Question

Assume that the high costs of performing under a contract cause the promisor to breach the contract and pay perfect expectation damages to the promisee. Would the promisee have preferred that the promisor perform? Explain your answer.

Answer 1

Under the theory of contract law, efficiency is derived or restored when the sum of the net benefits available to the promisee and the promisor is maximized. This is done when the contract is able to able to affect only the promisee and the promisor. In that case, the liability for perfect expectation damages provides the right incentive to perform, otherwise breach.

Promisor breaches when the net benefits from performing falls short of the net benefits from breaching net of his liability. This can occur in a situation with high transaction cost, the case similar to that of bad luck.

In such a scenario, the loss from breaching is smaller than the loss from performance so the promisor breaches. The promisee is indifferent because, if the promisor performs, she will have the project done at its pre-determined cost. In case the promisor breaches, the promisee will receive full compensation as a remedy which is equal to perfect expectation damages. Hence, in both cases, the promisee will receive the same net benefits.