You do have to keep your promises: a disgorgement theory of contract remedies.

Author:Thel, Steve
 
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ABSTRACT

Contract law is generally understood to require no more of a person who breaches a contract than to give the injured promisee the "benefit of the bargain." The law is thus assumed to permit a promise-breaker to keep any profit remaining from breach, after putting the victim in the position he would have been in had the promise been performed. This conventional description is radically wrong: across a wide range of circumstances, standard contract doctrines actually do require people to keep their promises, or to disgorge their entire profit from breach if they do not. Rather than protecting the expectation interest of injured promisees, therefore, the law of contract remedies is better characterized as enforcing "promisor expectation" or disgorgement, a regime that puts breaching promisors in the position they would have been in had they performed, even when that means overcompensating injured victims.

We offer two explanations for why we so often see "promisor expectation" remedies, even though contracting parties would prefer the remedy of perfect promisee expectation damages. First, promisor expectation is often much easier for courts to compute or implement than promisee-based remedies. Second, promisors themselves prefer to be subject to the promisor expectation regime because it allows them to commit credibly to perform their promises. Such commitments are valuable but cannot be sustained if the law awards damages that fall short of perfect promisee expectation, as it invariably does. By agreeing to a remedial scheme that makes it unprofitable or impossible for them to profit from breach, promisors can credibly commit to perform and thus realize a higher contract price ex ante. An "overcompensatory" remedy thus paradoxically serves the interests of promisors by providing them a valuable bonding mechanism.

TABLE OF CONTENTS INTRODUCTION I. THE ARGUMENT A. The Conventional Wisdom B. Prior Scholarship on Disgorgement . II. THE AVAILABILITY OF PROMISOR EXPECTATION REMEDIES IN CONTRACT LAW A. What's a Widget?--The Continuity of Promisor Expectation Remedies 1. Hypothetical Cover--Promisor Expectation When the Price of Performance Is Clear 2. Specific Performance--Promisor Expectation When the Price of Performance Is Not Clear a. The Ordinary Remedy b. Ancillary Equitable Remedies c. Negative Injunctions d. Efficient Breach 3. The Inadequacy Test Promisor Expectation in Between B. Promisor Expectation Elsewhere in Contract Law 1. The Exclusive Benefit Rule 2. Promisor Expectation by Characterization 3. Promisor Expectation Through Rescission C. Innocent Breach--When Promisors Can Keep the Expenses They Avoid by Breach III. EXPLAINING PROMISOR EXPECTATION A. Promisor Expectation as a Simple Remedy B. Promisor Expectation as a Promisor Bonding Mechanism 1. The Example of Fiduciary Duties 2. Bonding in Ordinary Contractual Settings CONCLUSION APPENDIX: A COMPARISON OF UNDERCOMPENSATORY- EXPECTATION AND DISGORGEMENT RULES INTRODUCTION

"The only universal consequence of a legally binding promise is, that the law makes the promisor pay damages if the promised event does not come to pass. In every case it leaves him free from interference until the time for fulfillment has gone by, and therefore free to break his contract if he chooses."

--O.W. Holmes, Jr., The Common Law, 301 (1881)

"It is no reason for not enforcing a contract that the defendant can make ... more money by avoiding his agreement than by carrying it out."

--Roberts v. City of Cambridge, 49 N.E. 84, 84 (Mass. 1898)

Suppose that Jack promises Jill to deliver a pail of water in one week for a price of $10, payable on delivery. Jill values the pail of water at $12. Before the time for delivery arrives, though, Mr. X offers Jack $17 for the pail of water. Jack has only one pail, so he decides to breach his contract with Jill and sell the water to Mr. X instead. What happens next?

According to the conventional wisdom represented by the quotation from Holmes in the epigraph, if Jill, the injured promisee, sues Jack, the promisor, for breach, she can recover her expectation interest--the "benefit of the bargain"--which in this case is the $2 surplus she would have had if Jack had performed and she had paid him the contract price. Jack, meanwhile, has received $17 from Mr. X. Even after paying the damages he owes Jill, Jack is still $5 better-off than he would have been if he had kept his promise to her. That extra $5 is his to keep, because the law of contract remedies supposedly requires only that he fully compensate Jill for her losses, leaving her with no claim to anything beyond that amount.

