Econ 522 Economics of LawLast week…Slide 2Three broad types of remedy for breach of contractExpectation damagesReliance damagesOpportunity cost damagesExample: expectation, reliance, and opportunity cost damagesSlide 9Ranking damagesHawkins v McGee (“hairy hand case”)Slide 12Recapping different types of damagesOther court-ordered remediesSlide 15Slide 16Party-designed remediesPenalty DamagesLiquidated damagesPenalty damagesPenalty clausesSlide 22Slide 22Remedies and breachSlide 25Efficient signingSlide 26Paradox of compensationIncentives for reliance (airplane example)Three questionsSlide 31So…Slide 32Investment in performance (continuing with airplane example)Slide 35Slide 36What do these results mean?Slide 37Econ 522Economics of LawDan QuintSpring 2010Lecture 132Formation defensesIncompetenceDuress, necessityAdhesion, unconscionability (lesion)Fraud, failure to discloseMutual mistakeBut not unilateral mistakePerformance excusesImpossibilityFrustration of purposeConceptsEfficient bearer (low cost avoider) of a riskUniting knowledge and controlLast week…3Remedies for breachof contract4Party-designed remediesRemedies specified in the contractCourt-imposed damagesCourt may decide promisee entitled to some level of damagesSpecific performanceForces breaching party to live up to contractThree broad types of remedy for breach of contract5Compensate promisee for the amount he expected to benefit from performanceYou agreed to buy an airplane for $350,000You expected $500,000 of benefit from itExpectation damages: if I breach, I owe you that benefit($500,000 if you already paid, $150,000 if you didn’t)“Positive damages”Make promisee indifferent between performance and breachExpectation damages6Reimburse promisee for cost of any reliance investments made, but not for additional surplus he expected to gainRestore promisee to level of well-being before he signed the contractYou contracted to buy the plane and built a hangarIf I breach, I owe you what you spent on the hangar, nothing else“Negative damages” – undo the negative (harm) that occurredReliance damages7Give promisee benefit he would have gotten from his next-best optionMake promisee indifferent between breach of the contract that was signed, and performance of best alternative contractYou value plane at $500,000You contract to buy plane from me for $350,000Someone else was selling similar plane for $400,000By the time I breach, that plane is no longer availableI owe you $100,000 – the benefit you would have gotten from buying the other seller’s planeOpportunity cost damages8You agree to sell me ticket to Wisconsin-Michigan football game for $50Expectation damages: you owe me value of game minus $50If I pay scalper $150, then expectation damages = $100Reliance damages: maybe 0, or cost of face paint and giant foam fingerExample: expectation, reliance, and opportunity cost damages9You agree to sell me ticket to Wisconsin-Michigan football game for $50Expectation damages: you owe me value of game minus $50If I pay scalper $150, then expectation damages = $100Reliance damages: maybe 0, or cost of face paint and giant foam fingerWhen you agreed to sell me ticket, other tickets available for $70Opportunity cost damages: $80(I paid a scalper $150 to get in; I would have been $80 better off if I’d ignored your offer and paid someone else $70)Example: expectation, reliance, and opportunity cost damages10Ranking damagesExpectationDamagesOpportunity CostDamagesRelianceDamages ContractI SignBestAlternativeDo Nothing Breach +ExpectationDamagesBreach +Opportunity Cost DamagesBreach +RelianceDamages $100 $80 $0-20 11Hawkins had a scar on his handMcGee promised surgery to “make the hand a hundred percent perfect”Surgery was a disaster, left scar bigger and covered with hairHawkins v McGee (“hairy hand case”)12Hawkins v McGee (“hairy hand case”)Hairy Scarred Nextbestdoctor100%Perfect$HandInitial Wealth+ Reliance Damages+ Opp Cost Damages+ Expectation DamagesReliance DamagesOpp Cost DamagesExpectation Damages13Expectation damagesGive promisee benefit he would have had from performanceOpportunity cost damagesGive promisee benefit he would have had from next-best contractReliance damagesGive promisee benefit he would have had from doing nothingExpectation Dam Opp Cost Dam Reliance DamBut order can be reversed when calculated incorrectlyRecapping different types of damages14RestitutionReturn money that was already receivedDisgorgementGive up wrongfully-gained profitsOther court-ordered remedies15RestitutionReturn money that was already receivedDisgorgementGive up wrongfully-gained profitsSpecific PerformancePromisor is forced to honor promiseCivil law: often ordered instead of money damagesCommon law: money damages more common; S.P. sometimes used when seller breaches contract to sell a unique goodLike injunctive reliefOther court-ordered remedies16RestitutionReturn money that was already receivedDisgorgementGive up wrongfully-gained profitsSpecific PerformancePromisor is forced to honor promiseCivil law: often ordered instead of money damagesCommon law: money damages more common; S.P. sometimes used when seller breaches contract to sell a unique goodLike injunctive reliefOther court-ordered remedies17Remedy for breach could be written directly into contractBut common law courts don’t always enforce remedy termsLiquidated damages – party-specified damages that reasonably approximate actual harm done by breachPenalty damages – damages greater than actual harm doneCivil law courts are generally willing to enforce penalty damagesBut common law courts often do notParty-designed remedies18Peevyhouse v Garland CoalPeevyhouses only wanted farm strip-mined if it would be restored to original condition afterSuppose coal extracted worth $70,000Garland paid $25,000 for rights to mine itRestoration work would cost $30,000Diminution of value was $300So liquidated damages would be $300Suppose Peevyhouses got $40,000 of disutility from land being left in poor conditionPenalty DamagesCoal worth $70,000Garland to pay $25,000Restoration would cost $30,000Liquidated damages are $300Peevyhouses value
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