Remedies on and off contract.

• Author: Brooks, Richard R.W.

ARTICLE CONTENTS INTRODUCTION I. BACKGROUND AND SKETCH OF ARGUMENT II. QUALITY AND CONTRACT REMEDIES A. Origins B. Quality as a Baseline of Expectation C. Quality as a Trigger of Rescission 1. Ex Ante Investment Efficiency 2. Redistribution 3. Ex Post Trade and Expenditure Decisions III. RESCISSION FOLLOWED BY ON-CONTRACT REMEDIES A. Traditional View (Rescission and Restitution) B. Rescission and Expectation Damages C. Rescission and Reliance Damages CONCLUSION INTRODUCTION

Not every wrong has a remedy, and some wrongs--like ordinary breach of contract, the subject of this Article--would appear to have very many remedies. Expectation damages, the common law default, are nowhere near an exclusive remedy for breach. Reliance, restoration, disgorgement, and specific performance are just some of the more familiar forms of relief available to disappointed promisees. Yet whether, and to what extent, promisees (or even courts) may choose among these conventional alternatives, as opposed to having the legally apposite remedy dictated to them by extant circumstances, are contested and unsettled questions. One remedial election, however, is unquestioned by observers. Aggrieved parties in appropriate circumstances may (1) "affirm" their contracts and seek money damages or specific performance on the contract or (2) "disaffirm" their contracts with the off-contract remedy of rescission followed by restitution. This fundamental choice, long part of the common law tradition, is doctrinal orthodoxy.

In the prototypical case, a buyer pays up-front for goods that are never delivered. Near-universal consensus holds that the buyer may elect to affirm the contract and receive an on-contract remedy or disaffirm the contract, which rescinds or, more sensationally, "annihilates the contract," after which the court "puts the parties in the same position as if [the contract] had never existed." (1) To put the parties in the same position as if the contract had never existed, the so-called status quo ante, it is necessary to restore the payment to the buyer; this restoration is achieved through an action in restitution. (2) Had the seller delivered goods that did not conform to the contract, so delivery was nonetheless a breach, then restitution to the seller in specie or in an amount equivalent to the reasonable value of the seller's nonconforming performance would apply as well. (3) As this last example reveals, the right to elect rescission and restitution is not limited to the prototypical case in which the breaching party wholly fails to perform.

Any breach of a sufficient degree by one party is enough to trigger the other's right to disaffirm the contract. No one disputes this basic proposition, but controversy has always surrounded the matter of what exactly counts as sufficient. For centuries, too low a threshold, which would allow easy availability of rescission followed by restitution, has been a source of great anxiety among legal authorities, who see it as a threat to commercial order and other normative values. Responding to these fears, authorities have limited the ease with which rescission may be elected. Their approach is often excessive and based on misunderstandings of the remedy's effects. Taking the economic effects of the remedy as a basis for its argument, this Article makes a case for a more liberal right of rescission followed by restitution.

The argument is relatively straightforward. First, foreseeing the possibility of rescission by counterparties, promisors will invest to enhance the quality of performance, thereby reducing the likelihood that the rescission right is triggered. Second, promisors can also make rescission less desirable for counterparties by reducing the price that they charge, implying a lower, less attractive remedy in restitution. Through its effect on quality and price, the option to rescind followed by restitution may be enlisted by parties to promote efficient contracting. The old concern about the stability of contracting, it must be conceded, is not entirely unfounded, but the problem is not primarily due to the ease with which parties are able to rescind following breach; rather, the problem lies with the remedy that follows rescission. Hence, the final point of our argument: the remedy in restitution following rescission should be limited to restoration of price or other conferred benefits to the promisor under the contract.

