Why Expectation Damages for Breach of Contract Must Be the Norm: a Refutation of the Fuller and Perdue "three Interests" Thesis

• Publication year: 2021

81 Nebraska L. Rev. 839. Why Expectation Damages for Breach of Contract Must Be the Norm: A Refutation of the Fuller and Perdue "Three Interests" Thesis

839

W. David Slawson(fn*)

Why Expectation Damages for Breach of Contract Must Be the Norm: A Refutation of the Fuller and Perdue "Three Interests" Thesis

TABLE OF CONTENTS

I. Introduction ... .......................................... 840
II. The Principal Institutions in a Modern Market
Economy in Which Contracts Are Used ....................... 843
A. The Institution of the Economic Market:
Contracts as Bargains .................................. 843
B. The Institution of Credit and Finance:
Contracts as Property .................................. 845
III. Meeting the Institutions' Needs ........................... 846
A. Providing a Remedy for Every Breach .................... 846
B. Making Contracts Enforceable as Soon as
They Are Made .......................................... 847
C. Compensating the Injured Party for What
He Has Lost ............................................ 848
1. Damages Under the Expectation Measure ............... 848
2. Damages Under the Reliance Measure .................. 849
a. The Shortfall .................................... 849
b. Attempts to Prove this Shortfall Is Unimportant
or Does Not Exist ................................ 850
3. Damages Under the Restitution Measure ............... 852
a. The Restitution Measure in Theory ................ 852
b. The Restitution Measure in Practice .............. 853
c. A Suggestion for Reducing the Unfairness
and Arbitrariness of the Restitution
Measure in Practice .............................. 854
D. Providing the Right Incentives for Decisions
Whether to Breach ...................................... 855
E. The Legitimate Uses of the Restitution and
Reliance Measures in Contract Law ...................... 856

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IV. The "Three Interests" Thesis of Fuller and Perdue ......... 857
A. Ignoring Context ....................................... 858
B. Using an Inappropriate Concept of Justice .............. 858
C. Describing the Institutional Approach as Circular ...... 859
D. Asserting that Contracts Have Present Value
Only Because the Law Enforces Them ..................... 860
E. Identifying the General Enforceability of Promises
as the Legal Basis for the Credit System ............... 861
F. Asserting that Expectation Damages Are Generally
Easier to Prove than Reliance Damages .................. 861
V. Conclusion ................................................ 862

Appendix: Excerpts from L.L. Fuller and William R. Perdue, Jr.,
The Reliance Interest in Contract Damages: 1 ......... 863

I. INTRODUCTION

Contract law uses three measures of damages. The expectation measure puts the injured party in as good a position as if the contract had been performed (i.e., not breached).(fn1) The reliance measure puts the injured party in as good a position as if the contract had not been made.(fn2) The restitution measure restores to the injured party any benefit the breaching party obtained from his breach at the injured party's expense.(fn3)

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Although the expectation measure has always been the norm,(fn4) Lon L. Fuller and William R. Perdue, Jr. famously questioned its primarystatus in an article that appeared in 1936.(fn5) They began by asserting that each of the measures compensates the injured party for the loss of an associated "interest" in the contract the expectation measure compensates for the loss of the "expectation interest," the reliance measure compensates for the loss of the "reliance interest," etc. They then ranked these "interests" in what they considered to be the order of their importance, putting the restitution interest first and the expectation interest last:

It is obvious that the three "interests" we have distinguished do not present equal claims to judicial intervention. . . . The "restitution interest," involving acombination of unjust impoverishment with unjust gain, presents the strong est case for relief. If, following Aristotle, we regard the purpose of justice as the maintenance of an equilibrium of goods among members of society, the restitution interest presents twice as strong a claim to judicial intervention as the reliance interest, since if A not only causes B to lose one unit but appropri

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ates that unit to himself, the resulting discrepancy between A and B is not one unit but two.

