Sample - A - Contracts Remedies for Breach

Sample - A - Contracts Remedies for Breach - The Search for...

Info iconThis preview shows pages 1–17. Sign up to view the full content.

View Full Document Right Arrow Icon
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 4
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 6
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 8
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 10
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 12
Background image of page 13

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 14
Background image of page 15

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 16
Background image of page 17
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: The Search for the Efficient Contract: A Discussion of Performance and Compensation as Remedies for Breach in the event of a breach of contract, the ultimate goal is not punishment; it is the determination of the most efficient re—allocation of resources. As E. Allen Farnsworth explains: “if a society were'seriously concerned with compelling men to keep their promises, it might be expected to treat a breach of contract as a crime and to punish defaulting promiscrs.“ Instead the law focuses upon the correct measure of relief to the breachee in event of a breach. In order to ensure efficiency for contracting parties, three objectives must be met. First, the courts must strive to encourage efficient breaches through use of the most effective compensation method. If one or both of the parties find that it is uneconomical to carry out the contract, it must be possible to change the contract to permit a more efficient transaction. Second, contract law must preserve parties’ incentives to form efficient contracts. The parties must have faith that contract law will assist them in their goal of wealth maximization. Finally, courts must aim to lower transactions costs. l’rohibitive costs of negotiation will ultimately prevent the best allocation of resources. Most economic scholars respectfully place aside the moral argument that a man should always keep his promises, and encourage the legal system to ensure that resources are rte-allocated efficiently in the event of a contract breach. While this is a common goal, the best method for reaching it is disputed. This paper will outline the two conflicting methods for ensuring the most ideal breach of a contract: the requirement of specific performance, and the awarding of money damages.2 Part I of this paper will discuss the ability of specific performance and money damages to ensure efficient breaches. The beneficial and detrimental effects of each ’ Famsworth. “Legal Remedies for Breach of Contract.” Columbia Law Review 76.7 (1970). 1t45 2 Schwartz. “The Case for Specific i’erfonnance.” The Yale Law journal. 89 (1979}. 273 solution wiii be considered. The variable of market type: whether the contract is centered around a fungible or unique good wiil also be taken into account. . Part1} of this paper will present arguments regarding the efiects of specific performance and money damages on patties’ decisions about contract formations. The need for pro-contract stipuiations and price alterations will be discussed. Part Hi of this paper wiii examine the effects of these two methods on the transactions costs of contract negotiation. Costs incurred through court disputes and negotiations independent of the court will be compared under each remedy. 1. Efficient Breaches Daniel Friedmann summarizes the View of proponents of efficient breach: “if the promisor’s profits from the breach exceed the loss to the promisee, the breach is to be permitted or even encouraged on the ground that it leads to maximization of resources.”3Adhering to this rule, in order for a breach to be efficient, the interests of the breaching and non-breaching party must be held equal. The breacher must be permitted to terminate the contract in order to carry out a more profitable transaction. At the same time, the innocent party must be compensated such that he is no worse off than if the contract had been carried out“ As Friedmann points out, this theory satisfies the Pareto standards of efficiency as there is a net gain for the contracting parties and no one is worse off than before.5 Currently, contract law accomplishes this with a payment of expectation damages to the injured party in the majority of cases. The courts allow an exception of specific performance as the remedy in cases where it is uneconomical for 3Friednnmn, Daniel. “The Efiicient Breach Fatlacy.” Journal of Legal Stsdics 18.1 (1989). 329. 4 ramsworm E 148 5 Friedmann 329 courts to try to determine the price of those damages.6 While many confidently support the law’s current stance, some economists, such as Alan Schwartz, Anthony Kronman and Thomas Uien disagree. They see damages as an obstacle rather than a remedy for efficiency. Schwartz argues: “The class of cases in which damage awards fail to compensate promisees adequately is... broader than the class of cases in which specific performance is now granted.”7 Through a consideration of different market circumstances, this section will present the difficuities and benefits both methods offer in the goal of the efficient breach. I A. The Challenge of Damage Calculations Specific performance grants the innocent party exact compensation for the breach of coritract.8 The method of compensation strives for the same, but depends upon the court to define the sum that would restore the benefit of a fulfilled contract upon the breachee.9 The slightest over or undercompensation destroys the balance of the original covenant.10 Determining this exact compensation is as difficult as it is crucial. To calculate “expectation” injury, courts must determine an unrealized value: what profits the breachee would have gained from the fulfiiled promise}1 This calculation is simplest in a market for tangible goods. For example, assume a buyer buys a book from a seller for $100. Before delivery, the market price of the book increases, and the seller finds another customer who will buy it for $120. He then breaches the contract with the original buyer to sell it to the second buyer. The original buyer then 6Cooter. Robert and Eisenberg, Meivin. “Damages for Breach of Contract.” California Law Review. 