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Efficiency, disgorgement and reliance in contract: a comment on Campbell and Harris

Published online by Cambridge University Press:  02 January 2018

Peter Jaffey
Peter Jaffey*
Affiliation:
Brunel University
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Extract

In a recent article in this journal, David Campbell and Donald Harris criticise the House of Lords decision in A-G v Blake, which held that in some circumstances there can be a liability to surrender the profits of a breach of contract to the other contracting party, ie a liability for disgorgement, as it will be referred to here. The criticism invokes what is sometimes referred to as the economic theory of efficient breach, which can be expressed briefly as follows. The performance of contracts generally increases aggregate wealth – ie is efficient – because parties will contract only on terms that provide them with a benefit that exceeds their costs of performance. But sometimes the circumstances will change after contracting, such that overall wealth will be maximised if the contract is not performed as agreed. For example, the defendant contracting party may discover an opportunity that he or she can take up only by abandoning the contract, and this opportunity may generate enough money to leave a profit, even after the claimant has been compensated for breach.

Type
Research Article
Information
Legal Studies , Volume 22 , Issue 4 , November 2002 , pp. 570 - 577
Copyright
Copyright © Society of Legal Scholars 2002

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References

1. Campbell, D and Harris, D ‘In Defence of Breach: a Critique of Restitution and the Performance Interest’ (2002) 22 LS 208 Google Scholar. Some of the arguments are also found in D Harris, D Campbell and Halson, R Remedies in Contract & Tort (London: Buttenvorths, 2nd edn, 2002)Google Scholar.

2. [2001] 1 AC 268.

3. The expression ‘disgorgement’ is not used in the judgment. Campbell and Harris, n 1 above, generally refer to ‘restitution’, but this tends to disguise the distinction between the different types of claim described as restitutionary; as to which, see Jaffey, P The Nature and Scope of Restitution (Oxford: Hart Publishing, 2000)Google Scholar ch 1. In particular, it blurs the distinction between a claim to reverse a transfer and a claim to remove the profit of a wrong. ‘Account of profits’ is used in A-G v Blake [2001] 1 AC268, but not all cases of account of profits are cases of disgorgement.

4. See eg Posner, RA Economic Analysis of Law (New York: Aspen Law and Business, 5th edn, 1998) pp 133–134 Google Scholar.

5. This is economic ‘allocative efficiency’. An allocation of goods or services (including an exchange) is efficient if it maximises the value of the goods or services measured by how much each possible recipient is willing to pay for them, relative to possible alternatives.

6. The increase in costs must be peculiar to the defendant, ie not an increase in costs that would affect anyone else who offered the same performance, since otherwise there would be exactly the same increase in the measure of damages (representing the cost of substitute performance).

7. This efficient breach argument has received some judicial support in the US: eg Patton v Mid-Continent Systems 841 F 2d 742 (7th Cir, 1988) at 750, per Posner J; cf n 4 above.

8. On the economic approach, the outcome in the particular case is in any case relevant only as the application of a rule designed to modify behaviour in general.

9. Campbell and Harris, n 1 above, at 232.

10. The difficulties arise from the problem of ‘strategic bargaining’: Campbell and Harris, n 1 above, at 232. In a ‘bilateral monopoly’ situation, the parties may not be able to agree on how to divide the surplus wealth.

11. Campbell and Harris, n 1 above, at 232.

12. ‘Literal enforcement’ is discussed extensively in Harris, Campbell and Halson, n 1 above, pt 3.

13. Campbell and Harris, n 1 above, at 225 n 93, that disgorgement may be justifiable on the particular facts of Blake. The two categories identified by the Court of Appeal in A-G v Blake [1989] Ch 439 also seem to satisfy the test. Where the defendant's duty is a negative one (the first category), the claimant will not be able to pay someone else to pmvide substitute performance, so damages are liable to be inadequate. The second category is ‘slamped performance’ the meaning of which is unclear, but the example given (City of New Orleans v Firemen's Charitable Association (1891) 9 So 486 (US)) is a case of contracting for the provision of safeguards against loss, namely, iire-fighten to be available if needed, and here damages are clearly lnadequate if the fire-fighters are not available when specified – otherwise the contract would be no more than a fire insurance contract. In fact the claim failed, and it does not appear that the claim was actually for disgorgement in any case.

