“After all, the chief business of the American people is business. They are profoundly concerned with buying, selling, investing and prospering in the world.’
President Calvin Coolidge’s address to the American Society of Newspaper Editors, Washington D.C., January 25, 1925.
After reading this chapter, the reader should have little doubt that the law of commercial contracts of a nation whose chief business was aptly described by its 30th president as “business” has been shaped not by statutes, court decisions or even learned treatises, but mostly by commercial practices among other socio-economic forces. This chapter should help answer the questions: What were these practices? Who were their principal shapers? And what were the socio-economic forces, values and attitudes behind such shaping? The answers will not be easy because the number of practices and shapers is large and the socio-economic forces behind them protean. But we will try.
Another purpose of this chapter’s identification of practices, participants, attitudes and values is to illustrate how some of the practices inspired the underlying principles of viable commercial institutions under United States law. Consider, for example, the eighteenth-century practice behind some of the chattel mortgage statutes that allowed a debtor to remain in possession of the collateral, thereby enabling him to repay his agricultural and commercial loans, and the principle that such loans should be self-liquidating.1 As will be discussed in Chapter 24, centuries later, this continued to be the seminal practice for the principle of self-liquidation or payment of secured loans not only in Article 9 of the U.C.C., but also for the regulation of the Federal Reserve Act’s “elastic” commercial loans.
Thus, a principal goal of this chapter is to establish the link between key legal principles involved in the development of United States commercial contract law and the practices, values, and attitudes that inspired them. Prominent among these principles are United States’ versions of: Freedom of contract and their good faith performance, legal and equitable protection of private ownership and of wealth creating labor, equal protection of equals and a growing inclusiveness of those considered equals, protection of third parties acting in good faith, and a second chance for those who failed in the marketplace, but may succeed under proper circumstances.
The shapers of these practices were not always traditional merchants. Consider, for example, the participation of farmers in the development of America’s local and international markets. As will become apparent in the next sections, farmers played a crucial role in such development. Not surprisingly, then, the definition of a merchant in U.C.C. § 2–104(1) is among the broadest found in any commercial code:
(1) “Merchant” means a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill.2
Unlike his French nineteenth-century counterpart, this is not the merchant/suspected usurer whose altruism and virtue had to be proclaimed by Judge Bedos of the Red Ink Case fame lest he be accused of usury.3 The roots of the U.C.C. § 2–104(1) merchant are found in a professional status “based upon specialized knowledge as to the goods (or as to specialized knowledge as to business practices or both…”)4 Indeed, when I first read this definition and comment, I was reminded of a radio interview with Jaume Sabater, Pablo Picasso’s friend and agent. In it, Sabater referred to Picasso as one of the most effective salesmen of his art, one who knew exactly how to sell his paintings to New York dealers during the Nazi occupation of France. Picasso, a merchant? Well, Official Comment 3 of the same U.C.C. provision found it necessary to clarify that universities can come within the definition of merchant “if they have regular purchasing departments or business personnel who are familiar with business practices and who are equipped to take any action required.”5
As we will find in Chapter 23, despite U.C.C. § 2–104, some United States courts characterized farmers as merchants, while others did not. Moreover, while some court decisions denied to farmers the status of merchants (with respect to the requirements of the Statute of Frauds in U.C.C. § 2–201), the Federal Reserve Act characterized negotiable instruments executed by farmers as commercial paper and thereby approved these instruments for discount-advances, especially when secured by “readily marketable staples.”6
As this introductory chapter will make clear, unlike farmers elsewhere, American eighteenth- and early-nineteenth-century farmers acted as merchants by selling what they had farmed or produced directly to consumers or to wholesalers. Accordingly, as we did with respect to the terms “tradesman” and “merchant” in the preceding chapter on English legal institutions from the seventeenth to nineteenth century, this chapter will identify archetypal merchants in the sale of goods and commercial loans, starting out with those doing business in colonial and independent America.
We will also discuss influential practices, values and attitudes among Puritan settlers and other colonial institutions such as: (1) “General” stores which supplied mostly household goods to the rural population and who initiated America’s “consumer 785revolution,” and (2) small family farms that produced and sold their farm products first in their communities and subsequently beyond. Thereafter, we will discuss the practices, values and attitudes of: (1) Wholesalers (including jobbers and factors) who supplied goods and credit to small farmers and producers as well as retail merchants; and (2) post-colonial institutions such as (a) department stores which implemented the consumer revolution by selling the broadest varieties of goods, including in one case, “his and her” actual submarines to loving couples during the Christmas season; (b) bankers who financed manufacturers, wholesalers and retailers; (c) the Federal Reserve Bank as the principal regulator of an unprecedented expansion of commercial and consumer credit following the end of the First World War; and (d) credit rating agencies that supplied data on actual and potential borrowers to their United States lenders. This discussion should help “demystify” certain practices such as the 30, 60, 90 and 180 maturity dates of negotiable instruments (in use in the American marketplace since the second half of the nineteenth century). For all these terms did was to reflect realistic assumptions by representative merchants of how long it would take them to sell the commodities used as collateral and repay their loans.
Among the Protestant sects that first settled the United States, the Puritans had the most lasting impact. They were dissatisfied with the reforms of the Anglican Church when it broke with Catholicism in 1535 and insisted in their belief in a spiritual authority based solely on Scripture. They also believed that by substituting king for pope as the head of the church, “England was only recapitulating an unnecessary, corrupt, and even idolatrous order.”7 Nonetheless, many Puritans chose to remain within the Church of England working for reform, and it was from this group that a much larger group of emigrants left from England for New England in the late 1620s and established their colony at Massachusetts Bay.
Even as the Puritans immigrated to New England, “they affirmed their ‘Englishness’ and saw the main purpose of their new colony as being that of a biblical witness, a ‘city on a hill’ which would set an example of biblical righteousness in church and state for Old England and the entire world to see.”8 Pilgrims, on the other hand, while sharing some of the Puritan beliefs, wanted to achieve “reformation without tarrying,” even if they had to part from their church and their nation. Thus when leaving England they did so in search of a new political and spiritual identity.9
In the preceding chapter, we examined an archetypal commercial relationship between the London House of Samuel Storke and its many agents, consignees and joint venturers in colonial North America.10 This examination revealed key features of 786Samuel Storke’s Londonbased trans-Atlantic business, but did not dwell on the distinctive features of the local (New England) trade of his correspondents, especially those that followed the 1630 Puritans’ settlements. Now we will examine the values, attitudes and commercial practices of New England Puritans when dealing with other local merchants and consumers.
Professor Stephen Innes of the University of Virginia referred to the New England Puritans as possessing a “productive ethic” which was “a fortuitous combination in a New World setting of the Protestant concept of “the calling” with the emergent doctrines of mercantile capitalism, as expressed in the civil culture of the New England Town.”11
He suggested that the Puritans of the Massachusetts Bay settlement succeeded in establishing their “City upon a Hill” because, among other factors, they linked land ownership to productive labor12 and premised their productive labor on an “ethically autonomous (grace bearing) individual as the fundamental constituent of society, rather than the order, guild or corporation.”13 This Puritan individual, then, was not only intensely commercial, but was also an assiduous contributor to his family, church and community as well as to schools, especially those “voluntarily organized, or privately controlled.”14 As Calvinist “elect” (or “saints”), these Puritans attempted to bridge what Emile Durkheim (and in our time, the biologist E. O. Wilson) referred to as the “duality of human existence,” i.e., the co-existence in the same person of self-interest and altruism, or what Professor Innes labeled a “moral capitalism.”15
Hence, in Professor Innes’s opinion, the Puritan Massachusetts Bay Colony was the New World’s “first capitalist commonwealth”16 whose practices were imbued by an ethic of strong families and town organizations and a religiously inspired “culture of discipline” which fostered:
(I)ndustrious and “striving” behavior, communal responsibility, and a high ratio of savings and investment relative to income by its limitations on leisure … both to maximize production and reinvestment and to attend to the needs of the economically vulnerable. It required that human beings “improve every bright and shining moment” while also ensuring that the “rich and mighty” not “eate upp [sic] the poore.”17
In addition, the pronouncements made by Puritan pastors and theologians:
(R)eveal the degree to which the labor theory of property developed in William Petty’s Verbum Sapienti (1665) and John Locke’s Second Treatise (1690) had its roots in ascetic Puritanism. Work for the saints was the 787warrant and source of all wealth: God gave the use of the world to the industrious and rational; title to the property came principally from work; the fruits of labor belonged to the worker; men and women only had a right to what they actually could use.18
As pointed out by Yale University’s Professor Edmund Morgan:
The first duty of a Puritan parent was … to give food, shelter and protection to his children…. The laws obliged all parents to perform this duty: No New England father could loaf away his time while the cupboard was bare. When a complaint was made in Watertown against Hugh Parsons, “he was Sent For, and advised to imploy his time to the better providing For his Family, and for his incouragement” he was supplied “with some present Corne.”19
Other Puritans guilty of the same idleness usually received a harsher punishment. For example, one Samuel Mattock was sentenced to incarceration in the house of correction and was made to pay a fine by a court in Suffolk “for Idleness and neglecting his family.”20
Puritans also took seriously their duty to educate their children in religious matters.21 Thus, Massachusetts law required parents to teach their children and apprentices to read and understand the doctrines of Christianity.22 Although the Puritans’ educational goal was to promote the observance of their religion, their support for quality, humanistic education resulted in their founding of some of the United States’ and the world’s leading universities, including Dartmouth, Harvard and Yale.23
Another key factor in the commercial success of the Puritan merchant was his familial connections and network of business correspondents. Professor Morgan’s collection of letters of prominent Puritan merchants reveals their preference for doing business with relatives, close and distant, who often became their commission agents, consignees and joint venturers. Please recall the pervasiveness of credit extensions in the colonial businesses conducted by Storke in the preceding chapter.24 Not surprisingly, we re-encountered in Professor Morgan’s collection of letters some between the Storke and Seawall families of the preceding chapter.25 As you may recall, trustworthiness was apparent in the lack of written contracts or of even simple executory promises to pay or perform: Most of these familial transactions were evidenced only as credit and debit entries in Samuel Storke’s books of accounts.26
Eventually, the industriousness for the sake of one’s family welfare acquired a different meaning in non-Puritan America among many a business owner: Every effort that would help the merchant’s business grow and expand geographically was owed to that business. While conducting seminars for business lawyers and businessmen on the recently adopted U.C.C. Article 9 on secured transactions law in various states during the early 1970s, I noticed that one of the most popular issues with business lawyers was whether to file their financing statements centrally with the secretary of state’s office or locally at the county recorder’s office.
One of the variables involved in this determination was that many a secured debt had been assumed by branches or subsidiaries of the same business, and this brought into play the issue of the secured debtor’s independence from the head office. It was apparent that many of these businesses were of recent formation and that shortly after signs of success appeared, their owners sought to form as many branches or subsidiaries as they could. My “coffee break” question to business owners was: “Why did you branch out as quickly as you did?” The answer was quick and unanimous: “We owe it to our business.”
The more I came in contact with the industriousness and striving of businessmen during the ensuing years, the more it became apparent that one of the signs of a business entity’s success was its geographic multiplication. However, with the maximization of its growth often came a maximization of contractual rights, albeit at the expense of rights present in the original Puritan notion of a “moral capitalism.”
You will find an illustration of the decline of the Puritan notion of a moral capitalism in my discussion of Justice Cardozo’s Meinhard v. Salmon decision.27 In what various New York lawyers have told me was and is not an unusual contractual behavior, a successful joint venturer did not disclose to his investor that as a result of the success of the original joint venture, a larger and potentially more lucrative venture was offered to him, thereby excluding the original joint venturer from participating in the new venture, allegedly because it was about to expire. After characterizing Salmon as a trustee for his joint venturer-investor, Justice Cardozo based his decision on a moral capitalistic principle:
A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior…. [T]he level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd.
Please note that with the maximization of Defendant’s Salmon’s rights as a managing partner or joint venturer (including his asserted privilege not to disclose an offer made to a joint venture whose life based on a twenty year lease was about to expire) came Cardozo’s remedy of a constructive trust on 50% of Salomon’s future profits of the defendant in the new joint venture.
Harvard University Professor Bernard Bailyn describes the main challenge of Puritan dogma in a commercial environment:
[C]onstantly exposed to sin by virtue of his control of goods necessary to other people. [And] [s]ince proof of the diligence he applied in his calling was in the profits he made from precisely such exchanges, could a line be drawn between industry and avarice? Puritans answered, as had Catholics for half a millennium, that it could, and they designated this line the “just price.”28
The meaning of the Puritan just price was provided by the Reverend John Cotton:
‘A man may not sell above the current price, i.e., such a price as is usual in the time and place, and as another (who knows the worth of the commodity) would give for it, if he had occasion to use it….’ A merchant’s personal losses or misfortunes ought never to be reflected in an increased valuation, ‘but where there is scarcity of the commodity … there men may raise their price, for now it is a hand of God upon the commodity, and not the person.’29
The reverend’s definition of a just price reflects Catholic dogma but adds to it an important element. Please recall that, as formulated by Saint Thomas Aquinas, the just price was determinable in accordance with the “appraisal of the marketplace” (secundum aestimationem fori).30 In the preceding quote, Reverend Cotton added precision to the appraisal by listening to the opinion of an archetypal merchant who “knows the value of the commodity.” This addition contributes reasonableness to the determination of the Puritan just price because it relies on the appraisal of a presumptively disinterested, but knowledgeable third party.
As apparent in Puritan sermons, trustworthiness which resulted in the granting of credit to the participants in their networks was central to their social and trade relationships. Puritan preachers were keenly aware that trade required close attention to detail and complete honesty in the performance of its promises or contracts, including avoiding the slightest trace of dishonesty, corruption or nepotism. In fact, it was not unusual for them to quote a Biblical text such as: “ ‘The LORD abhors dishonest scales, but accurate weights are his delight’ (Prov 11:1).”31
The emphasis on honest weights and measures also made it easier to instill in the American marketplace the British and European merchants’ preference for fixed, posted prices instead of haggled over and thus often “unjust” and not trustworthy prices, especially in the trade of everyday goods.32
As noted earlier by Professor Innes, the Puritan settlers chose private over communal property rights. This choice became apparent during the first half of the seventeenth century, and was a choice later echoed and justified in 1689 by John Locke in his Two Treatises of Government:
Though the Earth … be common to all Men, yet every Man has a Property in his own Person…. The Labour of his Body, and the Work of his Hands, we may say, are properly his. Whatsoever then he removes out of the State that Nature hath provided, and left it in, he hath mixed his Labour with, and joyned to it something that is his own, and thereby makes it his Property…. that excludes the common right of other Men.33
Dr. Gary North of Chalcedon34 describes how from 1621 to 1623, a Pilgrim colony required that those working in the commonly held fields contribute their work-product to a common storehouse that divided their unequal work product equally among all the participating families.35 This contribution resulted in an inequality between the work product and the rewards received by all the contributors. When those who worked the fields refused to continue doing so, the colonial Governor abolished the practice of common storage and equal distributions per family. Once this happened, “(i)mmediately, men and women returned to the harvest fields.”36
In their settlement of New England, Puritan colonies applied the lessons learned from the bad experience of the Pilgrims with common ownership. In addition to an unequal distribution of work product, the common ownership of land caused serious nuisances associated with the settlers’ rights to the use of common property day and night. Problems and disputes resulted from such things as: “pigs without rings in their noses running through the town, and midnight tree cutters on the commons.”37 Eventually, the Puritans who had a share in the common pasture and common lands decided to limit the use and distribution of property:
In town after town … private ownership and private control of property [replaced common ownership] even among men who had grown up in English communities that had used the open field system of farming.38
The experience of the Puritan settlements with private property highlighted two convictions: One was the link between the labor that transformed or added value to property and the legitimacy of its original acquisition by Puritan settlers. The other conviction was that freedom of contract was the primary means to make one’s private property marketable but only on the basis of just and reasonable prices. And as just noted, the addition of reasonableness in the person of a respected and knowledgeable merchant who knew the market value of the property added precision to what could otherwise be an arbitrary price.
As shown by our earlier discussions of central planning in socialist regimes,39 the arbitrary and unrealistic pricing of goods and services not only made central planning ineffective but also very costly in economic and human terms. Recall the tragic experience with Mao Tse Tung’s decree that forced membership in the PRC agricultural cooperatives. The fact that each family was forced to contribute its animals or produce, year after year, and receive only whatever the collective enterprise distributed was in the end responsible for one of the largest famines in history.40
The same consequences will ensue when the price of property ignores the daily inconveniences and costs of nuisances associated with the ownership of shares in a common property. Simply put, the inability of contract prices to reflect what the parties are knowledgeably and freely willing to pay for property deprives purchasers from getting a fair bargain and prevents the property from ever having a realistic market value.
Among the values and attitudes that one can ascribe to the New England Puritans were: (1) A religiously inspired “moral capitalism” which resulted in the energetic pursuit of profit while also caring about the welfare of family and community; (2) A religiously inspired and sanctioned strict work ethic, including frugality, self-discipline and self-denial; (3) A familistic trade that lead to trustworthy contractual networks unburdened by costly legal formalities where commercial credit was routinely made available; (4) An honesty reflected in just prices whose justness could be verified by the opinions of reasonable third parties and by the strict observance of promulgated weight and measures; (5) A preference for private (over communal) ownership whose original title belonged to the contributors of labor that transformed the value of the property. To facilitate the identification of the effects on United States commercial contracts law wrought by some of these values and attitudes as well as of other socio-economic factors, these effects will be summarized at the end of most of the following sections.
The Encyclopedia Britannica defines a general store as a “retail store in a small town or rural community that carries a wide variety of goods, including groceries….”41 In the United States, the general store (at times also referred to as “country” store) succeeded the trading post. A significant portion of its trade consisted of barters among Native Americans, pioneers and early settlers. The general stores served neighboring communities and especially farmers,42 regardless of their ethnic origin or religious affiliation.
They were usually located at a crossroads or in a village and sold or bartered a wide variety of products made by others. Although they were supposed to be paid in cash because of the scarcity of money in rural areas, much of the rural trade was accomplished through barter. Rowena Olegario, a historian of the culture of credit in the United States estimates that during the general store period the amount of debts paid in cash generally did not exceed one-third of the amounts outstanding.43 Accordingly, credit played a central role in a consumer revolution that spread from rural to urban America and from there to market economies throughout the trading world.
