EYAL ZAMIR AND BARAK MEDINA, LAW, ECONOMICS, AND MORALITY

Ariel Porat*

I. INTRODUCTION

In their fascinating book LAW, ECONOMICS, AND MORALITY (Oxford University Press), Eyal Zamir and Barak Medina contend with one of the most important dilemmas in legal theory: how the law should accommodate consequentialism with deontology. The authors, of course, assume the existence of such a dilemma. Devoted consequentalists, as many law and economics scholars are, would deny such a dilemma; for them, the value of an act is measured only by its consequences. But for many others – lawyers, philosophers, economists, social scientists, politicians, regulators, and legislators – the dilemma exists and is troubling. The aim of the book is to resolve this dilemma. Many lawyers, both academics and practitioners, are deterred by law and economics, since they find it difficult to accept pure consequentialism as both a normative and positive theory of the law. The book thus seeks to propose a theory that has the potential of serving as common ground for deontologists and consequentialists, especially for those who advocate the application of cost-benefit analysis in the law or elsewhere. Part I of this essay discusses the theory propounded by Zamir and Medina on how to accommodate consequentialism with deontology. Part II then looks at the applied chapters of the book, focusing on contract law. The underlying conclusion of this essay is straightforward: LAW, ECONOMICS, AND MORALITY is an important and interesting book, excellently written, and, primarily, very challenging. I expect it to garner considerable attention – as I’m sure it has already begun to do – from anyone interested in legal theory.

* Many of the ideas developed in this paper have been expressed in another paper, published in Hebrew: Eyal Zamir & Barak Medina, Law, Economics, and Morality, 41 MISHPATIM 415 (2011). 92 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT

II. PART I – THE THEORY

In their book, Zamir and Medina propose a theory comprised of three stages: 1) economic (or other consequentialist) analysis is the default rule; 2) once a deontological constraint is present, economic analysis steps back and the deontological constraint prevails; 3) if the costs of abiding by the deontological constraint pass a certain threshold, however, then that constraint is ignored and economic analysis prevails. In Section A below, I briefly outline other possible methods for accommodating economic analysis with deontology. In Section B, I consider critically the particular method Zamir and Medina employ for deciding from among several courses of action that violate deontological constraints but are nevertheless permissible because the costs of abiding by those constraints exceed the required threshold. Section C then considers the claim made by Zamir and Medina that deontological constraints (sometimes) mandate ascribing higher social costs to large risks to life and limb than to small risks, beyond what is entailed by the proportion between the large and small risks.

A. OTHER POSSIBLE METHODS FOR ACCOMMODATING CONSEQUENTIALISM WITH

DEONTOLOGY

There are at least two other viable methods for accommodating economic analysis with deontology. Under the first method, which I call the “deontology as the default rule,” deontology, not economic analysis, is the default rule; however, if economic analysis indicates that abiding by deontology is overly costly, economic analysis prevails. To understand how deontology as the default rule could work, imagine a legislature that considers whether to impose criminal and tort liability on the mentally ill. Suppose that there are various deontological considerations for and against imposing either type of liability, but at the end of the day, the cons outweigh the pros.1 Now assume that cost-benefit analysis (CBA) moderately supports the imposition of liability. Under those circumstances, one could conclude that there is no deontological constraint against imposing liability, and thus the determination of whether to impose liability is contingent on the default rule. If the default rule is economic analysis – as Zamir and Medina advocate – liability should be imposed; if, in contrast, the default rule is deontology, liability should not be imposed.

1 See Avihay Dorfman, Reasonable Care: Equality from Beginning to End (on file with author) (discussing the question of tort liability for the mentally ill, from deontological perspectives). ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 93

