An information theory of willful breach.

• Author: Bar-Gill, Oren

Should willful breach be sanctioned more severely than inadvertent breach? Strikingly, there is sharp disagreement on this matter within American legal doctrine, in legal theory, and in comparative law. Within law-and-economics, the standard answer is "no"--breach should be subject to strict liability. Fault should not raise the magnitude of liability in the same way that no fault does not immune the breaching party from liability. In this paper, we develop an alternative law-and-economics account, which justifies supercompensatory damages for willful breach. Willful breach, we argue, reveals information about the "true nature" of the breaching party--that he is more likely than average to be a "nasty" type who readily chisels and acts in dishonest ways, and may have acted in other self-serving, counterproductive ways, which went undetected and unpunished. Willful breach triggers extra resentment for what underlies it--for all the other bad things that the breaching party likely did, or, more basically, for the ex ante choice he made to engage in such pattern of behavior. Thus, when the party is caught in the act of willful breach, he is punished not merely for this act, but for the (probabilistically) inferred mesh of bad conduct. This account provides a concrete foundation for the notion that willful breach violates the "sanctity of contract." We show that some remedial doctrines are consistent with the information-based account.

INTRODUCTION

1. The Puzzle

   Is willful (opportunistic) breach worse than inadvertent breach? Is it more wrongful and deserving of a harsher sanction?

   Strikingly, two opposite views now have a long-standing tradition within contract law, and they have not been successfully reconciled. On one end, the official position of the common law, as expressed in the Second Restatement of Contracts, is that the intent to breach is largely irrelevant:

   The traditional goal of the law of contract remedies has not been compulsion of the promisor to perform his promise but compensation of the promisee for the loss resulting from breach. "Willful" breaches have not been distinguished from other breaches.... In general, therefore, a party may find it advantageous to refuse to perform a contract if he will still have a net gain after he has fully compensated the injured party for the resulting loss. (1) The remedies available to an aggrieved party do not depend on notions of fault or "mens rea" of the breaching party. Subject to narrow exceptions carved by doctrines like excuse, there is no room for any inquiry as to why breach occurred.

   This strict liability approach to breach of contract has come to be known as the Holmesian approach, described here by Gilmore:

   [T]he contract-breaker's motivation, Holmes explained, makes no legal difference whatever and indeed every man has a right "to break his contract if he chooses"--that is, a right to elect to pay damages instead of performing his contractual obligation. Therefore the wicked contract-breaker should pay no more in damages than the innocent and the pure in heart. (2) This view is explained and supported by the standard law-and-economics account that the optimal remedial regime is strict liability. (3) Since the main goal of remedies is to provide incentive to breach or to perform, all that matters is to equate the remedy to the harm. Intentional breach is no different than negligent or innocent failure to take precautions--all ought to be subject to the same sanctions, and in general the expectation remedy is sufficient to provide optimal deterrence. (4) Indeed, the law-and-economics notion of efficient breach, as well as the Holmesian notion of a contractual promise being no more than an option to breach and pay damages, does not consider compensated breach to be wrongful. In fact, if it is efficient, it may be commendable. A willful efficient breach need not be deterred, merely priced, and the price tag need not include a fault premium.

   On the other end, there is a more popular and intuitive sentiment that regards willful breach--even if followed by full compensation--as opportunistic and wrongful, and that rejects the alleged normative equivalence between deliberate and inadvertent breach. For example, the drafters of the Third Restatement of Restitution have proposed a unique remedy to deal with deliberate breach: disgorgement of the breaching party's benefit from breach. (5) It is wrongful, the drafters presumably concluded, to gain a benefit from intentional disregard for a contractual obligation, and any such benefit ought to be stripped in full and recovered by the breached against party. Even within mainstream contract law, there are various ways in which the fault and willfulness of breach matter for the magnitude of damages. (6) One need only recall Cardozo's famous dicta: "The willful transgressor must accept the penalty of his transgression. For him there is no occasion to mitigate the rigor of implied conditions. The transgressor whose default is unintentional and trivial may hope for mercy if he will offer atonement for his wrong." (7)

