Legal uncertainty, economic efficiency, and the preliminary injunction doctrine.

AuthorBrooks, Richard R.W.

INTRODUCTION I. ARTICULATED STANDARDS FOR PRELIMINARY INJUNCTIONS A. Traditional Approaches B. The Error-Minimizing Leubsdorf-Posner Formulation C. Our Alternative Formulation II. MODEL AND ANALYSIS A. The Leubsdorf-Posner Formulation of the Traditional Balancing Rule B. If Preliminary Injunctions Were Never Available 1. Incentives when compensation is provided for nonobligatory performance 2. Incentives when there is no compensation for nonobligatory performance C. If Preliminary Injunctions Were Always Available 1. Incentives when compensation is provided for nonobligatory performance 2. Incentives when there is no compensation for nonobligatory performance D. Implications: An Asymmetry in Substantive Law III. WHICH RULE SHOULD BE EMPLOYED? A. Interim-Efficiency Rule B. Preliminary Injunction Liability Rule C. Error-Minimizing Rule in Practice CONCLUSION INTRODUCTION

In this Article, we consider preliminary injunctions from a radically different perspective than that articulated in judicial opinions and prior legal scholarship. By conventional accounts, when confronted with uncertain legal entitlements, courts should consider preliminary awards only if adequate compensatory remedies are unavailable. The trouble with this "compensatory" view is that it is unresponsive to the ex ante behavioral consequences of legal uncertainty. When rights are uncertain, parties appreciate the full benefits of their conduct, but they discount harm to others of this conduct by the likelihood that they possess a legal entitlement to so act. Hence, individual incentives to behave efficiently are distorted by uncertain legal entitlements. Preliminary injunctions correct this distortion by wielding a stick and providing a carrot for a defendant who would otherwise discount damages given some positive probability that she may not have to pay them. The powerful stick in this example is the in terrorem damages that defendant will be required to pay if an injunction is granted and she violates it. The carrot is the reimbursement of compliance costs if defendant prevails at the end of the litigation. These penalties and rewards come into play only if the plaintiff decides to pursue the injunction, which is to say that the preliminary injunction doctrine takes the conduct decision out of the hands of the biased defendant and places it in the hands of plaintiff who, by design, faces the proper marginal costs and benefits of the decision. Interestingly, although courts do not claim that they are promoting efficient behavior when granting preliminary injunctions, that characterization represents a good account for much of what courts are doing.

Preliminary injunctions are broadly used. Parties seek injunctions to enjoin patent, copyright, and trademark infringement, (1) corporate mergers, (2) breaches of contract, (3) nuisances, (4) marriages, (5) entertainment, (6) and even manner of dress. (7) In fact, almost any activity one can imagine is potentially subject to legal restraint through preliminary proceedings. (8) However, remarkably little attention has been paid to whether these proceedings tend to promote or discourage desirable activities. The neglect of this issue among law and economics scholars is particularly difficult to explain. (9) The doctrine specifying when a court will grant a preliminary injunction is cast in terms with obvious economic content. The preliminary injunction is only to be granted if plaintiff will suffer significant harm and stands to recover inadequate damages if she prevails at the conclusion of the case. Moreover, the right to a preliminary injunction depends in large part (under all versions of the controlling rule) on the probability that plaintiff will prevail if the case is litigated to a conclusion. These requirements seem, unmistakably, to represent an attempt to adapt efficiently to the uncertainty of the final outcome. In commonsense terms, there is a prevailing awareness that the requisite tasks to achieve the objectives of the controlling legal rule cannot be deferred until the conclusion of the litigation.

