The standard remedy for breach of contract is monetary damages. However, under certain circumstances – notably, when the subject matter of the contract is “unique” – the victim of a breach can obtain specific performance. There has been considerable debate about the appropriate scope of the specific performance remedy and about its efficacy relative to damages in varying contexts. Anthony Kronman (1978) argues that the uniqueness distinction is an appropriate one for demarcating the domain of the specific performance remedy. Steven Shavell (1984) emphasizes the distinction between contracts “to do” and contracts “to give.” Alan Schwartz (1979) and Thomas Ulen (1984) argue that the specific performance remedy should be routinely available to promisees. All of these invoke economic analysis to justify their conclusions. In Selection [5.1], William Bishop provides another economic analysis that proposes a slight modification of Shavell's distinction. I present some further thoughts on the specific performance remedy in Selection [5.2]. Part V concludes with Timothy Muris's [5.3] analysis of the merits of two alternative damage measures: the cost of completion versus diminution of value. Analytically, the problem turns out to be nearly the same as the specific performance versus damages question.

[Consider] the problem of the standard form contract. The … [standard economic] model treats the problem by assuming it away. If people voluntarily enter into contracts it is because it is in their best interest to do so. If the terms of one producer are unsatisfactory, the customer will shop around for others; if information on contract terms were costlessly available (and could be analyzed costlessly) he would continue shopping until he received precisely the desired combination of price, quantity, and other contract terms. This, implicitly, is how economists have handled the problem. Additional sophistication occasionally creeps in by the recognition of costs of attaining, processing, and evaluating information; the consumer then would engage in such information processing to the point at which the expected marginal benefits of the additional information are equated to the marginal costs of its acquisition.

Suppose, however, that rather than view the standard form contract as a voluntary agreement, we view it instead as private legislation; the legislature in effect delegates the lawmaking process to private parties. … We will first stipulate that we are interested here only in the “hidden” terms of the contract – those beside the basic price and quantity terms. While such terms could be tailor-made for each contract, there are substantial economies to be gained by spreading the costs of producing (and analyzing the impact of) these terms over a large number of contracts.

Most contract rules are permissive, applying only if the parties do not otherwise agree. By providing standardized and widely suitable risk allocations in advance, the law enables most parties to select a preformulated legal norm “off-the-rack,” thus eliminating the cost of negotiating every detail of the proposed arrangement. Atypical parties remain free to bargain for customized provisions, much as a person with an unusual physique may purchase custom-tailored garments for a premium rather than accept a standard size and cut available at a lower price.

Ideally, the preformulated rules supplied by the state should mimic the agreements contracting parties would reach were they costlessly to bargain out each detail of the transaction. Using this benchmark raises two separable issues: First, what arrangements would most bargainers prefer? And second, what atypical arrangements should be supported as benign alternatives?

The model developed in this article will show that the contractual obligee and obligor would agree in advance to minimize the joint costs of adjusting to prospective contingencies, assigning the responsibility of mitigating to whoever is better able to adjust to the changed conditions. The occurrence of contingencies requiring adjustment, however, may encourage strategic behavior by both parties: The obligor may attempt to evade his performance responsibilities while the obligee may bargain opportunistically whenever his cooperation is requested. Any effort legally to regulate one manifestation of this strategic behavior almost inevitably exacerbates the other. But where a developed market for substitute performances exists, the potential for opportunism is negligible; parties can therefore focus on eliminating evasion of contractual obligations without losing the benefits of cooperation.

1. It seems a rather curious use of language to view strikes as acts of God. Why are they usually included as an excuse in a force majeure clause?

2. Posner and Rosenfield argue that the Suez Canal cases were rightly decided. Why do they argue that the carrier's obligation should not be excused? Do you find their explanation persuasive?

1. 2.1 Suppose that the port at which a carrier is supposed to deliver its cargo is blockaded. As a result, the carrier discharges the goods at another port. Completion of the contract (that is, delivery of the goods to the original destination) would require that someone incur additional expenditures. Who should bear the additional costs, the carrier or the shipper? How would Posner and Rosenfield decide that matter?

