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Anglo-American Contract and Torts Prof. Mark P. Gergen Class 13. Contract Remedies—Day One. How US law students generally are taught to think about contract remedies. “The theory of efficient breach” also known as “The option theory of contract”.
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Anglo-AmericanContract and TortsProf. Mark P. GergenClass 13 Contract Remedies—Day One
How US law students generally are taught to think about contract remedies “The theory of efficient breach” also known as “The option theory of contract” There is no obligation to perform a contract. Rather there is an option—a choice—either to perform or to pay damages.
What led to this curious way of thinking . . . The proposition is true. As a legal matter, if one breaks a contract, then the usual consequence is an obligation to pay damages. • Oliver Wendell Holmes, Jr. and the “bad man theory of law.” Holmes told entering law students it is useful to think of the law from the perspective of a bad man who wants to know the practical consequences of breaking the law. Holmes used contract to make his point. • “The Path of the Law,” 10 Harv. L. Rev. 457 (1897) In the same speech Holmes argued for “the prediction theory of law.” A statement of law is a prediction of what a judge will do.
The theory of efficient breach does accurately describe (or fit) some features of contract law. The usual measure of damages is “expectation damages,” which compensate the promisee for its loss from non-performance. The standard account is that this damage rule encourages “efficient breach” when resources can profitably be shifted from performance of a contract to other uses.
Posner, Economic Analysis of Law • Contract price for widgets = 10 cents • Value to buyer at time of performance = 14 cents • Value to seller at time of performance (what a 3rd party will pay) = 15 cents • The expectation measure properly encourages seller to breach for it nets a 1 cent profit per widget after paying the disappointed buyer 4 cents damages per widget (or 14 cents if the buyer prepaid).
These cases involving the “duty to mitigate” often are used to make a similar point. Rockingham County v. Luten Bridge, Supp 63 (contract to construct bridge was cancelled by county, held construction company improperly failed to mitigate damages by completing work and is entitled only to damages for its lost profit and cost incurred up to time of stop order). Clark v. Marsiglia, Supp 63 is similar. D cancelled contract for cleaning and repair of paintings. P completed the work. Held P is not entitled to contract price. He recovers only lost profit and cost incurred at time of stop order.
Further support for the point sometimes is found in the “lesser of two rule” that limits damages for defective work to the loss in market value when the remedial cost (cost of repair) is much greater. Plante v. Jacobs, Supp 70. Contractor misplaced wall in home, narrowing living room by one foot. The error did not reduce market value of house and will cost $4,000 to correct. Held owners get no damages. Peevyhouse v. Garland Coal & Mining Co., Supp70 n. 20 is similar. D breached promise to restore P’s land after strip mining. Restoration cost was $29,000. Land was worth $300. Held P’s damages are limited to $300 damages.
English law students are not taught to think about contract remedies in this way. Duty to mitigate—the starting position under English law is that there is a right to complete performance and collect the contract price in response to a stop order (repudiation). See Supp 64 n. 9, White & Carter. Lesser of two rule—when remedial cost is grossly disproportionate to loss in market value, then award an intermediate amount to compensate the plaintiff for his probable subjective loss. See Supp 70, n. 20, Ruxley.
In the article excerpted in the Supplement I argue US law is closer to English law than we teach our students and that the high value placed on remedial simplicity in US contract law explains most of the differences. Under US law the only damage options available for defective work and property damage are remedial cost and loss in market value. The intermediate subjective award in Ruxley is unavailable. Subjective non-economic damages (e.g., damages for emotional disturbance) generally are not available under US law in a contract action.
Parker v. Twentieth Century Fox, Supp 61. The studio has Parker (Shirley MacLaine) under contract to play the lead in Bloomer Girl, a 14-week commitment with $750,000 minimum guarantee. It cancels Bloomer Girl and offers her the female lead in Big Country, Big Man for the same time period and minimum guarantee. Had Parker taken the offered role (or done other work in the 14 week period) the money she earned would be subtracted from the money she was promised as an avoided loss. Parker would not be compensated for other losses she may suffer from the loss of the role as such losses are too speculative or non-economic.
After Parker refused the substitute role, she offered to take $600,000 to settle matters. The studio offered $400,000. Parker sued. The studio raised failure to mitigate as a defense. Parker moved for summary judgment. Trial court granted summary judgment for Parker. Affirmed by the California Supreme Court.
Parker was allowed to decline the role because it was a reasonable thing to do. The standard of reasonableness applied is strikingly unlike the reasonableness standard in negligence. See p. 62 bottom for some differences. An English expression of the difference here is that it is between being “merely unreasonable . . . and . . . wholly unreasonable.” p. 66.
Parker illustrates that subjective interests are protected indirectly. Parker may decline the role to avoid a subjective loss. Parker illustrates that sometimes contract remedies over-compensate and put the promisee in a better position than performance. Parker was paid $750,000 to take a 14 week vacation. Parker illustrates the high value the common law (even US law) places on vindicating contract rights.
US law students focus on the remedies a court can provide on breach of contract, in particular damages. English law students often begin remedies with conditions and the law on discharge (material breach and substantial performance). I believe the English approach is preferable as a practical matter for the many defects in the damage remedy make discharge a preferred remedy if a party can protect themselves from breach by conditioning their performance obligation on performance by the other party.
