The Yale Law Journal


Some Reflections on Richard Brooks’s “Efficient Performance Hypothesis”

23 Jul 2007

Though falling comfortably in the genre of economic analysis of contract, Professor Brooks’s essay nevertheless provides some relief from the excesses of economic theorizing about the law. I will confine my comments to the conceptual and normative features of the economic analysis of contract, leaving it to others more versed in economic analysis than I to assess the success of his objections to the conventional view.

It would be something of an understatement to say that economists of law sometimes mangle the normative categories embodied in law. To be fair, this mangling is not always the result of ignorance, misunderstandings, or bad theory—though often it is. At bottom, economic analysis takes the law’s normative categories to be merely of instrumental value. The economist’s view is that if taken too seriously the law’s normative categories will prove to be obstructions rather than guides to clear thinking. Quite the contrary is true, however.

I. The Holmesian “Option View” of Contract

As Brooks notes, much of the economic approach to contracts draws on the Holmesian “option view” of contracting. On this view, in contracting to deliver goods to or provide services for Smith, Jones incurs an obligation whose content is a disjunction: a duty either to perform as promised or to pay damages to Smith. So construed, Jones can discharge his obligation either by performing or by paying damages ex post. We can put this another way by saying that Jones is both obligated and at liberty. By contracting, a wide range of options otherwise available to Jones is no longer available to him; he has bound himself to a course of conduct. On the other hand, within that constraint, Jones remains at liberty with respect to the two options available to him. He is at liberty either to perform or to pay.

If Jones is at liberty to choose whether to perform or to pay damages, then he has a privilege to exercise that option free from Smith’s interference. Thus, by contracting with Jones, Smith has not secured the right to demand Jones’s compliance. There has been no transference of right as between the two of them. This is important because we would normally think that the one thing that occurs in a promise is that certain important normative powers have been exchanged between the parties. In particular, we might think that Smith, who prior to the contract had no power to demand that Jones provide certain services or deliver certain goods to him, has by contracting with Jones secured precisely the power to make that demand. On the Holmesian view, Smith has secured no such power, for Jones maintains the liberty (that is, the normative power) to perform or not as he desires. What has happened is that Jones must pay damages in the event he chooses not to perform. He is constrained in the exercise of the liberty. The key idea is that, in the economic analysis, Smith has not, by contracting, secured a normative power from Jones to control Jones’s choice—and that is the one thing we might otherwise have thought that Smith did secure.

II. The Efficient Breach Hypothesis

Understood along Holmesian lines, efficient breach identifies the conditions under which it would make sense for a contractor to exercise the option of paying damages rather than performing. It is, therefore, natural to infer that the efficient breach hypothesis and the Holmesian view of contractual obligation are inextricably linked. Though undoubtedly natural, the inference is nevertheless unwarranted.

Nothing could be more obvious than that the concept of an efficient breach entails the concept of a “breach” of a duty. A contractual breach is a failure to live up to one’s end of a bargain. The claim that some contractual breaches are efficient is the claim that sometimes failing to live up to one’s end of a bargain is individually and collectively rational. The efficient breach hypothesis is the claim that one is justified in failing to live up to one’s end of a bargain when doing so is individually and collectively rational.

As a purely conceptual matter, then, the efficient breach hypothesis assumes that contracts between parties alter the normative relations between them. In promising Smith to deliver goods, Jones has incurred a duty to deliver those goods. If prior to contracting with Smith, Jones was at liberty to provide those goods or not as he saw fit, he has in contracting with Smith relinquished that prerogative. The contract changes the normative relations between the two of them. The fundamental effect of the contract is that relevant normative power resides in Smith, not Jones. A transfer of right has taken place. In contrast, as we have just seen, in the Holmesian account no such transfer has taken place.

To be sure, even under the efficient breach hypothesis, Jones retains a capacity or power to deliver the goods or not as he sees fit. Too often people do what they have no right to do—or indeed what they have an affirmative duty not to do. But that does not mean that in so doing, they have exercised a liberty or a normative power. Jones can fail to perform, but in doing so would breach his duty to Smith and thus wrong him. Arguably, the fact that the victim has been wronged explains why he is owed damages.

