The expectation interest remedy [for breach of contract] requires the promisor to transfer a sum equal to the promisee’s expected gain from performance [or loss from nonperformance] 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 promisee's [foregone] gain would exceed the [promisor's] gain from reallocation, or breach when the promissee’s [foregone] gain is below.In other words, the law of contracts demonstrates that it doesn't care about the morality of breach of contract because it limits damages for breach to a promisee's loss rather than the breaching promisor's gain. If the promisor comes out ahead, even after covering the promisee's losses, everyone is (or at least should be) indifferent.
While many have decried the morally agnostic status of the efficient breach hypothesis, Markovits/Schwartz make a more intriguing argument: there is no such thing as an efficient breach. Ever.
How can this be?
Consider two contracts. Contract A lays out a single path to performance: The promisor must trade a specified good or service for a price. Contract B, which we call a dual performance contract, provides alternative paths to performance: The promisor must trade the good or service item or transfer a sum to the promisee that equals the gain the promisee would have realized from the trade. Let the promisor not trade the item, but transfer the sum instead. This would be a breach if the parties wrote contract A, but not if the parties wrote contract B. The promisor would breach even Contract B, however, if she failed both to trade and to transfer the sum. Neither the failure to trade nor the failure to transfer could be efficient breaches if the applicable contract terms were efficient. Hence, to ask whether a breach is efficient is to ask the wrong question.Putting this another way (and with a HT to Oliver Wendell Holmes, Jr.), if parties enter into a dual performance contract they have agreed that the promisor has an option to perform or pay. Thus, non-performance coupled with reimbursement of the promisee's losses is not even a breach much less an efficient one.
Of course, most contracts are not explicitly of the dual performance variety; most specify that the promisor will do something and leave it at that. So what are we to do in such cases? Is it possible that courts should interpret contracts that specify only a single path as nonetheless permitting such dual performances? Markovits/Schwartz think so. In fact, they believe that most of the time most parties have already bargained for the dual performance. Perform or pay, in other words, is the presumptively correct way to interpret almost all contracts: "Contracts that are silent about remedies should be read to make dual performance promises."
Such a position doesn't strike most folks as immediately obvious. How do Markovits/Schwartz argue for it? In summary--and as amplified by me with respect to point (3)--as follows:
(1) The choice not to perform an agreed-upon exchange amounts to an invitation to renegotiate the original contract. (2) Renegotiations are expensive; thus, prudent parties should agree in the initial negotiation for a remedy should one of them choose not to perform. (2a) An agreement to permit one party not to perform in return for payment of the aggrieved's party's losses is a plausible remedy. (3) Nonetheless, commutative justice requires that the party who chooses not to perform pay something for the option of paying the other party's losses rather than giving up its gain. (4) The something paid for the option is a lower initial contract price.
There is nothing fundamentally invalid with this argument. As I argued in my Principled Pluralism piece, justice is served by a large range of remedies for breach of contract and the current expectation remedy fits comfortably within that range. Yet it remains the case, or so I believe, that the Markovits/Schwartz argument for the current state of affairs would leave most contract parties nonplussed. The fact that such an argument wouldn't occur to most contract parties and that judges have never deployed such an argument leads one to wonder if it isn't a "just so story" that seeks to explain a cause (expectation damages) solely in terms of an effect (putative lower prices).
The Markovits/Schwartz argument also fits uneasily in the widely-recognized doctrine of good faith in the performance of contracts. Even in its most narrow articulation. good faith is understood to limit a contract party's discretion otherwise permitted by the express terms of the contract. Yet on the Markovits/Schwartz hypothesis, a contract regime characterized by a rejection of good faith in performance would, like one limiting damages to a promisee's losses, generate lower initial prices. What on their view accounts for such inconsistent results?
Similarly, even if dual performance is presumptively efficient, why are there impediments to parties who wish to contract out of it? Default rules like expectation damages are understood to be efficient because they save parties the time and trouble of reinventing the wheel each time they enter into a bargain. Nonetheless, thoughtful parties to a particular contract (or with awareness of a particular counter-party) might want to contract in advance for performance or payment of the other party's gain instead of its losses. Yet courts remain resistant to permitting parties to contract for supra-compensatory damages. Liquidated damages are fine but even they remain subject to a plausibly demonstrable relationship to the promisee's losses.
In sum, I am not persuaded by the Markovits/Schwartz dual performance hypothesis. It is more plausible than the efficient breach hypothesis. It may even be proven correct. But not quite yet.