The law and economics doctrine and the alternative dispute resolution methods applied to construction agreements
Credit: Andrey Popov/Shutterstock
Renan Frediani Torres Peres
Barbosa Müssnich Aragão, São Paulo
rft@bmalaw.com.br
Introduction
The number of disputes involving long-term construction agreements in Brazil has steadily grown in recent years, impacting not only the parties, but also society at large. When parties need to resolve conflicts of this nature, besides resorting to the dispute resolution method sanctioned by the state – the judiciary – they can also seek mediation, dispute boards and, especially, arbitration. Although these private methods of resolving conflicts vary in their characteristics, they share one aspect: namely, the participation of a third party to render a decision or award, or communicate information about the conflict to the parties.
Simply put, arbitration can be understood as a private replica of the functioning of the judiciary. In other words, instead of submitting the dispute to the state justice system, where judges decide cases according to the applicable laws, the parties choose one or more arbitrators as their private fact-trier(s), possibly based on procedural and substantive rules different to those that would be applied by the judiciary.
In the case of Brazil, arbitration only became widespread with the enactment of Law 9,307 of 23 September 1996, despite being present in the nation’s legal system since the 19th century.[1] Adhesion to this practice has been consolidated primarily because arbitral awards no longer need to be recognised by a State court[2] and parties are allowed to choose this route through an arbitration clause or agreement.
In contrast, mediation and dispute boards are non-binding forms of resolving disputes, essentially replacing direct negotiation between the parties. Mediation is a process by which a neutral third party facilitates the negotiations between the disputing parties, seeking resolution of a conflict. Mediation is aimed at resolving the case by consensus rather than by a binding order.
The reliance on dispute boards was only recently regularised in Brazilian legislation, mainly by São Paulo Municipal Law 16,837/2018 and the new federal Law of Tenders (Law 14,133 of 1 April 2021).[3] The latter law was responsible for supplying nationwide normative treatment to the figure of dispute boards. Before this, they were only governed at the municipal level. Dispute boards, in summary, seek to resolve disputes in the corporate area, especially involving long-term contracts, such as those for civil construction. Therefore, dispute boards are a promising means of preventing and resolving conflicts involving infrastructure projects.
The referred boards generally consist of up to three independent and experienced experts, who periodically monitor the progress of the contract and work to resolve occasional conflicts that arise during their performance.[4]
These means of alternative dispute resolution have also been gaining traction in Brazil due to the similarity of their application across international jurisdictions. Indeed, these methods have been increasingly encouraged by the state courts, based on procedural legislation. In various areas, plaintiffs and defendants are obliged to first try an alternative dispute resolution method, before a lawsuit formally starts.
However, for situations in which an initial good faith attempt by a non-adversarial alternative method is not obligatory, various debates exist as to what leads parties to utilise alternative dispute resolution methods, and the respective advantages to the parties and wider society. In this regard, the economic approach to the law (also known as the doctrine of law and economics) gains relevance, as the parties will naturally consider the effects of the alternative dispute resolution method on the probable outcome of their conflict.
Therefore, considered here is a broad discussion on the application of economic analysis of the law in Brazil, identifying the conditions under which the parties are encouraged to use these alternative means.
Such analysis will not encompass all relevant aspects of the doctrine of law and economics, nor all the alternative dispute resolution means, but some relevant points deserve focus and will be considered in isolated form. This aims to shed light on the reliance on alternative dispute resolution by the parties in Brazil, in the context of long-duration contracts, such as civil construction agreements, as well as the criteria involved.
Economic analysis of the law and its application
The economic analysis of the law is a doctrine that advocates the need for approximation between the law and economics,[5] offering ‘a mature theoretical instrument to help in the comprehension of social facts, and mainly, how social agents will respond to potential alterations in their structure of incentives’.[6] As stressed by the doctrine in question, economists are able to answer questions the law alone would likely be unable to resolve.[7]
The economic analysis of the law proposes a rereading of the legal framework based on instruments of economics; that is, a reinterpretation of the legal system in conformity with the assumptions of economics, such as incentives, rationality, maximisation of results and minimisation of costs, among others. According to Ejan Mackaay: ‘Law and economics judge legal rules by their expected social effects, as opposed to their justice or fairness qualities. [...] Legal rules affect the costs and benefits of particular courses of action open to individuals and as a result may change the attractiveness of some actions in comparison with others [...] Individuals may adjust their behaviour in response to those signals.’[8]
Mota Pinto, in explaining the method used, defines the movement of the law and economics carefully, stating that it:
‘seeks an imposition and solution of legal problems fundamentally based on the “efficiency of allocation” of resources, submitting these problems and solutions to an economic analysis of “well-being”, according to the canons of the school of marginalism (the analysis of the marginal value of the behavioral options of agents under a constraint, and in general the comparison of costs and benefits of legislative solutions), complementing it with theoretical approaches such as the theory of games and the economy of information (152), specifically to analyze, on various points, the incentives resulting from the legal rules or the way these enable coordinated action.’[9]
Scholars of the law and economics had used the axioms and premises of both sciences to deepen their knowledge and support their conclusions
Although the author argues that the economic analysis of the law does not resolve the legal-normative problem presented in his work, he clarifies that this technique should ‘have an auxiliary role (especially in legislative or judicial options where the ethical-material implications are of lesser importance) to clarify the relevance of the guiding reality.’[10]
In dealing with the theme, Paula Forgini[11] details some premises applicable to the formulation, interpretation and application of the rules of law, as established by the economic analysis of the law, namely: (i) no right is absolute, so that the application of any rule or principle requires the previous examination of the costs and benefits to all the parties involved in the contractual relationship; (ii) the legal system should enable the reduction of transaction costs, facilitating exchanges between economic agents; (iii) a function of the law is to increase the degree of certainty and foreseeability of the relations, with the consequence of reducing the risks assumed by the economic agents, and hence, the transaction costs; (iv) governmental intervention generates costs, so it should only be used when necessary to correct market failures; (v) legal rules should be considered as incentives and disincentives to the action of economic agents, such that the sanction is a type of price to be valued by the economic agent; and (vi) the law should be endowed with ‘distributive neutrality’, rather than permeated with values other than allocative efficiency.
