Question

4. (15) Breach of Contract

            This question runs through the various concepts associated with breach of contract. Jack and Jill sign a contract whereby Jill must supply Jack with his fall line of clothing, which will be displayed in a fashion show whose date has already been set. Jack and Jill are both risk neutral and therefore base their decisions on their expected returns.

state	probability of state	Jack	Jill
good	0.9	20,000	10,000
bad (no breach)	0.1	20,000	- 30,000

a) (3)   Suppose that breach of contract is forbidden, and Jack demands specific performance. The penalties will be severe if Jill does not meet the terms of the contract, so in the bad state she has to pay top dollar for a replacement seamstress on short notice. The table above lists the outcomes of this contract. Will Jack sign the contract? Will Jill sign the contract? Is it socially desirable that contract be fulfilled in the bad state?

b) (3)   Now suppose that breach of contract is permitted, with no penalties. In the bad state, Jill will breach and Jack will have to deal with the problem. He will decide to cancel the fashion show, at a loss to him of $5000. The table is therefore altered to the following:

state	probability of state	Jack	Jill
good	0.9	20,000	10,000
bad (no breach)	0.1	20,000	-30,000
bad (breach)	0.1	- 5,000	0

Will Jack sign the contract? Will Jill sign the contract? Is it socially desirable that the contract be fulfilled in the bad state?

c) (3)   Suppose again that breach of contract is permitted, and that expectation damages are awarded in the event of breach. If Jill's gain from breaching is more than that Jack's loss, Jill will breach, and Jill must pay Jack enough to give him "the result he expected from her performance". The result he expected from her performance is that he get a surplus of $20,000. Thus, if she breaches Jill must pay Jack $25,000. The table is therefore altered to the following:

state	probability of state	Jack	Jill
good	0.9	20,000	10,000
bad (no breach)	0.1	20,000	-30.000
bad (breach)	0.1	20,000	- 25,000

Will Jack sign the contract? Will Jill sign the contract? Will the contract be fulfilled in the bad state? Is it socially desirable that it be fulfilled in the bad state?

d) (3)   Suppose again that breach of contract is permitted, and that reliance damages are awarded. Under reliance damages, Jill must make Jack as well off as if the contract had never been signed. Jill must therefore pay Jack $5,000. The table is altered to the following:

           

state	probability of state	Jack	Jill
good	0.9	20,000	10,000
bad (no breach)	0.1	20,000	-30,000
bad (breach)	0.1	0	- 5,000

Will Jack sign the contract? Will Jill sign the contract? Will the contract be fulfilled in the bad state? Is it socially desirable that it be fulfilled in the bad state?

e) (3)   Now modify the example slightly. Suppose that Jill had the option of training a back-up seamstress. If she had, this would have raised her costs by $6000 in the good state, but saved her $20,000 in the bad state if she does not breach. The original table is altered as follows:

state	probability of state	Jack	Jill
good (with seamstress)	0.9	20,000	4,000
bad (with seamstress and no breach)	0.1	20,000	- 10,000
bad (with seamstress and breach)	0.1	0	-11,000

If Jill had hired the back-up seamstress, would breach of contract have been socially desirable in the bad state? Would it have been socially desirable for Jill to hire the back-up seamstress (compare with d))? Under reliance damages, would Jill have hired the back-up seamstress?

Answer 1

15-a- The contract is heavily inclined towards Jack because inbad state Jill has to suffer a lot. The contract will be signed byJack but Jill won\t sign the contract.It is not socially desirableto fulfill the contract in bad state because for low level of riskmore stake is attached.

b- Both Jack and Jill can signed the contract because of lowvalue attached with the bad state in the contract. The contract issocially desirable also.

c- Jack will signed the contract but Jill will not signed it.The contract has more repurcasion for Jill in case of breach.so hemay not signed the contract. It is not socially desirable that lossof someone can be compensated .

e- Breach of contrcat will not be socially desirable in badstate. The pay off have win-win situation for both Jill and Jack.Hiring of backup seamstress have provided more value to Jill bysaving cost in bad state but in good state the rising in cost isnot much. It is desirable for Jill to hire because more value willbe added by hiring . Yes, Jill have hired under reliancedamage.