In (partial) defense of strict liability in contract

Michigan Law Review

Volumn 107, Issue 8, 2009, Pages 1381-1396

  Scott, Robert E ^a,b  

^a Department of Law al

^b Och Spine at New York Presbyterian Hospitals   (United States)

Author keywords

[No Author keywords available]

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EID: 66749179825     PISSN: 00262234     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (83)

1. George M. Cohen, The Fault Lines in Contract Damages, 80 VA. L. REV. 1225 (1994) [hereinafter Cohen, Fault Lines];
2. George M. Cohen, The Fault That Lies Within Our Contract Law, 107 MICH. L. REV. 1445 (2009) [hereinafter Cohen, Fault Within Contract Law];
3. George M. Cohen, The Negligence-Opportunism Tradeoff in Contract Law, 20 HOFSTRA L. REV. 941 (1992).
4. See Richard Craswell, When Is a Willful Breach "Willful"? The Link Between Definitions and Damages, 107 MICH. L. REV. 1501, 1502-1504 (2009) (criticizing Cohen and others for lack of clarity and precision in analyzing different fault-based notions of contract).
5. RESTATEMENT (SECOND) OF CONTRACTS ch. 11, introductory note, at 309-312 (1981).
6. See infra Part I.
7. The doctrine of unjust enrichment and the doctrine of unilateral mistake both have compound liability rules that hinge on the "reason to know" standard. For unjust enrichment, see Day v. Caton, 119 Mass. 513 (1876); for unilateral mistake, see RESTATEMENT (SECOND) OF CONTRACTS §153(b).
8. Cohen, Fault Lines, supra note 1, at 1238.
9. Id.
10. This statement must be qualified to the extent that the promisor can establish an excuse owing to the fact that the risk in question was not allocated in the contract.
11. 129 N.E. 889 (N.Y. 1921).
12. 382 P.2d 109 (OkIa. 1962). In Peevyhouse, the diminished market value was $300 while the cost of completion was estimated to be $29,000. Id. at 112.
13. See, e.g., Gerodetti v. Broadacres, Inc., 363 So. 2d 265, 267-68 (Miss. 1978);
14. Johnson v. Black Bros., Inc., 879 So. 2d 525, 527 (Miss. Ct. App. 2004).
15. As Cardozo famously stated, "the willful transgressor must accept the penalty of his transgression." Jacob & Youngs, 129 N.E. at 891.
16. Peevyhouse, 382 P.2d at 115 (Irwin, J., dissenting).
17. See Craswell, supra note 2, at 1502 (" "The word ... "wilful" ... is seldom accompanied by any discussion of its meaning or classification of the cases that should fall within it.' " (quoting 5 ARTHUR LINTON CORBIN, CORBIN ON CONTRACTS § 1123 (1951)));
18. Steve Thel & Peter Siegelman, Wilfullness Versus Expectation: A Promisor-Based Defense of Willful Breach Doctrine, 107 MICH. L. REV. 1517, 1525-26 (2009) (arguing that the willful breach doctrine is "largely epiphenomenal").
19. Alan Schwartz & Robert E. Scott, Market Damages, Efficient Contracting, and the Economic Waste Fallacy, 108 COLUM. L. REV. 1610 (2008).
20. The standard construction contract contains a separate promise by the contractor to correct any defective construction. This promise remains binding even after substantial performance of the contract. See e.g., AMERICAN INSTITUTE OF ARCHITECTS, AIA DOCUMENT A201-1997: GENERAL CONDITIONS OF THE CONTRACT FOR CONSTRUCTION (1997).
21. This argument is formally set out in Schwartz & Scott, supra note 15, at 1652-1657
22. See Craswell, supra note 2, at 1502 ("The builder in Kent used the wrong brand of pipe, apparently by accident .... ");
23. see also Patricia H. Marschall, Willfulness: A Crucial Factor in Choosing Remedies for Breach of Contract, 24 ARIZ. L. REV. 733, 743(1982).
24. But see Thel & Siegelman, supra note 14, at 1526-27 (characterizing the contractor's behavior as negligent but justifying the result on other grounds).
25. Jacob & Youngs, Inc. v. Kent, 129 N.E. 889, 892 (McLaughlin, J., dissenting) ("[N]o examination ... was made by the plaintiff, the subcontractor, defendant's architect, or anyone else, of any of the pipe except the first delivery, until after the building had been completed.").
26. Note that we must assume, per Cardozo, that the failure to install the contract-specified pipe was, in fact, a breach. This assumption is supported in the case by the architect's refusal to give his certificate.
27. Schwartz & Scott, Market Damages, supra note 15, at 1654 n.108.
28. See Judith L. Maute, Peevyhouse v. Garland Coal & Mining Co. Revisited: The Ballad of Willie and Lucille, 89 Nw. U. L. REV. 1341, 1429 (1995).
29. See id. at 1413.
30. Schwartz & Scott, supra note 15, at 1624-1634
31. Id. at 1625-1627
32. Id. at 1659 & n. 123.