Forgini also presents different ways that economic analysis can contribute to the law, namely by: (i) permitting the identification of the effects of a determined rule or decision, based on the cost-benefit analysis of legal policies; (ii) explaining the reason why determined rules are found in the legal system; and (iii) determining which rules should or should not be accepted by the system.[12]
Most scholars interested in the economic analysis of the law attribute its origin to Ronald Coase in his 1960 article, ‘The Problems of Social Cost’, in which he proposed a debate on the allocation of resources.[13] Indeed, that work marked a watershed in the doctrine of law and economics, but long before Coase’s writings scholars of the law and economics had used the axioms and premises of both sciences to deepen their knowledge and support their conclusions.[14]
The topic of law and economics rose to another level in 1972, when Richard Posner, a judge and professor at the University of Chicago, published his book, Economic Analysis of Law, in which he established the pillars of economic analysis of the law by applying economic postulates from several fields of law, such as contractual rights and remedies, civil liability, criminal law and antitrust law.[15] According to Posner, the economic analysis of the law has heuristic, descriptive and normative aspects.[16]
One of the first opportunities when the economic analysis of the law was applied in the Brazilian justice system was the publication of Rachel Sztajn’s ‘Notas de Análise Econômica: Contratos e Responsabilidade Civil’ in 2005.[17]
Among the Brazilian authors who have undertaken the economic analysis of the law are Mariana Pargendler and Bruno Salama, in their article ‘Law and Economics in the Civil Law World: the Case of Brazilian Courts’, in which they analyse decisions by Brazilian courts and conclude that, contrary to common sense, ‘Brazilian judges habitually employ concepts borrowed from economics to forecast the likely consequences of events or rules when such a prediction is called for by relevant legal rules.’[18]
Pargendler and Salama begin the article by explaining that their analysis takes into consideration situations in which judges have based their decisions on principles and lessons from economics as instruments to apply the law, although not making express reference to these principles. One of the cases mentioned is the debate over the constitutionality of the Maria da Penha Law (Law 11,340/2006), involving domestic violence.[19] As demonstrated in the article, the justices of the Supreme Court used typical economic reasoning, focused on the consequences of the different options available and on human behaviour in each specific situation and the related incentives, to conclude in favour of the constitutionality of the rule allowing the prosecution of violent spouses, even without a formal complaint by the victim.[20] After analysing various decisions rendered by the Supreme Court and the Superior Court of Justice (STJ, the highest court for non-constitutional matters), the authors conclude that Brazilian judges are increasingly receptive to economic principles and lessons.[21]
In the same line, Rachel Sztajn argues that it is a mistake ‘to claim that economics seeks efficiencies while the law is tied to promotion of the issue of being/ought to be’, and that the positions defended by the law and economics are far from being ‘irreconcilable’.[22] According to Sztajn, the economic analysis of the law should not be feared by legal practitioners, but rather seen as a way to think about legal rules, while paying heed to rewards and punishments.[23]
Some authors argue against an economic analysis of the law in the Brazilian system, the majority of whom posit that this current thinking is incompatible with civil law. Among these authors is Paula Bandeira, who when equating the economic analysis of the law with the ‘criterion of efficiency’ – just one of the various elements of the law and economics doctrine – concludes that the economic analysis of the law ‘despite being a relevant method for analysis employed by lawmakers or interpreters in certain situations, does not deplete the values composing the legal system thus not having the constitutional wherewithal to dictate the interpretive criteria for solution of concrete cases.’[24]
Calixto Salomão, in describing the modern theories applicable to corporate law, also mentions the economic analysis of the law and criticises one of its currents, that of the Chicago School, by equating the economic analysis of the law with the theory of efficiency.[25] According to him, both in common law and civil law, the attribution of efficiency as the only objective legal rule, without being contested based on ‘valorative and distributive considerations’ is hard to accept, making it necessary to ‘restrict the economic analysis of the law to a purely analytic instrument, without attributing any valorative character to it’.[26]
Many of the critiques posed result from a miscomprehension of the purpose of the economic analysis of the law, which borrows a method of investigation from economics, consisting of the analysis of individual or collective decisions on the allocation of scarce resources.[27] This does not involve, as some think, an intrinsically capitalist and egotistical reasoning. According to Ivo Gico Jr, it is ‘a big mistake to think that an individualistic method of analysis necessarily involves an individualistic system of values’.[28]
For this reason, as pointed out by Paula Forgioni, the economic analysis of the law should not be taken as an ‘instrument seeking colonization of our system’, much less ‘a messianic solution’ to the problems faced by the law.[29]
Economic assumptions applied by the economic analysis of the law
Various relevant economic concepts and assumptions are used in the economic analysis of the law. The exposition of economic concepts is not the objective of this work, so the below refers only to some of the main presuppositions that relate to the definition of the use of alternative means of resolving disputes, with the depth and expansion necessary to facilitate the exposition and comprehension of the central theme in question.
One of the basic assumptions of economic reasoning is that economic agents will always try to maximise their interests, by extracting the greatest utility from each commercial relationship. Ivo Gico Jr defines utility as the ‘ranking’ among the possible choices of the economic agent.[30] This rational choice of agent from among the available options, with the object to maximise utility, is among the basic assumptions of economics. According to economics, rational choice means knowing the marginal utility of a good or service by the agent, based on knowledge of the advantages and costs of such good or service, with preference for that which provides the greatest utility.[31] Posner also deals with maximisation of the utility of the law, stating that ‘the participants in the legal process indeed behave as if they were rational maximizers: criminals, contracting parties, automobile drivers, prosecutors, and others subject to legal constraints or involved in legal proceedings act in their relation to the legal system as intelligent (not omniscient) maximizers of their satisfactions’.[32]
In this line, the rationality of agents is far from an absolute presumption. As explained by Rachel Stajn and Decio Zylberstajn, the so-called ‘New Instrumental Economics’ ‘rejects the neoclassical premise of hyper-rational choices and maximizing behavior, instead adopting the concept of limited rationality’.[33] Although the rationality of agents is a useful abstract assumption and a way to simplify the reality of the behaviour of economic agents, it is not always borne out empirically.[34]
This reality is better represented by the limited rationality of agents, recognised and studied in Behavioural Economics,[35] according to various factors,[36] among them (i) the finite cognitive capability of agents, who will always be subject to flawed reasoning; (ii) the limited willpower of agents, who can act against their long-run interests; and (iii) the limitation of ‘selfish action’, since agents often act not only according to their own interests, but also in favour of third parties’ interests.
