ECO320H1 Study Guide - Expectation Damages, Spot Contract, Specific Performance

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15 Jan 2011

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Chapter 7 Topics in the Economics of Contract Law
- Optimal remedy for breach secures optimal commitment to the contract (efficient formation,
performance and reliance)
Remedies As Incentives
- 3 types: Party-designed, court-imposed, specific performance
Alternative Remedies:
1. Expectation Damages: positive damages, victim of breach is better off than if no contract was
in place, perfect expectation damages: promisee indifferent between performance and breach
Sellers Breach:
Calculating perfect expectation damages: Xk(Ps Pk)
if initially purchased Pk, breached, thus had to purchase Ps, amount X
Buyers Breach:
Xk(Pk Ps)
Buyers Breach w/ Unique Good:
Vk-Va, if Vk > Va, but breached and Va delivered, Vk expected
2. Reliance Damages: - investing in reliance increases lost as a result of breach, perfect reliance
damages: indifferent between no contract and breach
Sellers Breach w/ Substitute: 0
Buyers Breach: Xk(Pw Ps)
3. Opportunity Costs: - perfect OC damages leave victim indifferent (negative damages) if
current contract was not available, what other contract could have been performed, this is the
measure of opportunity cost Xk(Ps Po), difference between spot price and best alternative
4. Problem of Subjective Value: Hawkins vs. McGee
- Hawkins suffered childhood accident left scar on his hand
- Skin from plaintiffs chest was taken for his hand, result was hideous, small scar was large and
irreversibly worse and became covered with hair
- Expectation damages: if 25 percent was performed, 75 percent needs to be accounted for
(shortfall) (assumption: $10,000 w/ 25% = perfect hand), IC drawn hits horizontal axis at 100%
- Reliance damages: Uninjured state is condition without contract, 50% hand is uninjured state,
operation brought it to 25%, therefore 25% needs to be accounted for (assumption: $5,000 w/
25% = 50% hand) IC drawn hits horizontal axis at 50%
- Opportunity cost measures: lost opportunity for successful operation, if another doctor could
have brought to 75%, then must measure difference between 25% and 75%, in this case $8000,
IC drawn hits horizontal axis at 75% ($8000 and 25% hand = 75%)
TOTAL DAMAGES: $10,000 + $8,000 + $5,000 = $23,000 (Expectations + reliance + opp cost)
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Usually this holds under perfect measure: exp. damages >= OC damages >= reliance damages
Not always however: imperfect damages awarded at times,
- B pays D $10,000 to deliver on October 1st,
- Does not sign similar contract for $10,050 as a result of this one,
- D contracts w/ shipping company S to transport, B agrees to sell for $11,000 to another party on
October 1st,
- B pays $100 in advance for delivery (reliance)
- Grain takes water, ruined, sold for $500
- B purchases grain for $12,000 to deliver
Expected Profit: $900
Expected Gain from Opportunity cost: $400
Loss: $12,000+$10,100 - $11,000 = $11,100
5. Restitution deferred exchange: one party gives something in exchange for something in
future, if breached, breaching party must return (down payment), restitution is thus minimal does
not compensate for expectation damages
6. Disgorgement Perfect compensation completely internalizes the cost of an injury, thus when
completely internalized efficiency requires freedom of action, not deterrence. Rationality: injury
will be purposely caused when perfect compensation can be awarded and profit left over.
Disgorgement damages: damages paid to victim to eliminate injurers profit from wrongdoing.
(trick into selling valuable asset, sell asset to third party, disgorgement damages: must return
profit, if loyalty rules apply)
7. Specific Performance instead of damages, breaching party may be ordered to perform
remedy, in civil law countries specific performance is usually remedy, in common law countries
damages are traditional remedy
- typically this is adopted in sale of goods to which no close substitute exists
- done with unique goods to avoid impossible task of determining subjective value
8. Party-Designed Remedies: Liquidated Damages liquidated damages: promise breaker
pays innocent party, performance bonds given in event of breachvaluable assets”
- common law perevents courts from enforcing terms stipulating damages that exceed harm
caused by breach, instead they call upon liquidated damages
- civil law countries show more willingness to enforce
- reasons to enforce penalty clauses may be: premiums paid for guaranteed delivery
- wants to convey information, guarantee trust, willing to pay to guarantee trust in contract
- if a bonus replaces a penalty, then probability of enforcement can increase (illegal penalty vs
legal bonus)
Efficient Breach and Performance: - can efficiently breach when not viable, or renegotiate
- unfortunate contingency: low cost performance usually results in cooperation, if there is
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