The concept of efficient breach
Black’s Law Dictionary defines efficient breach as “the view that a party should be allowed to breach a contract and pay damages, if doing so would be more economically efficient than performing under the contract." Robert Birmingham in "Breach of Contract, Damage Measures, and Economic Efficiency",
Says that repudiation of contractual obligations of the promisor, in cases where he can benefit from such breach despite putting the promise in a position as though the promise had been performed, should be encouraged.
The concept of efficient breach was evolved in the case of Lake River Corp. v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985).by Richard Posner
Illustration of efficient breach analogous to Posner’s: Consider A is a bicycle manufacture buying spare parts such as chains and tires from B.B is contracted with A to supply him with 100 chains by 31.12.10 at the price of Rs.100 each. C, at a later date contracts with B to supply him with 100 chains at Rs.150 each. In supplying C’s consignment, B is unable to supply A with his order on 31.12.10, thereby breaching the contract
The breach, according to this hypothesis results in the transfer of the good from a lover value use to a higher value use.
As a corollary to the general presumption of an expectation measure of damages, courts have historically refused to award punitive damages for breach of contract. The reason being not treating a breach of a contractual duty as a tort for which punitive damages is awarded is that if the breached pays expectation damages, thereby putting the non-breaching party in as good a position as performance would have done, then no one is worse for the. Assuming the purpose for contract damages is compensatory, this objective is thereby achieved. Farther punitive damages would overcompensate the plaintiff. Such penalties would dis-incentivize efficient breach, and therefore efficient behavior, which would be undesirable for society as a whole. Economists describe efficient breach as a Pareto optimal theory, where each side is better off after the transaction than before. His fundamental notion behind this economic efficiency argument is that society’s wellbeing will be maximized if resources are allocated to those people or uses which value them the most.
However, take the case of the mortgage crisis in the USA between 2007-2009, during the recession, when owing to a massive fall in the real estate market , people deliberately defaulted their mortgage payments as their mortgage payments exceeded the value of their properties, along the lines of efficient breach. Here however, be non-breaching party is detrimented as the real value of the property that they get is less than the mortgage payments that are due to them ,owing to a rise in real value of money and fall in real value of commodities .This is an instance where the efficient breach hypothesis disintegrates, as this transaction is neither Pareto optimal, nor social welfare maximizing.
Thus contract law by prescribing expectation damages rather than punitive or exemplary damages for the breach of contractual obligations provides for efficient breach.
Efficient reliance is the reliance of faith one vests in a contract, or in the other party in a contract who owes him a duty , to perform that duty.
Consider an illustration where there is a contract between A and B.
On the reliance of his contract with A, on faith that A will fulfill his contractual obligations, B enters into a contract with C where he invests X. This investment coming to fruition is subject to A performing his promise. Thus the theory of efficient reliance promulgates that for B’s reliance to b efficient, his investment X should be proportionate to the apprehension of A breaching the contract and not performing his obligations.
Thus B if B’s potential gains from X is proportionate to P, his reliance is efficient, however if X is greater than P then his reliance is inefficient.
The contract law remedy of paying the breached against party expectation damages incentivizes efficient reliance, as B can safely rely on his contract with A and invest X as long as it is proportionate to P, knowing that if A does breach the contract, then the expectation damages will enable him to break even.
Under the strict liability rule which is followed for contract law, the defendant will pay the plaintiff expectation damages for breaching the contract, and so, the plaintiffs chances of making a loss abates, this will encourage the plaintiff to over reliant on the contract. However if fault liability is applied in which case the defendant may not perform his contractual obligation if it becomes frustrated by some interim events, or if he finds it more efficient to breach, then he should be allowed to do so. In this case the plaintiff cannot over rely on the contract and on A’s obligation, as the probability of nonperformance on A’s part increases, and thus this is a more efficient rule which dis-incentivizes over reliance.
In the case discussed by Posner in, the Plaintiff should be paid merely the cost of the film roll which the defendant misplaced, as this will induce him to take adequate precaution and incentivize an optimum efficient level of reliance. If the defendant was mad to pay him damages covering the cost of his expedition and all the various overheads he incurred, it assumes a punitive nature on the defendant.
Contract law thus incentivizes efficient reliance as it pays expectation damages and not punitive or exemplary damages.