A mistake often made by critics regarding the theory of economic analysis of the law [is] the opposition between the ideas of efficiency and justice, as if these were irreconcilable criteria
Another relevant presupposition in this regard is efficiency, which can be defined in several ways. The oldest concept is connected with utilitarianism, with Jeremy Bentham as a leading exponent.[37] As described above, the principle of utilitarian has a major drawback: the utility is different for each agent, so this aspect cannot be compared among agents. It is impossible to verify whether a given situation is efficient by the utilitarian criterion, because there is no way to make comparisons.
At present, the best-known and most-utilised models by economists to define efficiency are those of Pareto and Kaldor-Hicks. Pareto efficiency, also known as allocative efficiency, is named after the political scientist, sociologist and economist Vilfredo Pareto, based on the idea that goods should be transferred from the agents who least value them to those who give the greatest value.[38] This implies identifying, in a determined context, the situation of an agent that can be improved, without the situation of the other being aggravated.[39]
However, Posner observed that Pareto efficiency is rarely found in the real world, in which the majority of economic transactions also produce effects on third parties.[40] Because of the difficulty of finding a Pareto-efficient situation, economists developed a new version of the theory, called Kaldor-Hicks efficiency. According to this line of thought, a transaction is efficient if it increases the gains of the agents, independently of a change in the distribution of wealth. In other words, a transaction can be efficient even if one of the agents is harmed.
Further regarding the question of efficiency, it is important to point out a mistake often made by critics regarding the theory of economic analysis of the law; namely, the opposition between the ideas of efficiency and justice, as if these were irreconcilable criteria. Various authors, both Brazilian and foreign, have rebutted this interpretation.
As clarified by Ivo Gico Jr, efficiency is a technical term used in the Pareto-efficient sense, which implies the absence of another allocation of resources that manages to improve the situation of one party and worsen that of another. According to Gico:
‘a Pareto-efficient allocation will not necessarily be fair according to some normative criterion, but a Pareto-inefficient allocation will certainly be unjust, since someone can improve their situation without harming anybody. [Thus,] if the resources are scarce and the needs are potentially unlimited, all waste implies unsatisfied human needs, so any definition of justice should have the necessary, albeit not sufficient, condition of eliminating waste (ie, efficiency). While we don’t necessarily know what is just, we know that inefficiency is always unjust. For this reason, I do not envision any conflict between efficiency and justice; much to the contrary, one is a condition for the existence of the other.’[41]
Klaus Mathis, who dedicated a book to the contraposition between the principles of efficiency and justice, entitled Efficiency Instead of Justice?, recognises that most economists believe the relationship between efficiency and justice to be conflictual, but advocates that justice and efficiency are interchangeable to a certain point.[42]
Posner is also among the authors who reject the idea that justice and efficiency are contrary concepts. Posner argues that one of the ways of achieving justice is precisely via efficiency. When one describes as unjust the act of condemning someone without a proper trial, of appropriating something belonging to another without fair return consideration, or of failing to find a negligent driver liable for the damages caused to the victim, this can be interpreted as a ‘waste of resources’.[43]
The Brazilian legal system has various provisions that rely on the criterion of efficiency as a way to reach a fair solution to disputes. For example, there are provisions that make specific reference to efficiency, such as Arts 37[44] and 74, numeral II;[45] Art 126, sole paragraph;[46] and Art 144, ss 7 and 10,[47] of the Federal Constitution, and Arts 8[48] and 867[49] of the Civil Procedure Code.
It is not the intention of this work to delve into the debate around the concept of justice, much less advocate that the criterion of efficiency should be the only one considered in applying the law.[50] The intention is only to refute the fanciful dichotomy between justice and efficiency, which is nurtured by the same jurists who advocate that economics and law are immiscible.
Another concept of the economic analysis of the law relevant to this study is that of transaction costs. Put bluntly, transaction costs are those involved in making a deal, in its different stages. Hence, like in other contractual stages, the parties can incur costs in resorting to one of the methods of resolving conflicts. Such costs can be substantial, and of doubtful recovery, as detailed in the next section.[51]
Incentives for parties to resort to alternative dispute resolution means in long-term contracts
The advocates of alternative means of dispute resolution regularly claim that the use of those means reduces the transaction cost and leads to better outcomes than litigation, especially in long-term contracts, such as construction agreements.
In assessing the benefits and costs of these procedures, it is necessary to ask what the basis for comparison is. Normally, arbitration is compared with the judicial process, while mediation and dispute boards are compared with unfacilitated negotiation. The claims of the proponents are better understood by comparing judicial cases, arbitration, negotiation, mediation and dispute boards in various common dimensions, such as: if participation is voluntary or involuntary; the nature of the proceeding and degree of procedural formality; the role, if any, of a third party; to what extent the result is binding; whether the result should be reached by application of legal rules; and whether the process is public or private.[52]
Some specific aspects of these alternative means to resolve disputes against the backdrop of the Brazilian reality are analysed below.
The particularities of judicial and arbitral proceedings in Brazil
As mentioned, judicial proceedings are involuntary, in the sense that a magistrate appointed by the state has the power to coerce a defendant to participate in a lawsuit, and to suffer the consequences of a possibly negative judgment. The cases are highly structured, with formal rules that govern the production of evidence and the judgment itself – that is, what counts as evidence, the order in which evidence is produced and how the arguments are presented. The judge’s decision must be based on legal principles and rules, and at the first instance, these decisions are binding on the parties, but are subject to a broad range of appeals and motions. Besides this, judicial proceedings per se are normally open to the public, instead of being confidential.