One of the first urban general stores of colonial America was the Fielding Lewis store of Fredericksburg, Virginia.44 Its most famous customer was a young George Washington who had grown up on a plantation on the edge of that city and who continued to patronize this store after he moved to Mount Vernon. A letter he wrote to his mother in 1757 asked her to buy cloth, hose and thread from the Fielding Lewis Store. Over a 25-year period, his purchases regularly included items such as shoe buckles, salt, mirrors, and a wide variety of other goods.45
The State of Virginia’s official history of the Fielding Lewis Store emphasizes the transformation of consumption patterns that general stores helped bring about:
[T]he consumer revolution of the second half of the eighteenth century … changed the American economy and the lives of ordinary people forever. By 793the middle of the eighteenth century … the American colonies … [were] making … everything from lace tablecloths to brass shoe buckles—cheap enough for ordinary people to buy. Consumer demand skyrocketed, and merchants set up stores … to meet the growing demand. This consumer revolution was as fundamental to the lives of ordinary people as the more familiar American Revolution. Indeed, it gave tangible meaning to the ideas of the Revolutionary movement, which appealed to the ambitions of ordinary people for economic and social improvement. The Revolution asserted the right of all Americans to the “pursuit of happiness,” which, for ordinary people, included the opportunity to acquire things that had once been reserved to their social superiors. The consumer revolution turned the United States into a nation of shopkeepers and consumers, and redefined the idea of equality.46
The fact that George Washington, as well as many other inhabitants of rural America, could buy or barter at Fielding Lewis Store items as varied as cloth, hose, thread, shoe buckles, salt and mirrors (among many other products) stood in sharp contrast with the smaller and specialized inventory of eighteenth century European shopkeepers.47 Moreover, the general store goods were sold or bartered at prices accessible to a large segment of the population that could pay with seasonal cash, credit or through barter. These features, and especially the access to credit made possible acquisitive habits similar to those observed in seventeenth and eighteenth century England. As it turned out, the credit practices associated with these transactions were among the most powerful engines for the consumer revolution alluded to by the State of Virginia.
As was discussed in the preceding chapter,48 numerous networks of colonial credit originated in Britain and reached both colonial port cities and the interior of the country. As was pointed out by Professor David T. Flynn of North Dakota University,49 this credit was made possible in part because the colonists had a unit of account, the colonial pound (£), which served as a common denominator for what was lent and repaid. In addition to the colonial pound, other forms of money circulated in the colonies during seventeenth and eighteenth centuries. Among these were gold or silver coins, commodity money, paper currency, and later tobacco and even tobacco warehouse receipts.50
Most of these commercial and consumer loans took the form of book credit and promissory notes. Book credits were recorded as debit and credit entries in the merchants’ accounting books. Promissory notes, in turn, documented the existence of debts in standardized language that included their makers’ unconditional promises of payment, a specified amount of money or of commodities and a date of issue and 794payment. Promissory notes had the advantage that they could be assigned or sold prior to their maturity, which gave their holders an early exit to a questionable transaction, although usually at a loss reflected in the amount of the discount or negotiation earned by their endorsees.51
The duration of book credit ranged from several months to several years. For example, what were supposed to be cash sales of earthenware concluded on October 1, 1748 were still being paid in installments in April of 1749; thus, Professor Flynn’s average duration of these debts to retailers ranged, depending upon the goods sold and the creditworthiness of their buyers between 182 and 211 days.52 In contrast to book credits, the duration of the credits documented with promissory notes could only be estimated by determining their time of signature and the time of default, or more precisely, when their holders-payees filed their collection lawsuits. On average, this time ranged between 6 and 9 months.53 Annual interest rates in these loans fluctuated between 3.75% and 7% which, even low by contemporary standards, was surprising in a marketplace still haunted by the possible sin of usury.54
It is true that the precise volume of credit transactions, as distinguished from barter and cash, has not been established with precision. Nonetheless, Professor Flynn’s analysis of the eighteenth century book entries of Connecticut and Massachusetts merchants showed that most of their purchases were on credit. In fact, “In some regions…credit was so accepted that many employers, including merchants, paid their employees by providing them credit at a store on the [employers’] business’s [sic] account.”55 Moreover, probate court records of the inventories of the decedent merchants’ estates showed “the frequency of credit through the large amount of accounts receivable recorded for traders and merchants in Connecticut, sometimes over £1,000.…[Indeed] [a]lmost 30 percent of the estates of Connecticut ‘traders’ contained £100 or more of receivables as part of their estate.”56 Accordingly, Flynn points out that credit was a significant form of payment in colonial America and that its duration and cost allowed consumers to consume beyond their current means. In addition, book credit allowed colonists to economize on cash by assigning their “reckonings” and store indebtedness as payment to their workers. He concludes that the variety of credit 795instruments, their duration and the methods of incorporating interest shows credit “as an important method of exchange and the economy of colonial America to be very complex and sophisticated.”57 In this respect, the commercial and consumer credit associated with the general store served as a template for future even more complex and sophisticated methods of trade finance.
As will be described in greater detail in a subsequent section,58 the assignment of accounts receivable alluded to in passing by Professor Flynn was part of the commercial-financial practice of factoring. It consisted of the assignee merchant either acting as an agent for the collection of the accounts receivable owed to his assignor by his credit customers, or in the factor’s outright or “without recourse” purchase of these accounts. Other important features of colonial factoring were described by a contemporary major factoring company:
By the 1550’s AD, Colonial America was accustomed to using merchant agents in Europe to finance shipments of raw materials such as fur, timber, tobacco and cotton overseas. The European merchant bankers would also factor any shipments made to the colonists. Sellers on either shore were paid a discounted amount of the invoice due from the purchaser before goods were shipped and the factor would take a percentage for collecting for collecting the money owed to the seller. Until the early 1700, both English and American law forbade the selling of invoices unless the purchaser [of the goods] or debtor, was notified in advance. Eventually, US state governments adopted a rule that the debtor did not have to be notified, giving rise to non-notification factoring.59
Factoring made possible a commercial and consumer credit “pyramid.” At its bottom were the consumers and their retailers who generated the upward flow of book debts and other forms of accounts receivable including commercial paper such as promissory notes and bills of exchange. At the top of this private financing system were the factors. By helping to collect or by buying these accounts, the factors helped finance not only the trade of the general stores, but also that of their suppliers and indirectly that of their customers as well. Eventually, with the creation of the Federal Reserve Bank’s discount window in the twentieth century, the uppermost layer of the commercial and consumer credit pyramid of the United States was installed. With it came the most robust upward flow (to the Federal Reserve) and downward flow (to the retail merchant and consumer) of financing known to the commercial world.
By the time of the war of independence, the Puritans’ as well as the other settlers’ predilection for private property was apparent in rural America: More than 90% of 796Americans lived on farms they owned and worked on.60 And worked they did. As observed by Gordon S. Wood, a distinguished historian of the early American republic,61 the British embargos of manufactured items during its 1812 war with the United States caused Americans (and especially those in the Northern states) to manufacture and market a wide range of products, of which cotton was one of the key crops. Prior to 1808, only fifteen cotton mills existed in the United States, but only a year later, eighty-seven new mills were added. In New England, small factories were constantly springing up, supporting the common belief that “Spinning yarn and making cloth is…our greatest business.”62 Manufacturing was not confined to New England. By 1814, 234 cotton mills operated within fifteen states,63 and family business was not confined to cotton:
Even farmers who were not growing crops for export abroad were nonetheless scrambling to create goods to exchange in local markets—working with their wives and children spinning cloth or weaving hats, dressing deer skins and beaver pelts, making hoops and barrels, distilling whiskey or cider, and fabricating whatever they might sell to local stores…. [As was the case of] an English-born leather dresser [who] … hired country girls to come to his tannery in upstate New York to cut out gloves, which [he] then sent to farmers’ wives for sewing and finishing. By 1910 he discovered he had a market for his gloves among households in the Albany area. From these modest beginning grew the flourishing glove and mitten industry of the United States.64
Professor Wood provided another telling statistic on the economic and social importance of the above family enterprises: In 1810, 90% of the total $42 million textile production came from family households. Thus, as early as in 1790, a British visitor to Massachusetts and New Jersey noted that “housewives in every farming household kept their families busy carding and spinning woolen and linen cloth in the evenings and when they are not in the fields.”65 A French visitor stated that almost all households of Worcester, Massachusetts “were inhabited by men who were both cultivators and artisans; one is a tanner, another a shoemaker, another sells goods but all are farmers.”66 And as we will discuss shortly, the production and distribution of dairy products such as cheese and butter was another fast growing family business in some states, but especially in New York. It should be kept in mind that these farming, manufacturing and merchandising families came from numerous countries and practiced different religions or none at all.67
Unlike the extended and networking Puritan families, most of the farmer-merchant-manufacturing families of late-eighteenth- and mid-nineteenth-century America operated as individual family (not networked) enterprises. And surprisingly to many foreign visitors, these businessmen received credit from distant merchants. A Scottish shopkeeper, known to extend six months to a year of credit to his customers in Chesapeake Bay in the United States, explained his credit policy as follows:
Scottish storekeepers … ‘often trust to the labor and industry of many, who are in the Possession of little or no real property.’ … ‘In a young country where land may be got at a low rent, and where a valuable staple is raised, young men soon leave their Parents, and marrying, settle plantations for themselves.’ To do this, they need ‘household furniture and working tools,’ furnished ‘upon Credit, by some Factor or Storekeeper.’68
The British embargos of manufactured items during its 1812 war with the United States caused Americans to energetically seek economic self-sufficiency in their internal and international trade. Small, privately-owned family farms became the main engine of self-sufficiency and personal, unsecured credit (received and given) was the main lubricant of this engine. As commented by Oxford’s Senior Research Fellow Rowena Olegario, instead of relying on real property collateral, the distant suppliers of these American producers relied on the labor and honesty of the settlers69 and the latter relied on similar character traits when extending credit to their customers. Accordingly, a self-sufficient commercial credit system that did not depend upon the security of real and personal property was set in motion.
As became apparent in the preceding chapter, the close familial and religious connections between British and North American colonial merchants and their willingness to extend credit to their contractual counterparties was a major reason for England’s commercial success during the seventeenth and eighteenth centuries.70 The same was true in the nineteenth century despite the hard fought revolutionary and 1812 wars between the United States and England. These connections resulted in what Olegario referred to as a “transmission of mercantile practices from Britain to 798America”71 even though these practices encountered in America: “[A] chronic lack of money, combined with growing markets and ever-increasing competition.”72 The migration of practices occurred in at least two areas:
First, the British model of strong merchants (rather than banks) as the most important source of trade financing was replicated in the American trade. Wholesalers based in the country’s commercial centers-men like the Tappan brothers of New York … supplied the bulk of the capital that sustained the mercantile credit system. Second, American merchants, like their British counterparts, extended long credits over great distances to compensate for the shortage of money.73
Part of the large amount of commercial credit available in independent America from English sources was often used as start-up capital by ambitious Americans as well as by British immigrants; the same was true with the ample credit made available to United States retail merchants by large United States importers.74 And while British merchants were aware since the trading days of Samuel Storke that credits to American merchants often remained uncollected beyond the agreed upon repayment period, they also felt that they had to extend it as “a matter of necessity” because of the “competition of other capitalists.”75
Olegario quotes the French statesman Charles Maurice de Talleyrand for the assertion that it was British credit that truly enabled the commercial-consumer trade in America. (C’est donc réellement l’Angleterre… qui fait le commerce de consommation de l’Amérique).76 However, as will become apparent in subsequent sections, even though commercial and consumer credit practices were imported from England, they grew and diversified extraordinarily in the United States, to the point that if Calvin Coolidge was right in saying that the business of America was business, it was also true that the lubricant of that business was credit to fellow merchants and consumers.
Talleyrand notwithstanding, United States wholesalers, at times referred to as such, and at times as “importers,” “dealers,” “factors” and “jobbers” would soon take over the supply of inventory and commercial credit to smaller merchants in the United States. The terms “importers” and dealers were used as functional equivalents of the wholesaler who buys directly from the manufacturer. By buying directly from United States or foreign manufacturers, the wholesaler made these goods available on a discounted cash basis or on a credit basis to smaller merchants, usually acting as retailers or direct sellers to consumers. Their prices had to be low enough so as to enable their retail clients to sell them at a profit to consumers.
The term “jobber” applied to a wholesaler who purchased goods in lots (only occasionally including all the marketable types and sizes of a given item of inventory), thus generally stocking only select types and sizes (referred to in the trade as “odd lots”). Their sellers could be manufacturers trying to get rid of items that were not as popular as they expected or they could be insolvent retailers or wholesalers. By buying these lots very cheaply, the jobber was able to buy many of them and sell them to several retailers at one time.77
Olegario provides a telling statistic on the importance of wholesaler and jobber credit in mid-nineteenth century America. In an 1858 circular of the Mercantile Agency (a credit reporting agency discussed later) estimated that:
157,394 village and country [general] stores owed an average of $14,500 each to city jobbers, an aggregate value of nearly $2.3 billion…. Some jobbers advanced to country stores goods worth ‘three or four or even five times the amount of his (the jobber’s) capital’….78
The term “factor” had two meanings in United States nineteenth-century commercial practice. The first applied to merchants who acted as commercial agents for wholesalers or retailers who entrusted them with goods for sale or exchange to third party merchants or non-merchants. For their sales or exchanges, they received a commission. I will refer to this factor as the “factor-agent.” Although this meaning of factor is seldom used in present-day commercial practice in the United States, as I will discuss shortly, it had a significant impact on the law of good faith commercial purchases.
The other meaning of factor applies to a financial intermediary who provides funds to manufacturers and wholesalers (and less frequently to retail merchants) in need of working capital and inventory financing. These factors could provide funds as outright purchasers of the accounts receivable of the manufacturer, wholesaler or large retailer, in which case they purchased the accounts “without recourse” on their seller. Or they could act as secured creditors for manufacturers, wholesalers or retailers and lend on the security of their borrower’s inventory and accounts payable.79 They would then attempt to collect the accounts from the account debtors, i.e., the purchasers of the goods or services from the factors’ debtors. If he failed to collect or collected only part of the debt, he could demand payment from his borrower of the principal and 800interest that had become due.80 The economic and legal significance of both types of factors should not be underestimated.
Professor Grant Gilmore, one of the great commercial law scholars of the twentieth century, pointed out the significance of the so-called Factors’ Acts, which were applicable to factor-agents selling their principal’s goods in a regional or national market:
[A] recurrent situation came to be the misappropriation of goods by a faithless agent in fraud of his principal. Classical theory required that the principal be protected and that the risks of agency distribution be cast on the purchaser. The market demanded otherwise.
The reform was carried out through so-called Factor’s Acts, which were widely enacted in the early part of the 19th century. Under these Acts any person who entrusted goods to a factor—or agent—for sale took the risk of the factor’s selling them beyond his authority; anyone buying from a factor in good faith, relying on his possession of the goods, and without notice of limitations on his authority, took good title against the true owner. In time these Acts were expanded to protect … banks, who took goods from a factor as security for loans made to the factor to be used in operating the factor’s own business.81
And even though these Factor’s Acts were absorbed by the twentieth century law of commercial sales and secured transactions (as we will discuss shortly), they were the first to grant protection to the third parties of the secondary markets for the sale and pledge of goods, such as those just mentioned by Professor Gilmore.
Meanwhile, the factors who were purchasers of accounts and secured creditors were the first commercial intermediaries to provide credit based on the security of intangible goods such as accounts receivable. In doing this, they broke with a secured lending tradition in influential continental European countries such as France which restricted chattel mortgages to immovable or real property.82
By the middle of the nineteenth century, wholesalers, jobbers and factors not only acted as lenders but on occasion, they provided venture capital for the production and distribution of products made or manufactured by family businesses.83 As discussed 801earlier, in some sectors, such as in the sale of dry goods, they remained as principal suppliers of inventory on a credit basis to retail businesses and not as partners or joint venturers.84 However, in other sectors such as in the production and distribution of dairy products, their role was pervasive and often in conflict with the interests of the small businesses they financed. By participating in the financing, production and sale of milk and dairy products, they often fixed wholesale prices and, with this power, they displaced many a family business.
The following summary of a narrative by the Encyclopedia of New York State85 starts with what was at first an attempt by a railroad carrier to ship fluid milk produced in upstate New York to New York City. This attempt came only after the opening of railroad from upstate New York to New York City by the Erie Railroad line in the mid-nineteenth century.
Prior to the opening of this service, the dairy farming business was populated by a large number of small and independent family producers of fluid milk and dairy products such as cheese and butter. Their main customers were consumers with whom they did business on an informal, (mostly oral) face-to-face basis. Even so, by 1850, New York State was the nation’s leading dairy producer responsible for “almost half of the total cheese production in the United States.”86 But by that time, very few New York State farmers continued to produce “fluid” milk as a cash crop; the lack of sufficient buyers made them turn almost exclusively to the production of cheese and butter.
In 1842, however, a small dairy farmer agreed to participate in a merchandizing experiment proposed to him by an Erie Railroad station master: Fresh country milk would be shipped to the large consumer market of New York City via the Erie Railroad line. In the words of the Encyclopedia of New York State: “The few cans of milk that [this farmer] shipped in an unrefrigerated baggage car became the first upstate milk ever sold in New York City.”87 The number of cans increased from 45 cans per day in 1842 to 273 cans per day in 1843. By 1844, the number increased to 420 cans per day.88
One of the reasons for the success of the fresh country milk delivery to the big city was that for a number of years the New York’s growing population had consumed only “swill” milk, which is a milk produced by city cows after having been fed brewers’ waste.89 Predictably, this milk turned out to be as bad in appearance as it was dangerous to the health of consumers, especially New York children.90
As the number of fresh cans of milk shipped approached thousands per day, the shippers were no longer the subsistence farmers whose business was seasonal and dependent on the needs of their face-to-face customers. The new dairy farmer had to deliver milk regularly and in large quantities according to the railroad schedule and based on the number of orders placed by milk wholesalers (also known as dealers). Unlike their subsistence trade in upstate New York, the shipping farmers seldom knew their New York City consumers. Meanwhile, the production of butter and cheese started shifting (because of their volume) from the producers’ farms to factories which delivered them to wholesalers or to consumers. Thus, the making and selling of cheese and butter was no longer “the the domain of … [the farmers’ wives] and daughters….”91 They were part of big business which charged wholesale prices to New York City retail food shops and restaurants that in turn resold the milk or the dairy products to the public, who paid higher retail prices. After 1850, more than 1,500 cheese factories were active across New York State alone.
