Craswell & Schartz 2.3.1 Excerpts

§ 2.3.1 Specific Performance

Alan Schwartz, The Case for Specific Performance

[T]here are three reasons why [specific performance] should be routinely available. The first reason is that in many cases damages actually are undercompensatory. Although promisees are entitled to incidental damages, such damages are difficult to monetize. They consist primarily of the costs of finding and making a second deal, which generally involve the expenditure of time rather than cash; attaching a dollar value to such opportunity costs is quite difficult. Breach can also cause frustration and anger, especially in a consumer context, but these costs also are not recoverable...

Second, promisees have economic incentives to sue for damages when damages are likely to be fully compensatory. A breaching promisor is reluctant to perform and may be hostile. This makes specific performance an unattractive remedy in cases in which the promisor’s performance is complex, because the promisor is more likely to render a defective performance when that performance is coerced, and the defectiveness of complex performances is sometimes difficult to establish in court.

Further, when the promisor’s performance must be rendered over time, as in construction or requirements contracts, it is costly for the promisee to monitor a reluctant promisor’s conduct. If the damage remedy is compensatory, the promisee would prefer it to incurring these monitoring costs. Finally, given the time necessary to resolve lawsuits, promisees would commonly prefer to make substitute transactions promptly and sue later for damages rather than hold their affairs in suspension while awaiting equitable relief. The very fact that a promisee requests specific performance thus implies that damages are an inadequate remedy.

The third reason why courts should permit promisees to elect routinely the remedy of specific performance is that promisees possess better information than courts as to both the adequacy of damages and the difficulties of coercing performance. Promisees know better than courts whether the damages a court is likely to award would be adequate because promisees are more familiar with the costs that breach imposes on them. In addition, promisees generally know more about their promisors than do courts; thus they are in a better position to predict whether specific performance decrees would induce their promisors to render satisfactory performances.

In sum, restrictions on the availability of specific performance cannot be justified on the basis that damage awards are usually compensatory. On the contrary, the compensation goal implies that specific performance should be routinely available. This is because damage awards actually are undercompensatory in more cases than is commonly supposed; the fact of a specific performance request is itself good evidence that damages would be inadequate; and courts should delegate to promisees the decision of which remedy best satisfies the compensation goal....

Post-Breach Negotiations

... [One] efficiency argument for restricting the availability of specific performance is that making specific performance freely available would generate higher post-breach negotiation costs than the damage remedy now generates.

For example, suppose that a buyer (B1) contracts with a seller (S) to buy a widget for $100. Prior to delivery, demand unexpectedly increases. The widget market is temporarily in disequilibrium as buyers make offers at different prices. While the market is in disequilibrium, a second buyer (B2) makes a contract with S to purchase the same widget for $130. Subsequently, the new equilibrium price for widgets is $115.

If specific performance is available in this case, B1 is likely to demand it, in order to compel S to pay him some of the profit that S will make from breaching. B1 could, for example, insist on specific performance unless S pays him $20 ($15 in substitution damages plus a $5 premium). If S agrees, B1 can cover at $115, and be better off by $5 than he would have been under the damage remedy, which would have given him only the difference between the cover price and the contract price ($15). Whenever S’s better offer is higher than the new market price, the seller has an incentive to breach, and the first buyer has an incentive to threaten specific performance in order to capture some of the seller’s gains from breach.

The post-breach negotiations between S and B1 represent a “dead-weight” efficiency loss; the negotiations serve only to redistribute wealth between S and B1, without generating additional social wealth. If society is indifferent as to whether sellers or buyers as a group profit from an increase in demand, the law should seek to eliminate this efficiency loss. Limiting buyers to the damage remedy apparently does so by foreclosing post-breach negotiations.

This analysis is incomplete, however. Negotiation costs are also generated when B1 attempts to collect damages. If the negotiations by which first buyers (B1 here) capture a portion of their sellers’ profits from breach are less costly than the negotiations (or lawsuits) by which first buyers recover the market contract differential, then specific performance would generate lower post-breach negotiation costs than damages.

This seems unlikely, however. The difference between the contract and market prices is often easily determined, and breaching sellers have an incentive to pay it promptly so as not to have their extra profit consumed by lawyers’ fees.

By contrast, if buyers can threaten specific performance and thereby seek to capture some of the sellers’ profits from breach, sellers will bargain hard to keep as much of the profits as they can. Therefore, the damage remedy would probably result in quick payments by breaching sellers while the specific performance remedy would probably give rise to difficult negotiations. Thus the post-breach negotiation costs associated with the specific performance remedy would seem to be greater than those associated with the damage remedy.