When one describes as unjust the act of condemning someone without a proper trial [...] this can be interpreted as a ‘waste of resources’
In turn, arbitration also involves a neutral third party or parties (the arbitrator(s)), with responsibility for conducting the proceeding and making the necessary decisions to resolve the dispute. Contrary to a judge (a civil servant), the arbitrator is typically a private person chosen by the parties. The persons chosen to arbitrate the conflict generally have specialised knowledge of the subject matter at hand, with legal training only being necessary if the parties so specify.
A dispute that would otherwise be examined by the judiciary becomes subject to arbitration only by concordance of the parties. In this sense, arbitration is based on a contractual arrangement, according to the terms of a specific arbitration clause in their contract or by a side agreement (an accord reached before or after a dispute arises). Thus, the parties can specify arbitration in advance of any conflict or only after one has arisen.
Binding arbitration, unlike judicial resolution, is voluntary, in the sense that someone can be obliged to employ or respond to arbitration only by an accord. However, when an arbitration clause exists, compliance is involuntary, in the sense that the judiciary will only be activated against a recalcitrant party, and will refuse to judge disputes that are within the scope of the arbitration clause or accord. In an arbitral proceeding, the procedural rules can be set by the parties in the clause or accord. The decision of the arbitrator(s) is binding and final.
In comparison with the judicial process in Brazil, the potential advantages and disadvantages of arbitration result from three fundamental differences. In the first place, the parties can choose the arbitrators based on their experience or expertise in the disputed subject matter, while a judge is typically a generalist, who knows the legal procedures but does not necessarily have experience on specific topics. As a consequence, in comparison with a judge, the decision of an arbitrator tends to be better informed. Hence, arbitration can have lower transaction costs and higher-quality results than judgment by a state court.[53]
A second set of possible advantages is related to the fact that an arbitral proceeding can progress more rapidly because of the comparatively greater informality.
The third critical difference involves the scope of judicial reexamination. Unlike the decisions of a trial court, which are subject to various appeals and motions, the arbitral award cannot be annulled by the judiciary by discussions of merit of the dispute. The binding nature and comparative finality of the arbitral award are obviously a two-sided advantage. On the one hand, a final resolution can be much faster and the appeals less frequent, because the scope of re-examination is very restricted. On the other hand, the losing party lacks the safeguards of ordinary judicial re-examination, which theoretically could improve the ‘precision’ of the resolution.
The particularities of negotiation, mediation and dispute boards in Brazil
As is the case in most countries, unlike judicial resolution and arbitration, negotiation does not require the participation of a neutral third party with decisive authority. Instead, the parties themselves have the responsibility to decide the terms of any resolution. Negotiation is voluntary, in the sense that the parties in conflict are not normally forced to negotiate with one another. The negotiation process is informal and without defined procedural rules or standards governing the presentation of evidence or arguments. Since the objective of negotiation is a mutually acceptable resolution, the parties can mould this resolution to meet their own needs and interests, and do not have an obligation to reach a resolution based on principles, much less one that is justified by a grounded opinion that applies formal legal rules.
In turn, in the cases of mediation and dispute boards, like in judicial and arbitral proceedings, this involves the participation of third parties. But at least in Brazil, unlike the intervention of a judge or arbitrator, there is no authority to impose a definitive resolution on the parties.
In the case of mediation, the mediator’s goal is to facilitate the negotiation and help the parties to reach a mutually acceptable settlement of their conflict. Mediation is typically a voluntary process where the parties choose an outside person to act as a facilitator. It is private and confidential rather than open to the public.
Although the mediator is normally responsible for administering the process, there are no standard procedures or fixed rules. The process by which the mediator acts to facilitate the negotiation is often informal and unstructured. The practices of individual mediators can vary greatly. While most mediators mainly spend time working with both parties together, some prefer to utilise private sessions with each party – something that is not possible in judicial and arbitral proceedings.
The practices of mediators also vary in other aspects. For example, some mediators evaluate the legal merits of the positions of each party and express a view of the probable result of a lawsuit or arbitration. Other mediators avoid this evaluation and see their role as only involving facilitation, trying to help the parties to generate creative options that meet their underlying interests. Many mediators act eclectically to help the parties understand the opportunities and risks of pursuing their claims and to identify options to create value, unlike a judicial court or arbitral tribunal.
As long as the resulting resolution is mutually acceptable to the parties, there will be no need to involve the application of formal legal rules or imitate the result a court or tribunal might impose. Normally, there is no re-examination process. If the parties are able to resolve their conflict by means of a written accord, this will be enforceable like any other contractual instrument.
One of the advantages indicated for mediation is the fact that a mediator can help the parties attain better settlements with lower transaction costs. In other words, the mediated accord can often be classified as having greater Pareto efficiency than the parties could achieve on their own. But some legal scholars have identified various barriers to Pareto-efficient negotiations when not assisted.[54] By identifying these barriers, it is possible to explore how a neutral mediator can help the parties to overcome their differences.[55]
The theory of law and economics applied to settlements between the parties to a dispute suggests that they may not reach that outcome due to divergent expectations about what will occur in a judicial or arbitral proceeding.[56] That problem can, in theory, be minimised with the help of a neutral third party, such as a mediator.[57] A mediator can facilitate the exchange of essential information and improve the communication between the parties, as well as improving their understanding of each other’s claims and defences. Besides this, when the parties’ perceptions lead to excessively optimistic evaluations by one or both parties, a respected neutral mediator can overcome this bias. Steven Shavell[58] questioned the motives by which two rational opponents would not do this on their own. However, the problem at issue is precisely the irrational behaviour of the parties, or the ways by which strategic interaction can sometimes inhibit the exchange of essential information.