This change in the merchandizing of fluid milk and dairy products meant that farmers surrendered control of the marketing and sale of their milk, butter and cheese to wholesalers and factories. The contractual relationships between dairy farmers as suppliers and their purchasers-dealers as wholesalers (in conjunction with or separately from the factories) consolidated the legal status of dairy farmers as merchants and their contractual relationships with their counterparties as one “between merchants.” Consequently, as noted in the introductory section of this chapter, the term merchant was defined a century and a half later by U.C.C. § 2–104(1) and included farmers, among many others, who dealt “in goods of the kind” and who by their occupation held themselves out “as having knowledge or skill peculiar to the practices or goods involved in the transaction….”92
In due course, however, United States dairy farmers learned that during the time they were awaiting payment for the fluid milk they had sold on credit, they could sell or pledge their accounts receivable to factors or bankers, especially if the buyers of their milk or daily products and they themselves were credit worthy. It is true that the dairy wholesalers and factors had better financial resources and legal advice than they did.93 However, the allure of larger sales and profits induced both sides (dairy farmers and wholesalers and manufacturers of dairy products) to attempt to monopolize and restrain the dairy trade. This was a case of industriousness and striving gone awry.
Dairy farmers formed coalitions or cooperatives whose purpose was to restrict the supply of milk and raise its market price. At times, they were joined by the Erie Railroad as a member of their coalition fighting wholesalers and factory owners. Conversely, the factory owners and wholesalers unhappy with what they considered excessively high wholesale prices countered with their own monopolistic or quasi-monopolistic schemes, including the creation of a “Milk Exchange” whose prices they manipulated.94 The dairy farmers fought back in 1883 and, assisted again by Erie Railroad executives, implemented a strategy of strikes, lawsuits and milk spillings that 803caused serious dairy shortages in New York City and other cities they serviced. These battles continued until non-market forces, including repeated restraint of trade lawsuits, intervened and led to a regulation of the quality, safety and reliable distribution of dairy products and with it, price fixing battles subsided.
The migration of British sales and credit practices to colonial America continued after the birth of the United States, including the central role of wholesalers, jobbers and factors as commercial credit providers. Their credit was largely unsecured and relied on established relationships based upon mutual trust. In the case of the New York dairy industry, these intermediaries frequently battled with milk producers in an attempt to lower and fix the prices they were willing to pay.
Worthy of note is how quickly and serendipitously commercial practices came about. Please recall that the new distribution practice of shipping fresh milk from upstate New York to New York City did not come about from contractual negotiations between dairy farmers, wholesalers and factory owners. The negotiations were started by an imaginative, industrious and striving station master of the Erie Railroad line intent on finding cargo for his unused space in baggage cars and an intrigued, but not overly enthusiastic dairy farmer.
Note that these new practices could not have come about if America’s dairy farmers and railroad station masters, milk wholesalers and factory owners lacked the Puritan industrious and striving behavior that Reverend John Winthrop exulted in the ship Arabela while sailing to America in 1630.95 They would not have come about either if the general principle of commercial contracting was: Unless expressly allowed, the contract in question is forbidden. The guiding principle behind the emergence of the new practices had to be: That which the law does not expressly forbid, it allows. This is the reason why a lowly railroad station master felt sufficiently empowered to enter into a transportation contract that was not executed by Erie or another railroad’s cargo officials. Such a contractual relationship and its derived practices could not have come about in Stalin’s Soviet Union. For as we discussed in Chapter 15, in Stalin’s Soviet Union, a rail station master who wanted to use up empty baggage space to carry fresh milk to a big city would have had to join the ranks of the numerous black-marketers willing to bribe government officials.
On the other hand, the same perceived freedom to enter into any and all contractual relationships led milk farmers to form coalitions with other milk farmers and with the Erie Railroad to fix and defend their fixed prices. On the other side of the fixed pricing battle were the wholesalers and milk factories. It was apparent that both sides’ version of freedom of contract included the legitimacy of their respective price fixing. It was also apparent that their common version of competition included conduct that could drive the losing competitor out of business. Thus, theirs was neither a cooperative, let alone a fair type of competition in which both sides could stay in business even though one side emerged with a diminished share of the market as a result of the other’s superior products, best prices and services. It was a winner-take-all, loser-take-none type of competition. And as became apparent with the growing 804number of restraint of trade lawsuits and “street battles,” courts and, subsequently, administrative agencies had to collaborate in setting forth the reasonable boundaries of permissible competition. It became apparent that as family and religious ties subsided, so did the boundaries of permissible competition and the influence of the Puritan principles of a moral type of capitalism. In addition, as pointed out by Steve Pearlstein, a George Mason University Professor and the Washington Post’s distinguished economics journalist, prior to the nineteen eighties the ethos of American corporations was concerned with the welfare of society at large:
The earliest American corporations were generally chartered for public purposes, such as building canals or transit systems, and well into the 1960s were widely viewed as owing something in return to a society that provided them with legal protections and an economic ecosystem in which to grow and thrive. In 1953, carmaker Charlie Wilson famously spoke for a generation of chief executives about the link between business and the larger society when he told a Senate committee that “what is good for the country is good for the country is good for General Motors, and vice versa.96
The American College Dictionary defines a department store as “A large retail store handling several lines of goods, including dry goods, women’s wear, etc. and organized in separate departments.”97 This type of store largely replaced “general” or “country” stores starting in the mid-nineteenth century, especially in well-populated cities.98 They also introduced commercial practices that resulted from the massive purchases and sales associated with their seemingly ever-growing chains of retail stores.
Department stores also institutionalized and aggrandized, sometimes outlandishly, the consumer revolution referred to by the State of Virginia in its salutation to the Fielding Lewis Store. Having been born and raised in a developing nation, imagine my surprise when I read in a 1963 Nieman Marcus Christmas gifts catalogue that one of its special items was an actual “his and her” submarine in different shapes and colors.99
While some of the nineteenth century department stores were palatial such as the Turney Stewart “Marble Palace” (New York, 1848)100 or the John Wanamaker’s “Grand Depot” (Philadelphia 1876),101 others catered to lower-middle-class clientele such as Macy’s original store (Haverhill, Massachusetts, 1851)102 and others to thrifty buyers, such as F.W. Woolworth’s Five and Dime stores (Utica, N.Y., 1878).103 Customers who enjoyed shopping from their homes could also do so by ordering from Montgomery Ward’s and Sears and Roebuck’s mail order catalogues, which were distributed largely in rural America during the second half of the nineteenth century.104
After the Second World War, chains of national and regional “super-markets” changed the method of shopping for a large variety of food and household products. Their customers could select products from stacks located in separate aisles, place them in rolling metal baskets and pay for them to usually smiling cashiers as they exited the stores. Only a generation later, these super-markets had to compete with “hypermarkets” or “big-box” markets exemplified by Wal-Mart (presently the largest chain of stores in the United States and possibly in the world.)105 Finally, in our day, a new form of shopping originating from our home or place of business computers allows us to shop electronically for an increasingly wide range of products at low prices and with prompt delivery to our homes or places of business.
Having witnessed the displeasure of many retail merchants in my country of birth with customers who returned goods that they had recently purchased, imagine my surprise when a classmate at the University of Michigan told me that Chicago’s Marshall Field’s (where I had purchased tennis shoes with the naïve expectation that I could use them as skiing boots) would make no fuss about accepting my return of those shoes. He said that it was the practice of many department stores in the United States to accept the return of goods that the customer was unhappy with because their motto was, “The Customer is Always Right.” He had heard that a Mr. Selfridge, one of Marshall Field’s owners, was the author of that motto and that he had famously instructed his sales staff to “always give the lady what she wants.”106
Years later, I reflected on the sharp difference between a commercial practice that expected mature buyers to “be aware” of what they were buying and to assume responsibility for it, defects and all (caveat emptor) and another practice that encouraged merchants to always try to satisfy the reasonable expectations of their customers, even if a sale price of recently purchased goods had to be returned. While writing this book it dawned on me that Mr. Selfridge’s attitude provided the retail sales agreement with an archetypal version of its parties’ intent and with an equally archetypal presumption of good faith.
One of the least noticed effects of the sales of goods by department stores was the phenomenal expansion of the physical and legal boundaries of the Law Merchant’s custom of “Market Overt.” According to this custom, purchases in an open market granted good title to the goods bought in it notwithstanding that the seller may have had no title to them.107
In nineteenth-century English law the expansion of the Market Overt protection was halting: At times it included and at times it excluded the sale of goods that were not sold in a physically “open” market or were sold at the wrong time of the day Even though in principle every shop in the City of London was a Market Overt, as Dean Peter M. Smith of the Exeter Faculty of Law noted, the term shops also had a technical meaning. What constituted a Market Overt shop varied with the facts of each case. For example, a sale in a tavern was not a sale in a Market Overt, nor was a sale of lead from a wharf, while a sale in a building “[that] appears to have been little more than a warehouse was found to be a shop….”108
In contrast, § 1–201 of the U.C.C. relies on the notion of a “buyer in the ordinary course of business” and locates such an ordinary course as broadly as with a “person other than a pawnbroker, in the business of selling goods of that kind.” It then adds that:
A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller’s own usual or customary practices.109
Rather than restricting the Market Overt business of the shop and who is protected when purchasing in it, this provision opens the meaning of a shop to the place where seemingly endless types of goods can be purchased by as many methods of purchase as available in department stores. Indeed, as clarified by Official Comment 9 to U.C.C. § 1–201:
‘Buyer in ordinary course of business.’ Except for minor stylistic changes, identical to former Section 1–201 (as amended in conjunction with the 1999 revisions to Article 9). The major significance of the phrase lies in Section 2–403 and in the Article on Secured Transactions (Article 9)….110
U.C.C. 2–403 is one of the U.C.C. rules that absorbed some of the protections given to bona fide purchasers by the Factors Acts including the concepts of “entrustment” to the faithless factor and its validation of good faith purchase. Thus, U.C.C. § 9–320(a) provides: “a buyer in ordinary course of business, other than a person buying farm products from a person engaged in farming operations, takes free of a security interest created by the buyer’s seller, even if the security interest is perfected and the buyer knows of its existence.”111
The connection of this section with purchases made by buyers in the ordinary course of business from the inventory of a retailer, including prominently department store sellers, is direct and immediate. As noted by Official Comment 3 to § 9–320: “Thus subsection (a) applies primarily to inventory collateral.”112
In sum, the U.C.C. version of the Market Overt rule protects a huge segment of the population of the United States as third party purchasers of goods in the ordinary course of business from retailers and especially from department stores. The title to the consumer goods purchased, while subject to the good faith requirements of U.C.C. § 9–320(b), conveys possessory title supported by a document as informal as a retail or wholesale merchant’s cash registry or credit card receipt. Such an informal document is found daily in the hands of millions of buyers whose sellers often lack the traditional detailed documentation of ownership of the goods sold. This legal revolution against what Professor Gilmore alluded to earlier as the classical (Roman and English law) world of “No one can transfer what he does not own” (Nemo Dat Quod Non Habet) must rank as one of the most significant in the history of commercial law. It is suely one of the factors in the diminution of the status of title to personal property used as collateral as became apparent in the heading of U.C.C. § 9–202, “Title to Collateral Immaterial.”113
Department stores, especially those that were part of chains, had to buy products in large quantities and had to assure their buyers that their products were of a uniform and standardized quality, so that at least their most successful lines of products reflected well on the store’s trade name. This uniformity of quality made it easier for manufacturers and sellers to accompany their products with express and implied warranties of merchantability and fitness for the intended use or purpose of their products.
Presently, large department stores do much of their purchasing of inventory through “master” electronic supply agreements.114 Once such a store’s computer’s inventory control software detects the need to order or re-order certain items, it issues a purchase order which triggers an electronic request (or application) to its bank for the issuance of a letter of credit to its supplier(s). The notification or confirmation of the issuance of the letter of credit to the supplier’s bank or to the supplier triggers the 808supplier’s notice to its freight forwarder to request shipping space and procure the issuance of an insurance policy or certificate to cover the shipment(s). Eventually, once the supplier receives the necessary document or electronic message from his carrier, insurer and quality and weight inspector, it will also trigger the supplier’s issuance of a draft or demand for payment of the letter of credit from the paying bank.
This form of multi-party contracting (which will be re-visited in Chapter 22) is also used by other large enterprises intent on maximizing their efficiency by receiving and using their raw materials and products “just in time” to save the most costs. In doing this, as will also be discussed in that chapter, it does away with traditional components of purchase and sale agreements and creates another “dynamic” contract.115
As just noted, department stores popularized the use of cash registries that issued receipts of cash or check payments to their customers. Generally, this was the only written or printed record of the sale agreement and as such, bolstered informal practices that were consistent with their often massive and rapid sale transactions. They also shaped consumer-credit practices that allowed their customers to charge their purchases directly to their credit account with the store, to their charge card or to both. Charge accounts were among the most popular sources of consumer credit until the end of the Second World War. With proper identification, customers could make purchases on credit subject to a printed set of terms and conditions that were part of contracts of “adhesion” in which customers had no say on their terms and conditions.116
Finally, department stores contributed to the widespread use of credit cards, whose world-wide use continues to grow in our time. Although these cards were issued by independent financial intermediaries (many of them by well-known banks), they could be used not only for store purchases, but also for travel and entertainment. The department stores, as a rule, entered into an agreement with the issuers of the cards which enabled the issuer to earn a fee or discount for each use of their cards. Payments with credit cards provided their users with an easier enforcement of contractual warranties of merchantability and fitness of purpose, including by reversing charges for defective or returned products.
By increasing the variety of goods, standardizing their quality and easing their acquisition by means of informal transactions, charge accounts and eventually credit cards, department stores contributed significantly to an economy driven by consumption. From a commercial contract standpoint, department stores contributed to new forms of contracting with their customers and suppliers. With their customers, they replaced a “buyer beware” attitude with “the customer is always right” attitude, thereby creating an archetypal good faith intent. For their purchases, they, together with other large public and private entities, introduced multi-party contracts as part of paper-based and later electronic master agreements. These electronic master 809agreements governed contractual relationships with, in principle, a limitless number of suppliers, carriers, insurers and issuers of letters of credit.
In their sales to consumers, they also relied on informal receipts of purchase and master agreements usually associated with charge accounts or cards and eventually credit cards. Today, when most consumer purchases are paid with credit cards, department stores also join the growing number of public and private entities that rely on contracts of adhesion to document their extensions of credit. Payments with credit cards have made it easier to stop payments, return products or claim refunds as extrajudicial remedies for breaches of the warranties of quality. And as payees of credit cards, department stores generate enough discountable or saleable commercial paper to help finance their credit needs.
When it gained its independence, the United States had neither a central bank nor an official currency.117 The absence of these two components threatened the liquidity and solvency of the country. Alexander Hamilton, Secretary of the Treasury in President Washington’s cabinet, realized that unless the new nation could re-finance its war debts and those of its constituting states, it would lose whatever credit-worthiness it had. With this in mind, he proposed in 1790 the creation of a United States bank modeled, as described in the preceding chapter, after the Bank of England. When the First Bank of the United States opened in Philadelphia in 1791, it had not only “bundled” the state and federal debt and offered repayment bonds at an attractive rate, but also acted as a commercial bank by offering commercial loans to new and established businesses.118 And as with the Bank of England, its capital and ownership were both public and private—the federal government owned 20 percent of the bank, while private investors owned the rest. The First Bank of the United States achieved some of its creditworthiness goals, but “many politicians objected to the role that the private sector played in its operations; they believed that the government should have controlled it completely.”119
It was not long before states began authorizing their own banks and issuing their own currency. When the War of 1812 against England broke out, it not only disrupted the trade of the United States but it also sent the federal government back into debt. The federal government then established the Second Bank of the United States in 1816; it was larger than its predecessor (29 branches), had a regulatory role and acted as a depositary bank for private banks. It also “cracked down on financial institutions that appeared to be signing over too many notes.”120 However, its activism disturbed an equally strong-willed President Andrew Jackson who was responsible for the failure to renew its charter in 1836.
Following this came a “free banking” era that was followed by a “national banking” era. During the free banking era (1837–1864), each state had the power to issue charters for new banks to operate within the state boundaries and many did with little or no regulation. A large number of unregulated banks were opened and, predictably, many had to close because of poor management of difficult market conditions. Shortly after instituting this free banking regime, a financial panic ensued and lingered for several years.
As a result of mounting debts, including those attributable to the Civil War, the federal government created yet another national bank in 1863 which retained some of the principles of free banking. Thus, individual banks could receive charters at either the national or the state levels. Those that chose national charters were required to use government-issued bills and back them with U.S.-issued bonds (which they had to purchase and use as reserves). After the state charter option was phased out, the United States had its first uniform currency in almost a century of existence. Since that time, every bank in the country has used the same federally minted coins and printed bills.
At the present time, approximately 8,000 banks are doing business as commercial banks in the United States121 and some of them were founded at least two hundred years ago.122 In the United States, commercial banks are the principal players in its payments and credit system. It is through these banks that Americans make most of their payments by “writing checks, swiping credit cards issued by banks or tied to them, and by paying bills via online banking.”123 A financial dictionary defines “near money” or “quasi-money” as “Assets that are easily convertible into cash, such as money market accounts and bank deposits.”124 Much of the money in circulation in the American economy is this private “quasi-money” increasingly in “virtual” form and the remainder is the “legal tender” issued by the Federal Reserve as notes and coins. As pointed out by New York University’s Professor Richard Sylla:
We have confidence in bank money because we can exchange it at the bank or an ATM for legal tender. Banks are obligated to hold reserves of legal tender to make these exchanges when we request them.125
As also noted by Professor Sylla:
The second key function of banks is financial intermediation, lending or investing the money we deposit with them or credit they themselves create to business enterprises, households, and governments. This is the business side of banking. Most banks are profit-seeking corporations with stockholders who provide the equity capital needed to start and maintain a banking business.
