In his surprise 2005 bestseller “On Bull—t,” retired Princeton philosopher Harry Frankfurt explored the difference between what is commonly referred to as BS from the more serious sin of lying. A BS’er, Frankfurt wrote, has complete disregard for the truth. A liar, on the other hand, cares deeply about the truth – and wants his listener to believe something else.
The line between lying and BS explains why the Second Circuit Court of Appeals in New York threw out a $1.2 billion jury verdict against
The three-judge panel of the Second Circuit in the BoA case said the government had failed to prove an essential element of fraud: scienter, or the intent to deceive. Without that, the court ruled, all the government had was a routine breach-of-contract case, similar to when a manufacturer sells defective widgets to a distributor under a contract requiring it to take them back. In this case, the contract allowed Fannie and Freddie to force Countrywide to buy back any defective mortgages, but the government argued, and a jury agreed, that the government-sponsored agencies simply didn't have the time or resources to check each mortgage before they bought them.
That story worked with the jury and U.S. District Judge Jed Rakoff, who denied BoA’s motion to dismiss under the very argument the Second Circuit endorsed. And most people, on first impression, would consider it wrong to promise one thing and deliver another. The classic example might be Max Bialystock in the immortal Mel Brooks comedy, "The Producers." He sold a mathematically impossible 1,000% of his musical and then tried to make it the worst production ever to hide the fact he never intended to pay anybody back.
That's as lie, under the longstanding logic of courts in England and the U.K. Fraud in the inducement, they call it, a lie that induces somebody to enter into a contract the liar has no intention of honoring. But BS falls into a different category.
In this article, Willamette University College of Law professors Curtis Bridgeman and Karen Sandrik say “it is possible to make an insincere yet non-lying promise, what we call a bull---t promise.” This distinction, they write, “provides an opportunity for mischief, an opportunity that …many companies routinely take advantage of today when dealing with consumers.”
Philosophers and legal scholars long have wrestled with the meaning of the word “promise.” If somebody promises to meet you for lunch tomorrow at Le Bernardin in Manhattan does that mean she definitely will show up? That she has a duty to meet you? What if she lives in California and you doubt she can make it on time? Or if both of you are out of work and probably can’t afford lunch at the Michelin three-star restaurant anyway?
That’s one reason why centuries ago in England courts separated contract law -- how courts handle an express agreement between two parties -- from tort -- how courts handle disputes between parties with no such agreement. When two parties sign a contract, in theory they have thought through the potential repercussions if one side breaches, or breaks his promise. They’ve also specified a penalty. Legal scholars call it allocation of the risk, and judges long have avoided applying the heavier penalties of tort law, including punitive damages, to mere breaches of contractual terms. Unless there is fraud in the inducement -- Max Bialystock selling 1,000% of the musical -- it's a breach, not fraud.
The examples of contractual BS can be disturbing to non-lawyers. In one Virginia case, a stadium contractor certified it used high-quality materials when it actually used inferior wood that led to widespread rot. Verdict: Not guilty.
Wait. Isn’t failure to disclose a classic form of fraud? Not when there’s a contract and the buyer didn’t rely on misinformation to sign it, said Gregory M. Klass, a professor at Georgetown Law who wrote a book on this topic, “Insincere Promises,” with Ian Ayres of Yale Law School.
“The black-letter law on that is no, there’s no duty to disclose your non-performance,” said Klass. The Second Circuit decision, he added, reflects “classic policing of the contract/fraud boundary.”
This idea probably strikes most non-lawyers as strange, and Klass isn’t exactly a fan himself. Evidence at trial showed that Countrywide, which BoA bought in 2008, devised a “High Speed Swim Lane” program, better known as “Hustle,” to wisk mortgages through the pipeline to Fannie and Freddie with minimal underwriting and no final checks from compliance specialists. In rejecting BoA’s motion to dismiss, Judge Rakoff said Countrywide promisedto supply investment-quality mortgages but “they had been originated in such volume, at such high speed, and at such disregard for quality assurance that it was virtually certain that many would be of inferior quality.” Fannie and Freddie, which didn't do their own checks, ultimately reported more than $1 billion in losses on the Hustle-originated loans.
That didn’t matter, the Second Circuit said. What mattered was Countrywide’s intent when it made the promise, and the government didn’t provide any evidence that Countrywide lied when it said it would provide high-quality mortgages. In his opinion, Second Circuit Judge Richard Wesley even brought up the concept of “efficient breach,” which legal scholars use to describe a broken contract that benefits both sides. For example, a widget manufacturer may contract to sell 1,000 units at $10 apiece, then discover he can sell them for $15. As long as he pays the buyer the penalty provided for in the contract – presumably, the profits the buyer anticipated from selling the widgets – both sides are better off breaking the contract.
The efficient breach concept disturbs many people who feel it is morally wrong. But more importantly, Klass of Georgetown Law said, in an efficient breach, the party breaching the contract notifies the other side before doing it. Countrywide didn’t tell Fannie and Freddie it had relaxed its underwriting standards and there was evidence it hid internal studies showing dangerously high levels of flawed mortgages.
“This was not an efficient breach -- this was an opportunistic breach,” Klass told me. “This was as far from an efficient breach as you can think of, because it destroyed our economy.”
Lurking behind the fight between Judge Rakoff and the Second Circuit is a longstanding disagreement over the role of judges in determining when a BS promise has crossed the line into fraud. Rakoff, a former white-collar prosecutor, hews to the idea fraud laws should be general, so courts can adapt to inventive new ways of ripping people off.
This idea goes back to England in the 1750s, when Lord Hardwick wrote to Lord Kames:
Fraud is infinite, and were a court of Equity once to lay down rules, how far they would go, and no farther, in extending their relief against it, or to define strictly the species or evidence of it, the jurisdiction would be cramped, and perpetually eluded by new schemes, which the fertility of man's invention would contrive.
On the other side is the view that overly loose laws lead to arbitrary punishment. The Second Circuit is the same court that dramatically tightened the rules for insider-trading cases when it threw out the convictions of two men who traded stock without knowing exactly who’d been promised what for the information.
When it comes to fraud, Klass said, courts have long wrestled with “what are the clear lines you must not cross.” It’s hard to say fraud is a failure to disclose, especially when there’s a contract involved. It’s easier to say “don’t lie.”
“So Countrywide got off in this case because the Second Circuit said `We can’t find a lie,’” Klass said. ”And that’s the bright line.”
(For Klass's take on all this see his thoughtful blog post here.)
