Efficient breach canned by HCA

By Legal Eagle

What happens when you sign a contract? How binding is it? Can you force the other side to perform their side of the bargain?

Non-lawyers might be surprised to learn that from the perspective of contractual remedies, the principal remedy is damages, with specific performance of the contractual obligation said to be a secondary remedy when “damages are inadequate”.

Related to this is the concept of “efficient breach” of contract,  developed by law and economics theorists (most prominently Richard Posner). The idea is that when one party breaches a contract because they have an opportunity to make a greater profit elsewhere, we should let her do so. There is no detriment to the other party, because expectation damages for breach of contract will place the other party in the position which they would have been in if the contract had been performed. In fact, efficient breach is to encouraged, as it leads to efficient allocation of resources in society.Therefore, we should not penalise those who breach contracts with remedies such as punitive damages and disgorgement damages lest this provide a disincentive to efficient breach.

I was fascinated to learn that the High Court has recently put the boot into efficient breach in Tabcorp Holdings Ltd v Bowen Investments Pty Ltd [2009] HCA 8.

It’s a case that is worth reading, because, as Marcellous has pointed out, the opening two paragraphs are almost at the standard of the late Lord Denning. You can tell the way the wind is tending immediately. It is reminiscent of Lord Denning’s judgment in Miller v Jackson [1977] QB 966 (please follow link for Denning quote – it involves cricket).

I wish I knew which judge was responsible for this gem…

Anyway, at para [13], the High Court says:

Underlying the Tenant’s submission that the appropriate measure of damages was the diminution in value of the reversion was an assumption that anyone who enters into a contract is at complete liberty to break it provided damages adequate to compensate the innocent party are paid. It is an assumption which at least one distinguished mind has shared. It has been dignified as “the doctrine of efficient breach”. It led, in the Landlord’s submission, to an attempt “arrogantly [to] impose a form of ‘economic rationalism'” on the unwilling Landlord. The assumption underlying the Tenant’s submission takes no account of the existence of equitable remedies, like decrees of specific performance and injunction, which ensure or encourage the performance of contracts rather than the payment of damages for breach. It is an assumption which underrates the extent to which those remedies are available. However, even if the assumption were correct it would not assist the Tenant. The Tenant’s submission misunderstands the common law in relation to damages for breach of contract. The “ruling principle”, confirmed in this Court on numerous occasions, with respect to damages at common law for breach of contract is that stated by Parke B in Robinson v Harman:

“The rule of the common law is, that where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed.”

Oliver J was correct to say in Radford v De Froberville that the words “the same situation, with respect to damages, as if the contract had been performed” do not mean “as good a financial position as if the contract had been performed” (emphasis added). In some circumstances putting the innocent party into “the same situation … as if the contract had been performed” will coincide with placing the party into the same financial situation. Thus, in the case of the supply of defective goods, the prima facie measure of damages is the difference in value between the contract goods and the goods supplied. But as Staughton LJ explained in Ruxley Electronics Ltd v Forsyth such a measure of damages seeks only to reflect the financial consequences of a notional transaction whereby the buyer sells the defective goods on the market and purchases the contract goods. The buyer is thus placed in the “same situation … as if the contract had been performed”, with the loss being the difference in market value. However, in cases where the contract is not for the sale of marketable commodities, selling the defective item and purchasing an item corresponding with the contract is not possible. In such cases, diminution in value damages will not restore the innocent party to the “same situation … as if the contract had been performed”. [citations omitted]

I’m quite excited, because the High Court’s analysis squares very nicely with a theory I am developing. In essence, as the High Court has indicated, I agree that the policy of the law towards the performance of contracts should depend on whether the commodities which are the subject of the contract are freely available on the open market. Much, much more to be said, but I shall restrain myself for now.

(Hat tip to Marcellous)

15 Comments

  1. Posted February 14, 2009 at 2:00 am | Permalink

    Do I detect a contractual version of Doulton Potteries v Bronotte, aka the world’s most remarkable s-bend?

  2. Posted February 14, 2009 at 10:24 am | Permalink

    I’m no expert, but the following thoughts came up…

    * I wonder if the assumptions when assessing the difference in financial positions can be easily applied in a falling property market.

    * If it is recognized that there can be damages to reputation and stress in libel, then perhaps there can be damages to aesthetic sensibilities.
    And on a final note to Miller v Jackson…. a bit like backyard rules “6 and out out pocket”.