Banks make their profits and cover their expenses by charging borrowers more for loans than they pay depositors for keeping money in the bank. The intermediation function of banks is extremely important because it helped to finance the many generations of entrepreneurs who built the American economy as well as the ordinary businesses that keep it going from year to year.126
Banks in the commercial banking system of the United States are either nationally- or state-chartered and regulated. A national bank is “any commercial bank chartered and supervised by the federal government and operated by private individuals.”127 In contrast, a state bank or a state chartered bank is “a commercial bank incorporated under a State charter and not required to be a member of the Federal Reserve System.”128
Yet, as pointed out by banking law experts Geoffrey P. Miller and Avery I. Belka, even though the dual system of state and national chartering authorities has historically resulted in significant differences on permissible banking activities and in an increased complexity of the regulatory regimes, “federal legislation in the last decade has significantly nationalized banking law by expanding the jurisdiction of the federal regulators and increasingly subjecting state banks to federal banking standards.”129
The Office of the Comptroller of the Currency (OCC) is the federal entity with the authority to charter these banks. In the case of state banks the regulatory authority is allocated with each state’s chartering authority.130 In addition, because:
[N]early all banks are required to have deposit insurance, regardless of charter, the Federal Deposit Insurance Corporation (FDIC) also plays a significant regulatory role. Finally, the Board of Governors of the Federal Reserve (Board of Governors) also is a primary regulator of Bank Holding Companies and state chartered banks that are members of the Federal Reserve System.131
The Federal Reserve System of the United States was created on December 23, 1913 by the Federal Reserve Act.132 Its Board of Governors lists as the main purpose of 812this system to provide the nation with “a safer, more flexible, and more stable monetary and financial system.”133 Hence, it is charged with the following:
Conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices. [To supervise and regulate] banks and other important financial institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers. [To maintain] the stability of the financial system and containing systemic risk that may arise in financial markets. [And, to provide] certain financial services to the U.S. government, U.S. financial institutions, and foreign official institutions, and playing a major role in operating and overseeing the nation’s payments systems.134
One of the salient characteristics of the Federal Reserve is its considerable independence. The President of the United States selects its chairman, but in the words of its Board of Governors:
[It is] an independent entity within government. It is not “owned” by anyone and is not a private, profit-making institution.
[It] derives its authority from the Congress of the United States…. [but] its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve’s activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as ‘independent within the government’ rather than ‘independent of government.’135
Congress established 12 regional Federal Reserve Banks and organized them as private corporations, i.e., they issue shares of stock to their member banks as a condition of their membership. Nonetheless, since the Federal Reserve banks are not-for-profit entities, their stock may not be sold, traded, or pledged and their dividends are, by law, six percent per year.136
The Federal Reserve Bank of San Francisco describes the supervisory function of the Federal Reserve over banking institutions as follows:
[T]he Fed promotes the safety and soundness of the banking system, fosters stability in financial markets, and ensures compliance with laws and regulations under its jurisdiction. The Fed encourages banking institutions to meet the financial needs of their communities by making prudent loans, among other actions. Supervision involves examining the financial condition of individual banks and evaluating their compliance with laws and 813regulations. Bank regulation involves setting rules and guidelines for the banking system.137
As also described by the Federal Reserve Bank of San Francisco, it is the nation’s monetary policy authority which empowers it to influence the availability and cost of money and credit in pursuance of a healthy economy. In discharging this mission it pursues the above-mentioned goals of insuring a maximum sustainable output and employment and maintaining stable prices, meaning low, stable inflation. These dual policy goals require moderate long-term interest rates:
The Fed works to fulfill its dual mandate primarily by setting a target for a key interest rate, the federal funds rate, which is what financial institutions charge each other for loans in the overnight borrowing market. The federal funds rate serves as a benchmark for many other short-term interest rates and consequently broadly influences credit conditions. The Fed uses a number of tools to keep the federal funds rate near its target.138
One of these tools makes funds available to the banking system by purchasing government bonds on the market as part of its “open market” operations; “banks take those funds and lend them out in the form of [their depositors’] checking account balances, which amount to a significant multiple over the amount of funds introduced into the system by the government’s action.”139 Another tool is by discounting and re-discounting the member banks’ commercial paper. The latter is of considerable importance to commercial lawyers.
Paul Warburg devoted much of his life to the creation of a functional central banking system in the United States especially through the enactment of the Federal Reserve Act of 1913.140 He was born in Hamburg Germany in 1868, the offspring of the prominent German banking family M. Warburg & Co. He married an American citizen and became a permanent resident of the United States as well as a partner at his father-in-law’s firm, Kuhn, Loeb and Co., one of Wall Street’s most important and respected banking houses. As an experienced European banker, he was shocked at the undeveloped status of banking and finances in the United States during the early 1900s.
At that time, the United States was suffering from a rigid system of fixed reserves that prevented the printing of public money when needed, thus discouraging the creation of liquid private or “quasi-money.”141 It was one of the causes of periodic liquidity crises and panics such as the one of 1907.142 For this reason, manufacturers, 814wholesalers, retailers of hard and dry goods and their counterparts in the farming business were unable to obtain credit to finance the acquisition of their respective raw materials, equipment and inventories. As these crises spread, the stock market continued to plunge and bank failures proliferated.
Among the remedies proposed by Warburg was the creation of an American discount market for commercial paper similar to that available to European bankers and their customers-borrowers. He maintained that the United States’ central bank supply of money should vary with the short-term legitimate needs of commerce. When these needs increased, the discount by the Federal Reserve Bank of the customer-originated commercial paper held by member banks would provide these customers with ample credit at market rates. When the needs decreased, the supply of quasi-money would also decrease, thereby making it an elastic system of money supply.
The Federal Reserve Bank would accomplish its discount function by advancing to member banks significant portions of the face value of the commercial paper they had indorsed to the regional Federal Reserve Banks. The period for the repayment of the Federal Reserve advances reflected the time during which their member banks’ customers would normally repay their indebtedness to those banks. And this time fluctuated with the time it took the member banks’ borrowers-clients to sell or to manufacture and sell the respective goods or commodities to their users or consumers. Often the commercial paper (mostly bills of exchange or drafts) that signified the loans made to the merchants who borrowed from the member banks was secured (and accompanied) by documents of title such as ocean bills of lading or warehouse receipts similarly endorsed to the Federal Reserve Bank.
The following are excerpts from Paul Warburg’s “The Discount System in Europe”143 which summarize his speeches and writings in anticipation of the enactment of the Federal Reserve Act of 1913.
According to Paul Warburg:
No mathematical rule can state the correct proportion between reserves and demand obligations…. This general principle, however, may be safely laid down: with the present system of immense deposits payable on demand … only that structure is safe and efficient which provides for effective concentration of cash reserves [with the central banking authority] and their freest use in case of need, and enables the banks, when necessary, to turn into cash a maximum of their assets with a minimum of disturbance to general conditions…. It is now generally acknowledged … [European] central bank system…. [I]t was a victory of the ‘discount system’ over the system of cash advances….144
Warburg defined the discount of a draft as a temporary indebtedness paid off by the transaction the carrying out of which the loan was supposed to make possible. His example was that of a bill of exchange drawn for the sale of cotton while it was being harvested, was in transit for Europe, being manufactured into yarn, or during the time that a merchant had not yet paid for finished articles to the manufacturer, the holder of the bill. Thus, the maturity of the bill depended on the time for the payment of the underlying transaction, which usually was three months.
Bills of exchange or drafts could be drawn by a seller against his buyer and were known as trade acceptances. Or they could be drawn against the European bankers by the seller or exporter of the goods who was frequently also the beneficiary of their letters of credit.145 Warburg gave the example of an American merchant who bought coffee in San Paolo, Brazil. He generally paid for it by procuring the issuance of a letter of credit by a European bank with a three month maturity. Accordingly, the European banker agreed to accept a three months’ bill drawn on him, accompanied by the usual shipping documents such as an invoice, an ocean bill of lading and an insurance policy. The seller-beneficiary would have no difficulty in selling to a bank in San Paolo his bill drawn on a first-class European banking house and thus would promptly obtain the money due him for the goods sold. “The local bank in San Paolo will buy the bill without hesitation (if the shipper is not of the very best standing, the bank will demand that the letter of credit against which the bill is drawn be produced) because it knows that it need only send this foreign bill to England, Germany or France … where, owing to the extensive discount market in these countries, it can immediately rediscount the bill, thus securing repayment in cash for the amount invested.”146 Yet:
[N]o matter how good may be the credit of the American purchaser or of any American bank, whose acceptance the purchaser may offer to the shipper in China, South America, or Europe, no shipper in such countries will, as a general rule, take the acceptance of an American bank or banker, because the American bill has no ready market, while the European bill is of very easy sale.147
As will be readily apparent in the transcribed portions from the Federal Reserve Act, Warburg’s influence on its discount rules of commercial paper was decisive.148 He persuasively identified the key features of the supply and demand side of the creation of private money. On the supply side, the Federal Reserve Act had to grant its member banks the power to create a market for the commercial paper executed by the customers of these banks and accepted or endorsed (or both) by the member banks. Additionally, it had to concentrate ample enough cash reserves in the central bank to assure the necessary supply of loan funds throughout the system. Finally, to preserve and grow this market, the Federal Reserve had to carefully supervise the quality of the loans, i.e., their liquidity or the member banks’ ability to convert them into cash quickly and inexpensively. In identifying these features, Warburg also identified the characteristics of the commercial loans (including the underlying transactions they financed) so as to make them safe and sound to the lending banks and their regulators.
The chief characteristics of these loans were: (1) Faithfulness to their stated purpose so that their performance could be measured against the fulfillment of that purpose; (2) The ability of the loan to be repaid out of the proceeds of the contemplated manufacture, wholesale or retail activity of the borrower, and thus the exclusion of purely financial transactions; (3) The lender’s ability to rely on collateral whose market value could be easily and reliably ascertained and realized; (4) A loan maturity that did not exceed the customary period for the repayment of that transaction by the ultimate buyers or users, usually a short period measured in terms of no more than three months; (5) Accessibility to such a loan by anyone who dealt in the goods involved in the loan, regardless of whether such a borrower was an officially licensed merchant, a farmer or a professional producer, supplier or servicer of the goods.
Section 13 of the Federal Reserve Act (12 U.S.C. § 343) sets forth the powers of Federal Reserve Banks. Among these is the power to discount commercial, agricultural and industrial paper:
Upon the indorsement of any of its member banks, which shall be deemed a waiver of demand, notice and protest by such bank as to its own indorsement exclusively, any Federal reserve bank may discount notes, drafts, and bills of exchange arising out of actual commercial transactions; that is, notes, drafts, and bills of exchange issued or drawn for agricultural, industrial, or commercial purposes, or the proceeds of which have been used, or are to be used, for such purposes, the Board of Governors of the Federal Reserve System to have the right to determine or define the character of the paper thus eligible for discount, within the meaning of this Act. Nothing in this Act 817contained shall be construed to prohibit such notes, drafts, and bills of exchange, secured by staple agricultural products, or other goods, wares, or merchandise from being eligible for such discount, and the notes, drafts, and bills of exchange of factors issued as such making advances exclusively to producers of staple agricultural products in their raw state shall be eligible for such discount; but such definition shall not include notes, drafts, or bills covering merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds, or other investment securities, except bonds and notes of the government of the United States. Notes, drafts, and bills admitted to discount under the terms of this paragraph must have a maturity at the time of discount of not more than 90 days, exclusive of grace.149
Please note the emphasis on the commercial liquidity of the transaction envisaged by the Board of Governors. To improve this liquidity, it precluded the endorser of the commercial paper’s reliance on purely formalistic defenses such as lack of notice of non-payment or dishonor. And on the substance of the transaction, it requires that the commercial paper arise solely from actual commercial transactions (including factors-lenders as participants in these transactions). Hence, it forbids the discounts of notes, drafts, or bills that were “issued or drawn for the purpose of carrying or trading in stocks, bonds, or other investment securities…”150 In other words, the commercial liquidity it relies on is inconsistent with speculative transactions involving investment securities with few exceptions. Finally, it limited the duration of the discounted notes, drafts and bills to those with a maturity of not more than 90 days, exclusive of grace. Thus, the duration of the discounted commercial paper cannot exceed beyond what the market considers the prudent duration of short term commercial credits.
The Comptroller of the Currency of the United States acting under the aegis of the Department of the Treasury defines a readily marketable staple as:
[A]n article of commerce, agriculture, or industry, such as wheat and other grains, cotton, wool, and basic metals such as tin, copper and lead, in the form of standardized interchangeable units, that is easy to sell in a market with sufficiently frequent price quotations.151
In turn, state statutes that regulate the lending limits of state banks echo the powers granted and limitations imposed by 12 U.S.C. § 343. For example, Oregon’s Statutes § 708A.335152 state in relevant part that “[o]bligations secured by documents covering readily marketable staples” are discountable:
(1) In addition to obligations permitted under ORS 708A.295 (Limitations on amount of obligations to Oregon commercial bank), an Oregon commercial bank may make loans and acquire other obligations of a person secured by documents of title covering readily marketable staples, provided the obligation does not exceed: (a) 15 percent of the Oregon commercial banks capital, where the principle amount of the obligation does not exceed 85 percent of the market value of the staples…. [This percentage increases with the higher collateral to loan ratio.] (e) 40 percent of the Oregon commercial banks capital, where the principle amount of the obligation does not exceed 65 percent of the market value of the staples.153
It is true that Warburg’s elastic, commercial-loan-inspired supply of quasi-money did not play the pervasive, money supply role he expected. Open market operations consisting of buying and selling government bonds became the primary tool for implementing monetary policy, including establishing interest rates for short-term loans and the total amount of printed money in circulation.154 Nonetheless, as was just discussed, it was Warburg who identified the elements of discountable commercial paper: Its beneficiaries could be traditional merchants as well as farmers; and whatever were the goods or services involved in the underlying transaction, they had to be true to its purpose and enable the discounted loan paper to be self-liquidating during a short period of time. Thus, paper derived from speculative financial transactions would not qualify for Federal Reserve Bank discount even if its duration was shorter than three months.
By identifying these and related regulatory elements, Warburg did more than institute the discount of commercial paper as a permanent function of the Federal Reserve and state banking systems. He identified the crucial elements of America’s archetypal secured commercial loan, including its self-liquidating nature and the consistency between its avowed and real purpose.
Because commercial credit was as widespread in the eighteenth century in the United States as it was in England, if not more, the collection and distribution of reliable information on the creditworthiness of actual or potential debtors was a business waiting to happen, and it did during the early decades of the nineteenth century. As will be illustrated in the following sections (and will be discussed in detail in Chapter 22), the omnipresence of commercial credit, fueled by data on the debtors’ willingness and ability to repay, stamped American commercial contracts with dynamic and flexible features unlike those of the “civil” or not-for-profit contracts governed by the Code Civil and its progeny. It is worth repeating that if the business of America is business, the chief lubricant of that business in the United States, more than in any other nation, is credit, both to merchants and consumers. This role was propitiated by Warburg’s vision of an elastic central banking policy on self-liquidating commercial loans and paper as well as by the private sector’s collection and distribution of reliable information on creditworthiness.
Indiana University Professor Emeritus of History James Madison’s 1974 study on the evolution of credit rating agencies in the United States155 called attention to the reliance on personal ties for much of their credit information by early nineteenth-century American merchants. Their trade was often conducted with merchants they knew well:
Country merchants from the West and South traveled to seacoast cities where year after year they purchased their goods from the same wholesalers. Even if the seller did not know a prospective buyer personally, he had available sources of information in the form of the experience and opinions of other merchants.156
In his 2008 lecture at the German Historical Institute in Washington, “Civilizing Capitalism? The Beginnings of Credit Ratings in the United States and Germany,”157 Professor Hartmut Berghoff’s of Germany’s Gottingen University confirmed the same high level of entrustment found by Professor Madison. Despite the fact that newly arrived businessmen did not know each other and were of different ethnic and cultural backgrounds, their trust in each other was impressive; around 1850, U.S. retailers sold up to three-quarters of their stock on credit and, thus, were dependent on credit from their suppliers.158 However, as inter-regional markets expanded and business transactions took place increasingly among strangers, defaults “became rampant.”159
Olegario refers to a general perception among commercial credit suppliers during the first half of the nineteenth century in England and America “from about the 1840s onward … only between 3 and 10 percent of all businesses managed to avoid liquidity problems.”160 One response was for suppliers to “band together into trade protection societies, where members agreed to alert one another regularly about bad debtors.”161 Another response was to obtain information on potential debtors by hiring agents or spies, a method that proved costly and unreliable.162
Eventually, Lewis Tappan, a New York merchant, (also known for his anti-slavery and abolitionist views) founded the “Mercantile Agency” in New York in 1841. According to Professor Berghoff, Tappan began to sell credit information at the very moment “[when] the railroads [were creating] interregional anonymous markets” much, I would add, as the one mentioned earlier between milk and dairy producers and consumers in New York State.163 Paradoxically, as a strict Congregationalist, Tappan regarded credit as evil and so expressed in 1843: “How much wisdom there is in the advice of the apostle Paul—‘Owe no man anything.’ ”164 Nonetheless, since he had learned that to be in business in America one must have access to credit, he wanted to “purify” the business of credit. With such a celestial and earthly ambition, he created one of America’s first credit reporting agencies, one that eventually became the largest in the world.
In 1849, Tappan turned the agency over to Benjamin Douglass, one of his former clerks; Douglass expanded the network of offices and increasingly staffed them with full-time employees.165 A decade or so later, many of these employees became skilled credit reporters and interpreters of credit information. These skills made them cognizant of sound business and especially credit practices and thus they were respected professionals. Among such former reporters were four U.S. presidents: Abraham Lincoln, Ulysses S. Grant, Grover Cleveland and William McKinley. In 1859, Douglass turned over the agency to his brothe-in-law Robert Graham Dun, who renamed it R.G. Dun & Co. and continued Douglass’s expansion; by 1880 it had 69 branch offices and 10,000 correspondents.166
Also in 1849, John M. Bradstreet Company set up a competing agency in Cincinnati, Ohio. Its distinguished characteristic was its use of credit ratings. With the publication of the first book of commercial credit ratings, Bradstreet’s agency was a genuine competitor of Tappan’s and Douglass’s Mercantile Agency.167 It was not until 1933 that these two rivals merged and became what is still today Dun & Bradstreet (D & B).
The information provided by these credit rating agencies was not always reliable during the first decades of operation: Lack of objective (especially accounting) data on the potential borrowers’ creditworthiness and frequently shoddy and biased research 821on the business performance of subject merchants did not portend well. In due course, however, the analysis of creditworthiness improved and enabled commercial credit to grow to unprecedented levels.
During the 1960’s, D & B acquired new technologies including a Data Universal Numbering System, The D & B D-U-N-S® Number, which in our day “has become a standard business identifier for the United Nations, the European Commission and the U.S. Government.”168 At present, after having spun off major business information companies such as A.C. Nielsen, Cognizant, Reuben H. Donnelley and Moody’s Corporation, D & B provides business and credit information services, including credit ratings, by relying on a global database that “now covers more than 225 million businesses worldwide.”169 For the students of United States’ commercial contract practices, the data collected by credit reporting agencies provided as an additional bonus a closer view of the practices, attitudes and values of the contracting parties as well as of those who reported their practices and rated them as practitioners.