This analysis makes the crucial assumption, however, that the first buyer, B1 has access to the market at a significantly lower cost than the seller; though both pay the same market price for the substitute, B1 is assumed to have much lower cover costs. If this assumption is false, specific performance would not give rise to post-breach negotiations.

Consider the illustration again. Suppose that B1 can obtain specific performance, but that S can cover as conveniently as B1. If B1 insists on a conveyance, S would buy another widget in the market for$115 and deliver on his contracts with both B1 and B2. A total of three transactions would result: S-Bl; S-B2; S2-S (S’s purchase of a second widget). None of these transactions involves post-breach negotiations.

Thus if sellers can cover conveniently, the specific performance remedy does not generate post-breach negotiation costs.

The issue, then, is whether sellers and buyers generally have similar cover costs. Analysis suggests that they do. Sellers as well as buyers have incentives to learn market conditions. Because sellers have to “check the competition,” they will have a good knowledge of market prices and quality ranges. Also, when a buyer needs goods or services tailored to his own needs, he will be able to find such goods or services more cheaply than sellers in general could, for they would first have to ascertain the buyer’s needs before going into the market.

However, in situations in which the seller and the first buyer have already negotiated a contract, the seller is likely to have as much information about the buyer’s needs as the buyer has. Moreover, in some markets, such as those for complex machines and services, sellers are likely to have a comparative advantage over buyers in evaluating the probable quality of performance and thus would have lower cover costs. Therefore, no basis exists for assuming that buyers generally have significantly lower cover costs than sellers. It follows that expanding the availability of specific performance would not generate higher post-breach negotiation costs than the damage remedy....

[A possible objection to this analysis] assumes that sellers breach partly because their cover costs are higher than those of their buyers; it then argues that when cover costs do diverge, allowing specific performance seemingly is less efficient than having damages be the sole remedy.

Returning to the widget hypothetical, let Cb = the first buyer’s (B1’s) cover costs; Cs = the seller’s cover costs.

Assume that S has higher cover costs than B1, that is, Cs > Cb. If specific performance were available, B1 could threaten to obtain it, so as to force S to pay him part of the cover cost differential, Cs Cb. If B1 made a credible threat, S would be better off negotiating than covering.

Because only the availability of specific performance enables B1 to force this negotiation, one could argue that it is less efficient than having damages as the sole remedy.

This objection is incorrect, even if differential cover costs influence seller decisions to breach. A credible threat by B1 to seek specific performance would usually require preparing or initiating a lawsuit. This would entail costs of lost business time, lost goodwill and lawyer’s fees, and these costs usually exceed any cover cost differential (Cs Cb) that may exist.

This is because the magnitude of cover costs—and hence of the differential—are low in relation to legal costs. Locating and arranging for substitute transactions are routine, relatively inexpensive business activities. Since the legal and related costs necessary for a credible threat commonly exceed the cover cost differential, it would rarely pay buyers to threaten specific performance to capture part of this differential. Thus no post-breach negotiations would be engendered by any differences in the parties’ cover costs.

The second objection to the conclusion that post-breach negotiation costs are no higher under specific performance than under damages follows from the fact that in some cases sellers cannot cover at all. In these cases, buyers can always compel post-breach negotiations by threatening specific performance.

There are two situations in which a seller cannot cover:

• if he is a monopolist or
• if the goods are unique.

In either event, the first buyer would also be unable to cover. If neither the seller nor the first buyer can cover, no reason exists to believe that there would be higher post-breach negotiation costs with specific performance than with damages.

If specific performance were available, B1 and S would negotiate over B1’s share of the profit that S’s deal with B2 would generate, or B1 would insist on a conveyance from S and then sell to B2.

If only the damages remedy is available, B1 would negotiate with S respecting his expected net gain from performance rather than over the contract market difference, because he could not purchase a substitute.

This expected gain is often difficult to calculate, and easy for the buyer to exaggerate. There is no reason to believe that negotiations or litigation over this gain would be less costly than the negotiations over division of the profit that B2’s offer creates, or the costs of a second conveyance between B1 and B2.

Thus even when the seller cannot cover, specific performance has not been shown to generate higher postbreach negotiation costs than damages. Moreover, when neither party can cover—the case under discussion—buyers have a right to specific performance under current law.

To summarize, if the initial buyer has access to the market at a significantly lower cost than the seller, a damages rule generates lower post-breach negotiation costs than a rule that makes specific performance routinely available. It seems likely, however, that both parties will be able to cover at similar, relatively low cost, or that neither will be able to cover at all. In either event, post-breach negotiation costs are similar under the two rules.