law. Although legal theorists praise contract law because it allows “responsible people” to “prudently allocate risk and make sensible rules for themselves,” modern commerce belies the contention that there is equality between buyers and sellers. Modern commerce provides plentiful opportunities for strong parties to brutalize weaker ones because the law permits it. This is the dark side of legal rights. When human beings feel entitled to visit misery on others, they rarely forgo the chance. When the natural human impulse to dominate combines with the commercial impulse to win profits, the result is grim. Put simply, debtors do not stand a chance. In America, at least, they find themselves between a rock and a hard place: They must borrow money to buy necessities, to care for their health and to educate themselves. In so doing, they subject themselves to creditors’ “legal rights.” Those “rights” enable creditors to ruin debtors’ financial lives if there is any interruption at all in their tenuous income stream. It is not a pleasant way to live. And it never feels good to know that your entire life hangs on your ability to make regular payments, especially when experience confirms that life circumstances can change overnight. Today, you may be healthy and employed. Tomorrow, you may be paralyzed or laid off. But that means nothing to a creditor; he has his rights and you have your obligations. Unforeseen tragedy or disruption has no effect on his right to sink you. And he will exercise that right if he can.

True, our economy would not work if creditors forgave their debtors all the time. A “merciful economy” is a contradiction in terms. Commerce is warlike; warriors do not spare their foes or let their enemies escape. But that does not make our economy thematically appealing. In my view, forgiveness and mercy are positive qualities. Does it not say something about our society that such positive qualities simply do not belong in commercial life? To be blunt, we are engaged in a death struggle to fulfill obligations. When the law allows, we like to dominate our neighbors. We die if we fail to make payments. The law allows us our creditors to brutalize us, and it allows us to die. Guilt has nothing to do with it. No, contract law knows only power and survival, not conscience.

Perhaps the lesson is this: When possible, be a creditor. It is always better to be on top; and it is always easier to have the law on your side.

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