Economic analysis of contract remedies: The Theory of Efficient breach of contract

Economic analysis of contractual compensation is amongst the topics, which have been paid attention by the legal and economic scholars. The root of such a serious attention is the conflict of various goals and philosophies of enactment of the contractual compensation rules. In an economic perspective, the objective of establishment of compensation rules is to compensate for the loss sustained by the injured party rather than to punish the party in breach. This approach will lead to optional performance of contract, i.e. a free choice between compensation and specific performance. The outcome of such an approach will be that any obligor in any contract may breach the contract and pay a compensation for it. Those believing in advantages of further stipulation of moral principles in the Contract Law however do not go with this view. Infringement of contract may take place for the purpose of making more profit or avoiding further loss. By studying the types of efficient breach of contract – even in a traditional view to the Contract Law – this logical conclusion can be reached that some types of infringement of contract are in no contradiction with the spirit of justice and moral principles. Founded on economic analysis, mere performance of contractual obligations is not considered as the subject of a contractual relation, but contractual obligations are considered subject to efficiency and utility. Therefore, the replacement for specific performance that is contractual compensation may be the subject of contract and a desirable one. 

Methodology of justification of the “Theory of Efficient Breach” is based on the laboratory method. The justification is carried out on the basis of some certain and evidentiary data, gathered through studies and reviews in relevant areas. It’s, however, obvious that stating a legal theory, without comprehensive knowledge of social phenomena is impossible. Therefore, for the purpose of this research, we kept our eyes on legal and economic phenomena, getting organized in front of us.

Microeconomics, reviews the responses and reactions of the economic players to various factors and motives, and thereby determines which factors will lead to profitable and gainful outcomes. This eventually and consequently enhances the social wealth. In this regard, and in the economic attitude, there is an approach, known as “homo economic us”, on the basis of which, economic players have a stable and orderly list of preferences, which they reasonably select in order to maximize profit, and determinedly seek their personal interests. This means it’s assumed that the individuals are wise, and act in a way that will result in reduction of costs and increment of profit. And in case of increment of costs, they select – from the available options –which will cost them less. Hence, “homo economic us” approach and a logical player won’t, in the economist pattern, let the personal feelings stop a wealth-making transaction. Therefore, no specific and strong interpretation is required for “rationality” for the purpose of justification of this essential prediction of economics, which is simply saying: “the more costly, risky and difficult an option, the less will such an option be picked”.One of the legal institutions, which distinguishably offers a suitable ground for application of economic analysis, with regard to occurrence of economic and profit-seeking aspects, is contract. In economic analysis of contract law, a variety of issues of the contracts are reviewed and studied, but one of the subjects, which strongly attracted the attention of thinkers of both legal and economic areas, is ‘contractual damages’. Maybe the reason for such attention can be traced back in the answer to the question that what is the goal and philosophy of the damages in the contract law essentially.Taking into consideration the principle of necessity, the main and initial goal of all legal systems in the area of contract law, is enforcement of contract. In other words, it can be said that by formulating the rules and regulations on compensations, the legislator aimed originally at codifying a guarantee for compliance with and enforcement of contracts. Thus, since the necessity principle of contracts and liabilities has, in all legal systems, been accepted as an obvious principle, it can be stated that the initial objective of guarantees is to prevent breaking the promises and to implement the provisions of the contracts. The second function of contractual damages is that in case of violation of the contract, the promisor should recompense the promise's loss, and place the promise in the situation as if the contract has been executed.Then, from a traditional point of view, the objective of formulation of contractual damages, is to punish the party who has violated the contract, in such a manner that the promisor will be obligated to perform the contractual liabilities, because according to the moral approach, contract is a moral promise, therefore, violation of a contract is considered as a moral fault. In this respect, formulation of contractual damages can hinder the breach of contract, which by nature is considered as a moral promise. On the other hand, based on the economic analysis of the law, which assumes the contract as a means to achieve economic efficiency and to promote the wealth, the aim of contractual damages, is to compensate the damages resulting from violation of the contract, rather than to obligate the promisor to perform his/her promise. Therefore, compensation as a remedy for loss is an adequate substitute for specific performance for the damaged party. So, generally either of the parties, having been fully sure of their net profit even after full compensation of the damages to the damaged party, may find withdrawal of the contract more profitable. On this basis, violation of contract might economically be profitable, and consequently encouraged by the law. Therefore, on the basis of economic analysis, whenever breach of contract can lead to more profit or to prevent further loss in comparison with keeping the promise, it should be supported and promoted by the contract law, because it’s to the satisfaction of both promise, whose loss has fully been compensated, and promisor, who’s gaining even more profit. But this thought is unjustifiable for and rejected by a moral approach, which considers the violation of contract as breaking a promise. Therefore, there is an evident incompatibility between moral-promissory and instrumental approaches towards the contract law with respect to breach of a contract.
 

One of the conflicts of instrumental and moral approaches in relation to the contract law is that whether economic efficiency should be considered as a sole or prevailing goal in the contract law or such other goals as morality and justice – as traditional goals of law – should still be observed? In other words, which one is more desirable for the parties to a contract? Concentration on efficiency as a desire and goal in the law, has been paid attention by legal thinkers, especially the economists, and is of thorough and adequate acceptability. As a shortcut, however, it might be better to stop the arguments over whether the objective of law, particularly the law of contracts, should mostly be founded on economic efficiency or otherwise such goals as morality, justice and fairness; and instead to accept that there is no agreement in this regard. The law may, at the same time, be at the service of both: it can use the resources efficiently and serve the morality and justice as well.In this research, it was intended, while studying the contractual damages, to explain kinds of efficient breach of contract and to sort them – as a subject less gone over before; and to determine that in some cases of efficient breach, there is not necessarily any conflict between two mentioned objectives and goals; and instead in most cases, these two are compatible with each other, and what is an efficient economic solution, is in conformity with morality and justice as well.Moreover, in economic analysis of contractual damages, it is reviewed that whether the contractual liabilities are substantive in a contract solely, or such contractual liabilities may only be considered as peripheral to efficiency and desirability? Concentration on desirability and efficiency would have the advantage that instead of specific performance, a substitute i.e. contractual damages can be put in the place of the subject and substance of a contract as well.