The questionable ascent of Hadley v. Baxendale

The venerable case of Hadley v. Baxendale serves as the prototype for defau lt rules designed to penalize, and thus encourage disclosure by, an undesir able contractual counterpart. Penalty-default analysis is now widely accept ed as a plausible approach to the issues presented by incomplete contracts. The ambition of this article is to challenge and refine the accepted wisdo m. The article demonstrates that the structure of penalty-default theory as derived from Hadley rests on a faulty implicit premise. The premise is tha t damages from breach of contract are certain. In fact, damages are stochas tic. Consequently, the standard penalty-default model of Hadley overlooks t he potential incentive of a party to conceal information even though the pa rty is subject to a penalty-default rule. This incentive, which is shown to exist in other contexts, may greatly complicate the evaluation of a defaul t rule's efficacy. Thus, a lawmaker may have reason to be skeptical of her ability to identify an efficient penalty-default rule, the seeming simplici ty of Hadley notwithstanding.