(In)Efficient Breach of Contract
Parisi, F. (ed.), Oxford Handbook of Law and Economics, Oxford University Press, 2017 (Forthcoming)
28 Pages Posted: 5 Apr 2016 Last revised: 26 Apr 2016
Date Written: April 4, 2016
The expectation interest remedy requires the promisor to transfer a sum equal to the promisee’s expected gain from performance if the promisor reallocates her resources to another use. The theory of efficient breach justifies the remedy because the promisor will either perform, when the promisees’ gain would exceed the gain from reallocation, or breach when the promissee’s gain is below. Critics of the theory argue that breach is immoral, whether efficient or not, because the promisee has a right to performance or to its gains. Both critics and supporters mistakenly elide the real issue. Contract law defines a breach as the promisor’s failure to take an action the parties’ contract requires or to take an action the contract forbids. Hence, if business contracts are efficient, as is commonly assumed, breaches cannot be efficient. The real issue thus is what the parties’ contract requires. A contract that requires the promisor to trade a specified object or to perform a specified service is breached if the promisor fails to trade or to perform; but a contract that permits the promisor either to trade or to perform or to transfer the sum that equals the promissee’s gain would only be breached if the promisor neither trades nor transfers. The expectation interest remedy is a good default if parties more commonly write the latter “dual performance contract” than the former mandatory trade contract. Both supporters and critics of efficient breach theory mistakenly suppose that parties commonly write mandatory trade contracts. It follows for them that the failure to trade is a breach, and the dispute is over the morality of breach. We show that parties commonly write dual performance contracts so the failure to trade is not a breach. Whether this is so or not, the important result is that, because contracts can be efficient but breaches cannot be, the theory of efficient breach should vanish. Rather, attention should turn to the contract interpretation issue regarding which obligations, respecting trade or transfer, the parties actually assumed.
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