735 (1985). 1434 7 Schwartz 275 B Maris, Timothy 1. “Comment: The Costs of Freely Granting Specific Performance." Duke Law Journal. (1982). 1054 9 Schwartz 276 10 Center and Eisenherg 1444 “ ibid 1435 purchasos the book elsewhere for $115. The original seller will be required to pay him damages — the difference between the original contracted price and the price of the ' .12 in this case the efficient breach was permitted: the original buyer got his book for the price of the original contract, and the seller’s resource was aiiocated to the buyer who valued it more. While it is true that market prices can help a court determine the exact there are many cases —« even in a market for compensation the breachee is entitled to, fungible goods m when the promisee places a special, “unforeseeable” value on the good that he wilt never recover through money damages.13 As Faresworth defines the issue, . a crushing burden, granting unforeseeable costs to the injured party would “impose. greatly out of proportion to the benefit that [the breacher} originally expected to derive from his bargain.”14 Referring book he contracted for in order to complete a final paper that is due the next day. event of a breach he can procure a substitute text, but it would not come in time, and he would fail his class. The failing grade prevents him from graduating college and from getting a job, resulting in damages totaling $50,000. These costs are unforeseeable. The seller had no way of knowing that his breach would impose this great burden. While it is unjust to pin these costs upon the breacher, the injured party is not justly compensated with $15. In this case the breach is not truly efficient, as the breachee was undercornpensated. As Richard Craswell admits: “[ijpectation damages as awarded in law often fall short of a truly compensatory measure due to the exclusion of such items as M ‘2 Muris 1055 13 Famsworth 1207 ‘4 Famsworth, 1199, 1200 attorney fees, immeasurable subjective losses and unforeseeable damages.”15 Timothy Muris takes Famsworth’s statement one step further by accusing courts of applying the uniqueness label too sparingly. it is likely that many buyers have subjective standards of “uniqueness,” such as preference for a certain brand.“S Even in fungible goods markets, money damages often do not fully compensate the breachee. Just as there are challenges to compensation calculations in markets for fungible goods, there are, as is to be expected, challenges in markets of unique goods. The central difficulty in such a market is the lack of substitutes. For example, assume that the text in the book example is now the only remaining copy of an antique edition. Once the promisor breaches the contract and sells it to the second buyer, the original buyer will not find a substitute. In this case the appropriate damages are hazy. There is no market price or relevant transactions to refer to in calculating the expectation value of the book. There is also a good chance that the search for this rare book was costly and time consuming. If the original buyer is overcompensated, the breacher will be deterred from engaging in an efficient breach. If the original buyer is undercompensated, the hreacher is encouraged to breach even if it is inefficient.17 In the case of the unique good, the overwhelming likelihood is that the court will miscalculate damages and hinder the Pareto superior efficiency: one party will be granted a surplus, and the other will be harmed. It is challenging to determine appropriate damage calculations in both fungible and unique goods markets. In a market for non—unique goods, comts can depend upon the established market price and records of similar transactions to assist them in determining lsCraswcll, Richard. “Contract Remedies, Renegotiation. and the Theory of Efficient Breach.” Southern California Law Review 61 (1988). 637 ‘6 Muris 1058 ‘7 Crasweil 634 expectation compensation. However, even though evidence is concrete, it will leave out subjective, unforeseen costs, potentially undercornpensating the breachee. In a market for unique goods, the court must set the market price on its own before attempting to place a value on expected damages. These calculations are costly and likely ineffective. Through these considerations, it is evident that in many cases the compensatory method is an imperfect solution to the quest for an efficient breach of contract. B. The Specific Performance Suggestion Anthony Kronrnan defends an increased reliance on specific performance as breach remedy with an ode to the Cease Theorem. If specific performance is granted, and transactions costs are low, ultimately negotiations between two parties will result in the best allocation of the good.18 The provision takes the court and its damage calculation fumbling out of the negotiation process. Though specific performance seems to increase the likelihood that the good will be allocated efficiently, it does not identify who will reap the benefits. The provision ensures that the breachee will receive exact compensation, and that through private negotiation, the good will eventually be put to its best use. As Ulen points out, the allocation of surplus enabled by the breach should not be the court’s concern.19 in the case of specific performance, the breachee will hold the power to compel performance and will likely be able to use that power to take some of the breacher’s surplus. Neither party will be worse of than before, as the options are the prevention of breach, or the sharing of surplus from breach. ‘8 Kronman, Anthony T. “Specific Performance.” The University of Chicago Law Review. 