- •CONTENTS
- •CONTRIBUTORS
- •PREFACE
- •Introduction
- •I. A Positive Account
- •II. Normative and Historical Accounts
- •III. Explaining Legal Doctrine
- •A. Willful Breach
- •B. Comparative Fault
- •Conclusion
- •ACKNOWLEDGMENT
- •Introduction
- •C. Summary
- •Conclusion
- •Introduction
- •B. Some Striking Nuances in Common Law Systems
- •II. A Market Function Approach
- •A. Ethics or Economics – The Wrong Question
- •B. Party and Market Expectation as Guidelines
- •D. Fault, Foreseeability, and Other “Softeners” of Strict Liability
- •Conclusion
- •I. Fault and Uncertain Contractual Intent
- •II. An Expanded Law and Economics Approach to Fault
- •III. A Fault-Based Approach to Contract Damages
- •Conclusion
- •Introduction
- •A. A Model
- •B. Fault
- •C. A Comparison: Strict Liability Versus Negligence
- •II. Doctrine
- •A. Impossibility/Impracticability
- •B. Reasonable or Substantial Performance
- •C. Good Faith and Best Efforts
- •D. Interpretation/Implied Terms
- •E. Conditions
- •F. Damages
- •Introduction
- •I. Unconscionability
- •A. Markets
- •B. Moral Fault
- •II. Unexpected Circumstances
- •III. Interpretation
- •IV. Mistake
- •C. Cases in Which the Nonmistaken Party Neither Knew nor Had Reason to Know of the Mechanical Error
- •V. Nonperformance
- •Conclusion
- •Introduction
- •I. Modernizing Tort and Contract Around Fault
- •II. Explaining the Fault Swap
- •Conclusion
- •Introduction: From Fault to Negligence – and Back
- •I. Tort Law
- •III. Gratuitous Transactions: Bailment and Agency
- •A. Coggs v. Bernard
- •C. Siegel v. Spear and Comfort v. McGorkle
- •D. Medical Malpractice, Occupier’s Liability, and Guest Statutes
- •IV. Frustration and Impossibility
- •Conclusion
- •Conclusion
- •A. Analogies in Criminal Law
- •B. Lay Assessments of Culpability
- •C. Two Ways of Defining “Willful”
- •B. “Willful” as a Test for Inefficiency?
- •B. Optimal Damages Under Strict Liability
- •Conclusion
- •II. Cost of Correction Versus Diminution in Value
- •B. Treatment by the Courts
- •Conclusion
- •Introduction
- •C. An Information-Based Explanation
- •B. Informal Lessons from the Example
- •D. From Moral Hazard to Adverse Selection
- •II. Willful Breach Doctrine
- •A. Overcompensatory Expectation Damages
- •B. Tort Damages for Bad-Faith Breach
- •C. Restitution
- •Conclusion
- •Introduction
- •I. Expectation Damages and Willful Breach
- •II. Willfulness, Material Breach, and Damages
- •Conclusion
- •Introduction
- •A. Noncooperation
- •B. Overreliance
- •A. Setting the Stage
- •B. Noncooperation
- •1. When Should Avoiding Overreliance be the Default Rule?
- •Conclusion
- •Introduction
- •I. Stipulation, Fault, and Mitigation
- •II. Encouraging Stipulation
- •A. How Courts Encourage Parties to Stipulate
- •B. Two Advantages of Stipulation: Knowledge and Mitigation
- •Conclusion
- •Introduction
- •II. Comparative Negligence
- •III. Mitigation
- •IV. Reasonable Reliance
- •V. Causation
- •VI. Foreseeability
- •Conclusion
- •I. Summary of the Argument that Breach May Not Be Immoral Given the Incompleteness of Contracts
- •F. When Is Breach Immoral and When Is It Moral in Practice?
- •II. Criticism and Discussion of the Foregoing Argument
- •Conclusion
- •Introduction
- •I. Promise De-moralized, Contract Moralized
- •II. Contract and Promise: More on the Relationship
- •IV. Harm, Fault, and Remedies for Breach
- •V. Fault and Institutional Harm
- •Conclusion: Toward a Moral Law of Contract
- •I. Breach as Moral Harm
- •III. Moral Norms as Default Rules
- •Conclusion
- •CASE INDEX
- •SUBJECT INDEX
How Fault Shapes Contract Law • 67
breach.21 It is therefore no surprise that one of the most famous statements of the strict liability view that the reason for breach of contract does not matter in determining damages, by Justice Holmes in Globe Refining Co. v. Landa Cotton Oil Co.,22 comes in a case involving market damages. The market damage measure incorporates two fault-based presumptions. The first is that when a promisor breaches after the market price changes to his disadvantage (a price increase for a seller, a price decrease for a buyer), that breach is presumed to be for the opportunistic purpose of taking advantage of the new market price. In response to that presumption, the market damage rule disgorges any profit that the promisor would earn from making a new contract with a different party at the new market price. In this sense, the market damage rule is a restitution rule, and serves to deter opportunistic breach. At the same time, the market damage rule presumes promisees can easily mitigate, by procuring a substitute contract, and encourages them to do so when such mitigation is efficient.
If these presumptions hold, then the market damages rule obviates the need for a court to make any fault determinations. It need not inquire into the promisor’s motives for breach or the reasonableness of the promisee’s mitigation efforts or lack thereof. The problem is that the presumptions may not hold. Promisees may not be able to mitigate, or promisors may be able to do so more easily. Moreover, if other economic variables change simultaneously with a change in the market price, such as an increase in the seller’s costs or a decrease in the buyer’s valuation, the breach may not be opportunistic, and the market damage measure may not create optimal incentives. In these cases, a role for fault resurfaces and courts, at least implicitly recognizing this fact, tend to create exceptions to the market damages rule. Thus, the market damages rule does not justify a strict liability approach to contract damages. Rather, it is part of the menu of contract damage rules from which courts choose depending on the circumstances, and including fault considerations.