The analysis in this illustration assumes “gray” areas where, even though no deontological constraints apply, deontological considerations nonetheless pull in a given direction. Perhaps Zamir and Medina assume no gray areas with regard to deontology. In other words, perhaps they assume that whenever deontology pulls in one direction, there is a deontological constraint that applies and prohibits going in the other direction. If this were the case, the two methods – that proposed by Zamir and Medina and the “deontology as the default rule” method – would converge. Yet I believe that within any legal system - even if not within a specificdeontological theory – there are many such gray areas. Thus, for example, there could be competing deontological theories for a particular problem a legal system must solve, equally applicable but inconsistent with one another. In such cases, the legal system, even though guided solely by deontological reasoning, must make a choice among the theories. This choice could be difficult and, while satisfying some deontological considerations, would frustrate others. I don’t think that after a choice is made, there is necessarily a deontological constraint to choose the opposite alternative, just as if the latter where chosen, there would not necessarily be a deontological constraint to opt for the other choice. Under such circumstances, a legal system could take economic analysis into account, and the question of whether that analysis dictates the outcome would depend on what the default rule is. Thus, the legal system could give a preference to the deontological discourse, excluding CBA, but follow CBA if it pulls strongly to one direction (deontology as the default rule), or alternatively it could give a preference to CBA, unless there is a deontological constraint, and even then, follow CBA if it pulls strongly to one direction (CBA as the default rule). We can use the liability for the mentally ill example to illustrate this. Suppose two deontological considerations – or theories – pull in opposite directions. On the one hand, one could support, on deontological grounds, a no-liability rule based on the dignity of the mentally ill. On the other hand, a different view of the dignity of the mentally ill, or of their victims, could support adopting a liability rule. Let us suppose now that the legal system prefers a no-liability rule to a liability rule, adopting the first deontological approach to dignity in this case and rejecting the other. This preference by no means implies that imposing a liability rule should be considered – within the specific legal system – an infringement of a deontological constraint. Accordingly, then, if economic analysis moderately supports a liability rule, the decision of whether to impose liability would depend on the default rule endorsed by the legal system: that favoring economic analysis or that favoring deontology. A second method for accommodating deontology with economic analysis is by giving preference to the former in some areas and to the latter in other areas. Many 94 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT

(maybe all) legal systems can be characterized as employing such a “territorial” method in some respect. Take tort law, for example. Suppose the dilemma before the legal system is whether to impose no-fault liability on drivers. Assume that imposing such liability would violate a deontological constraint (although that could be controversial). Further assume that economic analysis favors no-fault liability because it saves more lives than any other form of liability or because it is cost-justified on other grounds. The legal system could prefer the economic analysis view, among other things, because drivers can buy insurance, thereby mitigating the injustice that a no-fault regime could yield. Indeed, if, from a social welfare perspective, there is a strong argument for no-fault liability, Zamir and Medina might concede that it passes the necessary threshold and that the deontological constraint must be ignored.2 Thus, the second method for accommodating economic analysis with deontology does not clash with Zamir and Medina’s approach. Rather, it is more like looking at the same problem from a different angle.3

B. CHOOSING AMONG ALTERNATIVES AND THE RELATIONSHIP TO THE THRESHOLD FUNCTION

Zamir and Medina discuss situations in which several available courses of action all violate deontological constraints but are justified under CBA. They argue that all those courses of action that pass the threshold function applied to the case are legitimate alternatives and the choice among them must be made according to CBA (unless one alternative is lexically superior to others).4 Thus, suppose an actor has three possible courses of action: kill 2 people to save 280 out of a group of 500; kill 3 people to save 290 of the 500 people; or kill no one and save no one of the 500.5 Assume now that the threshold function is a multiplier function6 and the factor for multiplication7 is 90, which means that killing 1 person to save 90 (but not less) is justified, even though it violates a deontological constraint. Under this threshold function, all three of the