Some reasons damages are inadequate: • A damage award is a judgment debt that must be collected through further proceedings and is dischargeable in bankruptcy. • Legal proceedings are costly, particularly under the “American rule” in which the victor is not awarded costs. • Damages are not awarded for speculative economic losses and non-economic losses.
Conditions, Text 178 Non-occurrence of a condition excuses the performance obligation that is the subject of the condition. The “obligor” is the party under the conditional obligation. The “obligee” is the party to whom the conditional obligation is owed. • Typical uses of conditions include: • To give the obligor power to withhold performance as a remedy in the event of breach. • To protect the obligor from the risk of the event covered by the condition.
Example One In a purchase agreement the purchaser will condition its obligation to accept delivery and pay for the object on conditions of quality and timeliness being satisfied. Example Two In an insurance agreement the insured makes no promises. The insurer ensures timely payment and protects itself from non-compliance with other terms by conditioning its obligation to pay the benefit on performance of all terms and conditions.
You have seen two tools used to avoid harsh application of conditions • interpretation (City and Westminster Properties v. Mudd, Text 137) • waiver and estoppel (some of the cases collected at pp. 116-117). • Other tools include • excuse for non-cooperation/“breach” • the duty of good faith • excuse for impracticability • excuse to avoid disproportionate forfeiture
The doctrines of material breach and substantial performance determine when a party has the power to withhold performance in response to breach in the absence of an express condition. These sometimes are called “constructive conditions.” The doctrines address some of the problems that result when performances cannot be rendered simultaneously.
If performances can be rendered simultaneously, then there is a presumption that they are to rendered simultaneously. English courts did not adopt a rule presumptively making the performance obligation conditional on counter-performance until 1773! • When performances cannot be simultaneous people use a variety of mechanisms to guard against default. • In real estate conveyance an escrow agent will hold the money until the transfer is recorded. • In sales a buyer will establish a letter of credit entitling the seller to payment by bank on presentation of warehouse receipt or bill of lading. • Construction contracts provide for progress payments and holdbacks. Credit risk is mitigated by bonding.
Substantial performance Text 179-180, Supp 67 n. 15 and Supp 70-71
In most US states a contractor who “substantially performs” a construction contract is entitled to be paid on the contract less any damages suffered by the other party from defective performance. In most US states a contractor who does not “substantially perform” a construction contract may still have a restitution claim for the “incontrovertible” value of the performance rendered and never more than the contract price less damages suffered by the other party. These doctrines apply in the absence of an express condition. Unexcused failure to fulfill a condition generally bars both a contract and a restitution claim.
Plante v. Jacobs, Supp 70. Contractor misplaced wall in home, narrowing living room by one foot. The error did not reduce market value of house. Contractor sues for $5,000 balance due on contract. Held contractor is entitled to the balance because he substantially performed. Had the deviation from the plans been more substantial or intentional the contract claim would have been denied.
Material breach Text 180-181, Supp 67 n. 15 and Supp 66-70
A contract involves on-going performance by both A and B. E.g., a construction contract with progress payments, a lease, an employment contract . . . Under US law, generally a “material breach” by B gives A the power to suspend performance. If the breach is “total”, then A has the power to terminate the contract and pursue legal remedies. A is discharged from his performance obligation. A has the power to waive the breach and continue to perform while insisting on B’s performance unless A’s duty to mitigate requires A to make other arrangements. Recall Luten Bridge.
Restatement Second, Contracts § 241. Circumstances significant in determining whether a failure is material (Supp 67 n. 15) • In determining whether a failure to render or to offer performance is material, the following circumstances are significant. • (a) the extent to which the injured party will be deprived of the benefit which he reasonably expected;(b) the extent to which the injured party can be adequately compensated for the part of the benefit of which he will be deprived;(c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;(d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;(e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.
Considerations relevant to whether a breach is material . . . • (a) the extent to which the injured party will be deprived of the benefit which he reasonably expected;(b) the extent to which the injured party can be adequately compensated for the part of the benefit of which he will be deprived;(c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;(d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;(e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing. Factors (a), (b), and (d) go to whether the aggrieved party needs to suspend performance or terminate the contract to protect their interest in receiving the promised performance. Factor (c) goes to the harm to harm to the other party from suspending or terminating the contract. It expresses a particular concern for forfeiture, meaning uncompensated expense and loss of investment.
Colonial Dodge, Inc. v. Miller, Supp 70. B ordered a car with special-ordered extra wide tires. S delivered a car without a spare extra-wide tire. B noticed this after driving one day and 400 miles. He has right to return the car under UCC if lack of a spare “substantially impairs value of car.” This is essentially the material breach standard. S will suffer a large loss if B is allowed to return car as it cannot be sold at list price. B suffers a small loss if he must drive without a spare until a spare is supplied. 13 judges hear the case. They split 7-6 for B. This is similar to the balance struck in Parker. Many think this result goes too far in favoring the promisee.
In determining whether a promisee should have acted differently to mitigate damages, a breach is substantial, or a breach is material two general interests are being balanced The interest of the promisee in receiving what he was promised (the expectation principle). The interest of the defaulter/promisor in minimizing its loss on default. The good or bad faith of the defaulter/promisor also bear on how this balance is struck.
The law tolerates much inefficiency and even an occasional windfall to a promisee in order to avoid inflicting a material uncompensated loss on the promisee. See Parker and Colonial Dodge. Plante v. Jacobs shows there are limits, particularly when the windfall is great. Often tough choices are presented because losses and benefits are not compensated directly with monetary awards or offsets.