2. 2.2 In fact, contracts for ocean shipping of grain routinely include a War Risks clause that holds that in the event of a blockade (and related risks), the carrier who delivers to a safe port would be paid the amount specified in the original contract, and, upon such delivery, the contract would be discharged. The shipper would be responsible for any additional costs that might be incurred by bringing the goods to their original destination. Why might this be the case?

3. […]

In the event of a contract breach, the victim is entitled to a remedy in the form of money damages, an injunction (specific performance), or sometimes reformation. In Part III we will focus on money damages. Damages are commonly classified as expectation, reliance, and restitution damages. The first would put the victim in as good a position as if the contract had been performed. Reliance damages compensate for expenditures made in preparation for performance of the contract. Restitution damages are equal to the benefits conferred by the victim on the breaching party (in the simplest case a refund of cash to a buyer when the seller refuses to perform). If neither party has yet performed, the restitution remedy is equivalent to rescission: tearing up the contract.

Historically, contract law focused almost entirely on vindication of the expectation interest. The First Restatement of Contracts did not explicitly recognize reliance damages. That has changed in the past half century, and the paper by Lon Fuller and William Perdue, from which Selection [3.1] is taken, played an important role in that change. Indeed, they suggested the primacy of the reliance interest and raised a provocative question: If no one has yet relied upon a promise, why should society bother to enforce it? Their answer is given in Selection [3.1]. Building on their suggestions, I argue in Selection [3.2] that one reason for enforcing such contracts, and for reckoning as damages the difference between the market price and the contract price, is to create a property right in the price. The questions that conclude Part III-A draw out some of the implications of that argument for measurement of damages.

The specific performance remedy provides … [an] illustration [of the Boomer problem]. Confining a buyer to a court-determined measure of damages short-circuits the market mechanism preventing the buyer from registering his true preferences. On the other hand, if after a seller's breach, performance is expensive and is of little value to the buyer, granting the buyer an injunction would result in “economic waste.” The waste will not, except by accident, entail actual performance of the obligation. Rather, as in Boomer, it would entail excessive rent seeking by the two parties.

Suppose that the costs that a buyer would incur if the contract were breached exceeded the damages that he could collect. In that case the seller would have an incentive to use the threat of termination to redefine the contract on more favorable terms. The buyer can be shielded from this threat by granting him specific performance so that the seller could not legally carry out his threat. This is very similar to allowing the buyer to invoke duress to disallow the contract modification that the threat produced. In both cases, the costs of rent seeking are avoided.

But avoidance of these costs itself involves costs. It encourages buyers to get into such situations in the first place. The routine granting of specific performance (just as a policy of liberal acceptance of the duress excuse or routine compensation of consequential damages) would in many instances provide perverse incentives to promisees inducing over-reliance on the contract. They could maintain tiny inventories, build machines that require inputs from a single supplier, and so forth, knowing that the specific performance remedy would bail them out.

My hostility to [the phrase] transactions costs must strike most readers as odd, since the “new institutional economics” and “transactions costs economics” are often thought of as synonymous. My concern in this instance is perhaps more semantic than substantive. It does seem to me, however, that “transactions costs” runs the risk of becoming the “imperfect capital markets” of the 1980s, the all-purpose answer that tells us nothing.

A bit of history. In his early paper on “The Nature of the Firm,” Coase [1937], in effect, said: If markets work as well as they do in our models, then no alternative system could do better, and most would probably do worse; why then, he asked, would anything but impersonal markets emerge and thrive? Since firms do exist and do thrive, we must ask how such organizations could be superior to the impersonal markets. The answer – or really the first part of the answer – was that impersonal markets weren't so darn perfect anyway; their imperfection he called “transactions costs.” Two decades later, Coase [1960] conducted the same sort of exercise with externalities. Economists were classifying goods in two categories: for normal goods (with zero transactions costs) markets worked perfectly; for externalities (with infinite transactions costs) markets worked not at all. Coase never bothered to give a precise definition of transactions costs because he didn't take the concept very seriously. It was only the name of whatever it was the economists had been ignoring; the intent in both papers was to move analysis away from a world in which market perfection was an all-or-nothing affair.