With regard to dispute boards, notwithstanding some of the advantages mentioned above (such as lower cost and greater specialisation of the third parties forming the board), this means of resolving disputes in Brazil is still very restricted, unlike in other countries. This limitation on the use of dispute boards is mainly due to some legal disincentives that hamper their effectiveness. An example of this is the objective restriction in the city of São Paulo, the capital of the state of the same name. São Paulo has the largest GDP of all Brazilian states: according to Decree 60,067/2021, which regulates Municipal Law 16,837/2018, only infrastructure contracts worth R$200m (roughly $40m) or more can stipulate the adoption of dispute boards, even though their use can help prevent conflicts of various natures.
One of the advantages indicated for mediation is the fact that a mediator can help the parties attain better settlements with lower transaction costs.
Another limitation on the use of this mechanism is the fact that the board cannot issue definitive and unappealable decisions like an arbitral tribunal. Nevertheless, the parties can stipulate that decisions reached by the board have the effect of preliminary judicial injunctions, with binding effect until overturned by a subsequent judicial or arbitral ruling.
Therefore, although they can be an interesting mechanism for the resolution of disputes, especially in civil construction and infrastructure agreements, dispute boards still do not offer an increase of legal certainty in Brazil, since a party that is dissatisfied with a decision by the board can appeal to an arbitral tribunal or judicial court seeking to overturn that decision (and the typical behaviour of lawyers and litigants in Brazil functions as a notorious disincentive in practical cases).
In other words, the incentives of the parties in a conflict (or potential conflict) to agree to the choice of an alternative means of resolving disputes results from the assumption that the referred means will enhance their wellbeing, by permitting a reduction of transaction costs to reach a settlement and/or opening a route to a result with better outcomes.
To define the increase in wellbeing of the parties, it is first necessary to identify the benchmark against which the alternative means of dispute resolution is evaluated. Steven Shavell[59] discusses the conditions under which the parties can have a greater interest in alternative dispute resolution mechanisms in comparison with a judicial decision. By describing these conditions and the private benefits of alternative dispute resolution mechanisms, the author makes a basic distinction between ex post alternative means (formalised after a conflict arises) and ex ante means (formalised before a conflict arises, normally in the contract negotiation stage).
Since the interests of the parties before the emergence of a conflict are typically not the same as those that arise afterward, the implications of the terms of the accord to resort to alternative dispute resolution during these two stages can be fundamentally different.
Besides this, the range of contingencies faced by the parties during each of the contractual steps can be different. Shavell demonstrates how the temporal distinctions and the cut-off point of the emergence of a conflict affect the range of benefits the parties can obtain when using alternative means of resolving disputes.
Indeed, by agreeing to resolve a possible conflict by an alternative dispute resolution mechanism before the emergence of a conflict, the parties can increase the contingencies and enjoy additional advantages that are not possible in post-conflict arrangements. The ex-ante agreements for alternative means of resolving disputes can motivate changes in pre-conflict behaviour, thus increasing the joint benefits to the parties in the interaction.
Reaching a consensus on an alternative means of resolving disputes in the contract negotiation stage can also positively affect the initial conduct of the parties – inducing them to comply with their contractual obligations and the substantive law, achieving more precise results or other characteristics. This is another source of mutual benefits. For example, when the arbitrators are more qualified than a judge to identify substandard performance, the ex-ante arrangement to resort to arbitration will induce the parties to satisfy the standard requirements. The greater precision in resolving a conflict by alternative means will create a stronger incentive to comply with the contractual obligations.
Besides these epistemic effects, the ex ante accord in respect of alternative dispute resolution mechanisms can positively affect the principal behaviour, by imposing future substantive rules that are better adapted than those employed by an arbitral tribunal.[60]
Ex ante accords can also: (i) positively guide the procedural behaviour of the parties, allowing them to make better informed decisions about the investment in gathering evidence and preserving information during interactions; (ii) permit the parties to overcome informational or strategic barriers, to achieve mutually beneficial post-conflict results, as described above; (iii) expand the zone of possible accords; and (iv) positively affect the incidence of conflicts, by inducing the parties to avoid conflicts.[61]
Naturally, the benefits mentioned above can only be enjoyed in the context of pre-existing relations between the parties, and even in these cases, the transaction costs can be high.
To summarise, a variety of ways exist by which alternative dispute resolution mechanisms lead to results that are less expensive and better for the parties.[62]
Conclusion
As canvassed above, resorting to the judiciary is just one of the possible ways to resolve conflicts. Many cases have been effectively resolved by alternative dispute resolution mechanisms, such as arbitration, mediation and dispute boards, especially regarding long-term contracts, such as civil construction and infrastructure agreements. These methods denote a series of other possible ways by which a third party (other than a state judge) can be involved in the resolution of conflicts.
Since alternative dispute resolution mechanisms help to overcome barriers to reach Pareto-efficient results, the effects of their inclusion as incentives to transact and the efficiency of the system to resolve conflicts certainly warrants further theoretical and empirical studies, both by legal practitioners and economists.
In closing, this brief analysis demonstrates the existence of clear incentives that can prompt parties increasingly to opt for dispute resolution methods other than the judiciary, especially when this choice occurs before the emergence of conflicts through ex ante accords.
[1] As described by Rafael Francisco Alves, although the figure of the ‘arbitral court’ existed in the Brazilian legal system since the Ordenações do Reino [‘Ordinances of the Kingdom’], dating to colonial times, and were contained in the majority of constitutions until reaching the Civil Code of 1916 and the Civil Procedure Code of 1973, the fact is that until 1996, the mechanism was practically not used in Brazil. This lack of tradition also had its reasons for being: before enactment of Law 9,307/96, there were various legal hurdles to the development of arbitration in Brazil. Among these obstacles, two stand out: the absence of efficacy of the arbitration clause and the need for judicial recognition of the arbitral award, which also meant double recognition of foreign arbitral awards (RF Alves, A Inadmissibilidade das Medidas Antiarbitragem no Direito Brasileiro (Atlas, 2009)).
[2] Art 18, Law 9,307/96.
