Efficient breach is when one party finds it more efficient to breach a contract and pay a penalty than to carry out its contractual obligations. In the case that it is more economically or otherwise beneficial for the party to break the contract, even with penalties, the best option is the efficient breach. However, the breach is only considered efficient if there is no harm done to the other party.

Efficient Breach Law

When a civil court hears a case of efficient breach, and finds the plaintiff is correctly benefited from breaking its obligation, generally there is no further compensation for the plaintiff. Penalties are included in the consideration, but monetary damages are usually not, as that is considered overcompensating to the plaintiff.

On the defendant's side, if the plaintiff accepts the penalties imposed by the breach, compensation is considered as complete as if the contract had been followed through as signed. While advocating immoral behavior, most courts agree that efficient breach is economically efficient, as at least one party is better off because of the breach and no parties are worse off.

Efficient Breach Example

Consider a commercial contract signed between parties A and B. A agrees to sell 100 units of product to B for $50 per piece. Party C then appears and wants to pay $100 per piece. A will have to give B its deposit back and pay B a fee of $25. However, A will still gain an extra $4,975 by selling the 100 units to C and breaking the contract with B. In this example, B has been fairly compensated for the inconvenience and A (and C) are both better off, therefore this breach of contract is economically efficient.

An efficient breach must fit the following criteria:

  • A valid contract must exist
  • Breaching the contract, by not performing the obligations defined within, must be done to the economic advantage of the breaching party
  • The non-breaching party must be compensated as outlined within the contract
  • The non-breaching party, after receiving compensation, must be no worse off economically

Breakdown of Efficient Breach

The 2008-2009 US mortgage crisis was the cause of many contract breaches nationwide. On the side of the consumer, the value of the real estate had fallen so far that what was owed was more than the current value of the real estate. Home owners purposefully defaulted, considering it more efficient than paying on an 'underwater' mortgage. Homes and land were then repossessed by the lender. The defaulted borrowers were of course left with a lower credit score, but could rent or buy a property with a lower monthly payment.

Unlike a true efficient breach, however, in said instances the lender was at a disadvantage. This is because the value of the property recovered is now much less than the amount of money that is owed to them in the contract. According to economic theory, and to the courts upholding contract law, this is not an efficient breach, as the non-breaching party is worse off while the breaching party takes an advantage.

Efficient Breach and Efficient Reliance

Efficient reliance is the concept that a signed contract is a legally binding document of trust between the parties involved. This means neither party is signing the contract in order to deliberately breach it later on. Under contract law, most legal contracts have a built in remedy in case of breach. Thus, while not expected, if one party does happen to breach the contract, the other will be compensated fairly per the built-in remedy. This is efficient reliance, and it enables the non-breaching party to break even rather than take a loss on the other party's breaking of trust.

The level of reliance in this case is only enough to break the non-breaching party even. It does not over-rely on the potentially breaching party by forcing it to pay punitive damages. It also does not make an example of the breaching party by imposing penalties far in excess of the crime. The breach, in this instance, is an efficient distribution of both contract reliance and economic resources.

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