2 One could also argue that once insurance is available there is no deontological constraint at all, and therefore no threshold to pass. This argument is beyond the scope of the present discussion. 3 For further suggestions on how to accommodate efficiency with corrective justice in tort law, see IZHAK ENGLARD, THE PHILOSOPHY OF TORT LAW 85-92 (1993); Gary T. Schwartz, Mixed Theories of Tort Law: Affirming Both Deterrence and Corrective Justice, 75 TEX. L. REV. 1801 (1997). 4 EYAL ZAMIR & BARAK MEDINA, LAW, ECONOMICS, AND MORALITY 82-83 (2010). 5 Id. at 81-83. Cf. John M. Taurek, Should the Numbers Count?, 6 PHIL. & PUB. AFF. 293 (1977). Taurek argued that we should not prefer the lives of the many over the lives of the few, since we should not aggregate different lives. 6 ZAMIR & MEDINA, supra note 4, at 84. 7 Id. ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 95 courses of action are permissible, and CBA must guide the choice among them. That analysis mandates – Zamir and Medina argue – that the second course of action should be preferred because it yields a net savings of 287 lives, whereas the net savings rendered by the first alternative is only 278 and that of the third alternative zero. The authors’ conclusion is surprising and seems to stand in contradiction to the threshold function applied to the case. The simplest way to understand this is to focus on the difference between the first and second courses of action, particularly on the marginal benefit of the second course of action (killing 3 to save 290) relative to the first alternative (killing 2 to save 280). An actor who prefers the second course of action to the first would have to kill 1 more person to save 10 more people. But if we take seriously the threshold function applied to this case, whereby killing 1 person is justified only in order to save 90 people (or more), then the inevitable conclusion is that the first course of action – and not the second – is the preferable one. Allowing the second course of action would imply that it is permissible to kill 1 person to save (only) 10 people. Interestingly, the authors maintain that in those cases in which several courses of action pass the threshold function, but one course of action is lexically superior on deontological grounds, that course should prevail, regardless of CBA.8 Thus, according to Zamir and Medina, deontological considerations play a role not just at the stage where the threshold is set, but also at the point at which a choice is made among the courses of action that pass the threshold. What is puzzling, however, is why the same logic should not apply also to our example, to make the first course of action preferable to the second. In other words, it is unclear why the rationale of the deontological constraint disappears when all the possible courses of action are evaluated in relation to one another. Further on in the book, in its applied chapters, Zamir and Medina seem to realize that the marginal, rather than the absolute, values of the courses of action should be taken into consideration.9 Still it is puzzling why they ranked the three courses of actions described above by their absolute, rather than their marginal values. Another possible criticism of the author’s preference of the second course of action over the first is that even were both courses of action permissible, the legal system should not “jump” from permission to obligation or duty; at the very most, the actor should be given the option to pick the second course of action. In fact, the authors

8 Id. at 83. 9 Id. at 149-50, 155-56. 96 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT assert that deontology would at times dictate that individuals not have an obligation to pursue the social good as required under CBA, but, rather, only the option to do so.10 This argument is applicable to our example as well, not only with respect to the choice between the first and second courses of action, but also to the choice of the third course of action. Under the latter alternative, the actor kills no one and 500 people therefore die. The authors argue, based on CBA, that this course of action is the worst of the three alternatives. Zamir and Medina’s theory should not automatically infer from the mere fact that the third course of action is the worst from a social welfare perspective that it must be prohibited. One possibility would be to allow the actor the option to take the third course of action and do nothing, when to do something means killing some people even if for the sake of saving many people. Another possibility is that the number of people who would die should the third course of action be taken, would be so high as to warrant its prohibition. The choice between option and prohibition must be made by the legal system according to its own values. But, again, the mere fact that, under CBA, the third course of action is the worst alternative does not imply – according to my reading of Zamir and Medina’s theory – a prohibition on choosing it. In sum, the internal logic of the authors’ theory implies that the first course of action (killing 2 to save 280) is preferable to the second course of action (killing 3 to save 290). The status of the third course of action (killing no one and saving no one) is less clear. Only where the legal system endorses the view that the cost of doing nothing under the circumstances is too high to be tolerated would it set a prohibition on opting for the third course of action; that alternative would then be ranked as the worst of the available three courses of action. If this were not the case, the third course of action would just be one of the options for the actor.

C. HIGH AND LOW RISKS

Following the path of other writers, Zamir and Medina suggest that a deontological constraint could exclude certain costs and benefits from the CBA or require ascribing them different weight from their value under conventional CBA. Among other things, the authors raise the possibility of a small reduction (or increase) in risk to life being valued less than a large reduction (or increase) in such a risk, beyond what is required by the proportion between the respective magnitudes of the small and large risks

