Anglo-American
Contract and Torts
Prof. Mark P. Gergen
Class 13
Contract Remedies—Day One
How US law students generally are taught to think
about contract remedies
“The theory of efficient breach”
also known as
“The option theory of contract”
There is no obligation to perform a contract. Rather
there is an option—a choice—either to perform or to
pay damages.
What led to this curious way of thinking . . .
The proposition is true. As a legal matter, if one breaks
a contract, then the usual consequence is an obligation
to pay damages.
Oliver Wendell Holmes, Jr. and the “bad man theory of law.”
Holmes told entering law students it is useful to think of the law
from the perspective of a bad man who wants to know the
practical consequences of breaking the law. Holmes used
contract to make his point.
“The Path of the Law,” 10 Harv. L. Rev. 457 (1897)
In the same speech Holmes argued for “the prediction theory of law.” A
statement of law is a prediction of what a judge will do.
The theory of efficient breach does accurately describe
(or fit) some features of contract law.
The usual measure of damages is “expectation
damages,” which compensate the promisee for its loss
from non-performance.
The standard account is that this damage rule
encourages “efficient breach” when resources can
profitably be shifted from performance of a contract to
other uses.
Posner, Economic Analysis of Law
Contract price for widgets = 10 cents
Value to buyer at time of performance = 14 cents
Value to seller at time of performance (what a 3rd
party will pay) = 15 cents
The expectation measure properly encourages seller to
breach for it nets a 1 cent profit per widget after paying
the disappointed buyer 4 cents damages per widget (or
14 cents if the buyer prepaid).
These cases involving the “duty to mitigate” often are
used to make a similar point.
Rockingham County v. Luten Bridge, Supp 63 (contract to
construct bridge was cancelled by county, held
construction company improperly failed to mitigate
damages by completing work and is entitled only to
damages for its lost profit and cost incurred up to time of
stop order).
Clark v. Marsiglia, Supp 63 is similar. D cancelled contract for
cleaning and repair of paintings. P completed the work. Held P
is not entitled to contract price. He recovers only lost profit and
cost incurred at time of stop order.
Further support for the point sometimes is found in the
“lesser of two rule” that limits damages for defective
work to the loss in market value when the remedial cost
(cost of repair) is much greater.
Plante v. Jacobs, Supp 70. Contractor misplaced wall in
home, narrowing living room by one foot. The error did
not reduce market value of house and will cost $4,000 to
correct. Held owners get no damages.
Peevyhouse v. Garland Coal & Mining Co., Supp 70 n. 20 is
similar. D breached promise to restore P’s land after strip
mining. Restoration cost was $29,000. Land was worth $300.
Held P’s damages are limited to $300 damages.
English law students are not taught to think about
contract remedies in this way.
Duty to mitigate—the starting position under English
law is that there is a right to complete performance
and collect the contract price in response to a stop
order (repudiation). See Supp 64 n. 9, White & Carter.
Lesser of two rule—when remedial cost is grossly
disproportionate to loss in market value, then award
an intermediate amount to compensate the plaintiff
for his probable subjective loss. See Supp 70, n. 20,
Ruxley.
In the article excerpted in the Supplement I argue US
law is closer to English law than we teach our students
and that the high value placed on remedial simplicity in
US contract law explains most of the differences.
Under US law the only damage options available for
defective work and property damage are remedial cost
and loss in market value. The intermediate subjective
award in Ruxley is unavailable.
Subjective non-economic damages (e.g., damages for
emotional disturbance) generally are not available
under US law in a contract action.
Parker v. Twentieth Century Fox, Supp 61. The studio
has Parker (Shirley MacLaine) under contract to play
the lead in Bloomer Girl, a 14-week commitment with
$750,000 minimum guarantee. It cancels Bloomer Girl
and offers her the female lead in Big Country, Big Man
for the same time period and minimum guarantee.
Had Parker taken the offered role (or done other work in
the 14 week period) the money she earned would be
subtracted from the money she was promised as an
avoided loss.