By the late 1840s, credit reporting agencies used a shared set of criteria to “calculate creditworthiness in a systematic way.”170 In addition to the borrower’s business ability or capacity to do business and repay their loans, the criteria included some of the same character traits encountered in eighteenth-century Puritan New England: Honesty, punctuality, thrift, sobriety, energy (or a strong work ethic) and focus.171 These character traits earned for their possessors a presumption of good faith dealing. However, before I discuss the contractual effects of this presumption I would like to briefly explore the meaning of honesty among credit givers with the help of Olegario’s helpful source materials.
Olegario found that merchants who had a reputation for honesty and ability, but encountered financial difficulties were frequently allowed by their creditors to continue to operate their businesses in the hope that they would recover.172 She quotes business writers on the practical value of being honest with one’s creditors:
These houses which have become insolvent or embarrassed, and have made a clean showing of their affairs, have found much sympathy and no difficulty in arranging a settlement.173
She also quotes Daniel Defoe’s similar advice to British merchants in trouble:
[H]onesty obliges every man, when he sees his stock is gone … and eating into the estates of other men, to put a stop to it; and to do it in time, while something is left…. ‘call his creditors together, lay his circumstances 822honestly before them, and pay as far as it will go … By breaking in time you will first obtain the character of an honest, tho’ unfortunate man.’174
In short, the honesty that credit givers expected to find in the reports or ratings was one that reflected not only a willingness to pay whenever possible, but also a willingness to disclose the debtors’ true business condition.
Honesty defined as a willingness to pay and to disclose all the facts relevant to his ability to do so helped the debtor in trouble establish his presumptive good faith and with it acquire a better chance for continuing credit support and perhaps commercial and social rehabilitation.
This presumption played an important role in a society whose state laws were known to be protective of debtors, often at the expense of creditors. As noted by Samuel H. Terry’s 1869 The Retailer’s Manual:
Wherever the laws shield a debtor, as they do so generally throughout the United States, the best guarantee for payment, that a creditor can have, is the moral and equitable obligation to pay, in the heart of the debtor.175
When such “moral and equitable virtues” (amounting to good faith) were detected in a particular borrower, entrustment followed even if it entailed shipping goods on credit to a distant merchant. As you will recall from our discussion on why the Code Civil lacked rules on offers and acceptances inter absentes,176 the main reason behind the uncertainty of communications was the generalized distrust of distant merchants. It would not have helped such merchants to prove their willingness to pay in past transactions or to disclose their present difficulties. Hence, while “rules of traffic” for offers and acceptances, i.e., when and where they bound the offerors and offerees, appeared in English law in the 1818 Adams v. Lindsell decision177 and thereafter in United States law;178 it took decades before similar rules appeared in jurisdictions governed or influenced by the Code Civil.
The ability to establish the neo-Puritan-inspired good faith character traits was especially important at a time when income statements and balance sheets (the present reliable indicators of the health of a business) were largely unavailable, and even when they were available, their credibility was questionable in the absence of 823uniform accounting standards.179 Thus, a simple report would refer to the debtors, whether as individuals or group businesses, in general terms such as:
John Doe and Richard Roe Buffalo City, Hardware. Both educated to merchandise, and been in business for about 10 years; men of correct business habits; honest, intelligent, and prudent. Doe aged 36, married, worth $15,000. Roe aged 30, single, worth $10,000—about half of their property in real estate, able friends and engaged in no other business. They are very safe men.180
Early credit reporting agencies such as Lewis Tappan’s Mercantile Agency relied, then, mostly on unprofessional and unpaid persons (usually bankers, lawyers, aldermen and merchants and other “putative dignitaries”) as their sources of information.181 What mattered to these largely volunteer-reporters were “certain personal traits such as religious faith, moderation in consumption and sexuality, and the ‘right’ ethnicity”:182 “The message was [neo-Puritanically] clear: a ‘good family man’—as the expression usually went—with modest financial security was a better risk than a rich but immoral rake.183
Berghoff attributes many of the initial ratings to America’s emerging WASP middle class, to which, “not surprisingly, the correspondents belonged” and he added that Tappan:
[H]oped to improve overall morals by disciplining people by means of credit reports….
On average, Jewish businessmen received lower ratings than Christians. One report said, ‘We should deem him safe but he is not a white man. He is a Jew,’ subsequently recommending he be kept on a short repayment leash, for ‘delay is always dangerous with Jews.’ In one case, the correspondent was obviously well versed in the bible and took a very long-term approach to credit history. He held an otherwise very solid [Jewish] merchant house responsible for what had happened during the Jewish exile in ancient Egypt. His report read: ‘Are doing an excellent business … character and habits good…. Considered good by all dealers, but they are Jews, and their ancestors took Jewels of the Egyptians when they left Egypt and never returned them.’184
Olegario reports a similar racist attitude with respect to Black businessmen:
Credit reports almost always indicated when a business was black owned. These individuals were designated as “free men of color,” “darky,” “negro,” “colored,” “quadroon,” “mulatto,” and—infrequently—“nigger.” As with Jewish business owners, the agency reports sometimes noted that an individual was a good risk despite belonging to a suspect group.185
Women-owned businesses were a minority within a minority (about 145,000 in 1870); they confined their businesses to women’s clothing, especially millinery and 824dressmaking and “[e]ven after the Civil War, a reported total worth of only a few hundred dollars was not unusual.”186
As noted by Professor Berghoff, negative credit reports could be devastating and prevent businessmen from ever obtaining credit:
If a report read “never trust him, will always be worthless” or took whole families into collective liabilities (“The whole lot of the Weatherbys are Bad Eggs”), relentless social execution took place. Judgments like “he has no energy & will never make a dollar” or “has never succeeded at anything & probably never will” make it clear that people were denied a second or even a first chance forever.187
Despite the serious consequences of such reports, the defense-friendly judicial standards of liability for sending erroneous and at times slanderous information on potential debtors discouraged many of the lawsuits brought against them, especially after the financial panic of 1873.188 Thus, Ormsby v. Douglass,189 an 1868 decision by the Court of Appeals of New York, protected the Douglass agency from a charge of slander by holding that:
[Defendant] whose business it was to obtain information respecting the credit and responsibility of persons in business, and to furnish the same to those who had just occasion to use it, his communications, made in good faith to a subscriber in respect to the character and standing of the plaintiff, are to be deemed confidential. Where communications are regarded as privileged, they are protected from the presumption of malice which is usually to be inferred from the charge itself.190
In addition, the 1867 decision in Gibson v. R.G. Dun191 by the Court of Common Pleas of Hamilton County, Ohio had already set forth a standard of “reasonable diligence” in searching for and supplying such information.192 This judicial attitude was in contrast to that of various state legislatures that would have imposed liability on the agencies responsible for disseminating the inaccurate reports for the losses they caused.193 Because of decisions such as the above, by the end of the Civil War, credit reporting and rating agencies had become regular participants in the commercial credit system of the United States with credit evaluation powers that exceeded those that many state legislators would have granted them.
Prior to the Civil War the normal terms for the repayment of commercial credits fluctuated between twelve to fifteen months, following the war they fluctuated between one and six months.194 Olegario attributes the shorter maturities to better transportation and communications facilities and to the specialization of lending: “slower-moving items such as jewelry were sold on longer time than canned goods, which in turn commanded more time than perishable items such as fruits and vegetables.”195 Thus, shorter maturities reflected realistic periods of sales and loan repayment. Not long thereafter, uniform accounting practices made it possible to appraise the market values of self-liquidating loans and their collateral which were also based on their shorter and more realistic maturities.
On the other hand, during the last decades of the nineteenth century, the United States experienced a high jump in productivity accompanied by a slow growth of its population. These were deflationary conditions and were accompanied by a keen competition among wholesalers and retailers.196 Meanwhile, business manuals counseled merchants to shop for the lowest prices during such pronounced buyers’ market conditions: “ ‘Be tied to no house or man….’ ‘Buy of the man who offers you the cheapest goods, and guarantees the quality to be equal to that of others.’ ”197 Clearly, this advice produced highly competitive conditions in which large buyers were able to extract cheaper prices and better credit terms from “suppliers anxious to obtain their business.”198
Deflationary and highly competitive conditions encouraged the creation of new dynamic types of contracts which required the parties to remain as contractually flexible as possible so as to adjust to rapidly changing market prices (These and other peculiarities of these contracts will be explored in Chapter 22). Olegario also refers to a popular business manual that recommended to merchants that they should try to turn their inventory every four weeks or so, “for the nimble sixpence is the coin that fills the pocket quickest.”199 One can still discern reflections of these “nimble” practices in U.C.C. Article 2 regulation of when a buyer may reject an allegedly defective tender of goods, on the manner and effect of a rightful rejection and on the buyer’s duties as to rightfully rejected goods.200 They are also discernible in rules that address one party’s reasonable concern with another party’s inability or unwillingness to perform as 826promised and is given the right to adequate assurance of performance or a cause of action for “anticipatory repudiation.”201
As noted with respect to the purchasing practices of department stores, standardized production and quality control practices made possible the massive issuance of warranties of quality. And uniform accounting practices made it possible to establish the realistic costs of these warranties and factor those costs as components of wholesale and retail prices. Thus, as standardization led to better quality control, uniform accounting standards led to more competitive and fairer prices.
The search for objective criteria of reporting and rating continued during the latter part of the nineteenth century. By 1869, the Bradstreet agency required, in addition to character information, objective data from potential borrowers such as: Time in business; amount of capital, net worth, (after deducting all possible liabilities), estimated wealth including real estate, personal property including investment securities, character, habits, business qualifications, and prospects of success.202
Two decades later, the need for reliable accounting practices and standards was voiced by an industrial commission created by the United States Congress in 1898.203 The purpose of this commission was to examine monopolization as a result of industrial concentration and its effect on railroad fares, the immigration of cheap labor and labor markets.204 Among its recommendations was the creation of an independent public accounting profession to prevent corporate abuses such as stock watering and that “trusts be required to publish annual audited reports detailing their profits and losses as well as assets and liabilities.”205
Meanwhile, a National Association of Credit Men (NACM) was created in New York State in 1897. Its goal was to represent the views of the corporate officials in charge of extending credit (“credit men” or “specialists”) to other businesses. These specialists were concerned with improving the timeliness, accuracy and transparency of credit reports, and the quality of the financial statements submitted to them. They were also concerned with costly and unreliable commercial practices such as the payment with local checks for purchases or borrowings in other states, stopping “bulk sales” of goods whose purpose was to defraud creditors.
As the NACM grew in importance so did the realization among these specialists that sharing credit information about debtors’ payments with other specialists would 827help the entire credit industry.206 Payment records, then, came to be regarded by many of its members as the most objective indicators of creditworthiness. In due course, NACM circulated a standard trade inquiry among its members on their respective debtors’ payments records (also referred to as “ledger information”).207 This information, albeit in more refined fashion, continues to be provided today. The NACM’s role as the representative entity of credit professionals in the United States was highlighted in the somewhat grandiose announcement of its 2014 annual meeting:
For NACM, this marks 118 years of excellence, vision and unity at the nation’s largest meeting of business credit practitioners. Share our excitement as the business credit community grows and excels, proving itself as a cornerstone of the world of business.208
At the turn of the twentieth century, the NACM estimated that “70% of all the orders [in the United States] were shipped based on [credit] agency reports.”209 Its Bulletin regularly published letters from NACM members praising the credit agencies’ services. When Dun and Bradstreet merged in 1933, they became the largest providers of credit information to members of the NCM, banks and other credit providers in the United States and abroad. As noted earlier, D & B was also responsible for the Data Universal Numbering System that is being used throughout the world to identify businesses numerically for data-processing purposes and especially by the European Commission and the U.S. Government. In 2011, its website noted with pride that it had credit relevant information on more than 225 million businesses worldwide.210 At the end of the twentieth century, this credit was the single largest source of business financing, exceeding the volume of bank loans.211 As found by Olegario in a Federal Reserve Flow of Funds Report:
As of the last quarter of 2005, receivables outstanding for nonfarm, nonfinancial corporate businesses was a torrential $2.0 trillion, only slightly smaller than the $2.2 trillion of household consumer debt outstanding for the period.212
She concludes that the founders of the credit reporting business in the United States would have marveled at how “the institution became so tightly woven into the fabric of the country’s business culture.”213 Thus, while credit reporting practices were 828practices deeply rooted in the neo-Puritan American business culture, they also contributed to this culture. Recall that one such a contribution rewarded not only those debtors who were willing to pay their obligations when they matured, but also those who disclosed all the facts that could make repayment difficult. And as has been the case with a United States culture of progressive inclusion, credit reporting also contributed to that culture.
I witnessed the impact of the culture of commercial credit inclusion on my family’s welfare. Shortly after I started my law teaching career, I befriended a D & B credit examiner. He came to know my father who had just arrived from Cuba with meager resources, after having left behind a highly successful retail and wholesale dry goods business in Cuba (about which more in later chapters). Fortunately, he was able to obtain the records that supported my father’s high credit ratings and based on those records, he prepared a favorable credit report. Shortly thereafter, my father, with the help of this credit report, was given a line of credit by a Dallas commercial bank. The small business that obtained financing in significant measure because of this report proved successful enough to support three family partners and several employees for over two decades.
Commercial credit in present day America is not only a product of good credit reports, but also of secured or asset-based lending. According to a 2000 report by the Federal Reserve Bank of San Francisco:
Banking industry statistics show that commercial loans represent a very large share of the assets of the banking industry…. Assets and Liabilities of Commercial Banks in the United States, commercial banks held $1066.5 billion dollars in commercial and industrial loans as of June 2000; these loans accounted for 18.1 percent of all bank assets. Over the ten-year period from 1989 to 1999, commercial and industrial loans outstanding at U.S. commercial banks increased by more than 50 percent.214
And as reported by a 1990 study authored by staff members A. N. Berger and G.F. Udell of the Board of Governors of the Federal Reserve, nearly 70% of all commercial and industrial loans of the United States are made on a secured basis.215 Even if one assumes that one-half of all commercial loans are secured by real estate mortgages and personal guarantees (a highly unrealistic assumption in light of commercial banking loan practices), 35% of all the commercial loans would still be secured by assets such as the borrower’s inventory, equipment, contract rights, accounts receivable, proceeds and intangibles such as intellectual property.
This was not the case at the turn of the twentieth century. As noted by George Lee Flint, Jr. and Marie Juliet Alfaro, early American court opinions revealed that various types of chattel mortgage and pledge statutes allowing debtors to remain in possession of the mortgaged property were on the books since the eighteenth century (first in five Southern states and early in the next century in Northeastern states).216 And these statutes often had conflicting rules. For example, the first chattel mortgage act passed in New England during the 1830s only covered filing for chattel mortgages. In contrast, chattel mortgage acts of the Southern English-American colonies covered both real estate and personalty, sales as well as mortgages.217 Because of these conflicting rules, many secured creditors were uncertain whether their security interests perfected in one state were considered perfected in another, and, if not, how and when could they be enforced, especially when debtors were close to insolvency.
A 1917 Manual on Credit and Collections by Richard Prentice Ettinger and David Edwin Golieb vividly described the uncertainty:
If one creditor had suspicion that a debtor was about to fail, immediately such creditor would rush to court and levy an attachment or execution. Then would begin a mad race for precedence between executions, attachments etc.—between the sheriff, receiver, assignee and mortgagee—to see which one would get possession of the debtor’s property first, the receiver frequently finding upon arrival that he was forestalled by the sheriff under a levy or by some preferred mortgagee or assignee placed in possession by the debtor.218
Such was the uncertainty by the late nineteenth century that “adjustment bureaus” were being formed “in nearly all major cities to apportion assets more equitably among creditors”219 Similar institutions were created by a large number of trade groups as “boards of trade” and many creditors preferred trying to collect through them rather than through bankruptcy proceedings.220
The notion that Bankruptcy should afford repentant and honest debtors a second chance or a fresh start in business has deep roots in Judeo-Christian theology. Isaiah 43:16–31 is frequently quoted by Christians as one of the bases of a “second chance” theology: “Consider not the things of the past, the things of long ago consider not; see I am doing something new, says the Lord.”221 Similarly, the Gospel of St. John for the Fifth Sunday of Lent reflects on the case of an adulterous woman and Jesus’s reaction to those who insisted on stoning her: “Let the one among you who is without sin be the 830first to throw a stone at her.”222 The second chance doctrine resonated with Judeo-Christian theologians, preachers and merchants. Olegario quotes from a lecture-exhortation to Boston’s Young Men’s Christian Union by a preacher named J. H. Allen in the mid-1850s:
[With] ‘the utmost degree of circumspection, losses will occur.’ The Creditor ‘spurns the idea of an advantage over his neighbor … Neither will he, if the bankrupt appears to be honest, oppress the spirit bowed down with sadness.’223
The Bankruptcy Act of 1841224 was the first to adopt debtor protection provisions. It allowed voluntary bankruptcy filings by insolvent debtors, and allowing non-merchants to be debtors who could avail themselves of bankruptcy proceedings, including a discharge of their liability after they turned over their assets to their creditors.225 The Bankruptcy Act of July 1, 1898, which remained in effect for approximately eighty years226 enlarged the debtor protection provisions of its 1841 predecessor and provided that anyone owing debts, except a corporation, was entitled to the benefits of the law by filing a voluntary bankruptcy. It also provided that anyone owing debts of $1,000 or more could be adjudged an involuntary bankrupt and be fully discharged of liability, except when he had committed “an offense punishable by imprisonment as provided by the law or, with fraudulent intent to conceal his true financial condition and in contemplation of bankruptcy, had concealed or destroyed or failed to keep records of accounts.”227 The trend to allow bankrupts a second chance by allowing them to file a voluntary petition and discharging them after voluntary or involuntary proceedings led to the institution of corporate and individual debtor reorganization procedures in the 1933–1934 Amendments to the 1898 Bankruptcy Act,228 later amplified in the Chandler Act of 1938 and by the Bankruptcy Code of 1979.229
Meanwhile, Justice Sutherland’s opinion in the 1934 the United States Supreme Court decision in Local Loan Co. v. Hunt230 was able to formulate the spirit of the second chance doctrine:
One of the primary purposes of the bankruptcy act is to ‘relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes. This purpose of the act has been again and again emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.231
This was indeed a ringing endorsement of the second chance theology. Nonetheless, the latest, 2005 Bankruptcy law reforms attempted to curb abuses in debtor protection law and practices, thereby attesting to yet another swing of the pendulum of creditor and debtor protection. This shows that bankruptcy law has proven to be as sensitive to Biblically-inspired theology as it is to the advocacy and political pressures of creditor and debtors’ rights groups.