10 Id. at 46-47, 59-63, 83-84, 155-56. ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 97 reduced (or increased). In other words, the authors maintain that, due to deontological constraints, a non-linear relationship exists between the magnitude of the risks reduced (or increased) and the social value ascribed to such a reduction (or increase). Thus, if an actor must choose between creating a 1% risk to life for 200 people or creating a 25% risk to life for 4 people, a deontological constraint might mandate that the former be preferred over the latter, even though the total sum of the risk increased under the former scenario would be greater – much greater – than under the latter. This argument is problematic, especially when risks are repeatedly created for a large population. In those cases, a policy of investing disproportionately more in high-risks reduction than in small-risks reduction will ultimately result in more dead people than the alternative policy of investing in risk reduction that is proportionate to the magnitude of the reduction. Thus, for example, investing disproportionately more in a hospital’s high-risk patients than in its low-risk patients would result in more patients who do not recover. In this specific context, Zamir and Medina would perhaps hold that there is no deontological constraint mandating an investment policy that prefers high-risk to low-risk reduction. Nevertheless, it is my argument that the view that small and large-risk reductions (or increases) have different social values, disproportionate to their magnitudes, seems to preclude treating the case of hospitals any differently. Interestingly, prominent law and economics scholars also maintain that there is a non-linear relationship between the magnitude of risks to life and the social value in reducing them. They base their view on empirical studies, suggesting that people at high risk to life are willing to pay disproportionately more to reduce the risk than people at a low risk to life.11 This seems to imply that reducing high risks is socially more valuable than reducing low risks, even when their sum total is the same. Thus, quite surprisingly, at the outcome level, the view propounded by Zamir and Medina is not much of a departure from the conventional law and economics view, which makes no resort to deontological constraints. But as Avraham Tabbach and I have argued, the conventional law and economics view is simply wrong. We have shown that law and economics scholars ignore the fact that people at a high risk to their lives, who ascribe a lower value to their wealth

11 See, e.g., Eric Posner & Cass Sunstein, Dollars and Death, 72 U. CHI. L.REV. 537, 587-90 (2005); Jennifer Arlen, Tort Damages, in ENCYCLOPEDIA OF LAW AND ECONOMICS 709 (1999). Cf. RICHARD L. REVESZ & MICHAEL A. LIVERMORE, RETAKING RATIONALITY (2008) (discussing different possible methods for valuing people’s life and generally supporting the employment of the willingness to pay criterion in cases where people are subject to small risks to life). 98 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT after death than during life, discount the value of the costs they are willing to spend to reduce their risks by the probability of death after the risk-reduction takes place (“the discounting costs effect”).12 This underlies people’s willingness to pay more to reduce high risks than low risks to their lives, even if the magnitude of risk-reduction is the same.13 In order to derive the true private and social value of risk reduction from willingness to pay for that reduction, willingness to pay must be adjusted for the discounting costs effect. There is then no longer any reason to assume a non-linear relationship between the magnitudes of the risk reduction and its social value.

III. PART II – APPLYING THE THEORY TO CONTRACT LAW

One of the fields to which Zamir and Medina apply their theory is contract law. They discuss mistake and misrepresentation as well as remedies for breach of contract.14 I will focus on remedies. In this context, the authors put forth three main claims. The first claim is that any breach of contract is necessarily a violation of a deontological constraint. This claim counters the argument made by law and economics scholars that efficient breach is consistent with the contractual parties’ will and therefore does not give rise to any moral concerns.15 The second claim made by Zamir and Medina is that due to the inconclusiveness of both deontological and economic analysis of contract remedies, imposing deontological constraints upon the economic analysis may be too challenging at this development phase of contract theory.16 The third claim is that the law of remedies includes several rules that can be explained only by deontology and not by economic analysis. In the two sections below, I consider the first and third claims.

12 Ariel Porat & Avraham Tabbach, Willingness to Pay, Death, Wealth and Damages, 13 AM. L. ECON. REV. 45 (2011). This effect was discussed earlier in John W. Pratt & Richard J. Zeckhauser, Willingness to Pay and the Distribution of Risk and Wealth, 104 J. POL. ECON. 747 (1996), where it was referred to as the “dead-anyway effect.” 13 We explain that when risks are reduced to zero, the non-linear relationship between people’s willingness to pay and the magnitude of the risk-reduced disappears. Porat & Tabbach, supra note 12. 14 ZAMIR & MEDINA, supra note 4, at 257-311. 15 For recent writings on that issue, see, e.g., Richard Posner, Let Us Never Blame a Contract Breaker, in FAULT IN AMERICAN CONTRACT LAW 3 (Omri Ben-Shahar & Ariel Porat eds., 2010); Steven Shavell, Why Breach of Contract May Not Be Immoral Given the Incompleteness of Contracts, in FAULT IN AMERICAN CONTRACT LAW, id. at 257. For a deontological argument recently put forward against the efficient breach theory, see Seana Shiffrin, Could Breach of Contract Be Immoral? 107 MICH. L. REV. 1551 (2009). 16 ZAMIR & MEDINA, supra note 4, at 311. ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 99

A. EFFICIENT BREACH

Zamir and Medina rest their claim that any breach of contract violates a deontological constraint on three arguments, to which I will respond.

