Economically Efficient Breach of (Energy) Contracts


Many commercial and industrial companies find themselves locked into 2 + energy contract terms. While this may be highly beneficial where good rates are inked into the contract, the same cannot be said where the rates where either not good to start off with, or are no longer good due to unforeseeable and unfavourable market condition. Whatever the case may be, an important and common misconception in the industry is the thought that a company is unconditionally bound to a contractual agreement, and that the agreement in question either cannot be breached, or that it can be breach but that the only outcome would be a loss. 

Breaching a contractual agreement is certainly not advisable under most circumstances, especially when there is an enforceable contractual penalty provision that provides for damages that far exceed what the law would otherwise provide for to the non-breaching party (i.e. damages to which the non-breaching party would be entitled to had there been no penalty clause in the contract). However, the law of contracts was developed over a century ago, at a time when capitalism existed in its purest form. Under the capitalist mentality, a breach of contract could be seen as a profitable commercial outcome for the breaching party, otherwise known as an "efficient breach of contract". Black's Law Dictionary defines this theory as follows: "the view that a party should be allowed to breach a contract and pay damages, if doing so would be more economically efficient than performing under the contract". 

A classic and often-cited illustration of an efficient breach of contract is Judge Richard Posner's account in "Economic Analysis of Law", described immediately below:

"Suppose I sign a contract to deliver 100,000 custom-ground widgets at $.10 apiece to A, for use in his boiler factory. After I have delivered 10,000, B comes to me, explains that he desperately needs 25,000 custom-ground widgets at once since otherwise he will be forced to close his pianola factory at great cost, and offers me $.15 apiece for 25,000 widgets. I sell him the widgets and as a result do not complete timely delivery to A, who sustains $1,000 in damages from my breach. Having obtained an additional profit of $1,250 on the sale to B, I am better off even after reimbursing A for his loss. Society is also better off. Since B was willing to pay me $.15 per widget, it must mean that each widget was worth at least $.15 to him. But it was worth only $.14 to A – $.10, what he paid, plus $.04 ($1000 divided by 25,000), his expected profit. Thus, the breach resulted in a transfer of the 25,000 widgets from a lower valued to a higher valued use."


In short,  there is such a thing as an efficient (and profitable) breach of contract. However, all would be well advised to seek professional advice before making any such decision to breach a contract. Doing so will ensure that the breaching party has a clear understanding of the gains and losses to be made from an efficient breach of contract.

Comments