Preventing the Misuse of Preventive Adjudication: A Response to Bray

Henry Smith - Harvard Law School

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Henry E. Smith

Samuel Bray’s recent article in the University of Chicago Law Review1 proposes an innovative category—preventive adjudication—to capture how courts minimize the harm from legal uncertainty. In preventive adjudication, the court issues no command to the parties, applies a prospective remedy only, and applies the law to a given situation.2 Bray convincingly demonstrates that preventive adjudication is deeply entwined with uncertainty: preventive adjudication dispels uncertainty, making it particularly suited for cases of legal status and clouds on title to property. The article offers a range of reasons, both old and new, to regard uncertainty as particularly debilitating in these areas in exactly the way that a court can address through a preventive remedy. Likewise in terms of institutional costs, Bray shows how the advisability of preventive adjudication is tied up with the ease with which a court can reduce uncertainty and the comparative effectiveness of other avenues parties have of dispelling uncertainty—chiefly through probabilistic discounting. In other words, preventive adjudication is part of an institutional response to uncertainty that has to be evaluated in terms of both costs and benefits. And Bray presents some powerful reasons relating to reliance, investment, coordination, and the like, which render uncertainty in cases involving legal status and clouds on title particularly troublesome and preventive adjudication correspondingly welcome.

But, as Bray also notes, not all uncertainty is bad. In this Response, I will argue that there is a systematic reason to favor uncertainty that forms an important basis for limiting preventive adjudication: the problem of opportunism.3 Opportunists can “walk the line” or dance around it, looking for loopholes and weaknesses that allow them to take unforeseen advantage of bright-line law. Take the example of the million raves that Bray borrows from Timothy Endicott, which features a UK statute governing any night-time gathering with music that, “by reason of its loudness and duration and the time at which it is played, is likely to cause serious distress to the inhabitants of the locality.”4 Some raves are clearly permissible, some are clearly not, and some fall in the gray area in between. As Bray correctly notes, resolving this fact-based indeterminacy cannot have much issue-preclusive effect, because the planners of a rave need only tweak the rave, for example by reducing the volume slightly, in order to avoid a directive against a particular rave. But there is a more general problem: announcing a bright line invites exploitation of its inadequacy. It might turn out that a bright line of x decibels invites raves that consistently hit that level without a break, causing more distress than anticipated. Or, moving beyond raves, it is well known that in tax law closing loopholes ex ante has its limits: if there are ten loopholes and only nine are closed, some people will plan how to use the tenth. Under such circumstances, it may make sense to reserve discretion ex post to define a legitimate transaction, using a standard rather than a rule, in order to prevent evasion.5 Likewise, a liability rule, under which A can take B’s entitlement upon the payment of officially determined damages,6 can invite opportunism in the form of takers who will seek out (cherry pick) assets that are undervalued by the courts (and whose value cannot be credibly signaled by the owner to the court).7

Elsewhere I argue that equity, as developed in the equity courts and living on in various maxims, defenses, and remedies, set itself the goal of combating opportunism.8 Going back to Aristotle, equity would supplement the law when the law was inadequate owing to its generality,9 and a major source of inadequacy from general rules is the occasion for opportunism to which they give rise. The danger is that better-informed parties will use the system of legal and contractual norms in hard-to-foresee ways even if their actions decrease overall surplus.10 This is what is sometimes called “near fraud,” and the problem is that it is inherently hard to define.11 Because it is hard to specify ex ante, rules, including contractual provisions, will not be effective at eliminating it. Instead, as Justice Story recognized, because “[f]raud is infinite” given the “fertility of man’s invention,”12 equity must be open ended, vague, and discretionary. Again, the anti-evasion doctrines of tax law face this open-ended problem of opportunism in the same ex post, discretionary way.13

The real problem is coming up with proxies for the bad behavior in question, the opportunism, in a way that avoids doing more harm than good. The benefits of undoing and deterring opportunism must be set off against not just administrative costs but the chilling effect on legitimate behavior. More generally, the rap on equity has always been its arbitrariness and potential for expansion.14 Equity courts have tried mightily to avoid this charge. Certain self-limiting features such as employing equity only where the law is inadequate and limiting itself to only in personam effect, reflected the aspiration to keep equity cabined such that it would form only a limited safety valve for the law.15

What does this have to do with preventive adjudication? Not coincidentally, many of the preventive adjudication devices trace back to equity.16 As with equity, the greater certainty afforded by preventive adjudication is ex post, relative to some earlier act, and may in some circumstances head off opportunism. Thus, to revert to the example of the raves, a declaratory judgment does prevent someone from pleading ignorance after the fact if the rave violates the terms of the declaratory judgment. But, also like equity, preventive adjudication must itself avoid becoming a tool of opportunists. Thus, where all the margins of possible annoyingness cannot be foreseen, a declaratory judgment can become a road map for evading the substance of the law, if compliance with the declaratory judgment would be treated as a safe harbor.

