A Crisis of Confidence and Legal Theory: The Economic Downturn and the End of the Doctrine of Efficient Breach

Abstract

The doctrine of efficient breach is a staple of a first-year legal education. An efficient breach is said to occur when a party intentionally breaks a contract, enters into a second more profitable one, and is better off after compensating the non-breaching party. The primary purpose of this Article is to explore the merits of the doctrine of efficient breach in light of the present economic climate that is marked by subprime transactions.

Efficient breaches are similar in several meaningful respects to subprime activity: both are opportunistic, encourage short-term unilateral gains, eschew long-term thinking, overlook the widespread effects on third-parties and society more broadly, and entail negative externalities. The results of subprime activity suggest that confidence is a necessary predicate for a healthy, well-functioning economy, however economic behavior possessing these traits depletes trust in other market participants and in financial instruments designed to facilitate reliable social cooperation. At bottom, both efficient breaches and subprime behavior contribute to a destructive ethos in which unabashed individual financial enrichment is pursued at the expense of the greater good and at the risk of systemic breakdowns in the economy, but is sanitized nonetheless by the cover of individual rationality and individual wealth maximization. Given these economic and social consequences, I argue that the doctrine of efficient breach should be disapproved as a legal theory, its open promotion discouraged, and at a minimum its discussion tempered by an honest admission of its deficiencies and practical limitations.

This Article’s pragmatic treatment of the doctrine of efficient breach is the first to draw upon the realities of the economic recession in general and subprime transactions in particular to assess the relative worth of the doctrine as an academic theory and as a proposed means for improving social welfare.

Keywords: efficient breach, contracts, subprime, opportunism, recession, law and economics, legal scholarship