33. Roudis v. Hubbard, 574 N.Y.S.2d 95 (App. Div. 1991) (applying cost of completion where contractor intentionally omitted styrofoam insulation and footing drains required by the plans).
34. See, e.g., S. Nat'l Bank, of Houston v. TRI Fin. Corp., 317 F. Supp. 1173,1185 (S.D. Tex. 1970),
35. aff'd in part, rev 'd in part sub nom. S. Nat'l Bank of Houston v. Crateo, Inc., 458 F.2d 688 (5th Cir. 1972) ("Defendant had neither breached nor indicated an intention to do so; having not yet been injured by any breach of defendant's, plaintiff had no damages to mitigate.").
36. The classic article is Robert Cooter, Unity in Tort, Contract, and Property: The Model of Precaution, 73 CAL. L. REV. 1, 11-19 (1985).
37. See also Richard Craswell, Precontractual Investigation as an Optimal Precaution Problem, 17 J. LEGAL STUD. 401 (1988);
38. Charles J. Goetz & Robert E. Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligation, 69 VA. L. REV. 967, 989-95 (1983).
39. Under an award of full expectancy, the promisee will recover her full valuation, and thus she is motivated to invest in the subject matter of the contract until her marginal gain equals her marginal cost. But the promisee does not consider that performance would be inefficient in some ex post states of the world. In these states, the promisee's investment is a social waste. See, e.g., William. P. Rogerson, Efficient Reliance and Damage Measures for Breach of Contract, 15 RAND J. EcoN. 39, 47 (1984) (concluding that under expectation damages buyers will choose a greater-thanefficient level of reliance).
40. The discussion that follows draws on ROBERT E. SCOTT & JODY S. KRAUS, CONTRACT LAW AND THEORY 815-818 (4th ed. 2007).
41. E.g., Reliance Cooperage Corp. v. Treat, 195 F.2d 977 (8th Cir. 1952);
42. Mo. Furnace Co. v. Cochran, 8 F. 463 (C.C.W.D. Pa. 1881).
43. The Uniform Commercial Code permits the promisee to wait a "commercially reasonable time" following the repudiation, and thus also fails a comparative fault analysis. U.C.C. § 2610(a) (2004).
44. In principle, the arguments outlined here might also be applied to contracts made by commercially unsophisticated parties. But defending an extension of the argument to such cases would require additional analysis to take into account a range of considerations that I do not undertake here.
45. My argument that the law properly attends to the revealed preferences of commercial parties can be supported on both efficiency and autonomy grounds. And, to be sure, moral theorists may offer other normative arguments in favor of strict liability.
46. This discussion draws on Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 YALE L.J. 814 (2006) [hereinafter Scott & Triantis, Anticipating Litigation]
47. and Robert E. Scott & George G. Triantis, Incomplete Contracts and the Theory of Contract Design, 56 CASE W. RES. L. REV. 187 (2005).
48. Scott & Triantis, Anticipating Litigation, supra note 35, at 817.
49. Under conditions of uncertainty, contracts will be incomplete in the sense that information costs will make it impossible to distinguish ex ante the ex post states of the world that call for different obligations. See, e.g.,
50. Oliver Hart & John Moore, Foundations of Incomplete Contracts, 66 REV. ECON. STUD. 115 (1999);
51. Oliver Hart & John Moore, Incomplete Contracts and Renegotiation, 56 ECONOMETRICA 755 (1988);
52. Oliver D. Hart, Incomplete Contracts and the Theory of the Firm, 4 J.L. ECON. & ORG. 119 (1988).
53. One solution is for the parties to renegotiate the contract once uncertainties are resolved. But renegotiation raises the risk of a hold up; and this, in turn, undermines the incentives for parties to make specific investments in the first place. For discussion, see Oliver Hart & John Moore, Property Rights and the Nature of the Firm, 98 J. POL. ECON. 1119 (1990), and
54. Benjamin Klein, Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited, 4 J.L. ECON. & ORG. 199 (1988).
55. See Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law, 113 YALE L.J. 541, 602-603 (2003).
56. The options available to the parties are even broader than the stark choice between rules and standards. With the aid of interpretation maxims, parties can design combinations of precise and vague terms that define more exactly the "space" within which a court has discretion in interpreting the contract. For discussion, see Scott & Triantis, Anticlpating Litigation, supra note 35, at 848-856
57. See, e.g., Schwartz & Scott, supra note 39, at 545.
