|What the Efficient Performance Hypothesis Means for Contracts Scholarship|
|Eric A. Posner, Sunday, 22 July 2007 [View as PDF]|
The standard contract remedy of expectation damages treats a promissory obligation as an option: the promisor has the option to breach or pay damages equal to the difference between the value of performance and the contract price. In his interesting essay recently published in this Journal, Richard Brooks asks, Why not give the option to the promisee rather than the promisor? If the promisee is given the option to force the promisor to perform or pay damages equal to the difference between the promisor’s gain from breach and the contract price (disgorgement damages), then the promisor has the same incentive to perform or breach as under expectation damages. So giving the promisee the option to compel performance or disgorgement is no less efficient than the expectation damages remedy. Meanwhile, the disgorgement-option remedy, as I will call it (to distinguish it from the normal remedy of disgorgement), is ethically superior if we believe that moral principles do not permit the promisor to choose to pay damages rather than to perform, and if we believe instead that the promise should have the right to determine whether the promisor performs. If it is no worse on efficiency grounds, and better on non-welfarist ethical grounds, the disgorgement-option remedy may in the aggregate be superior to expectation damages.
Brooks’s argument is not that the disgorgement-option remedy is necessarily superior to expectation damages. His comparison of these two remedies is meant to illustrate a larger point: that we can have efficiency and ethics, too—or at least some of our ethics. Ethics might tell us that the promisor should have the option to choose whether to perform or to pay damages or that the promisee should have the option. Whichever is true, we can design a remedy that is efficient. In the first case, in which the promisor has the option to choose, expectation damages is efficient (at least, within the confines of Brooks’s perform-or-breach model). In the second case, in which the promisee has the option to choose, the promisee-disgorgement remedy is efficient. Of course, ethics might demand something more, and there is no guarantee that ethical and efficiency considerations are consistent. But efficiency analysis is flexible enough to allow at least some ethical considerations to play a role in the design of contract damages.
As noted above, Brooks’s central example of this type of flexibility involves a comparison of expectation damages and the disgorgement-option remedy. Expectation damages produce efficient outcomes by forcing the promisor to internalize the effect of his breach: because the promisor must compensate the promisee for the promisee’s lost profits, the promisor will breach only if his own gains from breach exceed this loss. The disgorgement-option remedy is the mirror image. In the disgorgement-option remedy, the promisee decides whether the promisor performs or not. So that the promisee will not force the promisor to perform inefficiently, the disgorgement remedy gives the promisee the promisor’s gains from breach. Because the promisee both gets the benefit from breach and incurs the cost, he has optimal incentives to compel performance or not.
Brooks’s argument does not depend on his simple perform-or-breach model being the whole truth. He appears to argue that even if we consider all types of contract-related behavior such as reliance and renegotiation, in principle we can construct a promisee-option remedy that has exactly the same effect on incentives as any promisor-option remedy. Although Brooks does not prove this proposition, it sounds right, and I will accept it as true for the purpose of argument. But what is its significance? If it were an analytical claim, then Brooks would indeed be right that courts have more flexibility to design ethically sensitive remedies than had previously been recognized. But as Brooks’s discussion makes clear, the claim is actually empirical, not analytical. To use his main example, if it turned out that courts could more easily measure the lost profits of promisees than the value of the outside opportunities of promisors, then, all else equal, the promisor-based expectation measure would be more efficient than, and therefore superior to, the promisee-disgorgement remedy. Brooks is skeptical about this empirical claim, and perhaps his skepticism is justified, but even if it is, the point is that the source of flexibility in the efficiency analysis is empirical uncertainty, not the existence of previously overlooked remedial structures. Put differently, if the empirical puzzle is ever resolved, then an efficiency-oriented court will not have the flexibility to choose a remedy that is sensitive to non-efficiency ethical considerations.
But it has long been clear that because of empirical uncertainty, contract scholars do not know what the optimal remedy is for breach of contracts. As long as such empirical uncertainty exists, one could choose remedies on the basis of non-efficiency considerations without worrying too much that efficiency would be reduced. In light of these points, I see the main value of Brooks’s paper as a demonstration to economically oriented contracts scholars that a final judgment about the optimality of contracts remedies is even farther beyond the horizon than had been thought.
It is bad enough that no one can agree whether expectation damages or specific performance is the superior remedy. But Brooks shows that there is a range of previously overlooked promisee-option remedies that are just as likely to be optimal as they are. In other words, the degree to which the literature appears to reflect a consensus on the optimal contract remedy—and, as I have said, this consensus is limited if it exists at all—is exaggerated because of artificial restriction of the domain to contract remedies that can be found in the law. Contracts scholars have not addressed Brooks’s hypothetical remedies, but they will have to if they want to make a persuasive case that their favored remedy is optimal.
Eric A. Posner is Kirkland & Ellis Professor at the University of Chicago Law School. He thanks Rick Brooks for his comments.
Preferred Citation: Eric A. Posner, What the Efficient Performance Hypothesis Means for Contracts Scholarship, 116 Yale L.J. Pocket Part 438 (2007), http://yalelawjournal.org/2007/07/23/posner.html.