A penalty is just one element of the consideration for a contract. The party received something of value because it was willing to take the risk of having the penalty imposed upon it. Courts do not, in general, inquire into the adequacy of the consideration for a contract; yet if it is possible to characterize an element of a contract as a penalty, the court will scrutinize the adequacy of that element of the consideration more carefully.

The judicial hostility to penalties goes too far. Society would, I am quite certain, be better off if it adopted a more accommodating approach to liquidated damages and resisted the temptation to eliminate the right to terminate a relationship at will (if the initial contract allows for such terminations). There has been considerable effort to protect both employees and franchisees from such terminations, and courts have become more sympathetic to these efforts in recent years. Some of the hostility is undoubtedly due to a lack of appreciation of the mutual benefits to parties of arranging their affairs so that one could impose costs on the other. Nonetheless, I suspect that more than ignorance is involved.

It seems clear that the acceptability of certain penalties is culturally dependent. Society will simply not enforce certain penalties because that society perceives them to be wrong. You cannot contractually agree that in the event of breach you will become the other party's slave. At least you can't in twentieth-century America. It seems reasonable to take these social attitudes as given “tastes.” That is not to say that economic analysis will be useless in generating propositions about these attitudes. It is probably true that “morality” is income elastic.

In contract cases concerning nonperformance of the promise, the problem of events of very low probability is dealt with mainly under the doctrines of frustration, impossibility, and common mistake. The law of contract also has a doctrine called remoteness of damage, the rule in Hadley v. Baxendale. Where nonperformance of the contractual promise is in question, this contract doctrine of remoteness of damage deals most importantly with the adverse selection problem rather than with the problem of low probability events.

Where an event of very low prior probability occurs, should courts hold a promisor to his promise? Performance may have become very expensive or impossible, or the consequences of nonperformance may be very much more expensive than was contemplated when the contract was made. In general a promisor is excused performance where an uncontemplated event of very low prior probability having expensive consequences has occurred, as noted, chiefly under the headings of common mistake and frustration (or impossibility). The main distinction between frustration and common mistake is a formal one. Common mistake deals with cases where both parties make and act on an incorrect assumption about facts existing at the time the contract is made; the usual consequence is that such a contract cannot be enforced. Frustration deals with events arising subsequent to the time of contracting; the usual consequence here is that a contract is discharged from the time of frustration. Unilateral mistake, as we shall see, deals with a different problem, with adverse selection and not with events of low probability.

When two parties enter into a contract, the outcome might ultimately depend upon the subsequent behavior of both of them. The first two selections in Part II begin with this essential insight. Thus, Robert Cooter [2.1] focuses on the harm arising from the breach of a contract and the ability of the parties to avoid that harm – the promisor by reducing the probability that it will breach and the promisee by reducing its reliance on the promisor's performance. Cooter emphasizes the similarity between the problem of controlling the harm arising from a contract breach with that arising from an accident, a nuisance, or a taking of private property by the government. In each context the rules should assign the task of avoiding costs to the party in the best position to do so – the least cost avoider. He points out that the manner in which contract law treats excuses closely parallels the treatment of no liability versus strict liability in torts. He also notes that so long as the victim can influence the magnitude of the harm, a rule of strict liability that places all the avoidance burden on the breacher (or tortfeasor) is inefficient.

Charles Goetz and Robert Scott [2.2] argue that when entering into an agreement the parties rationally attempt to minimize the joint costs of adjusting to prospective contingencies. If that requires them to adjust their behavior over time in response to changed circumstances, then they will want to assign the job of adjusting to particular contingencies to the party in the best position to do so.

We will try to get some mileage out of Security Stove & Manufacturing Co. v. American Railway Express Co., hardly the latest thing. The defendant broke its promise to deliver the plaintiff's gas furnace to Atlantic City to be exhibited at the American Gas Association Convention. The plaintiff intended to display, not sell, the particular furnace token it shipped. Profit would have come by increased sales and was uncertain. If exhibited, the furnace might have malfunctioned so the plaintiff would have sold fewer furnaces than it actually did. Or the plaintiff might have sold every furnace it could manufacture anyway.