On the other hand, the promisee who has actually relied on the promise, even though he may not thereby have enriched the promisor, certainly presents a more pressing case for relief than the promisee who merely demands satisfaction for his disappointment in not getting what was promised him. In passing from compensation for change of position to compensation for loss of expectancy we pass, to use Aristotle's terms again, from the realm of corrective justice to that of distributive justice. The law no longer seeks merely to heal a disturbed status quo, but to bring into being a new situation. It ceases to act defensively or restoratively, and assumed [sic] a more active role. With the transition, the justification for legal relief loses its self-evident quality. It is as a matter of fact no easy thing to explain why the normal rule of contract recovery should be that which measures damages by the value of the promised performance.(fn6)

After thus concluding that "it is . . . no easy thing" to explain why the expectation measure is the norm, they went on to explore what the reason or reasons might be. They eventually concluded that although there were no good reasons for protecting the expectation interest,(fn7) there was a good reason for using the expectation measure of damages as the norm: because, they claimed, it generally results in the same recovery as the reliance measure would and is easier to prove.(fn8)

The Fuller and Perdue article and its "three interests thesis" has had an immense scholarly and academic influence in the United States. Richard Craswell cited over sixty publications treating the three interests thesis in his article on the subject published in 2000.(fn9) A recent Lexis search of the "Law Reviews, Combined" database revealed twenty-six citations to the article within the last two years.(fn10) The effect of the article has been to throw the question of the proper measure of damages into doubt. Although it has been convincingly shown that the article's conclusion is incorrect that the expectation measure generally results in the same recovery as the reliance measure would(fn11) so that the article's further conclusion that the expectation measure generally makes a good surrogate for the reliance measure is wrong, no one has yet come up with any other generally accepted reason or reasons for the expectation measure being the norm. The Restatement (Second) of Contracts states the three interests thesis almost verbatim as Fuller and Perdue stated it and offers

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no reasons for preferring any one of the measures over the other two.(fn12) No hornbook, treatise or casebook in print offers any such reasons either, and nearly all of them mention the Fuller and Perdue article and comment upon it favorably.(fn13)

Despite its immense scholarly and academic influence, however, the article and its thesis have had no discernible effect on the law. The expectation measure continues to be the norm,(fn14) and even in the situations for which the contracts restatements have explicitly suggested a flexible approach to damages, the courts continue to use the expectation measure almost exclusively of the other two.(fn15)

As demonstrated below, the courts have rightfully used the expectation measure to the near exclusion of the other two measures. Toward that end, Part II of this Article sets forth the principal institutions in a modern market economy in which contracts are used. Part III refutes the Fuller and Perdue three interests thesis by explaining how the expectation measure meets the needs of these principal institutions in four crucial respects, while showing that neither of the other measures meets these needs in even one such respect. Part IV exposes further endemic weaknesses in the three interests thesis. Part V concludes by showing that the three interests thesis is too flawed to be of use for comparing the merits of the three damages measures.

II. THE PRINCIPAL INSTITUTIONS IN A MODERN MARKET ECONOMY IN WHICH CONTRACTS ARE USED

Almost every purchase and sale in a modern market economy involves a contract, even if the contract sometimes only consists of implied warranties. (By a "market economy" I mean an economy in which the dominant means of doing business is for sellers to compete with one another in largely unregulated markets.) I will deem a purchase and sale to have occurred in an economic market if the purchaser had a choice of whom to purchase from, because the availability of such a choice is the essential condition for the existence of competition. A purchaser nearly always has such a choice in a modern market economy. The economic market is one of the two principal institutions in which contracts are used.

The other is the institution of credit and finance. Contracts in this context are the things which are bought and sold as well as the usual means of buying and selling them. Stocks and bonds are contracts, for example. Although there are numerous kinds of contracts that are not typically used in either of these institutions, these two are so important to the functioning of a modern market economy that if contracts did not meet their needs, the economy could not function.

A. The Institution of the Economic Market: Contracts as Bargains

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Every developed country in the world has a market economy. The few socialist economies still left are in or near collapse. Economic...