How does the common law of contracts evolve in the electronic marketplace? There are two striking features about the ways in which contracts in this area are adjudicated today. The first is the steady decline in the number of cases litigated in state court, as compared with the federal forum. By 2015, federal courts adjudicated the vast majority of claims concerning formation issues in contracts in the electronic market. Drawing on data from consumer cases mostly involving electronic transactions, we show that state common law has all but disappeared. The second development is related to the first: the relative rise of class action suits. The use of class action suits to litigate consumer contract disputes arising from online transactions shouldn’t be surprising. Given the small amount generally at stake in such transactions, there is little incentive for consumers to bring individual suits. As Judge Posner once quipped, ‘only a lunatic or a fanatic sues for thirty dollars.’ The increased dominance of the federal forum is also likely driven by a federalization of class action law due, at least in part, to the Class Action Fairness Act, which facilitates filing in federal court or removing to federal court existing class actions involving state law claims with a broad interstate scope.

The result of this shift is that the common law of contracts in online consume transactions is developing in federal courts, under diversity jurisdiction, rather than in state courts. As a result, there is little state law for federal judges to apply in this area. Erie Railroad v. Tompkins was expected to end federal common law, leaving the development of common law to state courts. Under this model, when federal courts lack state law to apply, diversity jurisdiction allows federal courts to predict how they believe state common law would develop. Such decisions do not bind state courts, however, and are not even binding on federal courts in the same circuit. Erie’s prohibition notwithstanding, federal judges must decide the cases that come before them. And with no state law to apply, the substantive law is made by federal judges, while still maintaining a formal adherence to Erie. Indeed, the absence of common law initiative at the state court level might contribute to bolder rulings by federal judges, who are understandably less constricted by the absence of compelling state law authority and more willing to move the law in new directions.  This is especially true for cases involving new technologies.

How can governing rules emerge under these conditions? In our paper, we identify a ‘tournament effect,’ in which the law settles on a few influential decisions, regardless of the state law under which the case arose. In this tournament effect, the weight accorded to any particular decision turns on how innovative and persuasive it is. Unlike the traditional hierarchical model, in which state law as defined by the state supreme court controls, under the tournament model there is a constant battle for authority. The lack of state supreme court decisions creates a vacuum that is filled by the tournament winner. Clarity through authority is replaced by clarity due to the tournament. Under this second model, a ‘tournament winner’ emerges, and a single decision (eg, Judge Easterbrook’s ProCD opinion enforcing a shrink wrap license) begins to take on influence and govern subsequent disputes, largely irrespective of jurisdiction or court hierarchy. Even some state supreme courts follow influential federal cases. This is true despite the fact that, in crafting such opinions, federal judges are ostensibly predicting the development of state law. For an area of law that is purportedly the Erie-commanded province of state substantive law, that is an important and unsettling observation. 

How should such developments affect how the American Law Institute (ALI) produces Restatements of the law? The traditional ALI approach has been to identify the majority rule from the most recent decisions of the highest state courts. But in many cases, those decisions have been replaced by tournament winners from the federal courts. In light of such changes, simply focusing on state supreme court cases to find a majority rule would create an incomplete impression of current law. A better approach would be to look to the entire case law on a given issue over time—including tournament winners. 

Samuel Issacharoff is the Bonnie and Richard Reiss Professor of Constitutional Law at New York University School of Law

Florencia Marotta-Wurgler is a Professor of Law at New York University School of Law.