   This added hostility toward willful breach is common in continental European contract law systems. For example, under French and German law intentional breach raises the magnitude of liability to cover not only the foreseeable harm, but also any unforeseeable harm. (8) This sentiment is also widely supported by commentators. (9) Significant evidence also suggests that transactors consider willful breach as more wrongful than inadvertent breach and expect it to be more severely sanctioned. (10)

   Thus, we observe two opposite views, one that deems fault to be irrelevant and another that attaches harsher consequences to different types of willful, blameworthy breach. How can we reconcile the tension between these two polar approaches? If all that matters is the harm caused by breach, why is the intent of the breaching party relevant as a factor that increases the remedy?

2. The Traditional Explanation

   The traditional explanation for the hostile sentiment toward willful breach invokes notions of the sanctity of contract. (11) Willful breach is worse, so goes the argument, because it undermines more than just the expectation of the current promisee; it demonstrates indifference and disregard toward the "institutions" of contractual commitment and of trustworthiness, and it conflicts with the fundamental maxim of pacta sunt servanda. (12) Stated differently, a contractual right entitles a party to the peace of mind that a property right holder enjoys--the right not to be encroached upon. Deliberate breach is like theft: it undermines this security and diminishes the value of the right. (13)

   The problem with the "sanctity of contract" account is that it assumes the conclusion: it does not explain why the contractual "institution" is violated by willful-but-compensated breach; instead, it assumes that promisees, or members of the community, will suffer additional deprivation if the breach is deliberate, in the same way that they feel violated when their property is transgressed. For most contracting parties, however, a contract is not a gospel subject to some perceived sanctity, but merely a mutually advantageous instrumental arrangement that is negotiated in order to create value. Why condemn an attempt by one party to increase the overall contractual pie through, say, a willful search for more profitable opportunities? If such opportunities benefit one party and do not harm the other, why are they regarded with distaste? Many law-and-economics writers, most recently Shavell, contend that had the parties written a complete contract that anticipated potential breach opportunity, they would likely have included an express term releasing the promisor from the obligation to perform any time it turned out to be inefficient. (14) That is, the parties would have made a specific arrangement that permitted deliberate breach--in fact, encouraged it--only if it was fully compensated (either ex post through damages or ex ante through a price adjustment). If they could have been made better off by allowing a deliberate breach to occur, why should they be saddled with the costly burden of the sanctity of contract?

   Thus, to those who regard a contract as a vehicle for promoting the contracting parties' legitimate commercial interests there remains a puzzle: How is it that willful breach is considered, even by sophisticated parties, to be faulty and wrongful? Why are parties resentful to a practice that, at its core, appears to be joint-welfare maximizing? Why do businessmen reject the notion of efficient breach? Is there a more subtle reason why a willful breach is perceived to justify supercompensatory damages?

3. An Information-Based Explanation

   We argue that willful breach triggers a stronger resentment not because of the harm it causes, but rather because of the harm it reveals. Willful breach is not any more harmful, nor does it infringe any broader societal interest. There is no sanctity to contract and no social institution or public good is being violated by willful breach. Rather, willful breach is a probabilistic indication that the breaching party is the type of transactor who readily chisels and acts in a dishonest way, and has likely exercised such bad faith in other occasions without being sanctioned. An act of willful breach reveals the true nature of the contracting partner: one who would take any opportunity to divert value, if he can get away with it. This party may act in other self-serving, counterproductive ways that often go undetected and unpunished. Occasionally, when this party's opportunistic act is observed and its true nature is revealed, it triggers resentment for what underlies it for all the other bad things that he likely did, for the choice he made to engage in this pattern of behavior. That is, when this party is caught in the act of willful breach, he is punished not merely...