These points are elaborated in detail in the latter Parts of the Article, but first we provide more background and an intuitive sketch of the argument in Part I. The next task, a central one to the argument, is to address the role played by product quality in contract remedies. We briefly discuss how quality entered into contract law in Section II.A. We then show, in Section II.B, that integrating quality as a baseline for calculating expectation damages provides incentives for sellers to invest in the quality of their products. Section II.C goes on to demonstrate that the possibility of going off the contract facilitates the task of providing efficient incentives for investments in product quality. (4) Moreover, the availability of rescission followed by restitution can lead to redistribution from the seller to the buyer, which may have positive welfare effects when the seller has monopoly power. (5) We conclude Part II by considering suboptimal trade decisions, where promisees inefficiently return goods, and wasteful strategic expenditures as a consequence of the availability of rescission. (6) Part III addresses some implications of our findings for modern reforms and reform proposals, which appear to take the exact opposite of this Article's stance in favor of liberal rescission rights followed by limited remedies. Reformers seem to embrace restricting access to rescission, while at times allowing for generous ensuing remedies. We show that it is this position, ironically, that poses the real threat to contractual stability.

1. BACKGROUND AND SKETCH OF ARGUMENT

   Availing the right to rescind and recover price was a common occurrence in the historic markets of Rome. As market magistrates, the curule aediles allowed the victim of nonconforming performance to choose freely between actio redhibitoria (rescission and restitution) and actio quanti minoris (acceptance and apportionment). (7) From this liberal beginning, the impulse of subsequent legal convention, against which this Article provides analytical counterweight, has been to limit the ease with which rescission may be elected. Early civil law jurisprudence, influenced by medieval moral theology, (8) restricted the right of rescission to cases where the defect in the seller's performance, had it been known to the buyer at the time of contracting, would have led the buyer to abstain from entering into the contract in the first place. (9) Common law's developed practice also hewed tightly to stringent requirements before granting promisees the right to elect rescission, particularly in English courts. American courts were exceptional, as Samuel Williston observed: "In the United States the law is more liberal." (10) That was his view of late nineteenth-century U.S. courts, and since then the doctrine has only become more liberal.

   Too liberal, some argue. (11) Although not as permissive as the aediles, American courts have substantially weakened the old common law requirements for the right to elect rescission followed by restitution. Any nonconforming performance that amounts to a material breach triggers the right to elect between affirming and disaffirming the contract. (12) Figure 1 depicts the basic remedial regime following breach: on the one hand, when breach is not material, the right to rescind is not triggered and the promisee must find relief, if any is to be forthcoming, among conventional contract remedies like expectation damages, specific performance, and so on. On the other hand, when breach is material, rescission rights are triggered, giving the promisee a choice between (1) affirming the contract and looking to conventional contract remedies or (2) disaffirming and finding relief in the law of restitution.

   [FIGURE 1 OMITTED]

   Restitution steps in as the new legal basis for the promisor's obligation to provide relief as soon as the prior contractual obligation is disaffirmed. Students often gloss over this subtlety--mistakenly conceiving restitution as simply a contract remedy--but they can hardly be faulted for the oversight. Much of the confusion about rescission and restitution endures because contract law scholars have lost sight of the old and customary distinction between actions taken on and off the contract. Blurring the doctrinal distinction was no accident, (13) nor is the effect merely incidental or academic. The practical and theoretical implications are of great consequence. An option to pursue an off-contract remedy is immensely valuable in everyday legal practice; it is often an expedient bypass to the high costs of proving damages or enforcing specific performance on the contract. (14) The differences between actions on and off the contract are also theoretically compelling, though academics presently appear largely uninterested.

   Theorists tend to dismiss the important potential of disaffirming a contract, relegating its salience to practical convenience in the context of perverse cases. (15) Why, they ask, but for the costs of enforcement on the contract, would an injured party ever choose off-contract restoration of price instead of seeking expectation damages on the contract? Expectation damages, after all, give the promisee the "benefit of the bargain"--the value that would have been realized had breach not occurred, which is ordinarily greater than the contract price. (16) Only in those odd cases where realized value of performance is less than price--that is, in losing contracts--is the option to rescind and pursue restitution preferable to expectation...