The disgorgement interest in contract law.

• Author: Eisenberg, Melvin A.

Restatement Second of Contracts provided that contract law serves to protect one or more of three interests: the expectation interest, the reliance interest, and the restitution interest. There is, however, a fourth interest that contract law should and does protect: the disgorgement interest, which is the promisee's interest in requiring the promisor to disgorge a gain that was made possible by the promisor's breach, but did not consist of a benefit conferred on the promisor by the promisee. It is not clear why Restatement Second excluded the disgorgement interest. Perhaps the drafters believed that this position was compelled by positive law. That proposition, however, would have been doubtful even when Restatement Second was published, and it is clearly wrong today: some appellate cases, and a handful of trial court cases, have denied protection to the disgorgement interest, but a dozen or so American appellate cases, as well as cases decided by the highest courts of several other common law jurisdictions, have afforded such protection. Alternatively, the drafters of Restatement Second may have believed that the disgorgement interest should not be protected as a normative matter. That proposition also cannot be supported. On the contrary, there are strong efficiency reasons, as well as moral reasons, for protecting the disgorgement interest, because in certain categories of cases, protection of that interest in contract law is necessary to provide efficient incentives to the promisor, to effectuate contracts, or to prevent unjust enrichment. Of course, the disgorgement interest should not be protected in all cases in which a promise is legally enforceable, any more than the reliance interest, the restitution interest, or, for that matter, the expectation interest are protected in all cases. Rather, as in the case of those interests, the disgorgement interest should be protected when appropriate, and in certain categories of cases protection of the disgorgement interest is always appropriate.

TABLE OF CONTENTS INTRODUCTION I. THE DISGORGEMENT INTEREST OUTSIDE CONTRACT LAW II. THE PUZZLE OF RESTATEMENT SECOND A. Positive-Law Considerations B. The Causation Arguments C. The Theory of Efficient Breach D. The Efficiency of Expectation Damages III. WHY CONTRACT LAW SHOULD AND DOES PROTECT THE DISGORGEMENT INTEREST A. The General Argument B. Cases in which the Promisee Has Bargained for the Promisor's Gain from Breach C. Disgorgement in Lieu of Specific Performance D. Disgorgement as a Surrogate for Expectation Damages E. Bargains Designed to Serve Interests Other Than Profit-making F. Externalities G. Disgorgement of Costs Saved by Breach IV. WHY DON'T WE SEE MORE DISGORGEMENT IN CONTRACT LAW? V. THE PROBLEM OF APPORTIONMENT CONCLUSION INTRODUCTION

Restatement Second of Contracts section 344 famously provides that judicial remedies in contract law serve to protect one or more of three interests of a promisee:

(a) his "expectation interest," which is his interest in having the benefit of his bargain by being put in as good a position as he would have been in had the contract been performed,

(b) his "reliance interest," which is his interest in being reimbursed for loss caused by reliance on the contract by being put in as good a position as he would have been in had the contract not been made, or

(c) his "restitution interest," which is his interest in having restored to him any benefit that he has conferred on the other party. (1)

There is a striking omission from this list: the disgorgement interest, which is the promisee's interest in requiring the promisor to disgorge a gain that was made possible by her breach but did not consist of a benefit conferred on her by the promisee. (2)

The disgorgement interest is the mirror image of the expectation interest. As stated in section 344(a), the expectation interest is the promisee's interest in being put in as good a position as he would have been in if the contract had been performed. Accordingly, perfect expectation damages would make the promisee indifferent between receiving performance, on the one hand, and receiving damages, on the other. In contrast, as Robert Cooter and Thomas Ulen have pointed out, disgorgement places the promisor in the position that she would have been in had the contract had been performed. Accordingly, perfect disgorgement would make the promisor indifferent between performing, on the one hand, and paying damages, on the other:

When disgorgement is perfect, the injurer is indifferent between doing right, on the one hand, or doing wrong and paying disgorgement damages, on the other hand. Thus, perfect disgorgement is identical to perfect compensation, with the roles of injurer and victim reversed. The injurer achieves no gain from the wrongdoing net of perfect disgorgement damages, just as the victim suffers no harm from the injury net of perfectly compensatory damages. (3) The omission of the disgorgement interest in section 344 was plainly deliberate. For one thing, the section is written as an exclusive catalog. For another, shortly after publication of Restatement Second, Allen Farnsworth, the Reporter for much of the Restatement, including section 344, wrote a leading article entitled Your Loss or My Gain?, in which he argued on normative grounds against recognition of the disgorgement interest in contract law. (4) Furthermore, at the time Restatement Second was published, it was widely assumed by commentators that the disgorgement interest was not protected in contract law. For example, Dobbs's treatise on remedies states:

Writers recognize that there is no general rule allowing restitution of profits [for breach of contract], and plaintiffs seldom seek such restitution.... It is "commonly assumed" that the breacher is not liable for collateral benefits.... The assumptions and practices of the bar, the implications of exceptional cases and the commentary all justify the belief that there is, in practice, a rule against restitution of profits.... (5) In contrast, the thesis of this Article is that contract law should and does protect the disgorgement interest. The Article proceeds as follows: In Part I, after showing that the disgorgement interest is widely recognized outside contract law, I address the puzzle why Restatement Second nonetheless rejected that interest. Perhaps the Restatement position was based on the belief that this rejection was compelled by the case law. Alternatively, the Restatement position may have been based on the theory of efficient breach--which was endorsed in a Reporter's Note to the Chapter on Remedies--or other unspoken normative considerations. As I show in Part II, however, rejection of the disgorgement interest is not compelled by the case law; the theory of efficient breach cannot be sustained; and other normative arguments against recognition of the disgorgement interest in contract law are equally unpersuasive. In Part III, I develop categories of cases in which the disgorgement interest in contract law should be protected on the basis of normative considerations, and I discuss a number of cases which have done exactly that. In Part IV, I address the question, if contract law should and does protect the disgorgement interest, why don't we see more disgorgement cases than we do? Finally, in Part V, I consider whether and when a promisor's gain from breach should be apportioned between the promisor and the promisee.

1. THE DISGORGEMENT INTEREST OUTSIDE CONTRACT LAW

   Damages in private law are usually based on the loss that the plaintiff has suffered as a result of the defendant's wrong. Often, however, a plaintiff's recovery is measured not by his loss, but by the wrongdoer's gain. Cases involving the recovery of a wrongdoer's gain are of two types. In the first type, the plaintiff seeks to recover the value of a benefit the plaintiff conferred upon the wrongdoer. This type of recovery protects the interest that Restatement Second section 344 calls the restitution interest. In the second type, the plaintiff seeks to recover the value of a gain that resulted from or was made possible by the defendant's wrong, but did not consist of a benefit that the plaintiff conferred on the defendant. This type of recovery protects the disgorgement interest. (6)

   Disgorgement is an important remedy in various fields of law. For example, it is a central remedy in the law of fiduciary obligations. A fiduciary who wrongfully makes a personal gain through the use of his position, or of property or information that he holds through his position, must disgorge that gain to his beneficiary even if the beneficiary has suffered no loss from the wrong. This principle is exemplified in an illustration to Restatement Third of Agency:

   P, who owns a stable of horses, employs A to take care of them. While P is absent for a month, and without P's consent, A rents the horses [for his own personal gain] to persons who ride them. Although being ridden is beneficial to the horses, A is subject to liability to P for the amount A receives for the rentals). (7) A fiduciary is made liable for his gain in such cases partly because a person should not profit from his own wrong, partly because requiring disgorgement gives effect to the beneficiary's implicit expectations, and partly because disgorgement is an instrument of efficiency, since it shapes the conduct of fiduciaries to reflect the reasonable expectations of beneficiaries and provides fiduciaries with correct incentives. (8)

   Disgorgement is also commonly awarded where property interests are involved. For example, if Wrongdoer appropriates Owner's property, Wrongdoer is liable in conversion for Owner's loss. Normally, Owner's damages will be measured by the market price of the converted property at the time of conversion. However, if Wrongdoer later sells the property to a third person at a higher price, Owner can require Wrongdoer to disgorge that price instead of...