As Exhibit 4.5 is drawn, changed conditions have shifted the seller’s indifference curve (Is2) back
toward the northeast origin.36 The seller now perceives the agreed upon post-performance result (R
c) as
35
Note that if we look at the situation in terms of S, the point Ro is unchanged. It represents S’s holding of $20,000
and 100,000 units of goods.
36
It should be emphasized that conditions inducing breach need not always be represented by a “shiftback” in seller’s indifference curve. It could equally occur where the buyer’s curve shifted. The essential condition to breach
an inferior outcome when compared to the status quo ante (Ro) and thus an incentive to breach exists. In
terms of Exhibit 4.5, the just compensation principle of modern contract theory is representable by B’s indifference curve Ib1. This curve not only indicates solutions equivalent (equally preferred by B) to full
performance at Rc, but also identifies end results southwest of Ib1 which would fail to provide the buyer
with an outcome meeting his original “expectations” of performance at Rc. Since Ibl does identify results
which are, from B’s standpoint, interchangeable with full performance (Rc), this important indifference
contour will be termed the “quasi-performance” curve. The concept of quasi-performance expresses the fact that any point on the curve places the buyer in the same preferredness situation as if performance had taken place.
As Exhibit 4.5 is constructed, full breach by the seller would require that S pay B $15,000 in damages in order to move the buyer from the non- performance solution Ro to the appropriate point Rf on the quasi-
performance curve. Point Rf is the appropriate solution precisely because it supplies B with the equivalent
of performance when no goods at all are delivered. Exhibit 4.5 is also drawn to reflect the fact that S can do even better by tendering partial performance of 15,000 units, thus creating the post-compensation result of Rb. Result Rb, permitting the seller to move to a new higher indifference curve 193, is preferable
to both Rc and Rf. It is the most preferred available to S since the law guarantees to B at least some point
on the quasi-performance curve. Not only is solution Rb unambiguously superior to performance at Rc,
but it also represents an “efficient” end result in the sense that there is no movement from Rb possible
without making at least one party worse off.38 In reaching R
b, the seller would collect the original contract
price of $1 per unit for the 15,000 unit partial performance, but would then be required to remit to the buyer $7,500 in damages in order to provide B with his quasi-performance expectation at Rb rather than
the no compensation result Rj.
This efficient damage model indicates that upon total or partial non- performance the seller’s obligation is to provide “just compensation” sufficient to place the buyer on his quasi-performance curve. Since the points along this curve represent the buyer’s subjective preferences between performance and compensation, “just compensation” may require consideration of nonobjectifiable elements in determining appropriate compensation to the non-breaching buyer.
QUESTIONS
1. What is meant by an “efficient breach” or an “efficient contract”? What are the “error costs” if an efficient breach is prevented? Does the term “inefficient,” as used in this context, mean about the same thing as “wasteful”?
2. The analysis in the text should suggest to you that the law actually encourages promisors not to perform their promises under certain circumstances. Explain why, under the standard contract rules of compensatory damages, the breacher gets all of the so-called efficiency gains when an inefficient contract is not performed.
3. Think about some of the alternatives to the standard system of contract damages. For instance, compare the normal system of compensation for “expectation” damages to one wherein the promisee had the right to specific performance. Would the latter result in the performance of inefficient contracts? How about a system wherein the breacher and breachee “split” the gains fifty-fifty? Why is that the changed circumstances indicate that the parties’ indifference curves are no longer tangent at the contract point (Rc).
37
The movement from Ro to Rc is a movement down the preferredness surface for the seller. It places S on an
indifference curve (Is2) which is northwest of Ro and thus inferior to Ro in S’s eyes.
38
The point Rb is superior as Exhibit 4.5 is drawn because it makes the seller better off by putting him on
indifference curve Is3 while retaining the buyer on his indifference plateau Ib1. The result is also “optimal” in the
do you think the standard legal rule is for compensatory damages rather than any of these other possible rules?