1. AVOIDING-LOSS VERSUS REAPING-GAINS CASES

The first argument is that a distinction must be made between two types of breaches: in the first type, the promisor breaches because the costs of performance are exceeding the price paid by the promisee; in the second type of breach, the promisor breaches the contract because a second bidder has offered him a higher price than that paid by the promisee. The authors maintain that at least the second type of breach would not be consistent with the parties’ will and, therefore, would violate a deontological constraint. This claim is in fact supported by experimental studies that indicate that laypeople are more resentful of the second instance of breach than the first type.17 One possible explanation is that to many, avoiding out-of-pocket losses is a more acceptable excuse for breaching a promise than the mere desire to reap more gains.18 At first glance, this claim does not seem persuasive. The reaction of laypeople notwithstanding, it seems unlikely that sophisticated parties would distinguish between a breach to avoid a loss and a breach to reap a gain. So long as the promisee would be fully compensated for the breach, the option for the promisor to breach efficiently in both cases – whether to avoid a loss or reap a gain – would increase the contract’s surplus, thereby serving the interests of both parties. Indeed, ex post, the breach would benefit only the promisor; but if we assume that the parties would price into the contract any ex post advantage, both would benefit from the promisor’s option to breach efficiently. This conclusion could be false if the promisee is not fully compensated, as is often the case. But the problem of partial compensation is a concern that seems equally applicable in both types of breach.19 Yet the authors’ call to distinguish between the two types of breaches could be supported on economic grounds. This would be viable, however, only if we assume

17 Tess Wilkinson-Ryan, Fault in Contracts: A Psychological Approach, in FAULT IN AMERICAN CONTRACT LAW, supra note 15, at 289. 18 EYAL ZAMIR,, Loss Aversion and Law’s Formation, available at http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=1638527 (last visited August 1, 2011). 19 Even if compensation is full, so it can be argued, not every party to a contract would agree to an efficient breach rule. This is certainly true; but for contract law, under the economic understanding, it is enough that most parties would prefer an efficient breach rule, to have it as a default rule. 100 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT partial compensation for breach. Under this realistic premise, promisees would be more reluctant to allow a breach option for promisors in reaping-gain cases than in avoiding-loss cases. This reluctance would rest on the different circumstances leading to the breach in the two types of cases. In reaping-gain instances, the breach is contingent on the appearance of a new bidder. The parties may have asymmetric information on the likelihood of such an occurrence, with the promisor typically possessing better information than the promisee. Thus, one reason for a promisee’s resistance to allowing the promisor an option to breach is his suspicion that the payment offered to him in the contract price for this option would not fully compensate him for his non-recoverable losses. But asymmetry of information in itself does not distinguish reaping-gain from avoiding-loss breaches, for in the latter case as well, the promisor typically has better information than the promisee about the likelihood of performance costs exceeding contract price and leading to breach. What does differentiate between the two types of cases is that in reaping-gain cases, the promisor has a strong incentive to increase the likelihood of breach, while in avoiding-loss cases, the promisor has a strong incentive to decrease the likelihood of a breach. This, in conjunction with the asymmetry of information characterizing both types of cases, could explain promisees’ greater reluctance to allow breach in reaping-gain cases than for avoiding loss. There is a straightforward reason for the promisor’s strong incentive to increase the likelihood of a reaping-gain breach: he would only gain with the appearance of a new bidder, and the higher the likelihood of that occurrence, the higher his expected gain. In avoiding loss cases, the reverse is true: the promisor has a strong incentive to decrease costs of performance – thereby reducing the likelihood of breach – since the lower those costs, the greater the difference between price and costs, and the greater his gain. Indeed, there is a risk that the promisor’s incentive to reduce costs in such cases – when he has the option to breach to avoid loss – would in fact be deficient; he would know that if performance costs exceed contract price, he can breach and pay less than full compensation. This could also explain the promisee’s resistance to allowing a breach option even in avoiding-loss instances, but this resistance – so I argue – would be weaker than in the case of allowing reaping-gain breaches.

