The Compensatory Disgorgement Alternative to Restatement Third's New Remedy for Breach of Contract

68 Pages Posted: 28 Jan 2016 Last revised: 26 Apr 2018

See all articles by Roy Anderson

Roy Anderson

Southern Methodist University - Dedman School of Law

Date Written: 2015

Abstract

Homeowners have carefully vetted potential applicants to lease their home while homeowners are in Europe for a year. As the selected lessee is well aware, he would not have been chosen unless he agreed not to sublet the premises. The lease agreement conspicuously states the sublease prohibition. Lessee, nevertheless, profitably sublets the property, but the breach is not discovered by homeowners until after the lease has expired.

Contractor agrees to use specified materials in building a home. He instead uses cheaper materials, resulting in significant savings in his building costs. The value of the home, however, is not affected by the substitution. The cost to replace the substituted materials with those specified by the contract will greatly exceed the value of the completed home.

As part of his contract of employment, an employee agrees never to divulge employer's methods of doing business or matters pertaining to employer's personal affairs. None of employer's methods are unusual and none constitute trade secrets, but employer, a well-known celebrity, highly values his privacy. After leaving his employment, employee publishes a very profitable book about employer's business methods and personal habits.

Despite the disparate facts in the above situations, they all have one thing in common: in none of them is an action for breach of contract likely to result in an award of damages that will adequately protect the contract right that has been violated. In each case, the promisee will probably be unable to prove actual damages with reasonable certainty because contract law typically deems intrinsic and other non-pecuniary losses to be too speculative and conjectural to support damage awards. Contract provisions that seek to protect these kinds of rights, regardless of their importance to the promisee, are thereby rendered practically meaningless. The denial of damages for their violation becomes particularly disturbing where the defaulting promisor is allowed not only to breach with impunity, but also to garner significant profits from the breach. Contract law's historical inability to recognize and evaluate non-pecuniary contract rights therefore represents a significant gap in its panorama of applicable damage remedies.

For over a half-century, leading scholars have maintained that contract law should fill this gap by providing promisees some type of a disgorgement restitution remedy that would allow a recovery of all or part of the profit that the breaching party has earned from the breach. In support of their arguments, they all reference the same handful of cases involving specifically identifiable fact patterns for which the courts have used various theories to award the promisee profits attributable to the breach. These theories, however, typically do not focus on, and the courts invoking them make no mention of, either restitution or disgorgement. A vowed disgorgement for breach cases are few and far between.

Restatement (Third) of Restitution and Unjust Enrichment § 39 proposes a disgorgement remedy for breach of contract that is expressly intended to apply not only in the aforementioned situations involving nonpecuniary contract rights, but also in any other situation where the promisor deliberately (and profitably) breaches but leaves the promisee with no adequate damage remedy. This article argues that the remedy is woefully designed for its task because it is framed by restitution principles, rather than those of contract law. Its application is limited exclusively to deliberate breaches, and, therefore, it contravenes the bulk of the cases noted above that have been identified by scholars as precedent for a disgorgement remedy for breach. Section 39, however, disingenuously uses these cases as precedent for its rule, enshrines them as illustrations of its application, but then reverses the results in most of them. The proposed remedy, therefore, will do little to close the aforementioned gap in contract law's current remedy scheme. Further, when the remedy does apply, it is purely punitive because it would take from the breaching party all of the identifiable profits, regardless of whether they are directly attributable to the breach, and even though they clearly exceed the value to the promisee of the contract right that has been infringed. The provision thereby undermines two benchmark contract law principles-that innocence or willfulness of the breaching party is generally irrelevant to a promisee's recovery for breach and that damages for breach may not exceed the value of the promisee's lost expectancy.

This article demonstrates that virtually all of the cases used by the new Restatement to support its new disgorgement remedy can be better understood and justified as compensatory awards that make use of all or part of the breaching promisor's profits to make the plaintiff promisee whole for non-pecuniary losses-as compensation-based rather than restitution-based judgments. Since the profits earned by the breaching parties establish that the otherwise non-pecuniary contract right of the promisees did indeed have a monetary value, the requirement of proving damages with reasonable certainly-which cannot be accomplished for purely non-pecuniary contract rights-should then no longer act to bar recovery .of compensatory damages. Precedent for taking profits from the promisor as a measurement of damages caused by the breach abounds in this country from decades of cases that have estimated reasonable royalties for patent infringements and also from Great Britain in all sorts of cases, where so-called "Wrotham Park" damages are used to measure the value of non-pecuniary contract rights.

This article, however, rejects the patent law and British approaches of measuring compensation on the basis of the amount the parties would have negotiated to allow the promisor to buy out of the contract (an ex ante settlement price) in favor of basing compensatory damages on a fact-intensive inquiry that would focus on the subjective value to the promisee of the contract right that has been infringed. Part II below briefly examines the historical structure of contract remedies and affirms that neither the common law of contract nor the Restatement (Second) of Contracts provides a disgorgement remedy for breach.

Part III summarizes both the types of cases that have, using various theories, rendered judgments awarding profits from breach and the scholarly writings that have called for a disgorgement remedy (of some sort) for breach of contract. Part W examines the requirements in § 39 that define the scope of the proposed remedy, requirements that are as familiar to the law of restitution as they are foreign to the law of contract. Part V examines the § 39 illustrations and the court decisions upon which they are based and demonstrates that most of these decisions do not support§ 39's criteria for a disgorgement remedy. The article groups these cases into categories based on theories that support a compensation-based recovery rather than the restitution-based recovery proffered by § 39. It suggests that this compensatory approach operates well within contract law's current rule structure and is thus preferable to 'the iconoclastic approach proposed by § 39.

Part VI then suggests how a compensation-based remedy should be structured so as to comply with contract law's primary remedy goal of allowing a recovery that will best approximate the monetary position the promisee would have occupied had the contract been performed, without penalizing the breaching party or otherwise allowing for windfall damages.

Suggested Citation

Anderson, Roy, The Compensatory Disgorgement Alternative to Restatement Third's New Remedy for Breach of Contract (2015). SMU Law Review, Vol. 68, No. 4, 2015, SMU Dedman School of Law Legal Studies Research Paper No. 219, Available at SSRN: https://ssrn.com/abstract=2722851

Roy Anderson (Contact Author)

Southern Methodist University - Dedman School of Law ( email )

P.O. Box 750116
Dallas, TX 75275
United States

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