Parker would not be compensated for other losses she
may suffer from the loss of the role as such losses are
too speculative or non-economic.
After Parker refused the substitute role, she offered to
take $600,000 to settle matters. The studio offered
$400,000.
Parker sued. The studio raised failure to mitigate as a
defense. Parker moved for summary judgment. Trial
court granted summary judgment for Parker. Affirmed by
the California Supreme Court.
Parker was allowed to decline the role because it was a
reasonable thing to do. The standard of reasonableness
applied is strikingly unlike the reasonableness standard in
negligence. See p. 62 bottom for some differences.
An English expression of the difference here is that it is
between being “merely unreasonable . . . and . . . wholly
unreasonable.” p. 66.
Parker illustrates that subjective interests are
protected indirectly. Parker may decline the role to
avoid a subjective loss.
Parker illustrates that sometimes contract remedies overcompensate and put the promisee in a better position
than performance. Parker was paid $750,000 to take a 14
week vacation.
Parker illustrates the high value the common law (even US
law) places on vindicating contract rights.
US law students focus on the remedies a court can
provide on breach of contract, in particular damages.
English law students often begin remedies with conditions
and the law on discharge (material breach and substantial
performance).
I believe the English approach is preferable as a practical
matter for the many defects in the damage remedy make
discharge a preferred remedy if a party can protect
themselves from breach by conditioning their performance
obligation on performance by the other party.
Some reasons damages are inadequate:
• A damage award is a judgment debt that must
be collected through further proceedings and
is dischargeable in bankruptcy.
• Legal proceedings are costly, particularly
under the “American rule” in which the victor
is not awarded costs.
• Damages are not awarded for speculative
economic losses and non-economic losses.
Conditions, Text 178
Non-occurrence of a condition excuses the performance obligation
that is the subject of the condition.
The “obligor” is the party under the conditional obligation. The
“obligee” is the party to whom the conditional obligation is owed.
Typical uses of conditions include:
1) To give the obligor power to withhold performance as a
remedy in the event of breach.
2) To protect the obligor from the risk of the event covered
by the condition.
Example One
In a purchase agreement the purchaser will condition its
obligation to accept delivery and pay for the object on
conditions of quality and timeliness being satisfied.
Example Two
In an insurance agreement the insured makes no promises.
The insurer ensures timely payment and protects itself from
non-compliance with other terms by conditioning its
obligation to pay the benefit on performance of all terms
and conditions.
You have seen two tools used to avoid harsh application of conditions
•interpretation (City and Westminster Properties v. Mudd, Text
137)
•waiver and estoppel (some of the cases collected at pp. 116117).
Other tools include
•excuse for non-cooperation/“breach”
•the duty of good faith
•excuse for impracticability
•excuse to avoid disproportionate forfeiture
The doctrines of material breach and substantial
performance determine when a party has the power to
withhold performance in response to breach in the
absence of an express condition.
These sometimes are called “constructive conditions.”
The doctrines address some of the problems that result
when performances cannot be rendered simultaneously.
If performances can be rendered simultaneously, then
there is a presumption that they are to rendered
simultaneously.
English courts did not adopt a rule presumptively making the
performance obligation conditional on counter-performance until
1773!
When performances cannot be simultaneous people use a variety of
mechanisms to guard against default.
•In real estate conveyance an escrow agent will hold the money until
the transfer is recorded.
•In sales a buyer will establish a letter of credit entitling the seller to
payment by bank on presentation of warehouse receipt or bill of lading.
•Construction contracts provide for progress payments and holdbacks.
Credit risk is mitigated by bonding.
Substantial performance
Text 179-180, Supp 67 n. 15 and
Supp 70-71
In most US states a contractor who “substantially performs” a
construction contract is entitled to be paid on the contract less any
damages suffered by the other party from defective performance.
In most US states a contractor who does not “substantially
perform” a construction contract may still have a restitution claim
for the “incontrovertible” value of the performance rendered and
never more than the contract price less damages suffered by the
other party.