2. THE LAW AND THE PARTIES’ VIEWS ON BREACH

The second argument Zamir and Medina make is that the law does not conceive of breach of contract to be a legitimate course of action for the promisor. Rather, they argue, the law sanctions breach, even if efficient, with damages. The authors are well ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 101 aware of the counter-argument, inspired by Calabresi and Melamed’s seminal article,20 that allowing damages as a remedy does not necessarily imply the law’s disapproval of breach. Given that the law can protect entitlements by property or liability rules, allowing damages can be considered as merely expressing the law’s preference of a liability rule, rather than a property rule, to protect a particular entitlement. But the authors seems to reject this argument, because, they contend, if parties to a contract were to regard breach as a legitimate option, promisors would routinely offer damages after breaching a contract, which is not the case.21 I disagree with the authors’ reasoning. First, I don’t know how often promisors breach contracts and offer damages to the promisees. The authors appear to derive their conclusion regarding promisor behavior following breach from cases litigated in court. But these cases are hardly representative, for they constitute those instances in which the breach and its consequences are in dispute – otherwise the promisee would not have taken the promisor to court to begin with. There is no reason in such cases to expect – under any theory of breach – to find the promisor voluntarily offering damages to the promisee. Second, and more importantly, it is impossible to learn anything about a promisor’s view of the nature of the breach from the mere fact that he did or did not offer damages to the promisee following breach. A decent promisor who breached the contract could offer damages to the promisee because he considered the breach either the exercising of an option or illegitimate behavior on his part. If anything, perhaps a decent promisor would feel greater urgency to offer compensation in the latter case than in the former just as a decent driver who hit a pedestrian would be more strongly compelled to compensate his victim if he were at fault than if he were faultless. Therefore, failure to offer damages to the promisee following breach should by no means be interpreted as the promisor’s acknowledgement that the breach was not the exercising of an option to breach but, rather, illegitimate behavior.

3. PARTIES WHO REJECT EFFICIENT BREACHES

The third argument made by Zamir and Medina to support their main claim that the law and economics view on efficient breach clashes with deontology is that it follows

20 Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 HARV. L. REV. 1089 (1972). 21 ZAMIR & MEDINA, supra note 4, at 266 (“In this hypothetical agreement [an option for the promisor to breach and pay damages – A.P.], the promisor’s nonperformance could only be considered moral if she exercised the option, that is, if she concomitantly offered to pay damages…. This is seldom the case, especially in adjudicated disputes”). 102 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT from this view that breaching a contract efficiently is warranted and encouraged even if it is counter to the parties’ expressed will. I don’t think that law and economics would endorse the view that efficient breach is justified when it is in contradiction to the parties’ will. Under the conventional economic theory of contracts, contract law in general, and the law of remedies in particular, provide the contractual parties with default rules that they are free to either adopt or reject. Providing these rules is intended to save the parties transaction costs that they would have to bear absent the rules. In order to fulfill this goal, contract law should provide default rules that most parties would have explicitly adopted had they negotiated them. Otherwise the default rules will increase, rather than decrease, transaction costs and sometimes even facilitate the creation of inefficient contracts.22 Given this background, it is clear why, under economic theory, courts should respect any actual intention of the parties, whether explicit or implicit (with some exceptions, related mostly to the contract’s effects on third parties), including their choice to disallow options to breach. The parties are considered the best judges of what best promotes their own interests, and the court’s role is limited to helping them achieve their goals. That said, I’m not arguing that under economic theory, any explicit or implicit intention of the parties that their contract be enforced by an order of specific performance, so as to deter breach, should necessarily be respected by the court. Ordering specific performance and supervising its implementation could be costly for courts, which should be a factor in their choice of remedy.23 Furthermore, changing circumstances could also justify regarding the hardship to the promisor if specific performance is imposed as a consideration for not ordering that remedy.24 But absent such special considerations, there is no reason, from an economic perspective, to force the parties, against their will, into a regime of options to breach.