    * Do judgements on efficient breach take into account impact elsewhere, including utility differences in the future because of the loss of contract? (Imagine a lease on a house that the landlord breaks in a rapidly tightening market… and the hassle a tenant has to go through to get a place with similar amenity at similar cost). The idea that capitalism is useless depends on the assumption that it is not merely a zero sum game of money changing hands, but that both parties benefit (i.e. it is a win/win) from the contract.

    * The rules applying here, “if sold on the open market” are inconsistent with many accounting rules for valuation of companies with stocks and loans… at “firesale” times, such assets are of almost no value.

    * There is also an interesting comparison with occupation health. What if an employer is happy to have an unsafe workplace because the employer can afford insurance that NOTIONALLY can compensate the worker.

    * On miller v jackson, I’m reminded of backward rules… “6 and out (of pocket)”

  3. Posted February 14, 2009 at 3:18 pm | Permalink

    LE: “Economic efficiency is not the only social good.”

    That’s one possible means, and the only valid and measurable end.

    You might end end up a Marxist yet!
    😉

    Back to efficient breach: If the frequency of permitted efficient breaches goes up, what does this do to general confidence in contracts? What are the consequences of such a drop in confidence?

    Aaaah…. I see…. contract lawyers get to write much more small print and pore over more small print written by others for longer…. hmmmm.

    And when does it become efficient for contract lawyers to breach client confidentiality? More small print…

    That’s either a sneaky little feedback loop or the kind of black hole that drove Cantor bonkers. Maybe both.

  4. Posted February 14, 2009 at 8:16 pm | Permalink

    [email protected] “merely maximising one’s economic gain”

    (Just to be explicit, even tho LE probably got it)

    The “loss of confidence” I was talking about was the GENERAL loss that could affect the wider economic efficiency. I think that perspective of POTENTIAL parties to OTHER contracts is relevant, not just to the two parties of a particular contract.

    Now, in criminal justice, the concept of “deterrent” to others not involved in the particular case, and is considering (however validly or invalidly) the bigger picture.

    Is this wider perspective held in mind when judges look at contract law cases? (Dunno… I’m not asking rhetorically)

  5. Posted February 14, 2009 at 8:35 pm | Permalink

    What would you have done if the decision falsified rather than confirmed your theory?

  6. Posted February 14, 2009 at 9:04 pm | Permalink

    [email protected]: I think I really do need to send you my thesis chapter, although I don’t know how clear it is for a non-lawyer!

    While not law, some who were doing a 3rd yr classical phil unit using me as an unofficial tutor (giggle: I’d done ONE phil first year unit), were science masters/honors in their “day studies”. They’d give me their theses to read on the basis that I was an intelligent lay person OUTSIDE their specific field, and if I couldn’t understand a bit, then the Explanation Fairy had departed.

    While that was useful for the sciences, I dunno if it would be useful for a legal thesis.

    It’d be interesting tho… along with any background links or notes as to how radical your position is.

    Also you said: “then everyone who is a party to a real estate contract might start to lose confidence”
    When that’s in criminal law, you end up with vigilantes, lynchings, etc.

    I’m trying to think what “contract-law vigilantes” would do, (and also getting an image of a bunch of horseriders wearing wigs/gowns rather than cowboy hats, with Kim Wasabe, trusty legal assistant, at their side)

  7. Posted February 14, 2009 at 9:27 pm | Permalink

    [email protected]: “breached his employment contract, and they were thereby entitled to the profit”

    It might have been an efficient breach if he was lured by money not ideology, and thus had a contract with the Russians.

    Oh no, another image of countries fighting in court about intellectual property of secrets when they both thought they had a contract with the information provider.

    Oh dear…. Werner von Braun….

  8. MikeM
    Posted February 16, 2009 at 5:03 pm | Permalink

    In his classic October 1960 paper, “The Problem of Social Cost” U of Chicago economist Ronald Coase provided an interesting analysis of the type of problem addressed in Miller v. Jackson. The court’s finding on the case is consistent with Coase’s view that conflicting rights are often a symmetrical problem.

    I suspect though that Coase would be in favour of efficient breach in the absence of transaction costs. Since though there are always transaction costs, analysis is more complex that described in the early part of the paper.

    http://www.sfu.ca/~allen/CoaseJLE1960.pdf

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