As will be discussed in Chapter 22, the principle of freedom of contract in U.S. law and practice is not just the freedom of mentally and physically able citizens and residents to enter into agreements that are binding on them as “their law” (as was proclaimed for the French by Article 1134 of the Code Civil).232 It is also the freedom to select the type and form of contract best suited for the transaction. Such a format could well be that of a pro forma invoice or receipt of payment, a notation on a check that relates the payment to the performance of work under a contract, email message, recorded telephone conference or a “Master” electronically accessed agreement. The reason for the informality of contractual formation is that, as will become apparent in Chapter 22, under the law inspired by U.C.C. Article 2, the parties’ contractual conduct (as manifest in their course of dealing, course of performance and usage of trade) is as influential in a court’s determination of the existence of a contract and its intent as any other source, and often even more so. Thus, United States law and practice on contract formation attest to the influence of one of its guiding principles: That which the law does not expressly forbid, it allows. It also attests to an often abusive maximization of this principle to the detriment of contracting and third parties. On the other hand, with the proliferation of abusive contractual rights comes a proliferation of remedies such as the earlier discussed constructive trusts, adequate assurances of performance, damages for anticipatory repudiation, and anti-trust and unfair competition remedies. In the final analysis, then, the longevity of this U.S. version of the principle of freedom of contract suggests that despite abuses and the need for continuous new remedies, the U.S. marketplace has been considerably better off with it than with restrictive, a priori limitations as apparent in totalitarian legal systems.
One of the remnants of the Puritan’s Moral Capitalism is the U.C.C. principle that contracts must be performed in good faith: “Every contract or duty within this Act imposes and obligation of good faith in its performance and enforcement.”233 Please recall the New England Puritans’ embrace of honest dealing as manifest in their reliance on honest weights and measures: : “The Lord abhors dishonest scales, but accurate weights are his delight.” Honesty, then, was an essential component of what they considered a good faith performance of a contract. But so was a just or fair price and its reasonableness could be ascertained, among other means, by relying on the judgment of a respected and knowledgeable third party. As we will learn in Chapter 23, these are essential elements of U.C.C. Article 2’s good faith performance.
In addition, please recall that, while discussing the disclosure practices expected by credit investigators from applicants to commercial loans, we learned that the disclosure of the facts that bore on the applicants’ willingness and ability to repay was a component of honesty. You may also recall Lord Mansfield’s requirement from applicants for insurance policies in the preceding chapter: If they knew about risks unknown to the insurer and these risks were material to his decision to insure, applicants had the duty to disclose them.
Since the days of the New England Puritan settlements, private ownership was the preferred form of ownership in the United States. Not surprisingly, then, private ownership was protected by the Fifth Amendment of the United States Constitution:
[N]or [shall any person] be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.234
In fact, the thirteen independent states considered private property a significant enough consideration to make the right to vote depend on it.235
On the other hand, the increasing commercial reliance (mostly since the nineteenth century) on “documents of title” such as negotiable ocean bills of lading and warehouse receipts contributed to the fragmentation of the ownership of movable or personal property. These documents of title were issued by ocean carriers and warehousemen and their holder acquired rights to the possession of the goods shipped or stored that were superior to those of the “historical” or “legal” owners of the goods (such as an unpaid “conditional” seller or a buyer who had paid a part or even the entirety of their purchase price). Unless they acquired possession of documents of title 833by paying what was owed to their holder, neither the carrier nor the warehouseman would release the goods to them.236
In fact, the rights of lawful holders of documents of title could co-exist with the rights of other holders of rights in the same collateral, such as secured creditors with rights in the debtors’ business inventory or equipment. The twentieth century proliferation of commercial credit and security interests in commercial assets (as will be discussed in Chapter 24) has continued the fragmentation of ownership rights in commercial assets to the point that much of the contemporary commercial property rights are possessory in nature.237
Ascetic Puritanism had much in common with John Locke’s theory of value.238 Industriousness for the Puritan saints was the source of all wealth. And since God gave the use of the world to the industrious and rational, entitlement to property came principally from work and the fruits of labor belonged to the worker. Examples of such values and attitudes abound in United States law and practice. Consider the rights of Homesteaders under the Homestead Act of 1862.239 It provided that claimants were required to “improve” the plot by building a dwelling and cultivating the land. It then provided that “[a]fter 5 years on the land, the original filer was entitled to the property, free and clear, except for a small registration fee.”240
Despite the Puritans’ seeming failure to take into account the role of capital in providing the wherewithal for the workers’ productivity, the Puritanical belief in the productive laborers’ entitlement also had a marked effect on commercial practices. In some of these practices, the laborers’ entitlement was exclusive, while in others it was shared with other contributors. Consider, for example, a dispute between a merchant whose work has made a trademark widely known to the public but who failed to record it in the trademark registry, and another whose work only consisted in recording such a trademark. The United States’ trademark law’s adoption of the Puritans’ view is apparent in a U.S Patent Office’s reply to the following query: Must I register my trademark? “No. You can establish rights in a mark based on use of the mark in commerce, without a registration….”241
An example of a practice which shares profits based upon what a worker has contributed to the wealth of the enterprise is that of rewarding “sweat equity.” A business dictionary’s definition of this term attests to its widespread use:
1. Increased worth of a business (over and above the money invested) created by the unpaid mental and/or physical hard work of the founder/owner.
2. Increased value of a property (over and above its purchase price) created by the hard work of the owner/occupant in enhancing its amenities and/or looks.
3. Extra percentage of a firm’s common stock (ordinary shares) allocated to the senior executives (over and above their current shareholdings) as an additional motivation for continuing hard work for the firm’s success.242
Similarly, consider the practice of giving a finder’s fee to the intermediary in a business transaction who found the capital or valuable labor needed by the principal of the enterprise. The movie industry is one among many in which finders’ fees are commonly agreed upon by movie producers and business agents as a reward to those agents who found the capital or labor used by the principal.243 In contrast, real estate brokers acting as agents for sellers of real estate in many states customarily, without a pre-existing agreement, reward fellow brokers who produce the eventual purchaser of the real estate.244
As discussed in Chapter 9, the principle of an equal protection of merchants regardless of national origin was practiced in the European fairs that granted foreign merchants their “Peace of the Marketplace.”245 This was, in effect, the foreign merchants’ safe-conduct against discrimination, including protection against being pursued for debts owed to local merchants by other merchants who were located in their same foreign countries or cities and were not present in the fair.
As pointed out by my colleague, James E. Rogers College of Law Constitutional Law Professor Roy Spece, continuous “trade wars” were common between or among the original thirteen states.246 In fact, these wars were one of the reasons for the adoption of the United States Constitution—ironically an enactment that would have been deemed unconstitutional under the then-governing Articles of Confederation. The new Constitution greatly enhanced the prospects of trade by giving the central or federal government the right to govern interstate commerce, and, to a lesser extent, by providing in Article IV, Section 2 that “[t]he Citizens of each State shall be entitled to all the Privileges and Immunities of Citizens in the several states.”
The latter provision at least required that if a state granted its own citizens a right falling within the group of privileges and immunities, it could not discriminate against citizens of other states with respect to that right.247 Privileges and immunities are limited to rights that are fundamental and thus available to all citizens and residents under all free forms of government. As such, they include the right to travel in and out of other states and to engage in economic activites “such as are necessary to ply one’s trade.”248 Accordingly, the United States Supreme Court held in 1870, for example, that a Maryland law that required nonresidents to pay a fee of $300 per year to trade in goods not manufactured in Maryland but exacted a lower fee, ranging from $12 to $150, to resident traders violated Article IV’s Privileges and Immunities Clause.249
The Articles of Confederation had provided for the free movement of persons and, “to some extent free movement of trade.”250 However, as noted by Louisiana State University’s Constitutional Law Professor Emeritus John Baker, the persons who were granted this freedom were only males and who were not slaves.251 Hence, the equality or non-discrimination aspect of Article IV’s protection of privileges and immunities of citizens and residents must be read in the historical context not only of the de jure, but also of the de facto discrimination against African Americans and other minorities. This was a discrimination that existed despite the adoption of the U.S. Constitution and even after the adoption of the Fourteenth Amendment in 1868. This Amendment guaranteed all persons equal protection: “All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the state wherein they reside.”252 Yet, de facto discrimination against the newly freed slaves continued and was in some respects, worse after their emancipation. Similarly, women were not even granted the right to vote until adoption of the Nineteenth Amendment in 1920.
This is not the place to review the history of racial and gender discrimination in the United States. Nonetheless, what this history shows is that the plight of racial minorities and women has improved markedly over the years, a process that continues to date. A transformative moment was the adoption of the 1964 Civil Rights Act, which prohibited discrimination based on race or gender. This Act gave these discriminated groups a strong tool to continue their struggles for equality and inclusion in trade and all other aspects of life in the United States.
It is gratifying that a century and a half after the Emancipation Proclamation in 1863 government statistics revealed the willingness of most American people to observe the equality of minorities and women. According to the U.S. Census Bureau’s Survey of Business Owners, from 2002 to 2007, the number of black-owned businesses increased by 60.5 percent to 1.9 million, more than triple the national growth rate of 83618.0 percent. In the words of the Census Bureau’s Deputy Director, Thomas Mesenburg:
Black-owned businesses continued to be one of the fastest growing segments of our economy, showing rapid growth in both the number of businesses and total sales during this time period.253
Further, recent data from the Bureau of Labor Statistics confirms that black self-employment has been on the rise, especially in small businesses. The number of self-employed blacks grew by 5.7 percent from 2007 through 2009, in contrast to the 3.4 percent decrease experienced by self-employed whites.254
Meanwhile, as of 2004, statistics on entrepreneurship and its ownership showed that women owned 10.6 million businesses in the United States, employed 19.1 million workers—that’s one in every seven employees, and their businesses accounted for $2.5 trillion in sales.255 In addition to leading in the ownership of small businesses,256 between 1997 and 2013, when the number of businesses in the United States increased by 41percent:
The number of women-owned firms increased by 59%—a rate 1½ times the national average. Indeed, the growth in the number (up 59%), employment (up 10%) and revenues (up 63%) of women-owned firms over the past 16 years exceeds the growth rates of all but the largest, publicly traded firms—topping the growth rates in number, employment and revenue of all privately held businesses over this period.257
In commercial contracting, third parties are persons or legal entities likely to be effected, positively or adversely, by the terms and conditions of pre-existent contracts, negotiable instruments, documents of title or investment securities. Examples of such parties abound: A merchant who purchases another merchant’s inventory or equipment unaware that the seller had previously pledged those assets to a secured creditor; A lessee of a fleet of automobiles from a lessor who waived the manufacturer’s warranties of merchantability and fitness on those vehicles; An indorsee purchaser for value of a negotiable instrument that turns out to be unenforceable because his indorser acquired it for a “past consideration” or as payment of a pre-existing duty or a gambling debt where its enforcement is forbidden; A purchaser of a mortgage bond 837unable to foreclose and collect on the mortgaged property because it was part of a pool of mortgages so “sliced and diced” that it was impossible to identify the mortgaged property; and so on.
As just noted, these third parties amount to a very large group of the everyday participants in the world’s commercial and financial markets. Third party protection has been a guiding principle of the commercial and financial contract law of the United States since its inception, although with some notable exceptions. One such an exception was the issuance of documents of title, receipt of shipments, or stored goods by an agent who lacked the authority to do so. For example, in the 1889 United States Supreme Court decision Friedlander v. Texas & Pacific Railway Co.,258 the plaintiff, a secured creditor and holder of a rail bill which on its face stated that a certain number of bales of cotton had been shipped on a railroad car, was unable to obtain the cotton from the carrier at the arrival of the cargo train. The defendant railroad carrier’s agent (without the carrier’s knowledge) had issued a rail bill on behalf of the defendant, but without actually receiving any cotton from the purported shipper. The Court decided to protect the carrier and held that his agent had acted ultra vires and, as such, could not bind his principal. This rejection of third party protection to the holders of rail bills, including the banks which financed the cotton trade of the United States with the rest of the world, proved a serious blow to that industry as well as to cotton exporters who had lost vital financing.259 Eventually, a uniform state law and a federal statute reversed the United States Supreme Court decision.260 As noted by The Cambridge Economic History of the United States: “American law also enlarged this medium of credit exchange by extending the principle of negotiability beyond British doctrinal limits to include new forms of commercial paper such as municipal and corporate bonds, the bank certificate of deposit, bills of lading, the check, chattel notes and even negotiable instruments paid in such valuables as ‘good merchantable whiskey.’ ”261
As it turned out, the United States state and federal legislation that protected holders for value of bills of lading from the ultra vires defense attained what I referred to in another study as “the highest level of abstraction available at that time.”262 The innocent holder of the bill who had given value for it in good faith was immunized against the ultra vires defense that stemmed from an underlying relationship. I should add that these statutory rules served as a model for the most widely adopted maritime convention on carrier liability. As stated by Article 3(4) of the Brussels International Convention for the Unification of Certain Rules of Law relating to Bills of Lading (“Hague Rules”):
(4). Such a bill of lading shall be prima facie evidence of the receipt by the carrier of the goods as therein described in accordance with paragraph 3(a), (b) and (c).263
Similarly, Article 2 of the U.C.C. (on Sales of Goods) influenced the UNCITRAL Convention for the International Sale of Goods, especially when assuring the conformity of goods purchased by a third party with the express or implied representations and warranties made by their manufacturer or distributor on the merchantability and fitness of the goods Additionally, Article 9 of the U.C.C. became a worldwide leader on the protection of third party secured creditors and bona fide purchasers of collateral. It provided these third parties, inter alia, with a highly functional system of perfection and priority of security interests largely based on a functional notice to third parties of the filed security interests and liens.264
Some United States judges have also led in the protection of third party purchasers of mass-produced goods.265 Perhaps the most influential of all such decisions was Justice Benjamin N. Cardozo’s opinion in McPherson v. Buick Motor Co.266 A purchaser of an automobile from a dealer (who was not the manufacturer) suffered an accident due to the defectively manufactured spokes of a wheel built by the defendant’s sub-contractor. When the purchaser sued the manufacturer, the defendant claimed that there was no direct contractual relationship (privity) between it and the plaintiff and that in the absence of privity, the common law precluded the plaintiff’s action. By an ingenious use of analogical reasoning (described earlier as reasoning by example) as well as of the logic of the reasonable,267 Cardozo circumvented privity and established the manufacturer’s duty based on reasonable foreseeability of the harm caused by a dangerous object or instrumentality when negligently manufactured. The precision with which Cardozo fashioned the rule that protected McPherson as a third party in the chain of production and distribution of his automobile continues to be a source of admiration:
If the nature of a finished product placed on the market by a manufacturer to be used without inspection by his customers is such that it is reasonably certain to place life and limb in peril if the product is negligently made, it is then a thing of danger. Its nature gives warning of the consequences to be expected. If to the element of danger there is added knowledge that the thing will be used by persons other than the purchaser [automobile dealer]…then irrespective of the contract, the manufacturer of this thing of danger is under a duty to make it carefully.268
Meinhard v. Salmon was another highly influential instance of Cardozo’s protection of third party investors.269 As partially transcribed in the Appendix to Chapter 23, the defendant Salmon had entered into a lease with the owner of a building with the obligation to convert it into stores and offices. Plaintiff Meinhard, a third party to the lease agreement, invested half of the cost of its reconstruction in exchange for a percentage of the profits. Salmon was the sole managing partner of the lease and of Meinhard’s investment. Near the end of the lease, the owner of the building proposed to Salmon that he tear down the building and build a larger one. Salmon did not inform Meinhard of the proposed deal and created a new company to manage the new business. Upon finding out, Meinhard sued Salmon claiming that he had been wrongfully excluded and that were it not for his original investment and its considerable success, the new venture would not have been possible.
On appeal, Cardozo held that Meinhard was entitled to almost one half of Salmon’s interest in the new lease and business venture and stressed Salmon’s fiduciary duties and the forthright conduct required by his status as a sole trustee. At a minimum, he was required to disclose to Meinhard the new project proposed to him, for “[such] [j]oint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty.”270
Cardozo’s following statement is permanently associated with the law of trusts as it intersects with the duties required when managing investments by third parties such as Meinhard’s. It is also permanently associated with the standards of fairness and good faith discussed in Chapter 23:
Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior…Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd.271
Chapters 22 and 23 and their appendices discuss the formation and judicial interpretation of commercial contracts. In addition to discussing the substantive law of contract formation and adjudication, they highlight key features of judicial adjudication in representative jurisdictions. This should enable the reader to form an opinion on how courts in representative jurisdictions function as adjudicators and lawmakers. Chapter 24 focuses on the formation of standard and best commercial practices and on the role of these practices in shaping the future law of commercial contracts. Finally, Chapters 25–30 and their appendices discuss key procedural and remedial aspects of commercial adjudication. Because the emphasis of these chapters is mostly on adjudication, I will devote the remainder of this chapter to an eagle’s eye view of the shaping of commercial legislation and to the administrative regulation on commercial contracts.
During the early years of independent America, there were two groups of legislators. In his Introduction to Professor Gordon S. Wood’s brilliant history of early independent America, Professor David Kennedy of Stanford University describes the men who made the Revolution and wrote the United States Constitution as:
[F]or the most part cultured gentlemen, patrician squires who believed in the foundational republican principle of self-government, to be sure, but who also expected the common folk to defer to their “betters” when it came to running the country. The Federalists like Washington, Adams, and Hamilton who presided over the first decade of nationhood were often appalled by the egalitarian excesses unleashed by the Revolution.272
The “middling sorts”, the other group of legislators, were members of a large segment of the population whom Professor Kennedy identified as a new social class of republicans. They included:
[U]npriviliged but energetically striving merchants, artisans, and entrepreneurs, [who] arose to dominate politics and define the very essence of the national character. They ferociously opposed all “monarchical” pretensions and insisted on nothing less than a society completely open to talent and industry…Their great champion was Thomas Jefferson, the quirky and brilliant Virginia aristocrat who articulated the dearest aspirations of the common people….273
These middling sorts also comprised the majority of the legislators in the thirteen independent states. James Madison (the most influential draftsman of the 1789 Constitution and often a supporter of Jeffersonian Republican and eventually “Democratic Republican” Party)274 complained that the abuses of the state legislatures were “so frequent and so flagrant as to alarm the most steadfast friends of Republicanism.”275 Madison regarded these abuses as caused by men of limited means and education who became:
[S]elf-appointed leaders, speaking for newly aroused groups…. [n]ew petty entrepreneurs … [who] had vaulted into political leadership [and]…. [in Hamilton’s words] ‘[men] whose ignorance and perverseness are only surpassed by [their] pertinacity and conceit.’276
Thus, in the eyes of many of the nation’s founders, especially federalists such as Hamilton and Adams, state legislators only cared for their parochial and personal interests and not for the national interests:
[F]armers in debt urged the lowering of taxes [and] … advocated [for] the suspension of court actions to recover debts and the continued printing of paper money….
