Equity, Efficiency, and Ethics in Remedies for Breach of Contract: Theory and Experimental Evidence

241 Pages·2022·3.23 MB·English

by  Sergio Mittlaender

International Law and Economics
Sergio Mittlaender
Equity, Efficiency,
and Ethics in
Remedies for
Breach of Contract
Theory and Experimental Evidence
International Law and Economics
Series Editors
Stefan Voigt, University of Hamburg, Hamburg, Germany
Anne van Aaken, University of St. Gallen, St. Gallen, Switzerland
Andrew T. Guzman, University of California at Berkley, Los Angeles, USA
Stefan Oeter, University of Hamburg, Hamburg, Germany
Joel P. Trachtman, Tufts University, Medford, USA
Naigen Zhang, Fudan University, Shanghai, China
The world has been experiencing a long period of globalization. At the same time,
ever more international law has been created to deal with the many consequences of
globalization such as problems of coordination, spillover effects across countries, the
protection of foreign direct investment or the prosecution of crimes against humanity.
To date, the economic analysis of international law has been lagging behind this
development. This series aims at changing this by contributing to the understanding
of international law. It strives to be a forum for contributions on all aspects of the
economic analysis of international law ranging from the analysis of the genesis of
international law, its ratification, its effects on government behavior, the means to
monitor compliance to sanctions against actors not complying with the law.
Sergio Mittlaender
Equity, Efficiency, and Ethics
in Remedies for Breach
of Contract
Theory and Experimental Evidence
Sergio Mittlaender
Fundação Getulio Vargas Law School
in São Paulo (FGV Direito SP)
São Paulo, Brazil
Max Planck Institute for Social Law
and Social Policy
Munich, Germany
ISSN 2364-1851 ISSN 2364-186X (electronic)
International Law and Economics
ISBN 978-3-031-10803-7 ISBN 978-3-031-10804-4 (eBook)
https://doi.org/10.1007/978-3-031-10804-4
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To my parents,
for everything.
Foreword
Do the Victims of Breach of Contract Want Vengeance?
Should a court punish someone for choosing to break a contract? After centuries of
legal development and decades of scholarship on the subject, one would think that
this fundamental question about contract law had been answered. And yet, scholars
continue to struggle to identify the appropriate remedy for breach of contract. On one
side of the debate, scholars like Charles Fried and Seana Shiffrin assert that a contrac-
tual obligation carries with it a moral promise that one will perform.1 Intentional
torts produce punitive damages, so why should the intentional breach of contract be
any different? On the other side stand the law-and-economics scholars, who worry
that punitive measures would discourage parties from efficiently re-allocating rights
when events develop in a way different than parties expect, from breaching whenever
breach is socially efficient, or even discourage parties from entering into contracts
in the first place.
Despite the scholarly debate, the law on the subject is completely clear. Except
for acts of fraud and a few other isolated exceptions, parties are not penalized with
punitive damages for breach of contract. Over a century ago, Oliver Wendel Holmes
stated that “the duty to keep a contract at common law means a prediction that you
must pay damages if you do not keep it,—and nothing else.”2 His assertion accurately
describes the state of the law then and the state of the law today.
Legal realities, however, have not stopped academic debate. And for good reason.
Those who argue that contract has a moral dimension have two points in their
favor. First, many contracting parties behave as if their contractual promise has a
moral dimension. Parties frequently honor their contractual obligations even though
they might be better off breaching and paying damages. Furthermore, these scholars
have intuition on their side. Extensive research by Tess Wilkinson-Ryan and David
1 Charles Fried, Contract as Promise: A Theory of Contractual Obligation (1981); Seana Shiffrin,
The Divergence between Contract and Promise, 120 Harv. L. Rev. 708 (2007).
2 Oliver W. Holmes, The Path of the Law, 10 Harv. L. Rev. 457, 462 (1897), reprinted in 110 Harv.
L. Rev. 991, 996 (1996–1997).
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viii Foreword
Hoffman shows that people treat breaches of contracts as immoral.3 For example,
people who are the victims of breach see themselves as “suckers” who foolishly
trusted another party. This reaction is hard to explain if performing a contract is simply
an economic choice. Furthermore, victims of breach assess the context surrounding
a breach in ways that an economic approach cannot easily explain. For example,
people are more apt to breach to avoid incurring a loss than to obtain an extraor-
dinary gain. They also perceive breach to avoid incurring a loss as less morally
reprehensible than breach to obtain higher profits,4 and react accordingly.5 To many
parties, contracts feel like a moral obligation. For those who argue that contracts
have a moral component, the law is simply deficient.
Enter Sergio Mittlaender into the debate. Mittlaender’s perspective is clearly
rooted in economics. His analysis of appropriate contract remedies is relentlessly util-
itarian. He does not, however, cling to the conventional approach. One of the primary
contributions of this book is his blending of behavioral economics—primarily behav-
ioral game theory—into the economic analysis of remedies. As he properly notes, one
of the core findings of behavioral game theory is that people punish deviations from
prosocial norms. For example, in ultimatum games, in which one party may propose
a split of a sum of money in a take-it-or-leave it fashion to a partner, the partner
will commonly reject any proposal that offers them less than half of the value of the
good.6 They do this even though rejecting a proposal means they sacrifice their own
offer. Similarly, in stylized behavioral economics games, people are willing to incur