Preliminary injunction doctrine recognizes that the task of protecting legal entitlements cannot be postponed until the conclusion of the litigation concerning the assignment of those entitlements. This fact is at odds with the usual law and economics understanding that the assignment and protection of entitlements can be separated and handled sequentially so long as damages at the conclusion of the case are adequate. (10) Accordingly, proponents of the current preliminary injunction doctrine cite the oft-mentioned claim that adequate damages at the conclusion of the case make the entitlement holder whole while encouraging efficient allocation of resources. The most prominent expression of this claim is the so-called "efficient breach hypothesis." (11) This hypothesis maintains that court-ordered expectation damages (a liability rule) lead parties to maintain or abandon prior agreements efficiently. Although this argument was initially focused on contracts, similar efficiency-based arguments have also been made to promote the use of liability rules within the context of tort, property, corporate, and constitutional law. (12)

The basic idea is that if a party is required to compensate anyone harmed by particular conduct, the party, in deciding whether, and with what frequency, to engage in the conduct, will internalize the costs imposed on others and engage in the conduct only to the point at which the benefits of doing so exceed the aggregate costs. Liability rules encourage parties to weigh the costs of avoiding liability--through performance (e.g., completing a contract) or nonperformance (e.g., not causing a nuisance or otherwise interfering with another's entitlement)--against the costs of facing liability (e.g., breaching the contract and paying the damage remedy or causing a nuisance and paying compensation). Thus, when properly employed, the liability rule remedy, we are constantly reminded, maximizes social welfare. The starting point of our analysis is that such efficiency claims often are wrong.

When the assignment of entitlements (and, hence, liability for interference with entitlements) is uncertain, parties rationally discount harms when selecting their course of conduct. Uncertainty biases the estimates that are required under the efficient breach and other efficient "takings" hypotheses. This kind of uncertainty is virtually always present in preliminary proceedings. Yet leading commentators see "no occasion to grant immediate protection" when a "final judgment can remedy the plaintiff's injuries." (13) We show, however, that the availability of an adequate final remedy is not a sufficient justification for denying preliminary injunctions: adequate compensation at the conclusion of the case does not provide parties with sufficient incentive to engage in efficient conduct before and during the case. (14) This point has been obscured by the static treatment of preliminary injunctions in the existing academic literature. (15) However, it is clear that the preliminary injunctive proceeding is a dynamic process--a process that compels consideration of ex ante motivations and strategic behaviors. (16) Viewed from this light, preliminary injunction doctrine can clearly be seen as an adaptive response to the impairment of parties' incentives resulting from the uncertainty of entitlement assignments.

For concreteness, consider the following hypothetical involving a contract for the provision of a well-specified good by a seller to a buyer who has paid a fixed amount up front. (17) If we set the seller's cost to 70 and the buyer's value to 100, performance of the contract would increase social welfare by placing the good in the hands of the higher-valuing party (the buyer, in this case). The possibility of expectation damages makes it in the personal interest of the seller to do what is socially desirable. If she does not perform, the seller saves 70 in terms of performance costs but must pay 100 in the form of expectation damages to the buyer. The remedy thus aligns the seller's incentives with that which is socially desirable. However, this simple implication does not hold when liability is uncertain--a state of the world which, we again emphasize, is reasonably presumed in the context of preliminary injunction hearings.

Uncertainty over entitlements changes the efficient breach calculation. For example, imagine that the seller believes there is a 50% chance that her obligation to perform, under the prevailing circumstances, will be legally excused. Under these circumstances, she will not perform (though performance results in the most efficient result), even when expectation damages are perfectly estimated and fully compensatory. When deciding whether to perform, the seller still compares the expected cost of performance (70) to the expected damages for breaching. In this case, however, her expected damages are now 50, reflecting the expectation damages (100) discounted by the likelihood that the seller will not be held liable for breach (50%). (18) So the rational, risk-neutral seller will not perform even though she may be required to make the buyer whole ex post. This is not an efficient result. Liability rules generally (and expectation damages specifically) do not preserve parties' incentives to behave efficiently in the context of legal uncertainty (19)--the quintessential context of preliminary hearings. (20)

The preliminary injunction restores efficiency to liability rules by taking the breach decision out of the hands of the compromised seller. At the point where the seller announces that she is going to breach, the buyer (if she does nothing) expects a 50% chance of receiving 100 and nothing otherwise, leaving her with an expected value of 50. If, however, the buyer seeks a preliminary injunction, she will receive a value of 100 through performance, which...

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