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The Myth That Promisees Prefer Supracompensatory Remedies: An

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The Myth That Promisees Prefer Supracompensatory Remedies: An The Myth that Promisees Prefer SupracompensatoryRemedies: An Analysis of Contracting for Damage Measures Alan Schwartzt Courts will not enforce liquidateddamage clauses when a stipulatedsum exceeds (i) the harmthat the promiseecould reasonablyexpect to suffer from breachor (ii) the actualharm that breach turned out to cause.' Courtstradition- ally have not awardedpunitive damages "for a breachof contractunless the conduct constitutingthe breachis also a tort for which punitive damagesare recoverable."2Courts also will not grant specific performance"if damages would be adequateto protectthe expectationinterest of the injuredparty," nor will courts enforce contractsthat accordpromisees a right to specific relief.3 These threerules sharethe goal of limitinga promisee'srecovery to his lost expectation.The liquidateddamage rule preventsthe promiseefrom contracting for a supracompensatoryremedy, and the punitivedamage rule preventscourts from awardingsuch a remedy.The specific performancerule achievesthe law's goal indirectly.A promiseewho has a rightto specific performancecan compel the promisor to perform even when the promisor'sloss from performance would exceed the promisee'sgain. A promisorcan purchaseher freedom,but sophisticatedpromisees sometimes will demandmore thantheir expectation as the price.Permitting specific performanceonly whendamages could not protect the expectation interest limits the ability of promisees to obtain supracom- pensatorypayments by threateningto seek specific relief. The ban on "specific performanceclauses" prevents a promiseefrom obtaining by contractthe power that the general specific performancerule aims to abolish. t William K. TownsendProfessor of Law, Yale Law School; Professor,Yale School of Organization & Management. Earlier versions of this article were presented at the 1989 Canadian Conference of CommercialLaw Professorsand a Symposiumon ContractTheory at Tel Aviv Law School held in March 1990. Peter Cramtonmade very helpful suggestions. Jules Coleman, RichardCraswell, Henry Hansmann, JonHanson, Jason Johnston, Avery Katz, andMichael Trebilcock made perceptive comments on priordrafts. The authoris an Associate Reporterto the AmericanLaw InstituteProject: Compensation and Liabilityfor Productand Process Injuries.The thoughtsexpressed here are the author's,reflecting neitherthe views of other Reporterson the Project nor the views of the ALI. 1. RESTATEMENT(SECOND) OF CONTRACTS? 356 (1981); U.C.C. ? 2-718(1) (1989). 2. RESTATEMENT(SECOND) OF CONTRACTS ? 355 (1981); U.C.C. ? 1-106(1) (1989) (by inference). 3. RESTATEMENT(SECOND) OF CONTRACTS ? 359(1) (1981); U.C.C. ? 2-716(1) (1989). 369 370 The Yale Law Journal [Vol. 100: 369 These three rules rest on a normativepremise and on a positive premise. The normativepremise holds thatsupracompensatory remedies are undesirable. The positive premiseholds thatpromisees prefer supracompensatory remedies, and so must be preventedfrom getting them.The normativepremise is truebut the positive premise is false. It is shown below that promisees do not want contractualdamage measures that would grant more than their lost expectation. Several legal implicationsfollow from this showing. First, the initial, or "ex ante," branchof the liquidateddamage rule is unnecessary.Courts do not have to preventpromisees from obtainingpenalty clauses if promiseesdo not wantpenalty clauses. The ex ante rule is not merely unnecessary:judicial review produces mischief. Courts sometimes mistake compensatorydamage measures for penalties,and so have foundthat particular liquidateddamage clauses would inevitablyovercompensate promisees when those clauses only protectedthe expectation.Thus, the ex ante branchof the liquidateddamage rule should be abandoned. The "expost" branch of the liquidateddamage rule, which bans clausesthat overcompensatein fact, seemsjustifiable at first glance. An ex ante reasonable estimate of the damages that the promisee will later incur may exceed the promise's actualloss. The normativepremise that supracompensatory remedies are undesirablethen apparentlyjustifies the ex post branchof the rule, because it implies that courtsshould not enforceliquidated damage clauses thatexceed actualdamages. This view is unpersuasive:party estimates may err, but courts generallydo not review contractsto ensurethat performance under a contract's termsyields the consequencesthat the partiesexpected it to have. The general absence of judicial review follows from two premises:even with the benefit of hindsight,courts seldom could do betterfor the partiesthan the partiescan do for themselves; and the willingness of courts to attemptto rescue parties from baddeals reducesthe