14. As Campbell and Harris say, n 1 above, at 228, this approach ‘does not attempt to do the necessary work of distinguishing when breach is and is not appropriate because it simply subsumes all these complex issues under the wrong of breach…’ Some commentators in the restitution literature do indeed argue that breach should generally attract disgorgement or punitive damages, eg N J McBride ‘A Case for Awarding Punitive Damages in Response to Deliberate Breaches of Contract’ [1995] Anglo-Am LR 369. Most argue for disgorgement in limited circumstances, although the general implication seems to be the non-performance is wrongful: eg L D Smith ‘Disgorgement of the Profits of Breach of Contract: Property, Contract and “Efficient Breach”’ (1994) 24 Can Bus LJ 21; D Friedman ‘The Efficient Breach Fallacy’ (1989) 18 JLS 1;PBirks ‘Restitutionary Damages for Breach of Contract: Snepp and the Fusion of Law and Equity’ [1987] LMCLQ 421.

15. Subject to concerns over the parties’ ability to make the relevant judgments and over privately agreed punishment.

16. Campbell and Harris, n 1 above, at 232. Or they would have to put up with a sub-optimal contract because of the cost of negotiation.

17. Campbell and Harris, n 1 above, at 235 (citing Millett U in Cooperative Insurance Sociefy Ltd v Argyll Stores (Holdings) Ltd [ 19961 Ch 287 at 305) and 236. The default term based on hypothetical agreement is then in effect a tacitly agreed term.

18. Eg Campbell and Harris, n 1 above, at 209, 217.

19. By the exercise of a normative power to do so.

20. See D Friedmann ‘The Performance Interest in Contract Damages’ [1995] LQR 628.

21. Ie leaving aside the case of frustration resulting from unforeseeable circumstances or defects in the contract under the doctrines of mistake, undue influence etc.

22. There may be good reasons for disallowing punitive damages in civil proceedings but permitting disgorgement: see further, Jaffey, n 3 above, pp 376–379.

23. Cf D Friedman, n 14 above.

24. Campbell and Harris, n 1 above, at 226227, 233, 236, 237.

25. Campbell and Harris, n 1 above, at 217.

26. Campbell and Harris, n 1 above, at 231, quoting R A Epstein ‘Beyond Foreseeability: Consequential Damages in the Law of Contract’ (1989) 18 JLS at 105, 106.

27. See eg Campbell and Harris, n 1 above: ‘Contract is but a legal institution facilitating exchange and not an essential component of that exchange’ (at 235); and ‘[tlhe typical advice … unquestioningly assumes pacta sund servunda, and it is this misundentanding…’ (at 236).

28. This approach was proposed in P Jaffey ‘A New Version of the Reliance Theory’ [1998] NILQ 107; and Jaffey, n 3 above, esp pp 33–33. There are, of course, other versions of the reliance theory: eg L L Fuller and W R Perdue ‘The Reliance Interest in Contract Damages’ (1936) 46 Yale LJ 52 and 373; J Raz ‘Promises in Morality and Law’ (1982) 95 Harv LR 916; and the ‘death of contract’ theory associated with Gilmore, G The Death of Contract (Ohio: Ohio State University Press, 1974)Google Scholar and Atiyah, PS, The Rise and Fall of Freedom of Contract (Oxford: Clamdon Press, 1979)Google Scholar.

29. One might argue that this is a conditional promise, but whether this is so does not matter for present purposes. The point is that it is not a promise of performance. In the justification of promising proposed by MacConnick, N in ‘Voluntary Obligations’ in MacCorrnick, N Legal Right and Social Democracy (Oxford: Clarendon Press, 1982) p 190 Google Scholar, a promise of performance is, in effect, equated with and justified as an assumption of responsibility for reliance on the expectation of performance. B ut there is a distinction between the two, as the discussion in the text shows.

30. They must also pay the other party for work in reliance on the contract, where this is not covered by an opportunity cost: see Jaffey, n 3 above, pp 30–32. This is not, strictly speaking, a loss.

31. On this approach it is necessary to construe expectation damages as a proxy for reliance loss, as was originally advocated in Fuller and Perdue, n 28 above. This is generally reasonable, especially in a competitive market, although it may sometimes overcompensate. Campbell and Harris, n 1 above, at 217 also reject the view that the expectation interest is a synonym for the performance interest, pace Friedmann, n 20 above.

32. See n 28 above. The death of contract theory holds that the ground for protecting reliance on an agreement is not the agreement, but the reliance in itself, the agreement being merely a material fact in justifying protection. This approach disregards the parties’ own judgments as manifested in the agreement.

33. Asin Seaman's Direct Buying Service v Standard Oil 686 P.2d 1158 (Cal, 1984). aUS case on punitive damages. For further examples, see Jaffey, n 3 above, pp 391–394.

34. Seen 22 above.

35. See n 14 above.

36. For an example of the contrary assumption, see eg O'Sullivan, J, ‘Reflections on the role of restitutionary damages to protect contractual expectations’ in Johnston, D and Zimmermann, R, Unjustified Enrichment (Cambridge: Cambridge University Ress, 2002).Google Scholar

37. This should not preclude the parties from contracting for express remedies to avoid the difficulty of determining when a duty arises.