When will the problem of opportunism be important enough to counsel caution in using preventive adjudication? Even at this higher level it may be a difficult to tell good from bad cases for preventive adjudication ex ante. As in the case of equity, some discretion to withhold a remedy may be one way of foiling the opportunists. Bray criticizes “retail sorting”—deciding on a case-by-case basis whether to afford a preventive remedy—for causing too much uncertainty and undermining the benefits of preventive adjudication.17 Bray attributes the insignificance of the federal declaratory judgment to the discretion that courts have—and routinely exercise outside the context of patents—to deny declaratory judgments to litigants seeking them. He also argues that rationales based on the need to prevent a flood of preventive cases do not uniquely point to retail sorting. As an alternative, Bray presents wholesale sorting, in which entire categories of cases are identified as being appropriate for preventive adjudication. Examples of candidates for cases that would automatically qualify for preventive adjudication include petitions to declare missing persons dead, petitions to declare legal paternity, and actions to quiet title. Once identified as belonging to such a category, a court would not have discretion to deny a preventive remedy like a declaratory judgment.

Bray is right that case-specific sorting is problematic, but the equitable role of preventive adjudication suggests that discretion cannot be eliminated altogether. Bray does note that no system can do away with all discretion in preventive adjudication,18 but he sees little reason to celebrate that discretion and he treats it as an unwelcome residue after the categorization for wholesale sorting has been pushed as far as it can be.

But the need to prevent opportunists from gaming the system suggests a systematic reason for allowing some significant amount of discretion, much like what Bray describes as “informal wholesale sorting.”19 Undue delay and misconduct—which are both highly related to opportunism—were used both by the equity courts and in a more limited way by the common law courts to serve a gatekeeping function over their jurisdiction.20 Bray notes that state and foreign courts, which subscribe to wholesale sorting in theory, use informal wholesale sorting in practice. This is no accident. Informal retail sorting is exactly like the version of equity that is partially constrained through case law and paradigm cases. The role of equity—and preventive adjudication—in using structured discretion to deal with opportunism suggests that informal wholesale sorting is likely to be very different from and much superior to both retail sorting and more “formal” wholesale sorting. As noted, equitable discretion to deny equitable relief typically involved misconduct (unclean hands), notice and lack of good faith, and other violations of common sense morality. In particular, the notion of disproportionate hardship is an important proxy for situations in which one party is being opportunistic.21

More speculatively, one might see a role for a distinction that Bray uses in his discussion of discounting: risk versus uncertainty. Frank Knight famously made a distinction between risk and uncertainty. Risk involves knowledge of the states of the world and some probability distribution over them. By contrast, uncertainty, also known these days as ambiguity, cannot be quantified in this fashion because either the probability distribution or the set of outcome states is unknown.22 Uncertainty (or ambiguity) can be illustrated by the Ellsberg Paradox.23 If presented with an urn containing thirty red balls and sixty balls that are each either black or yellow, people strictly prefer receiving $100 if a red ball is drawn over $100 if a black ball is drawn. Likewise they prefer $100 if a red or yellow ball is drawn over $100 if a black or yellow ball is drawn. Given the principle of insufficient reason and expected utility theory, this is surprising, and ambiguity aversion—stemming from the lack of knowledge of the proportion of the black and yellow balls—has been invoked to capture this phenomenon.24 Ambiguity aversion—or aversion to Knightian uncertainty as opposed to ordinary risk aversion—can be modeled in a variety of ways.25 For our purposes, preventive adjudication can sometimes have the effect of clearing up uncertainty—making more knowable the proportion of black and yellow balls, or in more radical cases the color or even shapes of objects in the urn—such that actors may misuse this information for their own nefarious purposes, like pushing their raves or tax planning in now more certain directions.

A comparison to the theory of entrepreneurship is instructive. As Knight himself noted, profit opportunities present themselves in the form of uncertainty.26 Economists interested in entrepreneurship have found in Knightian uncertainty a useful source of explanation for what entrepreneurs do.27 In general an entrepreneur is someone who can seize opportunities characterized by uncertainty and can turn some kinds of uncertainty into more manageable risk. This is usually considered a plus from society’s point of view. But the opportunists, like the expert rave organizer or a tax avoider, can use uncertainty to their advantage in an inefficient and unfair fashion. They are “bad entrepreneurs” looking for opportunities to use the system in unforeseeable and deceptive ways. Keeping such actors in uncertainty—about exactly which raves or tax-motivated transactions pass muster—can be beneficial from society’s point of view. In such cases we would want a court to use its discretion under informal wholesale sorting to deny a preventive remedy that would clear up the uncertainty.

