The other day we considered the legal theory of “efficient breach” – the idea that breaching a contract is actually a good thing to do provided doing so is “economically efficient.” It is a bit of an oversimplification, but “economically efficient” essentially means that everyone involved comes out at least as well as they would have if the contract had not been breached, and the breach causes assets to be devoted to their most valuable use.
So, if a party can breach a contract, make the other party to the contract whole by paying them damages, and still come out ahead, then “efficient breach” theory wants that party to breach the contract. By recovering damages for the breach, the other party will end up in the same position as if the contract had been performed, and if the breaching party can pay those damages and still come out ahead because of, say, a better deal which comes along, then theoretically at least the asset in question is being devoted to a more valuable use.
Let’s take a closer look at the calculation to be undertaken by the party thinking about breaching a contract. There are two numbers that party has to compare to each other: the amount of damages it is likely to have to pay the other party, against the gain it stands to realize, by virtue of the breach. According to “efficient breach” theory, if the former is smaller than the latter then the party should breach the contract.
It follows, therefore, that if you make the former number (the cost of breaching) smaller, or the latter number (the benefit derived from breaching) larger, then you are going to see more breaches of contracts.
Tomorrow we’ll close the loop by examining how ERISA affects this calculation. Here’s a hint: it makes that first number – the cost of breaching – artificially low, and therefore it causes more contracts to be breached (i.e. more valid insurance claims to be denied). And this from a law that was supposed to “protect … the interests of participants in employee benefit plans.”