58. This discussion, draws on Robert E. Scott, A Theory of Self-Enforcing Indefinite Agreements, 103 COLUM. L. REV. 1641 (2003).
59. See Schwartz & Scott, supra note 39, at 557 (asserting reputations work well in small trading communities, where information about others' actions is common knowledge and boycotts of bad actors are readily enforced).
60. Retaliation has its limits: the threat that the other party will no longer deal with the promisor may be insufficient to induce performance if parties come to realize that the relationship is soon to terminate. See, e.g., Benjamin Klein, Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships, 34 ECON. INQUIRY 444 (1996).
61. This substantial body of experimental evidence shows that individuals respond cooperatively to generous acts and, conversely, punish noncooperative behavior. Moreover, individuals will repay generosity and punish selfishness even if doing so is costly and yields neither present nor future material rewards. See, e.g., Ernst Fehr & Klaus M. Schmidt, A Theory of Fairness, Competition and Cooperation, 114 Q.J. ECON. 817 (1999);
62. Ernst Fehr et al., Reciprocity as a Contract Enforcement Device: Experimental Evidence, 65 ECONOMETRICA 833 (1997);
63. David K. Levine, Modeling Altruism and Spitefulness in Experiments, 1 REV. ECON. DYNAMICS 593 (1998);
64. Matthew Rabin, Incorporating Fairness into Game Theory and Economics, 83 AM. ECON. REV. 1281 (1993). For a review of the literature, see Ernst Fehr & Klaus M. Schmidt, Theories of Fairness and Reciprocity-Evidence and Economic Applications 2-3 (Univ. of Zurich Inst, for Empirical Research in Econ., Working Paper No. 75, 2001).
65. Scott, supra note 42, at 1667-1672
66. In complex interactions, a failure to cooperate may not be observable immediately, or else a cooperative response may be mistakenly interpreted as a defection from cooperative norms. Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 CAL. L. REV. 2005, 2050-53 (1987).
67. A disinterested adjudicator may be in better position to sort out complex behavior, detect a breach, and, by imposing a predetermined sanction, forestall attempts by the aggrieved party to respond disproportionately. ROBERT E. SCOTT & PAUL B. STEPHAN, THE LIMITS OF LEVIATHAN: CONTRACT THEORY AND THE ENFORCEMENT OF INTERNATIONAL LAW 100 (2006).
68. A number of studies have confirmed the crowding-out hypothesis. For discussion see Scott, supra note 42, at 1688-92. Other recent experiments also show that if there is some probability of continued transactions, then, legal enforcement that is limited to the verifiable dimensions of the agreement will enhance cooperation in the dimensions of the agreement that are nonverifiable.
69. Sergio G. Lazzarini et al., Order with Some Law: Complementarity versus Substitution of Formal and Informal Arrangements, 20 J.L. ECON. & ORG. 261 (2004).
70. For discussion, see Robert E. Scott, The Case for Formalism in Relational Contract, 94 Nw. U. L. REV. 847 (2000);
71. Robert E. Scott, The Death of Contract Law, 54 U. TORONTO L.J. 369 (2004).
72. Robert E. Scott, A Relational, Theory of Default Rules for Commercial Contracts, 19 J. LEGAL STUD. 597, 615 (1990).
73. See Cohen, Fault Within Contract Law, supra note 1.
74. Alliance Agreement between E. I. du Pont de Nemours & Co. and EarthShell Corp. (Jul. 25, 2002), available at http://contracts.onecle.com/ earthshell/dupont.collab.2002.07.25.shtml.
75. Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code's Search for Immanent Business Norms, 144 U. PA. L. REV. 1765 (1996);
76. Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms and Institutions, 99 MICH. L. REV. 1724 (2001).
77. Theodore Eisenberg & Geoffrey P. Miller, The Flight to New York: An Empirical Study of Choice of Law and Choice of Forum Clauses in Publicly-Held Companies ' Contracts (N.Y.U. Ctr. For Law & Econ., Working Paper No. 124, 2008), available at http://lsr.nellco.org/nyu/lewp/ papers/124.
78. Id. at 21, 36. Delaware was a distant second to New York, with, about 15 percent of the parties choosing its law. No other state accounted for even 10 percent of the choices of law.
79. Id. at 21.
80. Id. at 21.
81. Geoffrey P. Miller, Bargaining on the Red-eye: New Light on Contract Theory (N.Y.U. Ctr. For Law & Econ., Working Paper No. 131, 2008), available at http://lsr.nellco.org/nyu/lewp/ papers/131.
82. Id. at 1. 59. See
83. Cohen, Fault Lines, supra note 1, at 1312 ("But we have already seen that strict liability is a myth.").