Uncertainty is particularly relevant for preventive adjudication on both sides of the ledger. As Bray implies, it can be particularly debilitating and can prevent the use of discounting in ex ante decisionmaking by parties. But uncertainty can also be beneficial where we suspect that primary actors might have too much incentive to use knowledge—of risk—as a guide to illegitimate planning.

So while it is true that most of the time we welcome parties’ ability to discount, there are other situations in which maintaining uncertainty and not allowing it to be turned into risk are also important. Because these situations cannot by their nature be specified ex ante—they would then become sitting ducks for those seeking to game the system—the role of discretion remains important around the edges.

All of which is not to say that uncertainty is per se a good thing or that its benefits outweigh its costs. Quite the contrary. The benefits and costs identified by Bray that form the core case for preventive adjudication are likely to be the norm, and the need to combat opportunism arises (one hopes) around the edges. Thinking in terms of preventive adjudication will only further the goal of integrating these two decisionmaking modes. The challenge is to keep the residuum of necessary discretion and uncertainty—the equitable “safety valve”—operating around the edges and not to let it swallow the entire system whole. That was the challenge historically for equity, and it remains so for the echoes and analogues of equity today—including the important device of preventive adjudication.


Acknowledgments:

Henry E. Smith is the Fessenden Professor of Law at Harvard Law School.

Copyright © 2011 University of Chicago Law Review.