[Conversely] [m]erchants and creditors called for high taxes on land in place of tariffs, less paper money, the protection of private contracts, and the encouragement of foreign trade. [Meanwhile] [a]rtisans lobbied for … tariff protection…. And in the state legislatures representatives of these interests were passing laws on their behalf, in effect, becoming judges in their own causes.277
The Stanford Encyclopedia of Philosophy refers to the Enlightenment as a seventeenth- and eighteenth-century period characterized “by dramatic revolutions in science, philosophy, society and politics [that] … swept away the medieval world-view and ushered in our modern western world.”278 The ideas debated during this period contributed much to a French Revolution that did away with the absolute monarchy and the exclusive privileges of the French nobility, advocating for freedom and equality for all.
In the case of American thinkers of the stature of Thomas Jefferson, Alexander Hamilton, James Madison and John Adams, the Enlightenment prompted the equally lofty legal and political principles echoed in the opening sentence of the United States Declaration of Independence:
We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.279
They were also echoed in the First Amendment to the 1789 Constitution among others:
Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.280
Clearly, the Enlightenment in America was more about principles than about detailed norms in response to everyday political and economic conflicts, of which there were many. Meanwhile, at least Washington, Hamilton and Madison were determined to put an end to the egalitarian excesses unleashed by the Revolution. It is not surprising, therefore, that the Constitution of 1789 and its subsequent (1791–1804) 842amendments (1791–1804)281 had to incorporate a difficult set of compromises that were to be implemented by a limited government except in extraordinary circumstances.
One of the most important compromises of the 1789 Constitution was its choice of a dualistic, federal-state government. As stated by Sergio Garcia-Rodriguez, Esq. in his chapter in the NLCIFT’s “United States Law of Trade and Investment:”
The United State government is one of multiple sovereignties…. There were thirteen independent states before there was a national government. In the process of amalgamating these separate sovereigns into one government, it was contemplated that certain sovereign powers would remain with each state. As the United States expanded, and new states were added, each State, when admitted, was given the same powers as those recognized in the thirteen colonies, thus perpetuating a dual sovereignty system in all fifty states.282
As noted by Garcia-Rodriguez, while these two provisions are in apparent conflict, they are consistent with the original conception of the federal government:283 As a government “of limited powers,” … it may act only where authorized by the Constitution and … in the areas … [where] it is authorized … [its power is supreme].284 According to the doctrine of federal “preemption” “any valid federal law or treaty invalidates any inconsistent state constitutional provision, law or practice.”285 And while the dual form of government often results in dual regulation of the same activity, preemption may supersede state law regulation under certain circumstances.286
Professor Emeritus John Baker sets forth the chief characteristic of a government with limited powers, one we encountered when defining the United States version of freedom of contract as derived from the principle of that which the law does not expressly forbid, it allows:
The Constitution rests on the concept of “liberty under law.” This concept postulates that individuals are generally free to act without permission from government unless their action is barred by law. The concept of liberty assumes that individuals will act responsibly; that is to say, successful self-government requires citizens to govern, i.e., to control, themselves.287
As a government shared with the governed, the central government was given limited but significant powers, including the powers to tax and to regulate commerce among the states, and these powers were “separated and divided … among three co-equal branches.”288 The Constitution divided Congress into two houses, “added a separate … co-equal judiciary—not for the sake of convenience or efficiency but to protect liberty both by creating and, at the same time, restraining power.”289 Professor Baker also draws attention to an observation by the French political philosopher the Baron de Montesquieu, one of the greatest political thinkers of the Enlightenment, whose general principles were equally influential with friends and foes of the Constitution:
‘There can be no liberty where the legislative and executive powers are united in the same person, or body of magistrates,’ or, ‘if the power of judging be not separated from the legislative and executive powers.’290
Yet, what about slavery? Was not their lack of liberty not only morally repugnant but also inconsistent with the building of a nation based on a system of equality enshrined in its Declaration of Independence? Professor Wood summarized the state of the nation after the conclusion of the War of 1812 against England as follows:
[T]he country became seriously divided over the admission of Missouri as a slave state…. Northerners came to realize that slavery was not going to disappear naturally, and Southerners came to realize that the North really cared about ending slavery [in America].
Jefferson…. sensed that his ‘empire of liberty’ had a cancer at its core that was eating away at the message of liberty and equality and threatening the very existence of the nation and its democratic self-government; but he had mistakenly come to believe that the cancer was Northern bigotry and money-making promoted by Federalist priests and merchants….
The Civil War was the climax of a tragedy that was preordained from the time of the Revolution. Only with the elimination of slavery could this nation that Jefferson had called ‘the world’s best hope’ for democracy even begin to fulfill its great promise.291
In Swift v. Tyson, an 1842 decision by the United States Supreme Court292 the plaintiff was an endorsee of a bill of exchange and the defendant was the acceptor of the bill. The drawers of the bill were one Norton and another Keith. The bill was accepted by Tyson in favor of Norton as its payee. Norton endorsed the bill to the plaintiff and the defendant dishonored it at maturity.
Trial discovery showed that Swift met the requirements of a holder for value or in due course:293 He endorsed the bill before it was due in payment of a promissory note due to him by Norton and Keith; he had no notice of a defect in his title to the bill because he understood that the bill was accepted in part payment of some lands sold by Norton to a company in New York. Thus, in the eyes of the lower court he was a bonâ fide holder of the bill. The defendant offered to prove, that the bill was accepted by the defendant as a result of fraudulent representations by Norton and Keith. The plaintiff objected to the admission of testimony showing a failure of consideration for the defendant’s acceptance of the bill.
The judges of the Circuit Court were divided on whether the defendant, as an acceptor of a bill drawn against him, was entitled to raise the same defense against the third party indorsee he had against the drawers of the bill. This was the issue certified to the Supreme Court. According to Justice Story of the United States Supreme Court, there was no doubt that:
[A] bona fide holder of a negotiable instrument for a valuable consideration, without any notice of facts which impeach its validity as between the antecedent parties, if he takes it under an endorsement made before the same becomes due, holds the title unaffected by those facts, and may recover thereon, although as between the antecedent parties, the transaction may be without any legal validity…. As little doubt is there, that the holder of any negotiable paper, before it is due, is not bound to prove that he is a bona fide holder for a valuable consideration and without notice….294
The acceptance of the bill had been made in New York and the defendant argued that as a New York contract, it was governed by the laws of New York and especially by provisions of the thirty-fourth section of Chapter 20 of the Judiciary Act of 1789. Tyson further contended that by the law of New York, as expounded by its courts, a pre-existing debt does not constitute valuable consideration as required by the law of negotiable instruments.
After examining the New York decisions, Justice Story accepted Tyson’s version of New York law as correct, but asked whether admitting that the doctrine was fully settled in New York obligated the United States Supreme Court if the New York rule differed from “the principles established in the general commercial law.”295 He pointed out that the Courts of New York did not base their decisions on this issue on “any local 845statute, or positive, fixed, or ancient local usage: but they deduce the doctrine from the general principles of commercial law.”296 As to the defendant’s contention that Chapter 20 of the Judiciary Act of 1789 bound the Supreme Court to follow the decisions of the state tribunals, he replied that in “the ordinary use of language, it will hardly be contended, that the decisions of courts constitute laws. They are, at most, only evidence of what the laws are, and are not, of themselves, laws.”297 Story concluded that in all the cases which had come before the court, it had uniformly assumed “that the true interpretation of the 34th section limited its application to state laws, strictly local, that is to say, to the positive statutes of the state….”298 Further,
[T]he law respecting negotiable instruments may be truly declared in the language of Cicero, adopted by Lord Mansfield in Luke v. Lyde, 2 Burr. R. 883, 887, to be in a great measure, not the law of a single country only, but of the commercial world.299
Hence, Story decided that a pre-existing debt does constitute valuable consideration where the law of negotiable instruments was concerned. He derived this conclusion from national as well as supra-national general principles of commercial law.300
Swift v. Tyson was overturned by Erie Railroad Co. v. Tompkins301 in 1938 because, according to the Supreme Court, federal courts did not have the power to create general federal common law when hearing state law based claims between citizens of diverse states (“diversity jurisdiction”). Despite its reversal on such jurisdictional and public (not commercial) law grounds, Swift v. Tyson strongly indicated that America’s mid-nineteenth-century commercial and financial marketplace could not be governed by the archaic doctrines of past consideration and pre-existing debt as confirmed by the many negotiable instruments cases applying Swift v. Tyson from 1842 until its reversal in 1938.302 But there is more to Swift v. Tyson. Its reliance on Lord Mansfield is significant because of Mansfield’s insistence that common law courts should act as courts of equity when needed by the circumstances.303 This symbiosis between commercial law and equity had a profound influence on Justice John Marshall of the United States Supreme Court and on many of his successors, especially those on the federal bench.
As described by Professor Wood:
Jefferson [advocated a strict or literal interpretation of the law]…. ‘Relieve the judges from the rigor of text law, and permit them to wander into its equity,’ … ‘and the whole legal system becomes uncertain.’ … The goal of judges was … ‘to render the law more & more certain.’ The goal of Mansfield and Blackstone, according to Jefferson, had been the exact opposite. They 846intended ‘to render it more uncertain under [the] pretense of rendering it more reasonable.’304
Further, Jefferson “believed there was ‘so much sly poison’ in Mansfield’s ‘seducing eloquence’ that he wanted to forbid American courts from citing … decisions … by the Court of the King’ Bench since Mansfield acceded to the court.”305 In contrast, John Marshall believed Mansfield to be one of the greatest judges who ever sat on any bench and someone responsible for disabling many of the archaic formalisms that prevented English judges from dispensing substantial justice.306
It would be incorrect to assume that Marshall’s admiration of Mansfield’s contribution was shared by the majority of his fellow judges. In fact, rather than adjudicating in what Karl Llewellyn referred to as the “Grand Style”307 (much of which he found in Mansfield’s decisions), their adjudicative style was casuistic: Their holdings were so narrow that they could only be applicable to almost exact replicas of the facts and arguments they had decided on. Whatever appeared to be beyond the replica was obiter dicta. Casuistry provided comfort to lower court judges worried about being overruled because to overrule their narrow decisions appellate judges had to show what facts and applicable rules or doctrines were not taken into account by the lower court, something that appellate judges are supposed to avoid doing as judges of law and not of facts.
By the turn of the twentieth century, it was becoming clear in the writings of highly respected legal thinkers such as Roscoe Pound the long time Dean of the Harvard Law School and later in those of Karl Llewellyn and many other scholars of note (including my mentor Professor Hessel Yntema),308 that the time had come for a law that reflected what was really going on in American society and especially in its marketplace.
Meanwhile, as discussed in an earlier section, commercial statutes such as on chattel mortgages had begun to appear during the late eighteenth century, although the bulk of the United States’ commercial statutory law was enacted during the twentieth century. In fact, one of the most common misconceptions about United States law is that it is “unwritten” in the sense that it is not codified or incorporated into statutes or compilations thereof. The truth is the opposite; there are few countries in the world with a larger amount of statutory law than the United States. This does not mean, as we shall discuss shortly, that statutory and code law are drafted and interpreted in the same manner as they are in civil law countries.
As will be described in the following sections, the majority of federal and state laws are drafted in a casuistic and prolix manner, where one or more illustrations of what is meant by the formulated rules as well as the numerous exceptions and qualifications of it (as well as their illustrations) frequently follow such a rule. Thus, to 847a civil law lawyer, the United States statutes are often populated by multitudes of narrow rules derived from actual or hypothetical fact situations.
The Harter Act of 1893 was among the most significant of the late-nineteenth-century statutes of the United States.309 Its enactment was prompted by a growing practice among United States carriers to insert clauses in their bills of lading that sharply limited their obligations to shippers. In using very broad disclaimer of liability clauses, United States carriers were following the model of the English carriers. The United States Congress stepped in because shippers had no true bargaining power as contrasted with that of the carriers.310 The Harter Act achieved a compromise between carrier and shipper rights and claims by apportioning their liability depending on where the shipped cargo was at the time the damage took place. The Harter Act was followed a set of important commercial statutes. In 1953, while still lobbying for the enactment of the U.C.C. by some reluctant states, Karl Llewellyn listed the principal early-twentieth-century statutes that it would replace, absorb and modernize:311
I refer especially to the Uniform Negotiable Instruments Law of…312, which is the foundation of banking practice. I refer to the Uniform Sales Act (1906), which has served well … I refer to the short-term secured financing covered by the Uniform Trust Receipts Act313 and the Uniform Conditional Sales Act,314 one dealing with certain phases of inventory financing, and the other with the financing of individual consumer purchases.
As you will notice in Chapter 23, Professor Llewellyn’s opinion of the Uniform Sales Act, largely drafted by Professor Samuel Williston of the Harvard Law School, was quite different from that expressed in the above-quoted article in the Tennessee Law Review. Llewellyn’s harsher view of the Uniform Sales Act was, as history has proven, was the most accurate. The Uniform Sales Act was heavily influenced by the English Sale of Goods Act of 1893. And Professor Williston’s version was scholarly, but in the casuistic way, not the Grand Style way Llewellyn admired. One of the many examples pertained to standard sales practices among merchants, such as their tolerance for de minimus or insignificant deviations from literal terms and conditions 848of the contract (unless expressly otherwise required in the contract). These practices collided with the Sale of Goods Act of 1893’s insistence on a “perfect tender” rule.315
One of the early-twentieth-century statutes that Llewellyn did not mention was the above-discussed Uniform Bills of Lading Act316 and its progeny in United States and multinational treaty law. It is an important act not only because of its intrinsic merits, but because of the process of its enactment—it was part of a uniform commercial law movement promoted by two genuinely American law reform and modernization institutions.
By the mid-twentieth century, and largely as a result of the United States’ federal system of government, a multiplicity of federal and state legislative and judicial sources of law bore heavily on legal practice and on the predictability of the law, especially inter-state commercial law. The volume of sources of law that were at times unmanageable, multiple and not always consistent was responsible for the creation of two remarkable American legal institutions: The American Law Institute (hereinafter ALI) and the National Conference of Commissioners of Uniform State Law (NCCUSL), now renamed as the Uniform Law Commission (ULC), undertook the task of reviewing existing case law and statutory law for purposes of making them uniform.
The Uniform Law Commission (formally NCCUSL) was established in 1892 to provide non-partisan, carefully drafted legislation intended to provide uniformity to areas of the law governed by diverse and at times contradictory rules, concepts, and principles of interpretation. Members of the ULC must be lawyers qualified to practice law, judges, legislative staff and law professors who are appointed by state governments, the District of Columbia, the U.S. Virgin Islands, to act as researchers, drafters, and facilitators of the enactment of uniform state laws. Without any doubt, the Uniform Commercial Code has been one of its signal accomplishments.317
The ALI was created on February 23 of 1923 following the recommendation of a group of prominent American judges, lawyers and teachers concerned with the uncertainties of the United States common law.318 Its purpose was “to promote the clarification and simplification of the law and its better adaptation to social needs, to secure the better administration of justice, and to encourage and carry on scholarly and scientific legal work.”319
In short order, the ALI became known for its restatements of various areas of the law that were of interest to judges, lawyers and scholars of the law. Thus, the ALI produced restatements for the laws of agency, conflict of laws, contracts, judgments, property, restitution, security, torts, and trusts. Although the ALI’s restatements are 849often referred to as codifications of case law, they are better described as compilations of important cases or cases with precedential value whose holdings are distilled by the restatements as “black letter law,” i.e., the rules that courts would apply to similar cases in the future. In doing this, the restatements affirm not only their precedential value, but also the existence of a certain judicial trend which connects holdings to decision-making trends. Thus, this black letter law generally is not framed as a set of codified rules that result from a priori formulations of careful definitions and classifications of legal institutions as done by codes such as the Code Civil or the BGB. Neither are they deemed binding authority, although in many instances they are followed by courts as persuasive formulations of judicial trends.
Restatements also include comments and illustrations, often as “Reporters’ Notes,” which include a discussion of all the cases that went into the formulation of a principle summarized in a section. These comments and illustrations help contextualize the rules and thus enable lawyers and judges to rely more confidently on the black letter law set forth in the restatements. In doing this analytical work, albeit confined mostly to case law, the participants in the drafting of the restatements (including black letter law and commentary) craft the United States version of common-law-based legal science. For if by legal science one understands the most accurate and objective description of the state of a given branch of the law, as shaped mostly by court decisions and statutes, the restatements are the best products of American legal science.
My favorite is the Restatement (Second) of the Law of Contracts, whose reporters were two great figures of American contract and private law: Robert Braucher, the father of one of my distinguished colleagues, Jeanne Braucher, and E. Allan Farnsworth, a truly exceptional scholar and drafter. This Restatement is a model of insightful analysis, and of drafting precision and clarity. Its influence is now apparent in a less rigid and still predictable federal and state adjudication of commercial contract disputes (as will become apparent in Chapter 23 on contract interpretation) as it is also in important treaties such as the UNCITRAL Convention on International Sales of Goods law (Vienna Convention) and on the UNIDROIT European Principles of the Law of Contracts.
The ALI and the ULC have been allies in the drafting of a number of important statutes, including the U.C.C. Work on it began during the 1940s. It was first published in 1952, and in periodically revised form it is now the law in all 50 states. The ALI participants in the drafting of the U.C.C. were elected members of the ALI, including prominent judges, practitioners and scholars. The ULC participants, in turn, were state commissioners, officers, staff and representatives of the varioussectors involved in the various articles and underlying trades or professions. On the whole, these entities have done and continue to do a very creditable job of transforming mostly judicially formulated rules into statutory rules. The drafting of Article 5 on letters of credit, however, presented a problem to the drafters because many of the judicially formulated rules they intended to rely on, even for definitional purposes, did not reflect the standard and best letter of credit practices in the United States and worldwide.
As a participant in the drafting process, I witnessed drafters struggling for more than a year with judicial definitions of concepts as basic as “confirmation” or “assignment of the proceeds” which misunderstood and distorted the meaning of those 850everyday letter of credit transactions. The reason was simple—the courts that authored those definitions did not understand their meaning in letter of credit practice. However, many members of the drafting committee were reluctant to rely on the banking definitions of those terms because banking practices were suspected of being contrary to the best interests of other parties to the letter of credit transactions, such as the customers who applied for the issuance of the letters of credit or the beneficiaries who were paid by the letters of credit.