22 See ROBERT COOTER & THOMAS ULEN, LAW AND ECONOMICS 245-46 (2006); Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989). There are exceptions, of course, to the parties’ freedom to opt out of contract law default rules, the most important of which are the doctrines of unenforceability on grounds of public policy and (in the U.S.) the doctrine of unconscionability. RESTATEMENT (SECOND) OF CONTRACTS § 178-199, 208 (1981). The parties cannot opt out of these doctrines. 23 Alan Schwartz, The Case for Specific Performance, 89 YALE L.J. 271 (1979) (discussing the economics of the remedy of specific performance, including the consideration that granting the remedy could be costly for courts); RESTATEMENT (SECOND) OF CONTRACTS § 366. 24 RESTATEMENT (SECOND) OF CONTRACTS § 364(1)(b). ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 103

B. INEFFICIENT RULES THAT DEONTOLOGY COULD EXPLAIN

Zamir and Medina argue that there are several rules in the law of remedies that contradict the basic tenets of economic analysis and can be explained only by deontology. But do such rules indeed exist? If they did, the parties would try to opt out of them, thereby incurring transaction costs, which are both a private and social waste. Alternatively, if the transaction costs of opting out are high, some parties would adopt the inefficient rules and thus create inefficient contracts, which would be inconsistent with their will. One way or another, it is difficult to see what goal would be served by inefficient remedial rules. This notwithstanding, the authors offer two principal examples to illustrate their point of view, which I discuss below. It is my assertion that they are wrong in the first example, but right in the second.

1. LIQUIDATED DAMAGES FOR DELAYED PERFORMANCE AND BONUSES FOR EXPEDITED PERFORMANCE

In case law, courts make a distinction between two techniques to incentivize performance in due time, which, although identical from an economic perspective, nonetheless receive differential treatment by the courts. Under the first technique, the parties agree on a date of performance, T, and incorporate a liquidated damages clause that stipulates, for example, that for each day of delay in performance, the promisor will pay damages to the promisee in the amount of $500. With the second incentivizing technique, the parties agree on a date of performance, T+30 days, and incorporate a clause that stipulates that, for each day of expedited performance, the promisee will pay a $500 bonus to the promisor. If the former technique is used, the price is P, whereas if the latter is applied, the price is P-$15,000. Even though, economically speaking, the two techniques are equivalent – so Zamir and Medina argue – courts will scrutinize the liquidated damages clause and strike it down as a penalty (or, in some legal systems, reduce its amount) if they find the amount to be excessively high, but will not scrutinize the bonus clause and instead enforce it as they would any other term in the contract. Taking into account this approach, Zamir and Medina seek to infer that courts are not indifferent to a breach of contract and apply different standards to breach (the liquidated damages case) and to execution of an option (the bonus case). Only deontology, and not economic analysis, could rationalize such an approach, claim the authors.25

25 ZAMIR & MEDINA, supra note 4, at 301-03. 104 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT

I am not convinced by their argument for three reasons: First, as a positive matter, once it becomes clear to the courts that the bonus clause is in fact a liquidated damages clause in disguise, they will tend to scrutinize it. Section 356, Comment C, of the Restatement 2d Contracts, entitled “disguised penalties,” clarifies that the substance, rather than the form, of a clause is conclusive when courts consider whether to impose a penalty. Indeed, one of the Comment’s examples is “a discount for prompt performance.” Therefore, if the bonus case in our example were to be brought before an American court, the court would have to determine whether the bonus is a disguised penalty. Accordingly, if the market value of performance is P, the court would probably find that the clause allowing the promisee to pay the promisor just P-$15,000 for performing on T+30 days is a disguised liquidated damages clause and would strike it down as a penalty if it holds that damages of $15,000 for 30 days of delay are excessively high. Second, in those instances in which the court determines that the bonus clause reflects a real bonus and refrains from scrutinizing it (as would be the case in our example if the market price of performance were P-$15,000), Zamir and Medina could quite justifiably claim that this refusal is puzzling from an economic perspective, since it is hard to understand why a bonus clause, even if genuine, would not be scrutinized when similar liquidated damages clauses are often subject to scrutiny. This anomaly, however, is the product of a more general anomaly, namely, that liquidated damages clauses are scrutinized by courts, while all other clauses are not (with some exceptions, such as when the American doctrine of unconscionability is applied, but this is mainly to consumer contracts).26 Indeed, it is completely unrelated to any distinction between liquidated damages clauses and bonus clauses. Third and finally, the courts’ stringent supervision of liquidated damages clauses should not be construed as an indication of their condemnation of breach for deontological reasons, as Zamir and Medina conclude. In fact, scrutiny of liquidated damages clauses protects the breaching party from excessive penalty. Thus, the breaching party who undertook to pay damages, is better protected by the law than the promisee who undertook to pay a bonus. If anything, this implies that a breach of contract is not (too) morally bad.