45 (1977). 353 '9 Ulen, lhomas S. “The Efficiency of Specific Performance: Toward a Unified Theory of Contract Remedies.” Michigan Law Review 83 (1984). 335 While awarding specific performance does solve the problem of uncompensated unforeseeable costs in a non—unique good market, and the problem of blurry values in a market of unique goods, there is a grand but rare inefficient exception. in cases in which it is impossible for the breacher to perform, the requirement of specific performance is of infinite worth. In such an extreme case, the breach must he settled with money damages.20 Overall, the arguments of various economists seem to suggest that increased reliance upon the specific performance remedy should not affect the potential for efficient breaches. The method promises to allow the contracting parties to determine compensation and allocate surplus Without the assistance of the courts. While specific performance seems to increase the potential for efficient breaches, it will be important to consider the transactions costs, and changes in formation of contracts, resulting from an increased use of the remedy II. The Efficient Formation The methods of specific performance and compensation as breach of contract remedies do not only affect the efficiency of contract breach; they affect the behavior of the parties as they form a contract.21 Ensuring that efficient contracts are formed is the first step to promoting the ideal allocation of resources. As Uien asserts, “if the equitable remedy becomes widespread, the process of contract formation will. become more efficient. . .”22 This section will review two aspects of formation. First, arguments regarding the effects of each method on formation decisions will be considered. A discussion of predictions regarding the ensuing effects upon pricing will follow. 2° Ulen 344 2‘ ibid 336 23* ibid 338 A. Anticipation of Breach Remedy in Contract Formation If contract law relied entirely on specific performance, many men would think twice before making promises. Kronrnan argues that an increased reliance on specific performance as a breach remedy would encourage parties to “carefully identify their opportunities before committing to one.”23 Resolution of breach through money damages leaves entrants with a perceived way out. Those who would enter into a contract with specific performance as preferred remedy would be confident in their intention to perform, or at least secure in their ability to negotiate stipulations and prices Ulen further develops Kronman’s theory of correlation between the type of breach remedy and behavior of the contract entrant. He explains that if both parties anticipate that the court will require specific performance in the event of a breach, the threat would induce each of them to avoid the courtroom, and resolve the potential breach through a pre-wcontractual stipulation. 2‘; In the likely event that the cost of specific performance to the promisor exceeded the benefit to the promisee, the parties would choose to attach a stipulation for money damages to the contract.25 The mere expectation of this court remedy would shape their formation negotiations. Thus, it is likely that specific performance would not deter parties from entering contracts, but rather push them to do so more efficiently. In their defenses of specific reliance as breach remedy, Ulen and Kronrnan both find a strong connection between the expectation of specific performance and efficient, 23 Muris 1060 2“ Ulen 337 25 Kronman 366 independent, formation decisions. Crasweli suggests that this claim may he a bit too enthusiastic. He asserts that parties will be able to form- a contract efficiently so long as they know the legal rule with a fair amount of certainty. “This implies that the courts should concern themselves not so much with the substance of the legal rule as with its certainty and predictability.”26 With this in mind, perhaps the question of the effect of remedy on contract formation should not be one of specific relief vs. damages, but one of certain relief vs. uncertain relief. B. Pricing in Anticipation of Breach Remedy While the courts” remedy of breach can affect decisions regarding contract entry and the creation of stipulated remedy clauses, the parties’ opinions regarding each remedy is most clearly shown in price. Through the price of the good, sellers and buyers can allocate the risk of breach accordingly. A seller who prefers more freedom to breach will allow his buyer a break in price. A buyer who prefers a lower price will give up his security regarding breach. The determination of price is the parties’ key to maintaining efiiciency. Kronman explains the mindset behind pricing in anticipation of remedy for breach: Other things equal, a promisee will always prefer to have such a provision {for specific performance] included in the contract for it gives him additional right. .a promisor will always prefer a contract without such a provision m a contract, in other words, which he may unilaterally breach on the condition that he make a subsequent compensatory payment to the - 2 pronnsee. 