15 January 2012

More On Contract Remedies Part 1

I was surprised to see "Michael D. Knobler" listed as one of the articles editors on the masthead of the Yale Law Journal. At least I'm shocked that this excellent note (abstract here) was written by a student. But perhaps I'm easily impressed when someone tackles one of my favorite topics: how to justify contract remedies.

Knobler first writes a very comprehensible account of the "contract-as-option" theory of remedies. Beginning with Oliver Wendell Holmes in the late nineteenth century, economically-minded contract scholars have argued that a promisor's contract obligation is really an option either to perform or, when inefficient, to pay damages. Playing on parties' self-interest, either both parties will be better off by performance or one party by breach so long as damages are paid to make the aggrieved party whole. Either gains to both or gain to one and no harm to the other. This remarkably unintuitive theory is borne out in many rules of contract law ranging from the prohibition of punitive damages, the difficulty of getting an order for specific performance, the rule of Hadley v. Baxendale measuring the foreseeability of consequential damages from the time of contract formation, not breach, and the rule of Peevyhouse v. Garland Coal Co., which measured contract damages by the marketplace, not the subjective value to the aggrieved promisee.

But enter the empirical sciences. In reality, most contract parties firmly believe that they are bargaining for performance, not an option to perform. Knobler cites multiple studies that have confirmed that contract parties believe that contract (non)performance has an ethical dimension, and that dimension or perspective holds that breach, even when coupled with payment of compensatory damages, is a wrong. One example of the moral perspective on damages is the belief common even today that underwater mortgagors have an obligation to pay their mortgage even when its balance is greater than the value of their home. (See my comments on this topic here, here, and here.)

So what, the theorist of efficiency might argue? What difference does it make that contract parties are moralistic about contract remedies? Well, as Knobler observes, "the parties’ free choice—in other words, their consent to contract—fills a fundamental legitimating role." And if the background of parties' free choice includes performance, not payment of damages, contract law loses one of its most substantial claims to legitimacy when that law routinely disregards their choice. Consent is the key on any theory of contract law but what are we to make of consent as the gateway to contract creation and contract interpretation but not contract remedies? Indeed, even when contract parties explicitly agree to court-mandated performance in the contract, courts still won't make the breaching party perform. What gives?

Knobler suggests a third way. He notes that regular players in contract markets are probably happy with the option to perform or pay damages regardless of whether they want the "option" to breach or if they might be involuntary recipients of compensatory damages. They prefer the discount in initial price over greater certainty of performance, which would entail higher prices from contract promisors. After all, the thinking goes, repeater players have access to information (e.g., trade association reports) and non-legal remedies (e.g., creation of a bad reputation in the market place for breachers) that sufficiently compensate for the risk of non-performance and receipt of compensatory damages.

One-shot players, however, are different. "The one-shotter is likely to be substantially more risk-averse than the repeat player and thus would be willing to pay a premium for an increased assurance of performance." What should be done about folks who honestly believe they are contracting for performance when the law treats the contract as an option? Knobler's first suggestion is what has been done for a long time: nothing. Telling a shocked client that she has no right to contract performance, while a lawyer's duty, is hardly consistent with a consent-based theory of the justification for contract law.

What else? Education? Let's do more to tell the intuitively moralistic public that contract law is decidedly sub-moral. Given the state of American primary and secondary education, this seems unlikely to achieve much success and will simply do more--as if that's possible--to convince citizens that the law is an ass.

What about modifying the law? Here's where Knobler's suggestions get interesting, even if unlikely of remedial legislative action. But here's where I'll quit for today.

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