The case for punitive damages in contracts

The majority of American jurisdictions do not allow punitive damages for br each of contract unless the breach constitutes an independent tort. Increas ingly, courts and commentators have relied on the theory of "efficient brea ch" to explain the rule against punitive damages in contracts. lit this Art icle, Professor Dodge argues that economic efficiency supports a different rule-one allowing punitive damages for any willful breach of contract. Willful breaches fall into two categories: those that are "opportunistic" a nd those that are "efficient." An "opportunistic" breach does not increase the size of the economic pie; the breaching party gains simply by capturing a larger share of the pie at the expense of the nonbreaching party. An "ef ficient" breach, by contrast increases the size of the pie, allowing the br eaching party to compensate the nonbreaching party and still come out ahead Deterring opportunistic breaches with the threat of punitive damages is ef ficient because such breaches by definition do not increase societal wealth . Thus, punitive damages should be routinely available in cases of opportun istic breach, such as pretextual termination, stonewalling, and bad faith r efusal to pay a debt. Efficiency also supports extending liability for punitive damages to those breaches that are, in theory, "efficient." The threat of punitive damages w ill not require inefficient performance because the potentially breaching p arty may negotiate with the other party for a release Relying on Calabresi and Melamed's distinction between "property rules" and "liability rules," P rofessor Dodge shows that requiring the potentially breaching party to nego tiate for a release is more efficient than allowing her to breach and pay d amages because the transaction costs of negotiation, while not negligible, are generally lower than the assessment costs of litigation. He also explai ns why other forms of "property rule" protection, like specific performance and penalty clauses, are insufficient to ensure that negotiation occurs be fore breach.