by Renata Grossi, University of Technology Sydney

The interim report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in Australia tabled in parliament in September 2018 found that the financial services sector was motivated by ‘the pursuit of short term profit at the expense of basic standards of honesty’, and that ‘from the executive suite to the front line, staff were measured and rewarded by reference to profit and sales.’ And, that when misconduct was revealed, little or ineffective action was taken by the companies themselves, and – even more shocking – by the regulators.

While these finding have made front pages of media organisations, they have also been met with a certain degree of cynicism: ‘The financial sector is motivated by greed, who would have thought it?’ asked one journalist, and others have expressed the view that when the commission ends ‘things should return pretty much to normal’.

No doubt some changes to laws governing the provision of financial services will be made, and banks are already talking about changes to their code of practices. But to really change things we need to dig deeper into the laws that actually shape and motivate, as well as regulate economic behaviour.

At the heart of economic activity lies the law of contract; it is the fundamental underpinning of the market system, and the question we should ask is – does the law of contract require us to be ‘good’?

The philosophical underpinnings of our modern contract law are to be found in nineteenth century classical contract theory. Classical theory understands a contract as the expression of the will of self-interested and autonomous individuals operating in a free market. The central idea is that parties are free to enter into agreements with minimal interference from the state and the law. Sir George Jessel MR summed this view up in 1875 in the case of Printing and Numerical Registering Co v Sampson:

If there is one thing which more than another public policy requires is that men of full age and competent understanding shall have the utmost liberty of contracting.

The approach the courts have taken therefore has been to focus on technical rules to do with the formation and the consequences of an agreement, rather than engage with any analysis of the content itself. This is why for example contract law has been able to support evil practices such as slavery, and morally and ethically difficult practices such as surrogacy. While the lines between procedure and substance can be, and often are, blurred, the distinction remains an underlying principle. Take for example the consideration principle that courts will not look into the adequacy (the value) of a bargain. This was justified in Woolworths v Kelly by Justice Kirby, in part as a means of preserving economic freedom to contract.

When the courts do look at the quality of the agreement reached, they relegate it to the principles of Equity. Has there been unlawful or illegitimate pressure (duress)? Is there a possible relationship between the parties that has led to the exercise of undue influence? Does one of the contracting parties have a disadvantage which limits her ability to judge whether the contract is in her interests (unconscionability)? Again, while the lines are often blurred, these principles govern the nature of reaching an agreement, more than the actual content of the agreement itself. It is also important to note the range of legislation that exists to regulate contracts. For example in Australia at the federal level alone we have the Australian Consumer Law, The Australian Securities and Investment Act, the Insurance Contract Act, the Life Insurance Act, as well as various pieces of state legislation.

Regardless of these interventions, the principle of the freedom to contract remains the lynchpin of contract law and a significant driver of the culture of economic activity. But as critical scholars have enthusiastically argued, freedom to contract is a fallacy that is only available to the powerful. They argue that autonomy is differently experienced according to the position you occupy in society, and that the law privileges some experiences while silencing others. Anyone who has tried to negotiate contractual terms on various standard contracts like a mortgage with a bank, a car rental, or a mobile phone provider, just to name a few, will quickly agree with these arguments.

Another central idea in the classical theory of contract is the free market, not only as a generator of wealth, but (as per Adam Smith) a civilizing force, and (as per Nathan Oman) an avenue for human cooperation and development. But as with the freedom to contract, this too is fallacious. It ignores the hierarchical, unequal and exploitative nature of markets. The evidence heard in this royal commission is a case in point. As Aditi Bagchi says ‘the experience of market domination does not optimally prepare either the dominant or the dominated for egalitarian politics’. In this context then in the end a contract constitutes the enforcement of one party’s power over another. And as Betty Mensch put it at the heart of every bargain lies ‘coercion, including legal coercion.’

Reliance on Equity is not the answer. Duress, undue influence and unconscionability tell us that an agreement is not vitiated simply because there is overwhelming pressure (Crescendo Management v Westpac); nor if there is influence by one party over another (Allcard v Skinner); nor if there is an inequality of bargaining power (ACCC v Berbatis). It also tells us that a weakness in one party is only of concern when it meets with predatory behaviour and victimisation of one party by another (Kakavas v Crown Melbourne Limited). The level of protection which emerges from these Equitable principles do not even touch the sides of the basic inequalities that exist in the market place.

There are other ways to understand contracts philosophically. They can be seen through the paradigm of the morality of keeping promises we make to one another (Charles Fried), or of a transferral of entitlements consensually granted (Randy Barnett), or purely as a means by which we regulate economic activity (Eric Posner). But these theories like the classical will theory, do not focus on the actual content, or on whether an agreement is ‘good’. A good contract can only emerge from a theory which places at its philosophical core the need to balance out the power between the parties.

What this requires is a larger conversation about whether we really do care about equality and fairness in our society. This is part of a larger progressive political agenda and contract law has a part to play in this conversation.