None of this makes sense within the Holmesian framework. According to the Holmesian option theory, paying damages is a way of complying with one’s duties under a contract. The failure to deliver goods or provide services does not constitute a breach as long as payment is made. The difference between the Holmesian option theory and the efficient breach hypothesis is that in the latter damages are subsequent to a wrong, whereas in the Holmesian view compensation turns what would otherwise be a wrong into permissible conduct: damages constitute contractual compliance and do not represent a liability for contractual breach.

III. The Tort Law Analogue of the Holmesian View of Contract

The tort law analogue of the Holmesian option view is represented by the notion of a liability rule within the famous Calabresi-Melamed framework that provides both the conceptual apparatus and normative framework on which nearly all law and economics currently relies. Calabresi and Melamed famously distinguish among property, liability, and inalienability rules as ways of protecting entitlements. Here, in this Part, I describe the flaws that I and others have identified with the Calabresi and Melamed theory of tort—flaws that apply with equal force to the Holmesian theory of contract.

Brooks objects to the conceptual and normative features of the efficient breach hypothesis that he associates (mistakenly as I have just argued) with the Holmesian option view. The general objection, however, is one that Jody Kraus and I had previously made in an article titled Rethinking the Theory of Legal Rights. In fact, our objection runs deeper than the one Brooks advances and has two elements. First, we point out that the very idea of property, liability, and inalienability rules as ways of protecting rights rests on a conceptual confusion between the content of a right on the one hand, and the instruments available for protecting the right so conceived on the other. Property, liability, and inalienabilty rules do not protect rights. If anything, they are norms partially specifying the content of the entitlements that individuals have. For example, a property rule is best understood as the claim that the right holder has a power to exclude, trade, or waive that to which he is entitled. That is not a mechanism for protecting a right whose content is somehow otherwise articulated. It is a way of specifying in part the nature of the right that is otherwise to be protected or rendered secure, for example, by imposing liability, criminal sanctions, or the like.

Brooks’s objection to the efficient breach hypothesis does not note this kind of worry with the underlying economic framework, but that does not make the problem any less pressing. After all, it is hard to base an entire approach to thinking about the law on a theory that is itself a conceptual muddle. Conceptual confusions at the core of the theory multiply once the theory is applied. According to Calabresi and Melamed, when an individual has a right secured by a liability rule, he has no power to exclude or trade but is instead entitled to compensation in the event someone else “takes” what is his without his consent. And here is where mere muddle turns into serious confusion, for it makes no sense to say that my right is protected by a liability rule if that means that you (or others more generally) have the normative power to take that to which I have a right without my consent. Part of what it means to say that I have a right to something is that I have the relevant normative powers with regard to what is to be done with it. My right means that I possess the relevant liberty, not you. How can my right confer a liberty on you?

The second element of our objection to the Calabresi-Melamed theory of tort is that the Calabres-Melamed theory permits a tortfeasor (or, in contract law, a breaching promisor) to transform his wrong into morally permissibly conduct merely by paying compensation. If my right is protected by a liability rule in the Calabresi and Melamed sense, then you can satisfy your duty to me either by not taking what I am entitled to or by compensating me in the event that you do. And this makes the Calabresi and Melamed notion of a liability rule the analogue of the Holmesian option view of contracting. By compensating me you turn what would otherwise be a wrong into permissible conduct. The wrong is not taking from me what I have a normative power to control; the wrong would be to do so without compensating me.

Under the liability rule, the only wrong you can do me is the wrong of taking without compensating me. But of course in the standard case of a tort, compensation is owed me because you have wronged me. There is just no room in these theories for the case of you being liable to me because you have wronged me. There is no notion more central to tort than that of a duty of care. For it is upon the breach of a duty of care that one incurs a duty of repair. And this conception of the duty of care is entirely incomprehensible if we understand tort liability along the lines suggested by Calabresi and Melamed’s liability rule.

In fact, we need to distinguish among three different kinds of cases, only one of which fits in the Calabresi and Melamed account of liability rules. There are three different ways in which “wrongs” and “compensation” can be connected. (1) You wrong me and owe me compensation because of the wrong you have done me. (2) You pay me compensation and thereby make right (or make permissible) what would otherwise be a wrong to me. (3) You wrong me and owe me compensation, but your conduct is permissible even if you cannot and ultimately do not compensate me.

