Why do we enforce contract promises?

Over the course of my professional career, Law and Economics has grown from one school of thought among many to one so dominant that many of its postulates have virtually become unquestioned premises from which legal reasoning begins. The Law and Economics school of thought is wide-ranging, but might fairly be described the way Wikipedia puts it: Law and Economics is an “approach to legal theory that applies methods of economics to law. It includes the use of economic concepts to explain the effects of laws, to assess which legal rules are economically efficient, and to predict which legal rules will be promulgated.”

One of the most influential premises of Law and Economics is that contractual promises are enforced purely because of their capacity to maximize the society-wide allocation of resources. Thus, it is said that the contractual promise has no moral value over and above its economic value. This view both explains why typically someone suing for breach of contract can recover only the financial equivalent of the benefit they would have received had the contract been performed. There is no additional quantum of damages added to provide an incentive not to breach.

Thus, it is said, a contractual promise is in fact a promise either to fulfill the promise or to pay the damages that result from breach. This view, it is argued, has long been the view of the common law, as exemplified by Oliver Wendell Holmes’ late 19th Century statement that “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.” Thus, the thinking goes, if someone who has made a contractual promise can make out better by breaking the promise, paying damages for breach, and entering a different deal, that result is not merely tolerable — it is to be desired. Such a breach of promise is known as an “efficient breach” because it theoretically results in an increase in overall resources: the party injured by the breach is supposed to get everything he was supposed to get under the contract, the breaching party is getting something better, and the new party with whom the breaching party contracts is getting a deal he would not otherwise have gotten.

The Law and Economics view is by no means the only one current in the theorizing about the basis for enforcing contractual promises (and the interpretation Law and Economics devotees put on Holmes’ statement is disputed). As a contracts professor and litigator, though, my experience is that the idea that the contract promise has no moral value over and above its economic value is a very, very influential one.

It is a view, too, that is of a piece with the rise to virtual unquestioned dogma that unregulated free markets always result in the highest social good. One problem, though, is that unregulated free markets entrench the power of the wealthiest. So people bound by promises (the “promisor”) can force the person to whom they are bound (the “promisee”) to change the terms of the promises if the promisor has greater financial ability to force the promisee into a legal resolution that is unacceptable to the promisee.

The disparity in economic power the theory of efficient breach does not account for is on display in the power corporations hold to renegotiate employment contracts.  Since an employee can only recover for breach whatever damages are available to him through law, the threat of being limited to that remedy can be a powerful one. Thus, as the New York Times pointed out last week,

Contracts everywhere are under assault.

The depth of the recession and the use of taxpayer dollars to bail out companies have made it politically acceptable for overseers to tinker with employment agreements.

But, as David Skeel, a law professor from the University of Pennsylvania quoted in the article points out,

We run roughshod over some contracts and not over others. . . . Right now, employment contracts seem to be the type of contract that is viewed as eminently rewritable.

So we have Larry Summers, President Obama’s Chief Economic Adviser, arguing in connection with the bonuses paid to AIG employees that the contractual promises are too sacred under the law to undo: “”We are a country of law. . . There are contracts. The government cannot just abrogate contracts. Every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve system.” On the other hand, the UAW’s agreement to give up rights under its contract with the auto companies was required by the government as a condition of the federal monies the automakers received.

So, are contractual promises “sacred” in some way, or are they only worth whatever the parties to them can extract given their relative financial strength and political influence? I don’t think I know.

Who’s the good guy?

When they begin studying law my students most of my students, like children and cartoons, divide the world into good and evil. They believe that most cases can be explained by figuring out who’s the “good guy” and who’s the “bad guy.” To the beginner, every explanation is a strained effort to demonstrate why someone in a case has lied, cheated, or stolen. I try to explain to them that cases involving evil doers victimizing innocents are the easy ones. More importantly, perhaps, they’re the rare ones. The tough stuff to understand and explain are the vast majority of feuds, the feuds in which each side believes it is acting in good faith and for the best.

Life inevitably results in misunderstandings, accidents, mistakes, death, and failures (of investments, businesses, buildings and bridges, operations, etc.). Doing justice is most sensibly and correctly resolving the fights that result from those inevitable, though regrettable, events.

Justice, therefore, is blind.

So I am particularly disturbed by the willingness of people to cast aside the law on the grounds that certain lawbreakers meant only to do good. Charles Fried, Solicitor General under Reagan, for example (whose scholarship on Contracts I very much respect), condemns torture without qualification and yet argues we can’t prosecute people who decided to break the law and order torture because well, . . . unlike actual criminals the people who justified and ordered torture meant well:

But should the high and mighty get off when ordinary people committing the same crimes would go to prison? The answer is that they are not the same crimes. Administration officials were not thieves lining their own pockets. Theirs were political crimes committed by persons whose jobs were to exercise the powers of government on our behalf. And the same is even truer of the lower-level officers who followed their orders.

They are the same crimes — breaking the law in the belief that breaking the law is justified. Then why should Dick Cheney and the lawyers who lied about the law to justify torture get off?

Michael Mukasey is the Attorney General, and this week he apparently made the decision not to prosecute a former Justice Department lawyer who quite plainly could be indicted and tried for breaking federal law:

[A] former senior Justice Department official, Bradley Schlozman, set out to hire so-called “Right-Thinking Americans,” including members of the Federalist Society and other Republicans, for what were supposed to be apolitical career positions. He then gave them plum assignments on civil rights cases when he was helping to run the Civil Rights Division, beginning in 2003. . . . Mr. Schlozman . . . gave false statements to Congress when he repeatedly denied factoring politics and ideology into his hiring decisions.

The . . . case against Mr. Schlozman relies heavily on his words, from e-mail and phone messages to colleagues and underlings. His disdain for the traditional independence and mission of the Civil Rights Division is palpable. He spoke brazenly about reshaping the division by doing away with “pinko” and “crazy lib” lawyers and others he did not consider “real Americans.”

“As long as I’m here, adherents of Mao’s Little Red Book need not apply,” he wrote in one e-mail message. The report found that Mr. Schlozman transferred three lawyers out of the division because they were viewed as liberals who opposed his political agenda. The transfers, the report found, violated federal civil service law and “constituted misconduct.” All three lawyers brought federal discrimination claims and returned to the division after Mr. Schlozman’s departure.

Yet, without explanation, the Justice Department has decided not to prosecute Mr. Schlozman.

Charles Fried and Michael Mukasey can identify with federal officers and lawyers. They are or were federal officers and lawyers. They know even when people try hard things sometimes go wrong. But that doesn’t mean people who set out to do wrong things for even good reasons are above the law.

Fried and Mukasey know that, but somehow that knowledge escapes them when the defendants look and act just like them. That’s not the rule of law. It’s the rule of an aristocrats watching out for each other.