parties'incentive to write good contractsoriginally. These premisessupport foregoing judicial review of the liquidateddamage term just as they supportforegoing review of othercontract terms. Thus the ex post branchof the liquidateddamage rule should be repealed as well. Some courts have relaxed the traditionalprohibition against awarding punitive damages in ordinarycontract actions. The traditionalrule should be restored. A state-suppliedright to sue for punitive damages is similar to a contract-suppliedright to sue for a penalty; in both cases, a disappointed promisee would sue on the right if it existed. Showing that promiseesprefer the right not to exist implies both that a promiseewould reject a contractthat containeda penalty clause and would vote againsta punitivedamages regime if he could. This promisee preferenceshould control.4 4. Punitivedamage awardsare sometimesjustified on retributiveand deterrencegrounds. Retributive concerns are outside this Article's scope; they also seem irrelevantto the commercialbreaches that are its subject. Punitive damages will increase deterrencewhen the law is underenforced.For example, if some tort victims will not sue, injurersface a suboptimalincentive to behaveproperly. Letting plaintiff victims 1990] SupracompensatoryRemedies 371 Finally, parties should be permitted to contract for specific relief. The currentban on such contractscan be justified on groundssimilar to those that underlie the liquidateddamage rule. The ex ante aspect of this justification holds that a right to specific performancefunctions similarly to a right to sue on a penalty clause: both rights permitpromisees to compel inefficient perfor- mances. If promisees want this power, then they should be preventedfrom contractingfor specific relief, just as they are preventedfrom contractingfor penalties. But promisees do not want this power. Rather, promisees prefer specific performanceprimarily when their expectation cannot be monetized;in this circumstance,a promiseeneither could prove damages nor create a liquidat- ed damageclause. Because specific relief is efficientrelative to no relief, courts should enforce specific performancecontracts. If courts were to do this, then arguablythey should police these contractsspecially, just as they police liqui- dated damage clauses specially. Again, the ex post justification for judicial review holds that the parties' initial belief that specific performancewas necessary may turn out to be mistaken,but the promisee might then use his contractright to specific relief to extorta supracompensatorypayment from the promisor.As is shown below, promiseesdo not use the specific performance remedyto exploit today,and would be unlikelyto use the remedyfor exploita- tion were they able to contractfreely for it. Hence, courts should not police specific performance contracts specially.' If specific relief clauses become enforceable,the currentspecific performancerule would not be the best default (what would be is a difficult question). PartI shows thatpromisees prefer compensatory remedies. Part II explores the normativeimplications of this preference.Part III defends the use of certain assumptionsthat underliethe argument.Part IV considersone importantand sometimes unrealistic assumption in detail. This assumption holds that promisees always sue to protect their expectation interest; in particular, promisees always detect breachesand never are deterredfrom suing by high legal costs. The former aspect of the assumptionoften is plausible because breachusually is easy to detect;the latteraspect is more questionablebecause legal costs do seem to deter some suits. Part IV makes two claims. First, promisees prefer not to solve the "collection cost problem" with penalty clauses. Second, the state should not respondto the inefficiencies that some- times follow from underenforcementof the law with punitive damageawards. Rather, the state should encouragepromisees to sue by reducing collection costs. PartV considersthe recenttrend to awardpunitive damages for contract recover punitive damages responds to this underenforcementconcern. Part IV below considers whether underenforcementjustifies punitive damagesin contractcontexts. The claim made in the text above is that punitive damages should not be awardedto vindicate the promisee'sinterest in realizing gains from trade. 5. Courtsdo and should police all contractsto ensure thatparties do not violate the duty of good faith in performance.An early and perceptiveargument that the partiesshould be allowed to contractfor specific performanceis in Kronman,Specific Performance,45 U. CHI.L. REV. 351 (1978). 372 The Yale Law Journal [Vol. 100: 369 breacheswhich disadvantageindividuals. This trendis particularlymanifest in two contexts, the wrongfuldenial of insurancebenefits to individualinsured6 and dismissals from employment.7Awarding
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