[3] ‘Art. 151. In the contractual arrangements governed by this Law, alternative means can be utilized for prevention and resolution of disputes, notably conciliation, mediation, dispute resolution boards and arbitration. Sole paragraph. The provision of the main section of this article shall be applied to disputes related to disposable pecuniary rights, as well as questions related to the reestablishment of the economic-financial balance of contracts, the default of contractual obligations by either party and the calculation of indemnities.’
[4] See the rules of the Brazil-Canada Center for Arbitration and Mediation, available at https://ccbc.org.br/cam-ccbc-centro-arbitragem-mediacao/resolucao-de-disputas/dispute-boards accessed 13 July 2023.
[5] ‘The renewal of legal studies and the growing conviction of the need for them to be completed with support from other human sciences, notably sociology, political science and economics, have induced new treatment of the traditional legal mechanisms that distinguish Private Law, among them the contract’, O Gomes, Contratos (26th ed, Editora Forense, 2008) p 3.
[6] IT Gico Jr, ‘Metodologia e Epistemologia da Análise Econômica do Direito’, Economic Analysis of Law Review, 1(1) January-June, 2010, p 15: ‘[...] we need not only theoretical justifications to ascertain the abstract adequacy between the means and the ends, but also from theories higher than the mere intuition that helps us in judgments of diagnosis and prognosis. We need theories that permit, to some degree, a more accurate evaluation of the probable consequences of a decision or a public policy within the legal, political, social, economic and institutional context in which it will be implemented. In short, we need a theory about human behavior.’
[7] R Cooter and T Ulen, Law & Economics (6th ed, Pearson Addison-Wesley series in economics, 2012), p 3: ‘Lawmakers often ask, “How will a sanction affect behavior?” For example, if punitive damages are imposed upon the maker of a defective product, what will happen to the safety and price of the product in the future? Or will the amount of crime decrease if third-time offenders are automatically imprisoned? Lawyers answered such questions in 1960 in much the same way as they had 2,000 years earlier – by consulting intuition and any available facts. Economics provided a scientific theory to predict the effects of legal sanctions on behavior. To economists, sanctions look like prices, and presumably, people respond to these sanctions much as they respond to prices […] Economics generally provides a behavioral theory to predict how people respond to laws. This theory surpasses intuition just as science surpasses common sense. The response of people is always relevant to making, revising, repealing, and interpreting laws.’
[8] E Mackaay, Law and Economics for Civil Law Systems (Edward Elgar, 2013), p 6.
[9] PM Pinto, Interesse contratual negativo e interesse contratual positivo (vol I, Coimbra Editora, 2008), p 45.
[10] Ibid at p 47. Pinto also advocates that:
‘the substitution of legal rationale by economic analysis necessarily involves decisive aspects, and also analysis of the measure of the damages (of the pre-contractual and contractual “remedies”). This will not be serious whenever the results reached are presented, and seen, as merely auxiliary – as conveying only an external perspective describing the problem, or (according to an assumed standard that is not juridical, but rather is based on efficiency or “maximization of wealth”) to prescribe solutions. If this is not the case, i.e., if the economic analysis is intended, in a “normative” perspective, to substitute or override the Law as an autonomous discipline, we thus believe we will be faced with a serious methodological deviation, revealing a grave miscomprehension of the specific sense of the Law, when not even one anthropological option can be discussed, and if taken to the end, a cultural retrocession will occur. In the methodological plane, there would be a difference between the intention to materialize a practical and valorative rationale of the Law, and the application of the conclusions of a theoretical discipline or its applicative technique. With the intention of totally translating the legal values into economic categories, the legal rationale winds up being replaced by a technique whose success depends on a means–end relation, which has been previously fixed and leaves the jurist’s activity to be prudential [...] In particular in the private law, that perspective may not be adequate, because it will not be confined, nor will it confine the parties, to a perspective of efficiency and “before protecting the use of private autonomy within the limits that are also intended to measure the extent to which the individual holder makes of contrary employment to market valuations”. The civil law “is not a pure law of efficiency and also should not be”. Also, in private law, the use of economic analysis as a decisive criterion for legal problems thus has as a consequence the loss of autonomy of the “juridical standpoint” that is particularly constitutive of this branch of the Law. [...] We thus reject the perspective of the instrumentalism of the economic analysis, which leads not only to loss of criteria of the juridical-dogmatic theory of the distinction between the negative and positive interest, but also puts into play the very distinction. But we also reject other approaches (or “deviations”), which would remit, for example, to a consideration in psychological terms of the attitude of the parties with regard to the pre-contractual process, or to an alleged political-ideological meaning of the option for the interest in compliance or the interest in trust. But on the other hand, we cannot limit ourselves to a merely formalistic perspective – to a conceptual or positivist “formalism” that does not consider the values that can give sense to the problem involving the distinction’ (pp 57–58 ) .
[11] PA Forgioni, ‘Análise econômica do direito (AED): Paranóia ou mistificação?’, Revista de direito mercantil, industrial, econômico e financeiro (Malheiros, July-Sept 2005), pp 246–47.
[12] Ibid, pp 252–53.
[13] RH Coase, ‘The Problem of Social Cost’, The Journal of Law and Economics, vol III, October 1960. As described by Klaus Mathis in Efficiency Instead of Justice? Searching for the Philosophical Foundations of the Economic Analysis of Law (Springer, 2009), p 51: ‘Coase developed a theorem, now named after him, which would become one of the central tenets of economic analysis of law. The conclusion of the Coase theorem is that the world of law should be analysed in terms of its economic impacts so as to instill a dimension of economic efficiency into legal institutions.’
[14] EG Pimenta, HARP Lana, ‘Análise econômica do direito e sua relação com o direito civil brasileiro’, Revista da Faculdade de Direito UFMG, n 57, July-Dec 2010, p 85. See also: J Bentham, An Introduction to the Principles of Morals and Legislation (Batoche Books, 2000).
