A party in breach of contract cannot sue the victim of breach to recover what would have been the victim’s loss on the contract. The doctrinal rationale is simple: A violator should not benefit from his violation. This rationale does not, however, provide an economic justification for the rule. Indeed, efficient breach theory is founded on the proposition that a breach of contract need not be met with reproach. Yet the prospect of a recovery by the party in breach—that is, the prospect of negative damages—has received scant attention in the contracts literature. Close analysis reveals potential costs to disallowance of negative damages particularly where a party with private information about the benefits of termination also has an incentive to continue under the contract. These costs can occur both ex post, at the time of a performance-or-termination decision, and ex ante, in anticipation of that decision. Nevertheless, allowance of negative damages could impose its own costs, where background information would create an incentive to repudiate a contract before either party could gather more information, for example. Ex ante contractual provisions, such as liquidated-damages or specific-performance clauses, permit parties some latitude to balance the costs of disallowance and allowance of negative damages, albeit imperfectly. Common law limitations on the mitigation duty, moreover, may be seen as a mechanism to approach this balance in the absence of an explicit contractual solution.
Date of Authorship for this Version
Adler, Barry E., "Efficient Breach Theory Through the Looking Glass" (2008). New York University Law and Economics Working Papers. Paper 122.