Do Judges Do Contract Interpretation Differently During Crisis Times...


Scholars of constitutional law and judicial behavior have long conjectured that judges behave differently during times of crisis. In particular, the frequently made claim is that judges “rally around the flag”.  The classic example is that of judges being less willing to recognize civil rights during times of war (for discussions of this literature, see here, from Oren Gross and Fionnuala Aolain; and here, for an empirical analysis of the topic from Lee Epstein and co authors).

But what about financial crises?  Are judges affected enough by big financial crises to change their behavior and, for example, rule more leniently for debtors who unexpectedly find themselves being foreclosed on? In a paper from a few years ago, Georg Vanberg and I hypothesized that a concern with needing to help save the US economy from the depression of the 1930s may have been part of the dynamic explaining the Supreme Court’s puzzling decision in the Gold Clause cases (here).

A fascinating new paper from my colleague, Emily Strauss (here), analyzes this question in the context of the 2007-08 financial crisis.  Emily finds that lower courts judges, in a series of mortgage portfolio contracts cases during and in the half dozen years after the crisis, made decisions squarely at odds with the explicit language of the contracts in question.  From a pragmatic perspective, it is arguable that they had to; the contracts were basically unworkable otherwise.  But the clear language of the contracts said otherwise. And judges, especially in New York, like to follow the strict language of the contracts (or so they say).   Then, and I think this is the most interesting bit of the story, Emily finds that, starting in roughly 2015 (and after the crisis looked to have passed), the judges change their tune and go back to their strict reading of the contract language.

Here is Emily’s abstract that explains what happened better than I can:

Why might judges interpret a boilerplate contractual clause to reach a result clearly at odds with its plain language? Though courts don’t acknowledge it, one reason might be economic crisis. Boilerplate provisions are pervasive, and enforcing some clauses as written might cause additional upheaval during a panic. Under such circumstances, particularly where other government interventions to shore up the market are exhausted, one can make a compelling argument that courts should interpret an agreement to help stabilize a situation threatening to spin out of control.  

This Article argues that courts have in fact done this by engaging in “crisis construction.” Crisis construction refers to the act of interpreting contractual language in light of concurrent economic turmoil. In the aftermath of the financial crisis, trustees holding residential mortgage backed securities sued securities sponsors en masse on contracts warranting the quality of the mortgages sold to the trusts. These contracts almost universally contained provisions requiring sponsors to repurchase individual noncompliant loans on an individual basis. Nevertheless, court after court permitted trustees to prove their cases by sampling rather than forcing them to proceed on a loan by loan basis.

If you wish to go deeper down this rabbit hole, contracts gurus, Alan Schwartz & Tracy Lewis, have a paper on these portfolio contracts (here).  Their focus is on the flaws in the contract design itself though, and not the judicial decisions.  They were at Duke to present an early draft of their paper last year and that was the first time I heard about both the design flaws, how judges had dealt with them, and what the market reaction had been.

A couple of questions that I have here are:

  1. Have the flaws in the contract language identified by Alan, Tracy and Emily been repaired? (My understanding is no; they just sit there, waiting for the next crisis).
  2. As a normative matter, should society want judges to be acting in the fashion that Emily describes? I’m not so sure, even though I’m sympathetic to the dilemma the judges faced.  This precise question was certainly at the heart of the heated battle among the justices in the Gold Clause cases.