by Tom Stilp JD, MBA/MM, LLM, MSC, DBA, January 24th, 2025
The function of contracts is to organize economic activity. But according to the Efficient Breach Theory, a party to a contract should be allowed to breach a contract if not performing the contract would be more efficient. Efficient Breach Theory was championed by Judge Richard Posner and the Law of Economics school of thought in the 1970s (Posner, 1976).
People will act opportunistically for gain when circumstances change, contracts are incomplete, ambiguous or disadvantageous to one party (Stilp, 2023). Because performance of most agreements cannot realistically be completed the moment the agreement is signed, contracts allow performance to occur over time, days, months or years later (Posner, 2011). Dangers exist when simultaneity does not hold, that is, you perform and I perform at the same moment, and passage of time provides for changed circumstances allowing for opportunities to arise (Posner, 2011).
There is the question of morality, whether a breach of contract is immoral and ethically wrong. Justice Oliver Wendell Holmes believed the law intended a breach of contract and damages to be amoral, in other words, no moral judgment is made by the law, and said:
“The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it – and nothing else.”
OliverWendell Holmes, 1897.
Relational theorists, however, argue that breach of contract cannot be amoral because people who make contracts are not amoral (Cender, 1995). Despite these issues, contracts are voluntarily breached every day. The question remains why.
In hundreds of cases, we have seen that with greater perceived gains, the more likely a party will decide to engage in breach of contract behavior. Breach of contract and the resulting lawsuits create opportunities to realize gains by defaulting on agreements and changing the playing field.
True, breach of contract behaviors result in loss of reputation and future business opportunities, where the breaching party is shunned and deemed unreliable (Khouri, 2002). Yet, given the actions of certain companies, the assumption of a loss of reputation as controlling a decision whether to breach may be overly simplistic.
An interesting question is whether certain types of organizations breach agreements more frequently. Simply put, the answer is “Yes.” Companies that are more litigious maybe perceived to be more profitable. Litigiousness is a way to signal a party may engage in breach of contract behaviors.
For example, insurance companies routinely deny claims, discouraging customers from pursuing claims that courts later find should have been paid, in order to profit on claims not pursued. Airlines routinely overbook flights and bump passengers who have pre-paid for tickets to increase their load-factor and profits. Bankruptcy may be used strategically as a “constitutional right not to pay debts” and to restructure agreements more profitably for the debtor (U.S. Const., Art. I, §8 authorizes bankruptcy).
Experienced counsel will know how to draft contracts, recover damages and discourage opportunistic behavior when the other side thinks it may be better to breach an agreement rather than continue to perform under that agreement.
References
Cender,J. (1995). Knocking Opportunism: A Reexamination of Efficient Breach of Contract.
Ann. Surv. Am. L., 689.
Holmes, O.W. (1897). The Path of the Law, Harv L Rev, 10, 457 at 462.
Khorui, N. (2002). Efficient Breach Theory in the Law ofContract: An Analysis, Auckland
Univ. L Rev, 9(3), 739-763.
Posner, R. (1976). Antitrust law: An economic perspective (Univ. of Chi).
Posner, R. (2011). Economic Analysis of Law (8th ed.).
Stilp, T. Contract Law, Ch. 11, The Parol Evidence Rule and Contract Interpretation (2023).
U.S. Const., Art. I,§8.