With respect to the broken promise, the plaintiff sought reliance damages. … The defendant argued the plaintiff should get expectation damages or nothing (besides shipping charges refunded). The defendant complained the plaintiff was “endeavoring to achieve a return of the status quo in a suit based on a breach of contract,” thereby committing a conceptual error that the defendant invited the court not to endorse. The defendant said the plaintiff was “trying to recover what he would have had, had there never been any contract of shipment,” rather than correctly “seeking to recover what he would have had, had the contract not been broken.” Apparently, the defendant put squarely before the court the choice between protecting the expectation interest and protecting the reliance interest.

The court awarded reliance damages. The plaintiff had rented a booth at the convention. It had transported a workman and its president to Atlantic City and back and had maintained them there throughout the convention, waiting respectively to assemble the furnace and to point to it.

Most larger companies, and many smaller ones, attempt to plan carefully and completely. Important transactions not in the ordinary course of business are handled by a detailed contract. For example, recently the Empire State Building was sold for $65 million. More than 100 attorneys, representing thirty-four parties, produced a 400-page contract. Another example is found in the agreement of a major rubber company in the United States to give technical assistance to a Japanese firm. Several million dollars were involved and the contract consisted of eighty-eight provisions on seventeen pages. The twelve house counsel – lawyers who work for one corporation rather than many clients – interviewed said that all but the smallest businesses carefully planned most transactions of any significance. Corporations have procedures so that particular types of exchanges will be reviewed by their legal and financial departments.

More routine transactions commonly are handled by what can be called standardized planning. A firm will have a set of terms and conditions for purchases, sales, or both printed on the business documents used in these exchanges. Thus the things to be sold and the price may be planned particularly for each transaction, but standard provisions will further elaborate the performances and cover the other subjects of planning. Typically, these terms and conditions are lengthy and printed in small type on the back of the forms. For example, twenty-four paragraphs in eight-point type are printed on the back of the purchase order form used by the Allis Chalmers Manufacturing Company.

The importance of the impossibility defense is circumscribed by the ability of the parties to contract around the law. If the law were too liberal in excusing performance, the parties could narrow the range of acceptable excuses by explicit contractual language. Conversely, if the law were too niggardly, the parties could enumerate additional circumstances that would justify discharge of the contractual obligations. If the law were badly out of line in either direction, the problems could be vitiated by proper drafting of force majeure clauses. Such clauses, which are very common, will suspend or discharge a promisor's obligations for “acts of God.”

Indeed, it should not really matter whether we frame the problem of excuse in terms of implementing the parties' decision (“Does the fire constitute an act of God that excuses performance as per the initial agreement?”) or of identifying the conditions that would justify excusing performance (“Does the fire make performance impossible?”). Even if a contract had no force majeure clause, a court might infer that the parties would have included one had they thought of it. That is, instead of recognizing an impossibility defense, the court could achieve the same result by interpretation of a force majeure clause, express or implied.

Regardless of how the doctrine is labeled, courts, when considering a plea to excuse performance, should be constrained by the fundamental question: What would the parties have chosen? I will argue that, as a general rule, parties would not agree to excuse performance because of changed market conditions (neither supply nor demand shocks).

… [T]here are substantial benefits from stipulating damages. When these benefits exceed the costs of negotiating them, the parties will stipulate damages, adjusting the contract price accordingly. With such clauses, both parties reach preferred positions, economic activity is increased, and goods are produced at lower costs. Since the net benefits appear to be positive, it seems difficult to explain why stipulated damage clauses are not strictly enforced. Are the courts in error? Alternatively, are there costs associated with these clauses that we have yet to consider?

An important cost of stipulated damage clauses … results from activities that may induce breach and from activities to prevent breach inducement, both of which waste scarce resources. Consider, for example, a contract to build a bridge with a stipulated damage clause of $500 for each day of delay beyond a specified completion date chosen to correspond with the first day that the purchaser expects to use the bridge. If the clause is carefully drafted, the $500 will closely approximate the expected damage to the purchaser from actual delay. Suppose, however, that during construction (or, for that matter, even at the time of the initial contract) the cost of delay to the purchaser becomes zero because the bridge could not be used until much later than originally planned. Since the producer's breach would now actually improve the purchaser's position, the purchaser has an incentive to undertake activities to cause delay as long as the additional expected revenues from creating delay ($500 multiplied by the number of days of delay) exceed the additional costs.