  1. Samuel L. Bray, Preventive Adjudication, 77 U Chi L Rev 1275 (2010).
  2. Id at 1276.
  3. See, for example, Oliver E. Williamson, The Economic Institutions of Capitalism 47 (Free Press 1985) (defining opportunism as “self-interest seeking with guile”); Oliver E. Williamson, Opportunism and Its Critics, 14 Managerial & Dec Econ 97, 98 (1993) (defending the usefulness of the notion of opportunism against social science critics). See also Margaret F. Brinig and Steven M. Crafton, Marriage and Opportunism, 23 J Legal Stud 869, 871 (1994); Timothy J. Muris, Opportunistic Behavior and the Law of Contracts, 65 Minn L Rev 521, 521–22 (1981) (identifying opportunism as behavior contrary to a contracting partner’s expectations but not necessarily contrary to the contract’s explicit terms).
  4. Timothy A.O. Endicott, Vagueness in Law 57 (Oxford 2000), quoting Criminal Justice and Public Order Act 1994, ch 33, § 63(1).
  5. See, for example, Kyle D. Logue, Tax Law Uncertainty and the Role of Tax Insurance, 25 Va Tax Rev 339, 365–67 (2005); David A. Weisbach, An Economic Analysis of Anti-tax-avoidance Doctrines, 4 Am L & Econ Rev 88, 93–95 (2002) (analyzing anti-avoidance doctrines as standards that apply to transactions after the fact if they reflect excessive tax-avoidance motivation).
  6. Guido Calabresi and A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 Harv L Rev 1089, 1106–07 (1972) (describing a liability rule in contrast to a property rule and discussing the circumstances favoring liability rules).
  7. Henry E. Smith, Property and Property Rules, 79 NYU L Rev 1719, 1774–85 (2004).
  8. Henry E. Smith, An Economic Analysis of Law versus Equity *26–33 (Harvard Law School Working Paper, Nov 2010) (on file with author).
  9. Aristotle, Nichomachean Ethics 317 (Harvard 1982) (G.P. Goold, ed) (H. Rackham, trans) (stating that equity corrects “law where law is defective because of its generality”). Judges have often cited this passage in connection with equitable decisionmaking. See, for example, Riggs v Palmer, 22 NE 188, 189 (NY 1889) (“The equitable construction which restrains the letter of a statute is defined by Aristotle as frequently quoted in this manner: Æquitas est correctio legis generaliter latæ qua parte deficit {“Equity is the correction of the law where it fails owing to its generality”}.”).
  10. For examples of discussions of opportunism in economics, see sources cited in note 3.
  11. See James Gordley, Equality in Exchange, 69 Cal L Rev 1587, 1639 (1981) (describing the nineteenth-century view that disparity in price is evidence of fraud and the earlier view that disparity in price is a kind of fraud). See also Seymour v Delancey, 3 Cow 445, 532 (NY 1824) (citing cases).
  12. Joseph Story, 1 Commentaries on Equity Jurisprudence, as Administered in England and America 184 n 1 (Little, Brown 9th ed 1866) (quoting a letter dated June 30, 1759 from Lord Hardwicke to Lord Kaims). Or, as Chancellor Ellesmere put the point: “The Cause why there is a Chancery is, for that Mens Actions are so divers and infinite, That it is impossible to make any general Law which may aptly meet with every particular Act, and not fail in some Circumstances.” The Earl of Oxford’s Case, 21 Eng Rep 485, 486 (Ch 1615).
  13. Although equity relied heavily on ex post decisionmaking, and so can be characterized as employing standards, Louis Kaplow, Rules versus Standards: An Economic Analysis, 42 Duke L J 557, 565 (1992), the law–equity distinction is about more than the timing of decisionmaking. Smith, Law versus Equity at *4 (cited in note 8) (identifying in personam operation, ex post discretionary decisionmaking, emphasis on good faith and notice, the employment of moral standards, and inherent vagueness as features of equity contributing to its anti-opportunistic effect).
  14. John Selden, Table-Talk: Being the Discourses of John Selden, Esq. or his Sence of Various Matters of Weight and High Consequence Relating Especially to Religion and State According to the State 20 (E. Smith 1689); J.H. Baker, An Introduction to English Legal History 126–28 (Butterworths 3d ed 1990).
  15. Smith, Law versus Equity *4 (cited in note 8).
  16. See Bray, 77 U Chi L Rev at 1281 & n 17 (cited in note 1).
  17. See id at 1315–18.
  18. See Bray, 77 U Chi L Rev at 1325 (cited in note 1).
  19. Id at 1316.
  20. David L. Shapiro, Jurisdiction and Discretion, 60 NYU L Rev 543, 572 (1985) (“The criteria used by the common law courts to guide the exercise of discretion were similar to those a court of equity would consider on a prayer for an injunction. A petitioner might be barred by undue delay, by his own misconduct, or by the availability of an adequate alternative remedy, and any of these factors could operate to preclude issuance of the writ even when the plaintiff was able to prove the defendant’s unlawful conduct.”).
  21. Smith, Law versus Equity at *15–16, 29, 33–35, 37–38, 49–50, 56 (cited in note 8). See also Carol M. Rose, Crystals and Mud in Property Law, 40 Stan L Rev 577, 587–88, 599–600 (1988); Henry E. Smith, Rose’s Human Nature of Property, Wm & Mary Bill of Rts J *9–10 (forthcoming) (on file with author).
  22. Frank H. Knight, Risk, Uncertainty and Profit 19–21, 197–232 (Riverside 1921).
  23. Daniel Ellsberg, Risk, Ambiguity, and the Savage Axioms, 75 Q J Econ 643, 654–55 (1961).
  24. See, for example, David M. Kreps, Notes on the Theory of Choice 146 (1988) (“{T}he principle of insufficient reason { } says that if I have no reason to suspect that one outcome is more likely than another, then by reasons of symmetry the outcomes are equally likely, and equally likely probabilities may be ascribed to them.”); R. Duncan Luce and Howard Raiffa, Games and Decisions: Introduction and Critical Survey 284–85 (Wiley 1957); Stephen M. Stigler, The History of Statistics: The Measurement of Uncertainty before 1900 111–12, 117, 127–29 (Belknap 1986); Craig K. Ihara, Maximin and Other Decision Principles, 12 Phil Topics 59, 63 (Winter 1981) (“The ‘principle of insufficient reason,’ otherwise known as the Bayles, or LaPlace criterion, states that if we have absolutely no information about the relative probabilities we must assign equal probabilities to alternatives and then adopt the course of action whose expected utility is the highest.”). Not surprisingly, Knight explicitly questions the value of this assumption. Knight, Risk, Uncertainty and Profit at 222 (cited in note 22).
  25. See, for example, Larry G. Epstein, A Definition of Uncertainty Aversion, 66 Rev Econ Stud 579, 579–81 (1999) (proposing a definition of uncertainty aversion that aligns more appropriately with the Savage framework); Larry G. Epstein and Tan Wang, Intertemporal Asset Pricing under Knightian Uncertainty, 62 Econometrica 283, 284 (1994) (presenting “a formal model of asset price determination in which Knightian uncertainty plays a role”); Larry G. Epstein and Martin Schneider, Recursive Multiple-Priors, 113 J Econ Theory 1, 20 (2003) (extending the Gilboa–Schmeidler “atemporal model” and creating their own “axiomatic model of dynamic preference”); Itzhak Gilboa and David Schmeidler, Maxmin Expected Utility with a Non-unique Prior, 18 J Math Econ 141, 142–43 (1989) (modeling ambiguity aversion as based on maxmin expected utility).
  26. Knight, Risk, Uncertainty and Profit at 264–90 (cited in note 22).
  27. See, for example, Israel M. Kirzner, Discovery and the Capitalist Process 40–67 (Chicago 1985).

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