7 Kronrnan‘s argument holds true in the ideal sense, but there is a price tag on preference, For a promisee to have a provision for specific performance included in the contract m or 26 Crasweii 632 27 Kronrnan 366 a stipulation for damages excluded —— he will have to pay the promisor a premium for his loss of freedom. Craswell assumes that buyers will opt for a lower contract price than for the promise of fuller compensation upon breach. In making this assumption, Craswell holds true that buyers are more risk averse than sellers. They see the prospect of specific performance or an increase in damages as a “lottery prize” for which they are not willing to pay.28 Thus a buyer will seek a lower price before a provision for specific performance. While Kronrnan’s argument that buyer’s prefer specific performance may not hold true when they are offered a discount in exchange, his statement that sellers always prefer freedom to breach appears to remain true. The promisor is aware that the amount of release payment he would have to pay the promisee if specific performance were the remedy would be significantly higher than the compensation he would pay under the money damages rule.29 With that in mind, he would likely prefer to grant the promisee a price reduction in exchange for more freedom in the event of a breach. The only exception to this prediction would be in a case where the promisor was entirely confident he would not breach. While their preferences for breach method may diverge, anticipatory pricing allows parties to allocate risk efficientiy. Kronrnan’s argument applies not just to the standard market, but also for the market for unique goods. He amends it slightly, explaining that in a market for unique goods, buyer and seller preferences are equally inflated.30 Schwartz elaborates with the explanation that buyers in such. a market are especially interested in the provision for specific performance because they have incurred high search costs to find a good for 2‘; Crasweil 645 29 Kronrnan 367 3“ Kronman 367 10 which they will likely never find a substitute. Sellers are more interested in a breach remedy with money damages because unique goods have an inelastic supply. This means that if demand increases only slightly, price could increase dramatically.31 In a unique goods market, because the opposing interests of the buyer and seller are stronger than in the market for fungible goods, it is hard to guess which party is more risk averse. If it is the buyer, he will forego specific performance for a sharp reduction in the price of the good. If it is the seller, he will accept the provision for specific performance and charge the buyer a high premium. In both unique and non~unique markets, contracts can be formed efficiently regardless of the remedy for breach. Through negotiations regarding stipulated remedy clauses and prices, buyers and sellers can determine the most efficient allocation of the risk for breach. III. The Efficient Transaction Even if the breachee is justly compensated, the breacher is permitted to allocate his resource to a more efficient use, and the entrant is able to form an efiicient contract, transactions costs could prevent the realization of the ideal outcome. Although these costs seem at first to be a mere nuisance, they can grow to be the ultimate barrier to efiiciency. In order to complete this review of the contribution of specific performance and money damages to the effi ciency of contracts, the transactions costs of each must be considered. This section will analyze arguments regarding the potential increase or decrease of transactions costs occurring with the use of each remedy. First, the cost to the courts will be determined, as these costs ultimately affect the reform of laws. Second, the costs to the contracting parties will be considered. 3‘ Schwartz 283 ll A. Ejfict of Breach Remedy on Courts ’ Transactions Costs As the primary argument in favor of specific performance money damages goes: expectation value of a contract is extremely difficult to calculate. The limitation of transactions costs deters courts from attempting to calculate damages in markets for unique goods. For the courts, a “unique” good can be defined as one for which the transactions costs of damage calculations prohibit determination of value. Though the courts likely hold their calculation skills above those of the contracting parties, the evils of transactions costs encourage them to expand reliance upon specific performance as remedy for breach. While the transactions costs of damage calculations impede the efficiency of money compensation as remedy for breach, the costs of court supervision may impede the efficiency of specific performance. As Schwartz explains: “One final efficiency objection remains — that the remedy increases administrative costs. . .because of the expense entailed in ...irnplementing specific performance decrees.”32 While scholars such as Schwartz and Ulen cite this argument as one many use to point the finger at the inefficiency of specific performance, each swiftly dismisses it. The cost of supervision is not home by the courts — it is transferred onto the parties in conflict. Thus the cost of supervision promotes efficiency by deterring breaches where the benefit is less than the administrative cost of supervision. One final speculation of the effect of the two remedies on court transactions costs is the potential. correlation each has to the number of cases brought to court. Craswell’s states that as long as parties can confidently predict the outcome of a court decision, they will negotiate between themselves and conclude as to how best to allocate