Virtue ethics and efficient breach.

• Author: Katz, Avery
• Position: 'Contract as Promise' at 30: The Future of Contract Theory

INTRODUCTION

contracts scholars have been arguing over the concept of "efficient breach" for over thirty years. The issues at stake in this argument are well known, yet the debate fails to subside. Supporters of efficient breach contend that allowing a promisor to escape the obligation to perform by paying a money substitute both increases the potential gain from contractual exchange, and corresponds to the arrangement that most contracting parties would have wanted. (1) Critics of the concept respond that allowing promisors to avoid performance without securing the promisee's formal ex post consent works an injustice in the individual case, and undermines the social practice of contracting more generally. (2)

These arguments are thoroughly familiar to anyone who teaches and writes about basic contract law, because they have been rehearsed again and again in the literature. (3) Indeed, the debate has proliferated in recent years. (4) Why do the leading writers in the discipline continue to revisit a debate in which the main positions have long been staked out? one possibility might be that they are contending for the hearts and minds of their students, who, each year, encounter the concept anew as they are introduced to the basic normative underpinnings of contract law. on this explanation, efficient breach remains a contested issue in contracts for the same reason that the fault principle remains a contested issue in torts; it is a locus for conflict between values that are inherently in tension, yet both deeply rooted in our political and moral culture, so that the issue will never go away. An alternate possibility, however, which I explore in this essay, is that the debate remains active because there are important normative concerns that have still not been adequately clarified by efficient breach's critics or addressed by its defenders.

The purpose of this essay is to suggest that the debate over efficient breach has focused on deontological concerns (specifically, whether contract breach is equivalent to promise-breaking, and whether promise-breaking in the contractual context is necessarily wrong) to the exclusion of aretaic ones (specifically, that failing to follow through on a contractual relationship is not conducive to virtuous character or to the maintenance of a flourishing community). It argues that the standard deontological objections to efficient breach do not substantially undermine its basic analysis, because they can generally be addressed by reinterpreting or revising the underlying contract so that paying a money substitute in lieu of specific performance is explicitly authorized. on such a reinterpretation, paying money when performance becomes inconvenient is neither a breach nor a wrong; it is just an alternate way of discharging one's contractual duties. (5) In this way, "efficient breach" (perhaps relabeled "efficient performance" or "efficient cancellation option" in the interest of more favorable marketing (6)) can easily be squared with deontological ethics.

The essay also suggests that the intuitive resistance that many people experience to the concept of efficient breach may be better explained by aretaic concerns--that is, by virtue ethics. The aretaic objection, unlike the deontological objection, cannot be disposed of by reinterpreting the promise so that paying money counts as performance rather than breach, because it is not fundamentally based on the morality of keeping promises. Rather, it is based on the morality of making promises in the first place. on this objection, a promise that can be satisfied with a cash substitute is a cheap and superficial one, and not the kind that we should valorize.

While the concept of efficient breach can be squared with deontological ethics, accordingly, it cannot be squared with virtue ethics unless one is prepared to argue that seeking efficiency is a virtue, or at least that it is not a vice. The balance of this essay elaborates on these various claims.

THE CONSENSUAL BASIS FOR EFFICIENT BREACH

The practical problem that motivates the efficient breach debate is that circumstances change over time and so contracting parties' plans often must change too, even if those plans have been made the subject of a promise. For example, a farmer may promise to sell crops, but the crops may fail. A company that sells ice blocks for purposes of refrigeration may find itself unable to obtain supplies at a sustainable price due to an unexpectedly warm winter. (7) A coal company may promise to restore a parcel of land to its original condition after strip mining, but the cost of restoration turns out to be prohibitively expensive. (8) A consumer may promise to buy a boat, but then suffer health or financial reverses that make it unattractive to go through with the deal. (9) In each of these cases there are social gains to be achieved--or losses to be avoided--by adjusting the parties' plans. (10)

In the law and economics literature, this problem has generally been addressed from an ex post perspective. on this perspective, the contract has been formed, uncertainty about costs and benefits have been resolved, the parties are deciding what to do next, and the options are performance or breach (assuming that changed circumstances do not rise to the level of an excuse). At this point, performance is efficient if (and only if) the benefits of performance to the promise exceed the costs to the promisor. (11) If, conversely, the costs of performance exceed the benefits, both parties can be made better off by canceling the performance and having the promisor compensate the disappointed promise by paying properly measured expectation damages. In this instance, the promisee is no worse off than if the promisor had specifically performed, and the promisor is better off (because paying damages is less costly than specifically performing). The resultant cost savings represent a net increase in social welfare. (12)

Presenting the issue from the ex post perspective might suggest that there is a conflict between economic efficiency and deontological justice, because the cost savings are apparently achieved at the expense of the promisee's rights. A stereotypical rights theorist would thus say that a promisor who breaches a contract in order to achieve a larger profit or avoid a larger loss has appropriated something that belongs to the promisee--the right to performance--and used it for his own personal ends. On this view, an efficient breacher is no better than a thief who steals and resells a car on the theory that he knows where to get a price that is higher than the owner's reservation value (that is, the maximum amount she would pay to retain the car). Both the thief and the breacher profit from converting something that is not their own, implying that any surplus thereby created is properly the entitlement of the rightholder (in the case of the car theft, the owner; and in the case of the broken contract, the promisee). (13)

But there is another way to look at the matter, an ex ante perspective that shifts our attention from the later point at which the parties are deciding whether to perform, to the earlier point where they are choosing to enter the contract and specifying their duties. At this initial point, the parties have the opportunity to decide who will hold the right to decide whether the promisor specifically performs. As a matter of principle if not of law, they could allocate that right to the promisee, by stipulating their advance consent to injunctive relief. (14) On the other hand, they could also allocate that right to the promisor by providing for an explicit option to pay, in lieu of specific performance, an amount of money representing the value of the promisee's expectation. One way to do this is through a liquidated damages clause; but if the parties do not or cannot agree on a liquidated amount, another method is to leave it up to a court or arbitrator after the fact.

This ex ante perspective prompts the question: When is it desirable to provide promisees with an option to buy their way out of a contractual promise at a court-determined price, and when is it not? The answer offered by the proponents of efficient breach is that providing such an option is typically value-increasing, and thus in the interest of both parties. From this answer it follows that the more efficient default rule in cases where the parties have left the matter silent is to imply the option. (15)

Here is a concrete example that illustrates the point: imagine a homeowner who wants her driveway repaved and is shopping for a contractor. The homeowner places some reservation value on the repaving work; this is the maximum she is willing to pay in order to have it done. Without loss of generality, suppose this reservation value equals $2000. It does not matter for our purposes whether the homeowner's reason for wanting a new driveway is commercial (i.e., it will increase the potential resale value of her home by $2000) or personal (it will be more pleasant to look at, and will make the driveway easier to shovel in winter). In either event, the homeowner does not wish to spend more than $2000 on the driveway; if the driveway were going to cost more than $2000, she would prefer to take the same amount of money and spend it on her next-best budget priority, for example her wine collection.

Suppose the homeowner looks in the Yellow Pages and finds three possible contractors. The first, which operates under the trade name of Reliable Contractors, promises to finish any job it undertakes, "no matter what." The second, Efficient Contractors, does not promise to finish any job it undertakes, but does promise to pay a sum equal to the customer's lost expectation interest if it does not finish. The third, Manhattan Contractors, does not promise to finish its jobs and does not even promise to pay the customer's lost expectation interest, but it does promise that it...