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Efficient Breach of Contract

Efficient Breach of contract is a controversial theory. In short, it holds that it is sometimes better and more economical to voluntarily breach an existing contract (eating the damages from the breach) for the purpose of entering into a newer, more efficient contract. It is predicated upon the fact that it would be more costly to perform under the current, existing contract.

A prominent federal judge used the following example to illustrate this theory:

Suppose I sign a contract to deliver 100,000 custom-ground widgets at $.10 apiece to A, for use in his boiler factory. After I have delivered 10,000, B comes to me, explains that he desperately needs 25,000 custom-ground widgets at once since otherwise he will be forced to close his pianola factory at great cost, and offers me $.15 apiece for 25,000 widgets. I sell him the widgets and as a result do not complete timely delivery to A, who sustains $1000 in damages from my breach. Having obtained an additional profit of $1250 on the sale to B, I am better off even after reimbursing A for his loss. Society is also better off. Since B was willing to pay me $.15 per widget, it must mean that each widget was worth at least $.15 to him. But it was worth only $.14 to A – $.10, what he paid, plus $.04 ($1000 divided by 25,000), his expected profit. Thus the breach resulted in a transfer of the 25,000 widgets from a lower valued to a higher valued use.

What makes this way of thinking controversial is that it is unseemly to many to actively work to break covenants – to encourage people to go back on their own word. It is also the case that in contract litigation punitive damages are not awarded. Intentional wrongdoings sometimes warrant punitive damages. As such, those who espouse efficient breach are able to rely on this contract law exception to be able to justify an intentional breach as being economical.

As an aside, there is the outside chance that in certain circumstances a contract can be considered a security (See: Missouri Securities Fraud). If a contract can be classified as a security, then there is a case to be made that the willful and intentional breach thereof warrants punitive damages pursuant to statutory securities guidelines.

Because of the obvious legal implications, it’s important to consult with an attorney concerning such situations.

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