26 See Alan Schwartz, The Myth that Promisees Prefer Supercompensatory Remedies: An Analysis of Contracting for Damages Measures, 100 YALE L.J. 369 (1990). ZAMIR AND MEDINA, LAW, ECONOMICS, AND MORALITY 105

2. LOSING CONTRACTS AND RESTITUTION

The second example presented by Zamir and Medina refers to the rule under which the promisee is not limited to damages for his expectancy interest and can recover in restitution even if the compensation exceeds his expectation (“the restitution rule”). This rule enables the promisee to put himself in a better position than he would have been in had the contract not been breached. This seemingly contradicts the aspiration of law and economics to provide the promisor with efficient incentives to breach.27 To better understand this point, assume a sale of a widget at a price of $10,000. Prior to delivery of the goods but after payment, the market price of the widget drops to $8000. Assume now that the seller repudiates and refuses to deliver the goods. Under the restitution rule, the buyer would be entitled to recover $10,000, even though expectation damages would have yielded only $8000. Thus, the buyer would be saved from a losing contract due to the seller’s breach. Such an outcome, Zamir and Medina argue, is an inefficient one: efficiency-wise, contract law should have encouraged the seller in our example to breach if his costs of performance were higher than $8000. But under the restitution rule, the seller will breach only if his costs of performance are higher than $10,000! The only rationale for this inefficient rule is, therefore, deontology – or so Zamir and Medina conclude. I think this is a very neat example of contract law’s inefficiency. And it is quite possible that those who support the restitution rule are motivated by the belief that moral blame should be ascribed to the breaching party. Personally, I am not certain that deontology requires the restitution rule, since, as I have explained, I cannot see how deontology could support an inefficient default rule that the parties are free to opt out of. (Nor do I think Zamir and Medina believe that the restitution rule is an immutable default rule). But this is not the issue at hand. Thus, in the present context, I agree with Zamir and Medina that the restitution rule could be the product of a deontological perception—or perhaps misperception!

IV. CONCLUSION

With LAW, ECONOMICS, AND MORALITY, Zamir and Medina have made an important contribution to the understanding of one of the most controversial issues in jurisprudence and perhaps in philosophy in general: Is it possible to accommodate

27 ZAMIR & MEDINA, supra note 4, at 303-05. 106 JRSLM. REV. LEGAL STUD. VOL. 3, 2011 ARIEL PORAT consequentialism with deontology and, if so, how? To answer these two questions is the ambitious mission undertaken by Zamir and Medina in writing this book, and they should be praised for performing it so well. In contrast to a significant part of the theoretical scholarship, which is abstract and detached from real-life issues, Zamir and Medina’s book does not stop at the theoretical level, but applies the theory it develops to several legal fields. Delving into the intricacies of real-world legal problems is important not only for the purpose of facilitating the application of the theory to the law, but also to enable a thorough understanding of the theory itself. After all, a good legal theory is a theory that can be applied to the law; inapplicable legal theory is not good theory. In this short essay, I have tried to share with the readers some thoughts I had while reading the book. I have discussed some questions relating to the application of the theory in general, focusing on its application to contract law specifically. The book’s applied part is far richer than my comments might imply and touches upon a number of legal fields. My choice of contract law was motivated by my belief that I know this field better than the other legal fields covered in the book. My minor criticism of some of the arguments put forth in the book should not confuse readers of this essay: a great academic work always attracts controversy and criticism. That is what scholarship is all about, and Zamir and Medina’s book is no exception: the controversy and criticism it generates is precisely what makes it so worthwhile a read.