4. As the example was developed in the text, it was the breacher’s indifference curves that shifted, representing a post-contract change in his assessment of the relative values of goods and-money. Suppose that the breachee’s preferences had also shifted. Would the quasi-contract curve for “expectation” damages be based on the “old” indifference curve running through Rc or on the “new”
indifference curve existing at the time of breach? Explain.
E. CONSUMER CHOICE: MODELING PROMISSORY RELIANCE
In the initial “map-reading” section, one question dealt with the mutually agreeable relocation of a well site. That part of the problem involved what should now be recognizable as a variation of the Edgeworth Box trading model, several additional examples of which have been provided in the intervening sections. The other part of the map-reading section, however, involved a somewhat different type of model, one that traditional economics would label a “constrained maximization” model of consumer choice. In such models, the focus is on the adjustment of a single decision-maker to the opportunities confronting him, rather than two-party trade. In the antenna application, the constraint facing the decision-maker was a legal one, the boundaries within which the antenna could be placed, and the “maximand” (thing to be maximized) was the height of the ground as mapped by the contour lines. Almost identical constructions are used in traditional economics to model consumer choice. In most traditional applications, the constraints or boundaries are determined by the individual’s income and the rate at which the things open to choice must be substituted for one another in order to remain within the “budget constraint.” The maximand is the level of utility or “preferredness” as represented by the indifference curve map. This type of indifference curve model of consumer choice was explained briefly as Exhibit 4.2 above and will now be the focus of the next few application sections.
Indifference curve models of consumer choice have a great many legal applications. The following examples involve constructions that might be used in any undergraduate economic theory course, since they explicitly cast the analysis in terms of income and prices. Bear in mind, however, that the “goods” chosen do not have to be standard economic entities nor does the opportunity set open to the chooser have to be defined in terms of income and prices. In short, the antenna-location application is just as legitimate a use of the model as these more standard applications that follow.
[Excerpted and adapted from: Goetz and Scott, “Enforcing Promises: An Examination of the Basis of Contract,” 89 Yale L.J. 1261 (1980).]
A. The Function of Promises: Adaptation by the Promisee
In analyzing the promisee’s reaction to a promise, it is critically important to bear in mind the conceptual distinction between the promise itself and the future benefit that it foretells. By communicating a promise, the promisor informs the promisee about the proposed future receipt of a benefit. The promise itself is merely the production of a piece of information about the future. Normally, advance knowledge of a future transfer will increase the benefit to the promisee because he can more perfectly adapt his consumption decisions to the impending change in wealth. For instance, a person informed of a $25,000 bequest to be made one year hence may revise some of the plans that he otherwise would have followed in the intervening twelve months. Because of the revisions in his plans, the individual can achieve a higher level of satisfaction than if the wealth were transferred without any advance notice. Such adaptive gain from the information embodied in a promise may appropriately be termed “beneficial reliance.” The problem occurs, however, when the transfer foretold by the promise is not actually performed. In this case, the information conveyed by the promise turns out to have been
misleading and the promisee’s induced adaptation in behavior makes him worse off than he would have been without the erroneous expectation of a future benefit. Losses incurred by ill-premised adaptive behavior are commonly termed “detrimental reliance.” Because the role of promises as units of information is so fundamental to the entire analysis developed below, we will use an economic indifference curve model to give more rigorous content to such key legal concepts as reliance and the reasonableness of the promisee’s adaptation process.
1. Reliance Reactions of a Promisee
Exhibit 4.6 will be utilized to develop a very simple intertemporal allocation model, one in which a person must allocate his income between two periods, present and future. A, the potential promisee, begins with $100, which he can divide between consumption now and consumption in the future. In Exhibit 4.6, his possible choices are represented by the straight line budget constraint indicating all combinations of present and future consumption that sum to $100. His preferences about alternative combinations of present and future consumption are summarized by the indifference curves, which define a kind of topographic map of the desirability of different present-future consumption patterns. On these assumptions, the highest preference level consistent with the scarce resources is point e,, where indifference curve Il is tangent to the budget constraint. This consumption allocation involves spending $50 now together with a planned expenditure of $50 in the future.