Conclusion
I do not deny that strict liability captures an important part of contract law. Strict liability reflects contract law’s commitment to deterring promisor fault, and promisor opportunism in particular. Presuming promisor fault makes sense in a number of contexts, especially those in which promisors can easily
21See Cohen, Fault Lines, at 1316–48.
22190 U.S. 540, 544 (“If a contract is broken the measure of damages generally is the same, whatever the cause of the breach.”), 547 (“The motive for the breach commonly is immaterial in an action on the contract.”) (1903).
68 • George M. Cohen
procure substitute performance, such as sales of goods. But contracts and contract law encompass a much broader range of economic activity in which the presumption of promisor fault is less defensible or outweighed by other concerns, including promisee opportunism. In these cases, especially cases in which contractual intent is uncertain, economic theory supports a significant role for fault. Courts, whether guided by such theory or by a more intuitive sense of justice, on the whole share (or act as if they share) this view, which has, as a result, become embedded in contract doctrines like those concerning damages. Rather than continue to reach for some theoretically pure, yet impractical, unattainable, inefficient, and undesirable paradigm of strict liability, we should learn to live with, and improve, the contract law we have, with all its fault.
FIVE
Fault in Contract Law
Eric A. Posner
A promisor is strictly liable for breaching a contract, according to the standard account. However, a negligence-based system of contract law can be given an economic interpretation. This chapter shows that such a system is, in some respects, more attractive than the strict liability system. This may explain why negligence ideas continue to play a role in contract decisions, as a brief discussion of cases shows.
Introduction
Anglo-American contract law is said to be a strict liability system, but it could just as well be a fault-based system. Indeed, one can make a plausible case that a fault-based contract law would be superior to the strict liability system. A fault-based system would result in courts enforcing optimal contracts more systematically than they do currently – if courts could implement the system with sufficient accuracy. The disadvantage of such a system is that courts would need to make difficult inquiries and could make more errors. How the advantages and disadvantages balance out is hard to determine.
As many authors have noticed, although Anglo-American contract law is usually called a strict liability system, it does contain pockets of fault. Faultlike notions, such as good faith and best efforts, recur in the cases; and terms are often implied in order to ensure that obligations are reasonable rather than absolute. These doctrines reflect some of the advantages of the fault-based system, and strengthen the theoretical basis for the claim that fault ought to play a role in contract law.1
Th anks to Oren Bar-Gill, Omri Ben-Shahar, Richard Craswell, Daryl Levinson, Ariel Porat, Giesela Ruhl, Eyal Zamir, participants in a seminar at the European University Institute, and participants at the Conference on Fault in Contract Law, for their helpful comments.
1Cohen’s article is the most comprehensive discussion; however, he focuses on damages rules, which I will for the most part ignore. George M. Cohen, The Fault Lines in Contract Damages, 80 Va. L. Rev. 1225, 1237–9 (1994).
69
70 • Eric A. Posner
Th is chapter is divided into two parts. Part I lays out the case for a faultbased contract law. Part II shows ways in which this idea is reflected in doctrine – not in all doctrine, but in some cases and rules. In both parts, I limit my discussion to fault in the performance or breach decision: The question is whether the promisor’s breach may be excused because the breach was not his fault, or was not negligent. For the most part, I ignore negligent representation and other doctrines related to the decision to enter a contract in the first place.2 I also use a very simple model; a more complex model could well lead to different results.
I conclude that the case for strict liability for breach of contract is not particularly strong, and so we should not be surprised that so many pockets of fault-based liability exist in contract law.
I. Th eory
A. A Model
Consider a contract where Buyer values a good at V, Seller’s cost in producing the good is cH, with probability q (“bad state of the world”), and cL, with probability (1 – q) (“good state of the world”), where cH > V > cL. Buyer pays in advance a price, p, such that p just covers Seller’s expected costs. Prior to performance, Seller can incur some cost x; if Seller incurs this cost, q drops to 0; in other words, Seller can ensure that performance will be at the low cost. The contract is made at time 0; Buyer pays at time 1; Seller invests x or not at time 2; Seller’s cost of performance (c) is determined at time 3; and Seller performs or breaches at time 4. Damages (d), if any, are paid at time 5. Renegotiation is assumed to be impossible.
Th e conventional analysis of this setup in the literature is as follows.3 Performance is desirable if and only if the cost is low (the good state of the world), because V > cL and V < cH. The investment x is desirable if and only if x is less than the cost savings from reducing the probability of cH from q to 0.
2 On this, see id. at 1245–56.
3I use a simplified version of the model that has been developed in the literature. See Lucian Arye Bebchuk & I.P.L. Png, Damage Measures for Inadvertent Breach of Contract, 19 Int’l Rev. L. & Econ. 319 (1999); Robert Cooter, Unity in Tort, Contract, and Property: The Model of Precaution, 73 Cal. L. Rev. 1 (1985); Richard Craswell, Performance, Reliance, and One-sided Information, 18 J. Legal Stud. 365 (1989); Richard Craswell, Precontractual Investigation as an Optimal Precaution Problem, 17 J. Legal Stud. 401 (1988); Lewis A. Kornhauser, Reliance, Reputation and Breach of Contract, 26 J.L. & Econ. 691 (1983). These articles focus on the extent to which different damage measures provide the promisor with proper incentives to take precautions. With a few exceptions to be noted, they do not discuss whether a fault-based liability rule should be used.