risk of 32 Schwartz 293 breach.33 Holding this as true, either a predictable stance 0n specific performance, or a predictable stance on damages as compensation would decrease parties’ incentives to bring their arguments to court, and reduce overall court costs. In order to determine if this is effi cient, it is important to ask the next question: will independent negotiations between the two parties prove to be efficient? B. Eflect of Breach Remedy on Negotiations Independent of the Court The first indication of the cost to contracting parties of each method of breach remedy is the number of transactions in which the parties need to engage. Although some transactions are more costly than others, it is logical to focus first upon limiting the number of necessary negotiations. Friedmann outlines the potential for transactions in an example of a breach that has occurred because a second buyer is willing to pay more for a good than the first buyer. Suppose specific performance is the preferred remedy. A contracts to sell a good to B, and cannot breach when C comes along with a higher offer. There will be a transaction during which A sells the good to B, and then one in which B sells the good to C. If damage compensation is the preferred remedy, A will breach his contract with B and enter into a transaction with C. There will then be a dispute between A and 8.34 Friedmann uses this example to combat the argument, put forth by Judge Posner, that in the cases of compensation as remedy there are fewer transactions. Friedmann asserts that this argument leaves out the most expensive of the transactions — namely the negotiation of damages after A breaches his contract with B. In his defense of specific performance, Friedmann insists that the set of remedies that deter breach reduce the cost of transactions as compared to use of money damages as remedy. He points to 33 Craswell 633 34 Friedmann 331 l3 the high cost of damages disputes, and also the possibility that once A breaches with B, B could go on to sue C for inducement of breach. of contract.35 Although Friedmann makes a strong case for the high costs of transactions under a money damages rule, Maris points out that the negotiations under the protection of specific reliance often tend to be most expensive. He defends damages as the more efficient method: “if the law provides an easily calculable damage standard, the seller would be able to simply send a check for that amount to the first buyer and avoid costly negotiations.”36 There are no guidelines for specific performance negotiations, and the provision could leave parties in costly debate, as a promisor attempts to defend his potential profit from breach, and the promisee threatens him with the possibility of forced performame.37 Transactions costs are high regardless of the remedy of breach employed. It is expensive for courts to calculate damages remedies in the event of contract breach, but some argue that the supervision of specific performance leads to an increase in administrative costs. As Craswell asserts, perhaps it is not the remedy that could lead to decreased costs for courts, but the predictability of that remedy. The distinction between costs of transactions between parties as caused by remedy of breach is also blurry. It is expensive to dispute damages, but it is also expensive for parties to negotiate a release from the specific performance provision. Neither remedy always limits transactions costs. Conclusion Both the specific performance and money damages methods of breach remedy sometimes impede and sometimes improve the efficiency of contracts. In ensuring 35 ibid 331 3" Muris 1059 37 ibid 1058 14 efficient breach, an increased reliance on specific performance would likely limit the inefficiencies of miscalculated damages. In ensuring efficient contract formation, neither method seems to be detrimental. In ensuring limited transactions costs, an increased reliance on specific performance seems most efficient for courts, but neither method offers to reduce transactions costs for out of court negotiations. This paper has presented the effects of breach remedy upon the efficiency of contracts. The paper did not intend to suggest amendments to or confirm current contract laws. It merely sought to present and examine the many arguments of those scholars who struggle with the search for efficiency. 15 Works Cited: Cooter, Robert and Eisenberg, Melvin. “Damages for Breach of Contract.” California Law Review. 73.5 (1985). 1432-1481. Craswell, Richard. “Contract Remedies, Renegotiation, and the Theory of Efficient Breach.” Southern California Law Review 61 (1988). 629-670. Famsworth, E. Allen. “Legal Remedies for Breach of Contract.” Columbia Law Review 707 (1970). 1145-1217. Friedmann, Daniel. “The Efficient Breach Fallacy.” ournal of Legal Studies 18.1 (1989). Rpt. in Law and Economics Anthology. Ed. K. G. Dan—Schmidt, T. S. Ulen. Ohio: Anderson, 1998. 328632. Kronman, Anthony T. “Specific Performance.” The Universig of Chicago Law Review. 45 (1977). 351682. Maris, Timothy J. “Comment: The Costs of Freely Granting Specific Performance.” Duke law JOurnal. (1982). 1053~1069. Schwartz. Alan. “The Case for Specific Performance.” The Yale Law Journal. 89 (1979). 271306. Ulen, Thomas S. “The Efficiency of Specific Performance: Toward a Unified Theory of Contract Remedies.” Michigan Law Review 83 (1984). Rpt. in Law and Economics Anthology. Ed. K. G. Dan-Schmidt, T. S. Ulen. Ohio: Anderson, 1998. 332-346. 16 ...
View Full Document

Page1 / 17

Sample - A - Contracts Remedies for Breach - The Search for...

This preview shows document pages 1 - 17. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online