Mandating Precontractual Disclosure

Parties negotiating an arm’s length contract are generally not required to disclose facts to one another. Although this default rule is supported by both centuries of common law and freedom of contract principles, courts and legislatures treat certain transactions differently. This is particularly true in circumstances in which the default rule results in an unacceptable harm suffered by a broad group of persons. In such cases, lawmakers have acted to impose precontractual disclosure obligations. These decisions and statutes are largely reactive: a harm is identified in a certain transaction’s precontractual period and disclosure is mandated to rectify the harm. These reactive measures, although helpful, are insufficient in some instances. Large scale economic calamities are often caused by information asymmetries in individual contracts. This was true in the Great Depression (unregulated contracts for sales of stock) and the Great Recession (unregulated contracts for sales of mortgage-backed securities). This article proposes an analytical tool to prospectively identify such transactions. This tool, the Disclosure Framework, provides lawmakers a means of identifying circumstances in which it is appropriate to mandate precontractual disclosure. To accomplish this task, the Disclosure Framework directs lawmakers to identify the information asymmetry in a transaction and balance the respective harms of either disclosure or nondisclosure on the affected stakeholder group. Precontractual disclosure is a matter of compelling immediacy. Because regulatory agencies are currently struggling with how to structure the disclosure mandates of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the question of when it is appropriate to mandate precontractual disclosure is both timely and important. Although designed for legislators, the Disclosure Framework may also serve as a tool for consumer rights groups and agencies (such as the recently established Consumer Financial Protection Bureau) to help spur legislative action. Ultimately, the Disclosure Framework provides support for the imposition of precontractual disclosure that is both theoretically sound and consistent with common law and statutory exceptions to the default rule