Efficient Breach

In The Philosophical Foundations of Contract Law, G. Klass, G. Letsas & P. Saprai, eds., Oxford University Press, Forthcoming

Georgetown Public Law Research Paper No. 13-018

Georgetown Law and Economics Research Paper No. 13-006

31 Pages Posted: 4 Mar 2013 Last revised: 8 Mar 2014

Gregory Klass

Georgetown University Law Center

Date Written: March 2014

Abstract

The theory of efficient breach is the best known, and the most controversial, product of nearly half a century of economic analysis of contract law. In its simplest form, which is the one that dominates the legal imagination, the theory argues that expectation damages are good because they allow, even encourage, a party to breach when performance becomes inefficient, thereby increasing social welfare. Many noneconomists assume the theory is well supported by principles of neoclassical economics. Thus critics commonly focus on the theory’s moral failings, or on problems with the neoclassical approach more generally. But today no economic thinker defends the simple theory of efficient breach. Forty years of scholarship has established that even from the streamlined perspective of neoclassical economics, the simple theory simplifies too much. Expectation damages do not sufficiently deter some types of opportunistic breach. When a contract does become inefficient, other remedies can do as good or better a job of allowing parties to avoid performance. If expectation damages do provide efficient performance incentives, they might create inefficient incentives elsewhere in the transaction. And an exclusive focus on incentives ignores other welfare-enhancing functions remedies can serve, such as risk allocation and signaling. Many noneconomic critics of efficient breach criticize a theory that no economist would defend.

All this notwithstanding, contract theorists should pay attention to efficient breach. Most importantly, a revised theory of efficient breach demonstrates how remedies that apply at the end of a transaction can affect the terms chosen at its birth. In many transactions the remedy is likely to affect the price, complicating arguments about its fairness. Many parties are likely to prefer efficient remedies, posing a challenge to remedial theories that ignore efficiency altogether. And economic analysis suggest mechanisms lawmakers can use to delegate remedial choice to the parties while still giving weight to socially preferred remedies. Theorists who make principled arguments for one or another remedy should attend to economic analyses of remedial design, including the idea of efficient breach, which cast new light on these distinctive features of contract law.

Keywords: contract, remedies, efficient breach, expectation damages

JEL Classification: K00, K30, K39

Suggested Citation

Klass, Gregory, Efficient Breach (March 2014). Georgetown Public Law Research Paper No. 13-018; In The Philosophical Foundations of Contract Law, G. Klass, G. Letsas & P. Saprai, eds., Oxford University Press, Forthcoming; Georgetown Public Law Research Paper No. 13-018; Georgetown Law and Economics Research Paper No. 13-006. Available at SSRN: https://ssrn.com/abstract=2228072

Gregory Klass (Contact Author)

Georgetown University Law Center ( email )

600 New Jersey Avenue, NW
Washington, DC 20001
United States

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