In a nutshell, our thesis is that this description of contract remedies, although universally accepted by scholars, is radically wrong. The second quotation in the epigraph has it right: across a wide range of circumstances, standard contract doctrines do in fact require Jack to surrender the entire extra $5 profit from breach.

Therefore, the law of contract remedies is better characterized as enforcing "promisor expectation" (rather than promisee expectation), a regime that puts breaching promisors such as Jack in the position they would have been in had they performed, even when that means "overcompensating" injured promisees. Putting the breaching promisor in the position he would have been in had he performed the contract can usually be succinctly described by saying that the promisor has to disgorge his profits from breach to the promisee, and we will use "disgorgement" and "promisor expectation" as synonyms in what follows.

In this Article, we show why contract remedies as actually implemented by courts do entail promisor expectation/disgorgement, and then offer a normative defense of these rules. Before getting there, however, we set forth three implications of our findings.

The first implication concerns the relationship between economic and philosophical approaches to contract. The former, pioneered by Holmes--and in modern times exemplified by Judge Richard Posner (1)--understands contracts as options that entitle the promisor to perform or pay damages, as he chooses. The latter--represented, for example, by Charles Fried (2) or Seana Shiffrin, (3) and arguably supported by recent psychological research (4)--sees contracts as promises that promisors are morally obligated to keep. Our view is that the conflict between these two perspectives is largely beside the point. It is widely understood that, in practice, ordinary expectation damages are unavoidably undercompensatory, meaning that Jack would pay Jill less than the full $2 that would compensate her for the injury he caused. (5) In the light of this fact, the economists have it wrong: exercising the option to breach does not compensate the injured promisee and in fact is usually not permitted. At the same time, the philosophers also have it wrong: although bargained-for promises are in fact binding, it is not because of the moral force of the promise. Rather, promisors, operating in the shadow of the existing remedial regime, affirmatively choose to be bound because it raises the value of the contract to them.

The second implication relates to the role, if any, of the promisor's motive in breaching a contract. The conventional wisdom is that contract remedies are designed to compensate injured victims, which seems to leave courts no scope to consider the reasons for the injurer's behavior: it should not matter much to Jill whether Jack deliberately sold her pail of water to someone else or accidentally fell down and spilled it while attempting delivery. And yet the cases are full of references to "willful breach," and courts routinely suggest that they are augmenting damages because a promisor breached deliberately. (6) Our theory resolves this tension, based on the role of promisor expectation as a bonding mechanism that allows promisors to commit credibly to performance in settings in which they could not otherwise make such assurances. The promisor's motives for breach may be of no consequence to an injured promisee, but they are quite relevant to the question of whether the parties would have been willing to permit the breach when they entered their agreement. The award of disgorgement when a breach is "willful" binds promisors to perform precisely when performance is appropriate.

Finally, consider the controversy over "efficient breach." (7) Proponents of efficient breach theory point out that perfect expectation damages permit a breaching promisor to keep any surplus left over after he has compensated the injured promisee, (8) The existence of such a surplus is precisely the necessary and sufficient condition for a breach to be efficient--meaning that at least one party gains and no one loses. (9) Critics of efficient breach typically argue that the promisor's surplus is morally not his to keep, (10) but that argument is hard to reconcile with the existence of the traditional expectation damages rule. We suggest that efficient breaches in which the promisor keeps the surplus from breach are, in practice, very rare, precisely because the conventional expectation damages rule applies only in limited circumstances. (11) The efficient breach controversy is thus largely a red herring.

  1. THE ARGUMENT

    1. The Conventional Wisdom

      Contract law is usually thought to be concerned with compensating the interests of injured promisees, not with punishing breaching promisors or with preventing breaches. (12) One of the first contract principles law students learn is that "[t]he purpose of the law is to 'put the plaintiff in as good a position as he would have been in had the defendant kept his contract.'" (13) Contract remedies are usually both defined and evaluated in terms of how they compensate promisees for their losses. The Restatement of Contracts, following Lon Fuller and William Perdue, (14) introduces its treatment of contract remedies with the axiom that the purpose of contract...

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