[15] RA Posner, Economic Analysis of Law (8th ed, Aspen Publishers, 2011). Regarding Posner, Ejan Mackaay stresses that ‘from the very first edition of his treatise on the economic analysis of law, has put forth the thesis that all, or at least most, rules of the classical common law can be explained as efficient, and moreover that it is desirable for legal rules to be formulated so as to be efficient’ (see n 8 above, p 15).
[16] RA Posner, ‘Law and Economics in Common-Law, Civil-Law, and Developing Nations’, Ratio Juris, 1(17) March 2004, p 67: ‘As a heuristic, it seeks to display underlying unities in legal doctrines and institutions; in its descriptive mode, it seeks to identify the economic logic and effects of doctrines and institutions and the economic causes of legal change; and in its normative aspect it advises judges and other policymakers on the most efficient methods of regulating conduct through law.’
[17] R Sztajn, ‘Notas de Análise Econômica: Contratos e Responsabilidade Civil’, Revista de Direito Mercantil Industrial e Econômico e Financeiro, 11, 1998, pp 14 and 29:
‘It is to be assumed, in the field of contract law, that the rules are designed to facilitate the exchange, including safeguards against default or market failings . For this reason, default, both negligent and intentional, must have greater penalties than involuntary behavior. The facility is clear of application of economic analysis to legal figures such as contracts and civil liability . […] Based on examination of some of the rules of the Civil Code and the Bill for the Civil Code from the standpoint of allocative efficiency of appeals, it seems that the observations of Gilmore, Coleman, Calabresi and Melamed, among others, are also sensitive in Brazil . The economic analysis of the Law, applied together with the ethical and moral principles, can constitute an important instrument to build a fair and efficient legal system, aimed at the general well-being .’
[18] M Pargendler, B Salama, ‘Law and Economics in the Civil Law World: The Case of the Brazilian Courts’, Tulane Law Review, 90, 2015–2016.
[19] Federal Supreme Court, Direct Action for Constitutionality (ADC) 19, Reporting Justice Marco Aurélio, en banc decision, judged on 9 February 2012.
[20] ‘The court’s majority considered domestic violence victims’ well-known reluctance to file representations against their spouses, as documented in sociological studies presented to the court, and concluded that the imposition of such a requirement would effectively “eliminate the protection” afforded to women under the constitution, rendering the statute particularly inept to accomplish its desired objective of curbing domestic violence. Tellingly, the disagreement expressed by Justice Cezar Peluso in his dissent hinged at least partially on the presumed concrete factual consequences of mandating or dispensing with the victim’s representation – the type of inference typical of social sciences such as economics, but foreign to the deductive mode of legal reasoning that is said to characterize the civilian tradition. A behavioral theory – such as that offered by economics and other social sciences – about how actors respond to different rules and policies is therefore badly needed’ (see n 18 above).
[21] ‘A large body of literature documents the rejection of law and economics in the civil law world and offers an extensive list of possible reasons for this apparent incompatibility. [...] At least in Brazil, however, the assumed insulation of legal practice from economic reasoning is plainly mistaken [...] The cases described below, however, reveal that economic reasoning is no stranger to at least a part of Brazil’s judiciary and that Brazilian judges are not nearly as hostile to economic reasoning as the prototype of a civil law judge would suggest. [...] The preceding analysis of Brazilian cases suggests that the conventional assumption that economic reasoning is absent from legal practice in the civil law world is flawed. Brazilian judges habitually employ concepts borrowed from economics to forecast the likely consequences of events or rules when such a prediction is called for by the relevant legal norms’ (see n 18 above, pp 440–69).
[22] R Sztajn, ‘Law & Economics’, Direito e Economia: Análise Econômica do Direito e das Organizações (Elsevier, 2005), p 79.
[23] Ibid p 82.
[24] PG Bandeira, ‘O Contrato Incompleto e a Análise Econômica do Direito’, Revista Quaestio Iuris, 4(8) 2015, p 43.
[25] C Salomão Filho, O novo direito societário: eficácia e sustentabilidade (5th ed, Saraiva Educação, 2019), pp 42 –43.
[26] Ibid, pp 43–44.
[27] See n 6 above, p 16.
[28] Ibid, pp 23–24.
[29] See n 11 above, pp 246–42.
[30] ‘[...] each individual attributes a utility to each possible choice and is able to rank these choices according to the resulting utilities. Every time choosing between two options, the individual will choose the one bringing the greatest utility, i.e., agents are rational maximizers of utility. Note that utility as used here is a technical term that means any satisfaction that the individual extracts from a given choice, not restricted to material questions, much less to monetary ones’ (see n 6 above, pp 25–26).
[31] CH Perri, Aplicação da Teoria do Inadimplemento Eficiente aos Contratos Nacionais (Doctroal thesis, Faculty Adviser Maria Helena Marques Braceiro Daneluzzi – Pontifícia Universidade Católica de São Paulo Law School, São Paulo, 2017, p 37.
[32] RA Posner, ‘The economic approach to Law’ Texas Law Review, 53, 1975, p 763.
[33] See n 22 above, p 2.
[34] AM Porto, N Garoupa, Curso de Análise Econômica do Direito (2nd ed, Grupo GEN, 2021), p 146.
In the same sense: ‘Traditional economic theory postulates an “economic man”, who, in the course of being “economic” is also “rational”. This man is assumed to have knowledge of the relevant aspects of his environment which, if not absolutely complete, is at least impressively clear and voluminous. He is assumed also to have a well-organized and stable system of preferences, and a skill in computation that enables him to calculate, for the alternative courses of action that are available to him, which of these will permit him to reach the highest attainable point on his preference scale. Recent developments in economics, and particularly in the theory of the business firm, have raised great doubts as to whether this schematized model of economic man provides a suitable foundation on which to erect a theory – whether it be a theory of how firms do behave, or of how they “should” rationally behave’ (H Simon, ‘A Behavioral Model of Rational Choice’, The Quarterly Journal of Economics 1(69) 1955, p 99.
[35] H Simon, Administrative behavior: A Study of Decision Making Processes in Administrative Organization (MacMillan, 1947).