This perception prompted a vigorous form of drafting pluralism, but such a pluralism misunderstood, as I will discuss shortly, the nature of standard and best practices in the letter of credit business and how these practices are wrought in a manner that they become universally viable (as will be discussed in detail in Chapter 24). With the reader’s indulgence, I will discuss the Article 5 drafting process in greater detail than I have discussed legislative drafting in earlier chapters. This is necessary not to illustrate how the U.C.C. was drafted, because in many ways the drafting of Article 5 was atypical, but to illustrate the task that will be faced by other legislators whose main normative sources are standard and best practices that are widely respected in the sector in question as the usages of its trades.
Such was the importance attributed to pluralism during the revision of Article 5 that at first it stood in the way of adopting standard and best practices of the banking industry, even though this industry observed its binding usages in each phase of the letter of credit transaction. For banks were the issuers, notifiers, confirmers, negotiators, transferors and transferees, payors and reimbursers of the letter of letter of credit transaction. And these were the critical and exclusive “operations” of letter of credit banks. Furthermore, in doing so, banks had to act in the above capacities interchangeably, but always watching out for the best interest of their customers-clients as well as their own. And quite frequently, those interests coincided and were not in conflict. The pluralistic method of drafting, set in motion at first by the ALI and the ULC alike, expected that the drafters forcefully advocate what were assumed to be conflicting interests among, say, buyers-applicants for the issuance of letters of credit and seller-beneficiaries of the letters of credit or between issuing, confirming and negotiating bankers. Yet, as will be illustrated in Chapter 24, in the case of letters of credit, this form of drafting misperceived the nature of the letter of credit transaction. For in this transaction, as just noted, all of its regular participants have interchangeable roles or transactional functions instead of roles or functions that are fixed.
This means that today’s issuer Bank A, which depended on Bank B as its confirrmer in another issuance, becomes a confirming bank for Bank B as the issuer of the letter of credit. Similarly, today’s buyer-applicant for the issuance of the credit could shortly—after acting as a buyer-applicant for the issuance of Letter of Credit 1—act as a seller-beneficiary of the same goods to another buyer-applicant. After all, who could make a commercial living by only buying and not selling or by just issuing and not confirming and negotiating letters of credit? This meant that to designate a drafter “A” to represent the interests of buyers-applicants against the interests of “B,” the representative of sellers-beneficiaries was to ignore that this supposed “chemically pure” buyer was an artificial designation because if A succeeded in fashioning a rule that was more favorable to himself as A, he was likely to suffer the consequence of that rule when he acted as B. And the same was true with issuing and confirming banks or with negotiating and transferring banks, etc.
Perhaps the most important legislative lesson to be learned from the Article 5 experience was that statutory rules are best suited as markers of the bright lines of the letter of credit transactional traffic: Some of these are mechanical in nature and others are implementers of legality and public policy. The mechanical rules of traffic are mandatory rules and must be observed by all the participants in the letter of credit transactions. For example, these rules specify what must be done by each regular participant to get the transaction started and make it binding on each of them: When and where is a letter of credit “established” or binding on the issuer, confirmer, etc.? Or what are the time periods, if any, for the execution of subsequent phases?
The provisions that implement public policy and legality are also mandatory but, as a rule, specify what remedies are available to the affected parties. For example, what standards of diligence govern the execution of the various operations or transactions? What are the remedies, contractual, tortious or criminal, available to the aggrieved parties? The transactional or operational rules are those that set forth the meaning of basic practices such as that of issuing an irrevocable and confirmed letter of credit and its negotiation or payment, or of an acceptable commercial invoice, ocean bill of lading or insurance policy and so on. Since these rules are derived from the standard and best practices of letter of credit banking, they usually become widely observed usages of the letter of credit trade. The drafter of statutory law is best advised to rely on these usages rather than on his own legal instincts when setting forth the manner in which rights can be exercised or duties performed.
For example, during the discussion of the duties of a beneficiary or of a bank that presented documents for negotiation or payment to another bank, some drafters at first insisted on requiring the beneficiary and presenting bank to grant the same warranties required of a seller of goods under Article 2 or by the holders of negotiable instruments, documents of title and investment securities under Articles 3, 4, 7 and 8 of the U.C.C.
Yet, such a requirement ran contrary to a fundamental usage of the letter of credit trade which assumed that once a letter of credit was paid by the issuing or confirming banks, the payment was final.320 As such, its finality could not be re-argued by the issuing or confirming bank, and especially by contending that the beneficiary or presenting banks had presented documents that contained untruthful statements regarding the quantity or quality of the goods paid for by the letter of credit.321 Nor could the payment by the issuing or confirming bank be reversed by allegation and proof that the paid for documents did not strictly comply with the terms and conditions of the letter of credit.
Regardless of the possible legal analogies between a letter of credit draft or bill of exchange and the warranties ascribed in Articles 3, 4, 7 and 8 of the U.C.C. to the holders of “instruments”, “items” and “investment securities, the addition of these warranties to the presentation of letter of credit documents would have ended the treasured certainty and predictability of the payments of irrevocable-confirmed letters of credit. To their credit, once the advocates of the addition of warranties became aware of the importance of the letter of credit usage, they reversed their position on 852warranties and agreed to rules consistent with this key letter of credit usage.322 On the other hand, some of the drafters remained reluctant to adopt widely observed standard and best letter of credit practices when they were inconsistent with established case law. Hoping to persuade them, I sent them an extract of an article written by Francis B. James Esq., one of the first chairmen of the Committee on Commercial law of the Conference of Ccommissioners of Uniform State Laws in 1905:
A mercantile code should be a clear expression of well recognized commercial customs whether they have or have not yet found their place in judicial decisions. The merchants gave to the law their customs and the law should give their customs back to them clearly expressed and freed from mere technical expressions.
…
Where judicial decisions conflict with well recognized, economically and ethically sound customs, the mercantile customs should be embodied in the code in preference to the formal technical rules…323
From a civil law codification perspective, the U.C.C. is a compendium of individual norms, with the exception of the overarching application of a principle such as good faith performance and interpretation of obligations as discussed in Chapter 22. As with the ALI restatements, the raw materials for drafting the U.C.C. were an amalgam of case law, commentary thereon and customs and usage of trade. Thus, its rules were not derived from carefully crafted definitions, classifications and general principles as found in European codes such as the Code Civil or the B.G.B.
Its casuistry, aided by reasoning by example, is responsible for the narrowness and complexity of many of its rules. As an heir to the Anglo-American (and Roman law) tradition of elucidating the role and place of judicial remedies, the U.C.C. interpreter must learn about the cases that influenced its drafting and must also be able to appraise the effects of the U.C.C. rule upon future litigation. In this respect, the U.C.C.’s main preoccupation is with remedies rather than with transactions. Fortunately for the U.C.C. interpreter, the Official Comments to each rule provide required transactional as well as remedial background by discussing the implications of the various rules and providing the cases whose holdings were adopted and occasionally those that were rejected. The narrowness of the norms also affects the U.C.C’s method of definition. Because the definitions in the U.C.C. do not pretend to identify the Aristotelian eternal and universal elements of each institution, they are mere points of reference, declarations of context or at times, mere transcriptions of rules.
Although the U.C.C. is closer to commercial practice than any contemporary commercial code and is also the most faithful to judicial developments, it is not as logically consistent nor as clear and concise as are the commercial codes of major civil 853law countries. Thus, many U.C.C. definitions are tautological, i.e., they include the defined term as part of the definition. Consider, for example, the definition of a security interest in § 1–201(35) of the U.C.C.: “ ‘Security interest’ means an interest in personal property or fixtures which secures payment or performance of an obligation….”324 Yet, the concept of “interest” remains undefined—is it a right? And if so, is it in personam or in rem? Nevertheless, if you ask United States judges and commercial practitioners, they would still prefer consistency with actual practices over a sterile clarity, conciseness, and formal logic.
As discussed in Chapter 2, these different methods of defining legal concepts reflect the different roles ascribed by each system to formal logic. The European and Latin-American codes ascribe normative value to definitions and classifications. As discussed earlier, an undefined and unclassified contract or right in rem might not be enforceable in many civil law countries. The same is not true with U.C.C. definitions. Surely, some U.C.C. definitions, such as that of good faith, carry significant normative weight. On the whole, however, the U.C.C. relies on many definitions, mostly to clarify obscure or ambiguous terms, and its classifications carry little, if any, normative weight.
Because of the living law principle “that which the law does not expressly forbids it allows,” and its frequent abuses, the balance between strict regulation and permissibility of contractual practices is a delicate one. Permissibility requires a presumption that the contracting parties act in good faith (and by good faith I mean the same combination of honesty, reasonableness and fairness you will encounter in Chapter 23). Otherwise, the impulse to relentlessly pursue the business opportunities alluded to by Calvin Coolidge would be stifled. Yet, abusive and overreaching practices come in many garbs. Some are even inspired by ideologies espoused by economists as illustrious as Milton Friedman, the Nobel Prize winner who famously pronounced that “The Social Responsibility of Business is To Increase its Profits.”325
As described in a recent Washington Post article by Professor Steven Pearlstein of George Mason University and also a Washington Post economics journalist:
In the recent history of management ideas, few have had a more profound—or pernicious—effect that the one that says corporations should be run in a manner that “maximizes shareholder value.”
Indeed, you could argue that much of what Americans perceive to be wrong with the economy these days–the slow growth and rising inequality; the recurring scandals, the wild swings from boom to bust, the inadequate 854investment in R&D, worker training and public goods–has its roots in this ideology.326
Pearlstein shows how the ideology that urges corporate managers to maximize share prices has no foundation in history and law. On the contrary, there is ample evidence that a corporate practice that began during the nineteen seventies and eighties as a “useful corrective to self-satisfied managerial mediocrity has become a corrupting, self-interested dogma peddled by finance professors, money managers and overcompensated corporate executives.”327
Professor Pearlstein traces the origins of the maximization of share prices to the nineteen seventies and eighties when increased competition spurred by globalization significantly reduced American corporate revenues and share prices. This trend led to hostile takeovers by corporate raiders, many of whom financed their purchases of corporations with “junk” bonds. Disgruntled shareholders were eager to sell their shares and thus the threats of takeovers made corporate executives and directors “[F]ocus on profits and share prices, tossing aside old inhibitions against laying off workers, cutting wages, closing plants, spinning off divisions and outsourcing production overseas.”328
The corporate infrastructure of maximization of share prices was buttressed by corporate lawyers who invariably advised against any corporate action that might lower the share prices and invite shareholders’ lawsuits. It also relied on Wall Street investment advisors, brokers and underwriters who insisted on attractive corporate quarterly earnings and short term trading, and particularly on large pay packages for top executives “tied to the short-term performance of the company stock.”329 He concludes that while maximizing shareholder value has done much for top executives, it has done little for shareholders.330 The same could be said for the income of average company employees. Moreover, as pointed out by Pearlstein, chief corporate executives are the first to acknowledge that no enterprise can maximize long-term value for its shareholders without attracting excellent employees, producing great products and services, and doing their part to support effective government and healthy communities.331
Ironically, this dependence was also acknowledged (albeit tacitly) by the same Milton Friedman who placed the responsibility of corporate duty to pursue profits and high share values above the corporate duty to society’s welfare. For, as stated by Cornell University Professor Robert H. Frank, when Friedman proposed his equally famous “negative” income tax, he became the “architect of the most successful social welfare program of all time.”332
In light of Friedman’s safety net and of his evident compassion for the poor and infirm, the question one needs to address to his doctrine of corporate social responsibility to increase profits and share value is: at what social cost? Surely a Friedman disciple might reply that the duty to provide a safety net for the poor and infirm is the state’s responsibility, not the corporate business’. Yet, Friedman’s negative income tax could not function unless corporate businesses paid the taxes that made the negative income tax idea possible. In the final analysis, then, the corporate keenness in the pursuit of profits is the selfish side of a coin whose altruistic side consists of a fair treatment of employees and customers, and a brotherly treatment of the community’s poor and infirm.
As discussed earlier, the United States’ legal system has been able to counter (although not always effectively) the maximization and abuse of rights with judicial and administrative remedies. Recall that in the law of sales of goods alone, judicially or statutorily fashioned remedies such as adequate assurances of performance, damages for anticipatory repudiation and constructive trusts followed widespread bad faith attempts to maximize contractual rights. Also recall that the same marketplace that witnessed a large number of predatory and unfair practices also witnessed the proliferation of anti-trust and unfair competition remedies.
In the final analysis, then, the longevity of this U.S. version of the principle of freedom of contract suggests that despite abuses and the need for continuous new remedies, the U.S. marketplace has been considerably better off with it than with restrictive, a priori limitations, as apparent in totalitarian legal systems.
On the other hand, there is a contractual or extra-contractual conduct whose mere presence creates a rebuttable presumption of illegality or a violation of public policy. 856This was the case with the above-discussed nineteenth-century sectorial and inter-sectorial attempts to fix the prices of fresh milk and dairy products. It was also the case with the monopolization of commodities such as sugar, or services such as rail cargo, and “retail price maintenance agreements,” among other instances of “per se” violations.
The above unilateral actions or transactions by overreaching merchants prompted the enactment of statutory and administrative prohibitions and their implementation in court adjudication. As with court decisions, statutory and administrative regulations were inspired by the same principles discussed earlier—from freedom of contract (in the broadest sense) and equality of treatment of equals to third party protection.
Accordingly, statutory law enacted at the end of the nineteenth century intended to protect a fair type of competition as well as to curb consumer abuses such as those by the American Sugar Refining Company, which controlled 98% of the sugar production of the United States or by Northern Securities, which controlled the northeastern rail transportation. The principal legislative tool used by President Theodore Roosevelt when he launched his “trust busting era” was the 1890 Sherman Act, which remained largely unused by the Executive until 1902. Its purpose, as defined by the United States Supreme Court, was not:
[T]o protect businesses from the working of the market; [but] … to protect the public from the failure of the market. The law directs itself not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself.333
The Sherman Act was supplemented by the Clayton Antitrust Act of 1914, which prohibited, among other transactions, exclusive sales contracts or relationships, local price cutting to freeze out competitors, rebates, interlocking directorates in corporations capitalized at million or more in the same field of business, and inter-corporate stock holdings.
In addition, the enactment of the first and permanent income tax law of the United States on July 2, 1909 as part of the Sixteenth Amendment to the Constitution transformed business and accounting practices, including heightened requirements of transparency of business data. From then on, transparency in the recording and accounting of commercial transactions was no longer discretionary and accounting practices became not only essential when reporting personal and corporate taxes, but also when disclosing likely anti-competitive practices.
The Securities Act of 1933 (also referred to as the Truth in Securities Law) had, two basic objectives: (1) To require the investors to receive financial and other significant information concerning securities being offered for public sale; and (2) Prohibit deceit, misrepresentation and other fraud in the sale of securities.334
The disclosure required from the potential seller of securities was the same expected from Puritan merchants and complied with the definition of good faith in U.C.C. § 1–201: “[H]onesty in fact in the conduct or transaction concerned.” However, practices such as those of credit examiners required “a clean showing” of all the business affairs of the credit applicants. Query: what did the Truth in Securities Law mean when it required that the potential seller of securities provide the investor with financial and other “significant information”?
If that information appeared in audited reports, the standard of disclosure was likely to be that of the recently created Public Company Accounting Oversight Board (PCAOB), “a nonprofit corporation established by Congress to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports.”335
Yet what about the sellers’ of securities own disclosures? My son, Raphael A. Kozolchyk, Esq., a lawyer for the SEC, answered this question (in a personal and non-institutional capacity) from the vantage point of a regulator:
I believe that smart regulations provide a system wherein any potential investor has access to certain basic facts about an investment before buying it instead of trying to impart an articulated standard of fairness that proves time and again to be highly subjective from court to court and transaction to transaction.
Yet, whether the facts that must be disclosed are “basic” as he suggests or “significant” (as suggested by the Truth in Securities law), both standards are at their best when they take into account the reasonable expectations of archetypal third parties such as representative investors (who, depending upon the type of investment, can range from highly experienced to inexperienced). By relying on the opinions of honest, knowledgeable and identifiable archetypal market participants, the determination of what is reasonable is neither subjective nor arbitrary.
In the introductory section of this chapter, I expressed the hope that its reader would find answers to questions such as: What were the practices that helped shape the United States law of commercial contracts? Who were the principal shapers of those practices and laws? There can be little doubt that Puritanical character traits such as honesty, industriousness, frugality and willingness to trust counter-parties had much to do with a legal culture of trade (long distance and local) in which private ownership and a labor or transformative work theory of value remained influential to this day. There can also be little doubt that a version of a rural merchant who was a manufacturer-producer as well as a distributor of his own goods or products was responsible for the attitude that anyone can be a merchant in America (including farmers) and of the underlying value that commerce is a respectable and honest, if not an honorable, way for anyone to earn a living and more.
The consumer revolution that Virginians associated with the accessibility to the goods of a general store eventually begat department stores and huge multi-acre “big box” stores. Retailers depended upon wholesalers and jobbers for their commercial 858credit and consumers depended upon retailers for their consumer credit. Meanwhile, department stores popularized informal acknowledgments of their customers’ contractual liability and introduced adhesion contracts in their extensions of credit to their customers. Eventually, they also introduced multiparty electronic transactions for “just in time” inventory re-supply.
The commercial and consumer credit practices spawned by the above market participants undoubtedly have acted as lubricants of the economy of the United States. However, they would have been far less effective had courts and administrative agencies not have curbed violations of the Purtians’ principle of moral capitalism by maximizations of contractual rights based upon a definition of freedom of contract which presumed any contractual conduct enforceable unless expressly declared as unenforceable. Similarly, the contribution of commercial and consumer credit would have been much less significant were it not for Paul Warburg’s vision of the Federal Reserve as a bank that discounted commercial paper in an “elastic” (supply and demand) manner. In doing this, he provided the profiles of both an archetypal lender (observant of short-term, self-liquidating and truly commercial loans) and of an archetypal commercial borrower, able and willing to repay based on his business’s cash flow and the “readily marketable” nature of his commodities. After the creation of the Federal Reserve Bank, which was vitally interested in promoting commercial and self-liquidating credit, the United States was likely to acquire a healthy national and international credit market.
At this time, the trading world looks at the United States for its leadership in the protection of good faith and reasonableness in commercial contracting. It also hopes that the United States will continue its leadership in protecting third party purchasers, investors and creditors within its borders and beyond with a requisite dosage of moral capitalism. As will be explored in subsequent chapters, commercial lawyers can play a major role in satisfying these reasonable expectations.