Why breach of contract may not be immoral given the incompleteness of contracts.

• Author: Shavell, Steven

There is a widely held view that breach of contract is immoral. I suggest here that breach may often be seen as moral, once one appreciates that contracts are incompletely detailed agreements and that breach may be committed in problematic contingencies that were not explicitly addressed by the governing contracts. In other words, it is a mistake generally to treat a breach as a violation of a promise that was intended to corer the particular contingency that eventuated.

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There is a widely held view that breach of contract is immoral. (1) Yet it is manifest that legal systems ordinarily do allow breach--the law usually permits breach if the offending party pays damages (2)--and it is a commonplace that breach occurs. Thus, a tension exists between the felt sense that wrong has been done when contracts are broken and the actual operation of the law. This opposition has long been remarked by commentators. (3)

Recently I wrote on the question of when breach of contract should be considered immoral. (4) My primary point was that breach may often be seen as moral once one appreciates that contracts are incompletely detailed agreements and that breach may be committed in problematic contingencies that were not explicitly addressed by the governing contracts. In other words, because of contractual incompleteness, it is a mistake generally to treat a breach as a violation of a promise that was intended to cover the particular contingency that eventuated.

Seana Shiffrin has critically examined my analysis of the immorality of breach in her symposium contribution. (5) I here want to respond to her--mainly to disagree, but partly to agree. I will first review my prior argument and then will comment on Shiffrin.

1. SUMMARY OF THE ARGUMENT THAT BREACH MAY NOT BE IMMORAL GIVEN THE INCOMPLETENESS OF CONTRACTS (6)

   1. Definition of Moral Behavior in a Contingency (7)

      To discuss the immorality of breach, one must, of course, state what constitutes moral behavior in the contractual context. I make two simple definitional assumptions. First, I presume that if a contract provides explicitly for a contingency, then the moral duty to perform in that contingency is governed by the contract. Second, I suppose that if a contract is incomplete in the sense that it does not provide explicitly for a contingency, then the moral duty to perform in the contingency is governed by what a completely detailed contract addressing the contingency would have stipulated, assuming that the parties know what this hypothetical contract would have stated. (8)

      Consider, for example, a contract concerning the clearing of snow from a person's driveway and the contingency that the seller's snow clearing equipment is stolen. (9) Suppose that the contract specifies that if such a theft occurs, the seller still has an obligation to clear snow (perhaps because he can readily rent snow clearing equipment). Then the seller is assumed to have a moral duty to clear snow even if his equipment is stolen. However, if the contract mentions the possibility of theft and says that in that event the seller does not have to clear snow (perhaps because it would be very difficult to rent substitute equipment on the spot), then the seller would not have a moral duty to perform should his equipment be stolen. And, if the contract does not mention the contingency of theft explicitly, the seller's obligation to clear snow in that circumstance would be determined by what a hypothetical complete contract would have said, assuming that the parties know its nature.

      The appeal of the foregoing definition of moral obligation derives from the observation that a contract that provides explicitly for a contingency is similar to a promise that provides explicitly for a contingency, and that there are well known grounds for finding that individuals have moral obligations to keep such promises. (10) I will return to the subject of the appeal of my definition of moral obligation in the contractual domain in Part II. For the remainder of this Part, I put that matter to the side and develop the implications of my definition.

   2. The Observed Incompleteness of Contracts

      That the definition of moral obligation applies when contracts do not explicitly mention the contingency that arose is important because this may well be the state of affairs. We see that in reality contracts are far from completely detailed. Although a contract for removing snow from a person's driveway might mention a number of conditions, for instance whether clearing is to be done on Christmas day, it will typically omit a practically endless number of events that could matter to the seller--theft of his snow-clearing equipment, illness of his crew, snow so deep that it makes roads impassable--or to the buyer--unexpected travel out of town over the winter, sale of her home, inheritance of snow clearing equipment.

      It is true that contracts will often provide implicitly for many, and perhaps all, contingencies. "Suppose that a contract states that 'snow is to be cleared from the buyer's driveway if the snow is over five inches deep,' and that the contract mentions no other conditions." (11) This contract implicitly covers the contingency of theft because "in a formal sense the contract covers all contingencies: it divides them into two general categories, those in which the snow is up to five inches deep (whatever else happens), and those in which the snow is over five inches deep (whatever else happens)." But because the contract does not mention theft explicitly, I consider the contract to be incomplete as to that contingency.

      Why are contracts substantially incomplete in that they omit explicit mention of numerous contingencies? Most obviously, it is because time is needed to discuss and to include contingent provisions in contracts. If a contingency like theft of snow clearing equipment is sufficiently unlikely, the probability-discounted benefit of providing for it in the contract will be low and will be outweighed by the cost of the time that would be spent to do so. Other significant reasons for contractual incompleteness are that a contingency (such as whether a person had a stomachache) might be hard for a court to verify, which would make a clause depending on its occurrence unworkable; that parties might be able to renegotiate if a problematic circumstance arises; and that parties might be able to commit breach and pay damages if a difficulty arises. In all, then, the existence of significant contractual incompleteness is not surprising.

   3. The Morality of Breach When Contracts Are Incomplete

      Given the importance of incompleteness of contracts, we know that questions about the morality of breach will often concern situations in which the contingency that occurred was not specifically mentioned in the contract. If a snow clearing company breaches its contract to clear my driveway when its equipment was stolen but the contract did not explicitly address that contingency, we cannot assess the morality of the breach by pretending that the contract did address the contingency (in which case the breach would be immoral by hypothesis). We must engage in further inquiry. To determine whether the breach was moral under my definition, we have to ascertain "whether performance would ... have been required had the contingency been expressly addressed" in the contract, that is, we need to understand the character of hypothetical complete contracts. (12)

   4. The Nature of Obligations to Perform in Hypothetical Completely Detailed Contracts

      We can deduce a very important characteristic about the nature of a hypothetical complete contract agreed upon by rational parties. Namely, performance will be required in a "contingency if and only if the cost [of performance to the seller] ... would be less than the value of performance to the buyer." (13)

      The logic leading to this conclusion is that if the contract were otherwise, it could always be altered in a way that both parties would prefer--hence they would never settle on a contract unless it were of the claimed type. To illustrate, suppose in our snow clearing example that the buyer and the seller consider a contract that calls for performance in a contingency in which the cost of performance to the seller would be $300 and would exceed the value to the buyer of $100. Thus the contemplated contract is...