In the first case, compensation is grounded in a wrong; in the second case compensation rights what would otherwise have been wrong; in the third case, your wronging me is justified whether or not you compensate me, but you owe me compensation just the same.

Here are familiar examples of each kind of case. The standard tort falls into the first category (not the second as Calabresi and Melamed think). Several strict liability cases, like blasting, fall into the second category. Non-negligent blasting is permissible but only if the blaster compensates those who are injured as a result of his blasting. Blasting that causes injuries that are not compensated for is impermissible. Compensating for the injuries caused by blasting is necessary to render the blasting permissible. So far so good.

Vincent v. Lake Erie Transportation Co. provides a good example of the third case. The circumstances of necessity mean that the ship is permitted to dock and that the dock owner, who would otherwise be permitted to exclude the boat, is not permitted to do so. If the boat damages the dock, he owes compensation for the damage done. On the other hand, paying compensation is not necessary in order to make his docking permissible. Necessity makes the docking permissible; it does not relieve the boat of its duty to make repair. Failing to render compensation may be a further wrong, but it does not render the docking impermissible.

Like the Holmesian option view of contracting, the Calabresi and Melamed notion of a liability rule can account for only one of these kinds of cases; worse, it cannot account for the most basic case—the one in which compensation is for wrong done. And this makes it obvious that within the overall economic tradition the missing normative ingredient is the fundamental idea that in promising or contracting there is a transfer of right; and that in tort, in the typical case, the duty of repair is the consequence of the failure to discharge an underlying duty of care. If one doesn’t get the underlying normative structure of the relationships right from the outset, then it is no surprise that one’s views at the end of the day are completely unpersuasive.

IV. The Difference Between Philosophers of Law and Economists of Law

We philosophers are inclined to take the normative categories implicit in the law seriously. We don’t see how one can understand the law otherwise—and that, after all, is what we as legal theorists are trying to do. That’s the business we are in. Still, some economic analysts of law have very little patience for this kind of conceptual analysis. They are inclined to the view that the conceptual apparatus makes no practical difference. Why does it matter if you compensate me because you wronged me rather than because compensating me makes what you are doing permissible when otherwise it would be a wrong? What practical difference does it make?

The answer to that question depends on what you mean by a practical difference. In either case, I am compensated, and in either case, you get to do what presumably you have both the desire and capacity to do. The difference for the philosopher is that in one case you are doing what you have no justification or reason to do, and it is in virtue of that fact that the state is justified in using its coercive powers to extract liability or compensation from you; while in the other case you have every good reason to do what you are doing, but a condition of your doing it is that you pay damages. In this second case the state would have no power to prevent you and the exercise of its coercive powers against you would be unwarranted. That seems to be an important difference between the cases when we are talking about the law, since, whenever we are talking about the law we are not talking about incentives but rather about the collective use of force against some in the name of all. In that regard, the underlying issue is one of legitimate authority.

Moreover, the notion of authority itself entails the idea of reasons for acting; and this brings us to yet another point: namely, that when we are talking about practical differences in the context of the law we are talking about differences with regard to practical reasoning.

The law addresses us as agents capable of acting for reasons. The law regulates our conduct by providing us with reasons for acting. And the conceptual apparatus makes all the difference in the world from this practical point of view –the view of practical reason, which is the law’s point of view. To look at the law as the economist sometimes implores us to do, from the point of view of behavior, and not reasons, is not to understand the law at all. For what is distinctive of law is that it regulates our affairs by offering reasons for acting that are coercively enforceable. Thus, if asked what practical difference it makes to get the underlying normative categories right, the appropriate answer is: all the difference in the world.

Jules L. Coleman is Wesley Newcomb Hohfeld Professor of Jurisprudence, Yale Law School; Professor of Philosophy, Yale University; and Visiting Distinguished Professor of Philosophy, Rutgers University; Ph.D., The Rockefeller University, 1972; M.S.L., Yale Law School, 1976.

Preferred Citation: Jules L. Coleman, Some Reflections on Richard Brooks’s “Efficient Performance Hypothesis, 116 Yale L.J. Pocket Part 416 (2007),