These doctrines apply in the absence of an express condition.
Unexcused failure to fulfill a condition generally bars both a
contract and a restitution claim.
Plante v. Jacobs, Supp 70. Contractor misplaced wall in
home, narrowing living room by one foot. The error did
not reduce market value of house. Contractor sues for
$5,000 balance due on contract. Held contractor is
entitled to the balance because he substantially
performed.
Had the deviation from the plans been more
substantial or intentional the contract claim would
have been denied.
Material breach
Text 180-181, Supp 67 n. 15 and
Supp 66-70
A contract involves on-going performance by both A
and B. E.g., a construction contract with progress
payments, a lease, an employment contract . . .
Under US law, generally a “material breach” by B gives A
the power to suspend performance. If the breach is
“total”, then A has the power to terminate the contract
and pursue legal remedies. A is discharged from his
performance obligation.
A has the power to waive the breach and continue to
perform while insisting on B’s performance unless A’s
duty to mitigate requires A to make other arrangements.
Recall Luten Bridge.
Restatement Second, Contracts § 241. Circumstances significant in
determining whether a failure is material (Supp 67 n. 15)
In determining whether a failure to render or to offer performance is material,
the following circumstances are significant.
(a) the extent to which the injured party will be deprived of the benefit
which he reasonably expected;
(b) the extent to which the injured party can be adequately compensated
for the part of the benefit of which he will be deprived;
(c) the extent to which the party failing to perform or to offer to perform
will suffer forfeiture;
(d) the likelihood that the party failing to perform or to offer to perform will
cure his failure, taking account of all the circumstances including any
reasonable assurances;
(e) the extent to which the behavior of the party failing to perform or to
offer to perform comports with standards of good faith and fair dealing.
Considerations relevant to whether a breach is material . . .
(a) the extent to which the injured party will be deprived of the benefit which he
reasonably expected;
(b) the extent to which the injured party can be adequately compensated for the
part of the benefit of which he will be deprived;
(c) the extent to which the party failing to perform or to offer to perform will suffer
forfeiture;
(d) the likelihood that the party failing to perform or to offer to perform will cure his
failure, taking account of all the circumstances including any reasonable assurances;
(e) the extent to which the behavior of the party failing to perform or to offer to
perform comports with standards of good faith and fair dealing.
Factors (a), (b), and (d) go to whether the aggrieved party needs to
suspend performance or terminate the contract to protect their
interest in receiving the promised performance.
Factor (c) goes to the harm to harm to the other party from
suspending or terminating the contract. It expresses a particular
concern for forfeiture, meaning uncompensated expense and loss
of investment.
Colonial Dodge, Inc. v. Miller, Supp 70. B ordered a car
with special-ordered extra wide tires. S delivered a car
without a spare extra-wide tire. B noticed this after
driving one day and 400 miles. He has right to return
the car under UCC if lack of a spare “substantially
impairs value of car.” This is essentially the material
breach standard.
S will suffer a large loss if B is allowed to return car as it
cannot be sold at list price. B suffers a small loss if he
must drive without a spare until a spare is supplied. 13
judges hear the case. They split 7-6 for B.
This is similar to the balance struck in Parker. Many
think this result goes too far in favoring the promisee.
In determining whether a promisee should have acted
differently to mitigate damages, a breach is substantial,
or a breach is material two general interests are being
balanced
1) The interest of the promisee in receiving what he
was promised (the expectation principle).
2) The interest of the defaulter/promisor in minimizing
its loss on default.
The good or bad faith of the defaulter/promisor also bear
on how this balance is struck.
The law tolerates much inefficiency and even an
occasional windfall to a promisee in order to avoid
inflicting a material uncompensated loss on the
promisee. See Parker and Colonial Dodge.
Plante v. Jacobs shows there are limits, particularly when
the windfall is great.
Often tough choices are presented because losses and
benefits are not compensated directly with monetary
awards or offsets.