[36] CR Sunstein, C Jolss, RH Thaler, ‘A Behavioral Approach to Law and Economics’, Stanford Law Review, 50, 1998, pp 1476–79.
[37] See Bentham, n 14 above.
[38] See n 22 above, p 76.
[39] HR Varian, Microeconomia: uma abordagem moderna, translated by Elfio Ricardo Dooninello and Regina Célia Simille de Macedo (8th ed, Elsevier, 2012), pp 15–16.
[40] See Posner, n 15 above, p 154.
[41] See n 6 above, pp 22–23 and 27.
[42] ‘Efficiency and justice are by no means mutually exclusive; in fact, they stand in a complex interrelationship. Although this relationship is not without its strains, it is reasonable to conclude that the endeavour to realize both goals need not always be a competitive trade-off, and can in fact be undertaken cooperatively to large extent. The material crux of the positive correlation between efficiency and justice is the trivial point that it is only possible to distribute what is earned. If inefficiency reduces the domestic product, this also has repercussions for justice. [...] Thus efficiency is always one of the precepts of justice’ (see Mathis, n 13 above, pp 203–4).
[43] ‘The rules assigning property rights and determining liability, the procedures for resolving legal disputes, the constraints imposed on law enforcers, methods of computing damages and determining the availability of injunctive relief – these and other important elements of the legal system can best be understood as attempts, though rarely acknowledged as such, to promote an efficient allocation of resources’ (see n 32 above, pp 764– 77).
[44] ‘Art. 37. The direct and indirect public administration of any of the branches of the Union, States, Federal District and Municipalities shall obey the principles of legality, impersonality, morality, publicity and efficiency, and also the following [...].’
[45] ‘Art. 74. The Legislative, Executive and Judicial branches shall maintain, in integrated form, a system for internal control with the Purpose of: [...] II – proving the legality and evaluating the results regarding the efficacy and efficiency of the budgetary, financial and pecuniary management of the bodies and entities of the federal public administration, as well as the application of public resources by private entities [...].’
[46] ‘Art. 126. To resolve landholding conflicts, the Tribunal of Justice shall propose the creation of specialized courts with exclusive competence for agrarian questions. Sole paragraph. Whenever necessary for the efficient provision of jurisdictional satisfaction, the judge can be present at the place of the dispute.’
[47] ‘Art. 144. Public safety is a duty of the State, a right and responsibility of all, and is exercised to preserve public order and the safety of persons and assets, through the following bodies: [...] §7. The law shall regulate the organization and functioning of the bodies responsible for public safety, so as to guarantee the efficiency of their activities. [...] §10. Road safety, exercised for preservation of public order and safety of persons and their assets on the public roads: I – consists of education, engineering and oversight of traffic, besides other activities set forth in law, to assure to citizens the right to efficient urban mobility [...].’
[48] ‘Art. 8. In applying the legal order, the judge shall serve the social purposes and requirements of the common good, safeguarding and promoting the dignity of the human person and observing proportionality, reasonableness, publicity and efficiency.’
[49] ‘Art. 867. The judge may order the attachment of the fruits and proceeds of chattels or real properties when considering this more efficient for receipt of the credit and less burdensome to the debtor.’
[50] ‘[...] the criterion of efficiency [...] does not consist of the only value of the Brazilian legal system [...]. Although lawmakers and interpreters, in certain situations, resort to the criterion of efficiency, other constitutional values and principles, introduced in the open and mutable system at every historic moment, must be promoted by private initiative [...] The Economic Analysis of the Law, therefore, although being a relevant method for analysis employed by lawmakers or interpreters in determined situations, does not exhaust the complexity of values integrating the legal system, so that the constitutional legality does not have the power to dictate the interpretive criteria for solution of actual cases’ (PG Bandeira, Contrato Incompleto (Atlas, 2015), pp 42–47).
[51] ‘In order to carry out market transactions it is necessary to discover why it is that one wishes to deal with, to inform people that one wishes to deal and on what terms, to conduct negotiations leading up to bargain, to draw up the contract, to undertake the inspection needed to make sure that the terms of the contract are being observed, and so on’ (see n 13 above, p 15).
[52] SB Goldberg, FEA Sander, N Rogers, Dispute Resolution: Negotiation, Mediation and other Processes (2nd ed, 1992).
[53] ‘If the legal system does not provide an adequate degree of certainty and foreseeability, it will be harder to materialize economic transactions, because this materialization implies the exertion of a greater quantity of resources, thus increasing the risk’ (see n 11 above, p 247).
[54] K Arrow, RH Mnookin, L Ross, et al, Barriers to Conflict Resolution (The MIT Press, 1994).
[55] RH Mnookin, ‘Why negotiations fail: An exploration of barriers to the resolution of conflict’, The Ohio State Journal on Dispute Resolution, 8(2) 1993, pp 235–49 https://kb.osu.edu/bitstream/handle/1811/79715/1/OSJDR_V8N2_235.pdf accessed 13 July 2023.
[56] WM Landes, ‘An Economic Analysis of the Courts’, Journal of Law and Economics, 14, 1971, pp 61–107.
[57] See n 54 above.
[58] S Shavell, ‘Alternative Dispute Resolution: An Economic Analysis’, The Journal of Legal Studies, 1(24) 1995, pp 1–28 www.jstor.org/stable/724588 accessed 13 July 2023.
[59] Ibid.
[60] Ibid.
[61] D Kapeliuk and A Klement, ‘Changing the Litigation Game: An Ex Ante Perspective on Contractualized Procedures’, Texas Law Review, 91(6) 2013, pp 1475-98.
[62] Steven Shavell addresses the effects of adding procedural alternatives for resolution of disputes to options of the parties, using the standard model of judicial litigation (see n 58 above).
Renan Frediani Torres Peres is a partner at Barbosa Müssnich Aragão in São Paulo, a professor at Instituto Mauá de Tecnologia and a PhD Candidate at Universidade de São Paulo and can be contacted at renan@bmalaw.com.br. |