DF8 – The Theory of Efficient Breach
In law and economics, there is a well known theory called the “theory of the efficient breach. Under this theory, an efficient breach is a voluntary breach of contract and payment of damages by a party who concludes that they would incur greater economic loss by performing under the contract. For more information on this topic, check out this Wikipedia page: Efficient Breach (Links to an external site.)
For example, let’s say alpha contracts with beta to buy iron for $1000 per ton on May 1. Beta’s cost of the iron is expected to be $850. As it turns out, Gamma has a bunch of excess iron he needs to get rid of and offers it to alpha for $500 per ton. Under the theory of efficient breach, alpha should breach the contract with beta and not take delivery, and consummate the deal with gamma. Alpha can then pay beta the $150 of profit beta would have received and alpha’s overall cost becomes $650 per ton rather than $1000 per ton. Everybody wins. Right?
As a result of this theory, punitive damages are not available in a typical breach of contract in most states, even where the breach is deliberate and willful. This is one of the major differences between contract and tort law (i.e., the availability of punitive damages). But does this theory of efficient breach seemingly ignore the moral obligation of performing a contract and keeping one’s word? Or should we as a society continue to encourage people to breach a contract if it turns out that the payment of damages is a more cost effective outcome? What are your thoughts on this legal theory? Has a policy like this placed little economic value on morality? Do you think punitive damages should be available for breach of contract?
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