Efficient breach
Encyclopedia
Efficient breach is a concept within legal theory, particularly law and economics
, referring to a voluntary breach of contract
and payment of damages by a party who concludes that they would incur greater economic loss by performing under the contract.
The first statement of the theory of efficient breach appears to have been made in a law review article by Robert Birmingham in "Breach of Contract, Damage Measures, and Economic Efficiency", 24 Rutgers L.Rev. 273, 284 (1970) ("Repudiation of obligations should be encouraged where the promisor is able to profit from his default after placing his promisee in as good a position as he would have occupied had performance been rendered"). The theory was named by Charles Goetz and Robert Scott, "Liquidated Damages, Penalties, and the Just Compensation Principle: A Theory of Efficient Breach", 77 Colum.L.Rev. 554 (1977).
Efficient breach theory is associated with Richard Posner
and the Law and Economics
school of thought. It has been used to defend the traditional common law
rule that a non-tortious
breach of contract cannot be remedied by punitive damages
and penal damages
(unreasonably excessive liquidated damages
that are seen as a punishment for breach rather than a means to fairly compensate the other party). Such penalties would discourage efficient breach, and therefore "efficient" behavior, which would be undesirable for society as a whole. Posner explains his views in his majority opinion in Lake River Corp. v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985).
in his "Contract as Promise", have argued that morally, A is obligated to honor a contract made with B because A has made a promise. Fried wrote, "The moralist of duty thus posits a general obligation to keep promises, of which the obligation of contract will only be a special case – that special case in which certain promises have attained legal as well as moral force."
Others argue that the costs of litigation relevant to gaining expectation damages from breach would leave one or both of the original parties worse off than if the contract had simply been performed. Also, Posner's hypothetical assumes that the seller is aware of the value the buyer places on the commodity, or the cost of purchase plus the profits the buyer will make.
Law and economics
The economic analysis of law is an analysis of law applying methods of economics. Economic concepts are used to explain the effects of laws, to assess which legal rules are economically efficient, and to predict which legal rules will be promulgated.-Relationship to other disciplines and...
, referring to a voluntary breach of contract
Breach of contract
Breach of contract is a legal cause of action in which a binding agreement or bargained-for exchange is not honored by one or more of the parties to the contract by non-performance or interference with the other party's performance....
and payment of damages by a party who concludes that they would incur greater economic loss by performing under the contract.
Development of the theory
According to Black's Law Dictionary, efficient breach theory is "the view that a party should be allowed to breach a contract and pay damages, if doing so would be more economically efficient than performing under the contract."The first statement of the theory of efficient breach appears to have been made in a law review article by Robert Birmingham in "Breach of Contract, Damage Measures, and Economic Efficiency", 24 Rutgers L.Rev. 273, 284 (1970) ("Repudiation of obligations should be encouraged where the promisor is able to profit from his default after placing his promisee in as good a position as he would have occupied had performance been rendered"). The theory was named by Charles Goetz and Robert Scott, "Liquidated Damages, Penalties, and the Just Compensation Principle: A Theory of Efficient Breach", 77 Colum.L.Rev. 554 (1977).
Efficient breach theory is associated with Richard Posner
Richard Posner
Richard Allen Posner is an American jurist, legal theorist, and economist who is currently a judge on the United States Court of Appeals for the Seventh Circuit in Chicago and a Senior Lecturer at the University of Chicago Law School...
and the Law and Economics
Law and economics
The economic analysis of law is an analysis of law applying methods of economics. Economic concepts are used to explain the effects of laws, to assess which legal rules are economically efficient, and to predict which legal rules will be promulgated.-Relationship to other disciplines and...
school of thought. It has been used to defend the traditional common law
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
rule that a non-tortious
Tort
A tort, in common law jurisdictions, is a wrong that involves a breach of a civil duty owed to someone else. It is differentiated from a crime, which involves a breach of a duty owed to society in general...
breach of contract cannot be remedied by punitive damages
Punitive damages
Punitive damages or exemplary damages are damages intended to reform or deter the defendant and others from engaging in conduct similar to that which formed the basis of the lawsuit...
and penal damages
Penal damages
Penal damages are best seen as quantitatively excessive liquidated damages and are invalid under the common law. While liquidated damages are a priori calculations of expectation loss under the contract, penal damages go further and seek to penalise a party in some way for breach of a clause above...
(unreasonably excessive liquidated damages
Liquidated damages
Liquidated damages are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach ....
that are seen as a punishment for breach rather than a means to fairly compensate the other party). Such penalties would discourage efficient breach, and therefore "efficient" behavior, which would be undesirable for society as a whole. Posner explains his views in his majority opinion in Lake River Corp. v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985).
Posner's illustration
Judge Richard Posner gave this well-known illustration of efficient breach in "Economic Analysis of Law":
Suppose I sign a contract to deliver 100,000 custom-ground widgets at $.10 apiece to A, for use in his boiler factory. After I have delivered 10,000, B comes to me, explains that he desperately needs 25,000 custom-ground widgets at once since otherwise he will be forced to close his pianola factory at great cost, and offers me $.15 apiece for 25,000 widgets. I sell him the widgets and as a result do not complete timely delivery to A, who sustains $1000 in damages from my breach. Having obtained an additional profit of $1250 on the sale to B, I am better off even after reimbursing A for his loss. Society is also better off. Since B was willing to pay me $.15 per widget, it must mean that each widget was worth at least $.15 to him. But it was worth only $.14 to A $.10, what he paid, plus $.04 ($1000 divided by 25,000), his expected profit. Thus the breach resulted in a transfer of the 25,000 widgets from a lower valued to a higher valued use.
Criticism
Some, such as Charles FriedCharles Fried
Charles Fried is a prominent American jurist and lawyer. He served as United States Solicitor General from 1985 to 1989. He is currently a professor at Harvard Law School.-Early life and education:...
in his "Contract as Promise", have argued that morally, A is obligated to honor a contract made with B because A has made a promise. Fried wrote, "The moralist of duty thus posits a general obligation to keep promises, of which the obligation of contract will only be a special case – that special case in which certain promises have attained legal as well as moral force."
Others argue that the costs of litigation relevant to gaining expectation damages from breach would leave one or both of the original parties worse off than if the contract had simply been performed. Also, Posner's hypothetical assumes that the seller is aware of the value the buyer places on the commodity, or the cost of purchase plus the profits the buyer will make.