Why should the law ever protect the expectation interest?

In seeking justification for the rule granting the value of the expectancy … [i]t may be said that there is not only a policy in favor of preventing and undoing the harms resulting from reliance, but also a policy in favor of promoting and facilitating reliance on business agreements. As in the case of the stop-light ordinance we are interested not only in preventing collisions but in speeding traffic. Agreements can accomplish little, either for their makers or for society, unless they are made the basis for action. When business agreements are not only made but are also acted on, the division of labor is facilitated, goods find their way to the places where they are most needed, and economic activity is generally stimulated. These advantages would be threatened by any rule which limited legal protection to the reliance interest. Such a rule would in practice tend to discourage reliance. The difficulties in proving reliance and subjecting it to pecuniary measurement are such that the business man knowing, or sensing, that these obstacles stood in the way of judicial relief would hesitate to rely on a promise in any case where the legal sanction was of significance to him. To encourage reliance we must therefore dispense with its proof. For this reason it has been found wise to make recovery on a promise independent of reliance, both in the sense that in some cases the promise is enforced though not relied on (as in the bilateral business agreement) and in the sense that recovery is not limited to the detriment incurred in reliance.

1. Farmers often buy their seeds from seed companies. Sometimes the seeds are defective (they carry disease, they include weeds, they are an inferior variety, and so on) and the net result is a disappointingly small crop. The farmer's loss would be disproportionate to the price of seeds, since if the seeds are bad his expenses on other inputs (labor, land, irrigation, and so forth) are all for nought. Seed companies usually include limitations on liability in their contracts (or on their packages and in their catalogues). Typically, liability is limited to the purchase price of the seeds.

Such disclaimers do not fare well in the courts. Some courts have found the disclaimers unconscionable for a variety of reasons: (a) all the competitors' using a similar clause, (b) the farmers have relatively little bargaining power, (c) farmers are uncounseled laymen, (d) the fact that the defect is usually within the control of the seed company, which is in a better position to prevent the defect, and (e) the fact that the farmer could lose his entire livelihood while the seed company would lose only a relatively few dollars. (See, for example, Martin v. Joseph Harris Co., Inc.)

Mr. Pauly's paper has enriched our understanding of the phenomenon of so-called moral hazard and has convincingly shown that the optimality of complete insurance is no longer valid when the method of insurance influences the demand for the services provided by the insurance policy. This point is worth making strongly. In the theory of optimal allocation of resources under risk bearing it can be shown that competitive insurance markets will yield optimal allocation when the events insured are not controllable by individual behavior. If the amount of insurance payment is in any way dependent on a decision of the insured as well as on a state of nature, then the effect is very much the same as that of any excise tax, and optimality will not be achieved either by the competitive system or by an attempt by the government to simulate a perfectly competitive system. …

In this note I would like to stress a point which Mr. Pauly overlooks in his exclusive emphasis on market incentives. Mr. Pauly has a very interesting sentence: “The above analysis shows, however, that the response of seeking more medical care with insurance than in its absence is a result not of moral perfidy, but of rational economic behavior.” We may agree certainly that the seeking of more medical care with insurance is a rational action on the part of the individuals if no further constraints are imposed. It does not follow that no constraints ought to be imposed or indeed that in certain contexts individuals should not impose constraints on themselves.

The arithmetic underlying Tullock's paper is not, numerous law students and faculty have informed me, entirely clear. Herein follow some exercises that might help provide a better understanding of what is going on. I will concentrate on the simplest case in which there are two identical parties, Alan (who buys A tickets) and Bob (who buys B tickets). The central point of the rent-seeking model (an awful name, but we are probably stuck with it) is that the efforts of one party change the rewards to a given level of effort by the other party. In equilibrium each party, in effect, asks the following question: If I had to choose the number of tickets (or level of effort or whatever) first, and the other guy was then going to purchase his tickets knowing what I have done, what should I do? If I assume that the other guy would try to maximize his expected profits, then I can ask myself what would my profits be on the assumption that the other guy makes his best response. Then I choose that level that maximizes my expected profits.