costs to themselves to reduce the gains that other players obtain by defecting from a
cooperative norm.7 Behavioral economists have concluded that people actually enjoy
punishing wrongdoers.
This observation would seem to support the scholars who argue that breach of
contract has a moral component. After all, when someone fails to perform a contract,
they have defected from a norm of cooperating with their contracting partner. The
research from behavioral economic demonstrates that people want to punish such
defections. People’s intuitions thus seem to be in line with the arguments Charles
Fried and Seana Shiffrin make about the morality of contracts.
Sergio Mittlaender, however, stands this argument on its head. He argues that the
desire of victims of breach to punish those who breach contracts is inefficient, or
at least socially costly. In contrast, conventional, expectancy damages for breach of
contract are efficient in two different dimensions. Mittlaender contends that contract
damages not only incentivize promisors to perform if and only if performance is
3 Tess Wilkinson-Ryan & David Hoffman, Breach is for Suckers, 63 Vand. L. Rev. 1003 (2010).
4 Tess Wilkinson-Ryan & Jonathan Baron, Moral Judgment and Moral Heuristics in Breach of
Contract, 6 J. Empirical Legal Stud. 405 (2009); Sergio Mittlaender, Morality, Compensation, and
the Contractual Obligation, 16 J. Empirical Legal Stud. 119 (2019).
5 Sergio Mittlaender & Vincent Buskens, Retaliation, Remedies, and Contracts, 21 Am. Law &
Econ. Rev. 280 (2019).
6 Werner Güth, Rolf Schmittberger & Bernd Schwarze, An Experimental Analysis of Ultimatum
Bargaining, 3 J. Econ. Behav. & Organ. 367 (1982).
7 Ernst Fehr & Simon Gächter, Cooperation and Punishment in Public Goods Experiments, 90 Am.
Econ. Rev. 980 (2000).
Foreword ix
socially efficient, but they can also satisfy the victim’s desire to punish. He argues
that legal remedies can displace, or “crowd out” the desire to extract revenge on the
breaching party.
Although it is possible that Mittlaender is right, the victims might correctly
perceive the conventional contract remedy as no punishment at all. As the proponents
of the moral theory of contracting argue, conventional damages sometimes reward
breaching parties. When a party refuses to deliver a good or service to someone it
was promised to, they are free to sell it to someone else at a higher price, pay the
damages, and be better off. Why should the victim of breach be satisfied with simply
being compensated? And yet, as Mittlaender shows in a series of experiments, the
conventional remedy appears to assuage the victims of breach. People who find them-
selves the victims of breach in Mittlaender’s experiments decline to punish when a
conventional, compensatory remedy is available.
Sergio Mittlaender’s theory and data thus show that both sides of the debate
have it right. The moral theorists correctly identify a strong component of morality
in contractual obligation. In Mittlaender’s theory, victims feel aggrieved because,
among other reasons he identifies in this book, they often perceive the act of breach
as morally reprehensible, and retaliate against the wrongdoer accordingly. But the
economics theorists also have it right that the conventional remedy is an adequate
response in the face of breach. As Mittlaender shows, not only does the remedy deter
inefficient breaches, but it also avoids a loss of welfare by reducing costly forms of
retaliation by victims. Although there is much to be said for the moralists’ theories,
victims of breach seem satisfied with compensation and do not harbor further latent
desires for vengeance. To paraphrase the classic film, “The Godfather,” contract is
not “personal,” it is “just business” after all.
Jeffrey J. Rachlinski
Henry Allen Mark Professor of Law
Cornell Law School
Ithaca, US
Acknowledgements
First and foremost, I want to express my since gratitude to my promoters Vincent
Buskens and Jeffrey Rachlinski, as well as to Ann-Sophie Vandenberghe. I have been
amazingly fortunate to have promoters who gave me the freedom to explore on my
own and at the same time the guidance to recover when my steps faltered. During
the most difficult times when writing this thesis, they gave me the moral support and
the freedom I needed to move on.
I am very thankful to Vincent for encouraging the use of correct grammar and
consistent notation in my writings and for carefully reading and commenting on
countless revisions of this manuscript. Independent of whether the subject matter
was moral philosophy, jurisprudence, contract law, neurocognitive psychology,
game theory, experimental economics, econometrics, or comparative law, Vincent
was always there to read lengthy texts and to provide precise suggestions for
improvements.
I am especially thankful to Jeff for advocating the use of straightforward syntax
and simple language in my texts and for ingeniously bringing whole arguments and
sections back on track when they seemed not to advance the thesis. In any of the
subjects mentioned above, Jeff was always there to listen patiently to my ideas and
thoughts, and to grasp the whole picture that I was so often unable to see.
Moreover, I am thankful to Ann-Sophie for defending existing theories against any
accusation of incompleteness and thereby reminding me that different explanations
exist and must be confronted, independent of how unpersuasive or implausible they
may sound to the lawyer or economist. Our meetings often ended in long checklists
of points to be tackled in my writings, and from which this thesis benefited.
The road to my graduate degree has been long and winding, so I would also
like to thank some people from the early days in Brazil and Germany. My former
promoters of my bachelor thesis in law, Celso Campilongo, and in economics, Zilton
Macedo, guided my first investigations in law and economics and taught me how
to develop independent research. My former promoters of my master thesis in law,
Joseph Drexl, and in economics, Ekkerhart Schlicht, advised me in my supervening
theses and taught me how to produce more mature research.
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