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Information and the Scope of Liability for Breach of Contract: The Rule of Hadley V. Baxendale

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  • Lucian Arye Bebchuk
  • Steven Shavell

Abstract

According to the contract law principle established in the famous nineteenth century English case of Hadley v. Baxendale, and followed ever since in the common law world, liability for a breach of contract is limited to losses "arising ... according to the usual course of things," or that may be reasonably supposed "to have been in the contemplation of both parties, at the time they made the contract, ..." Using a formal model, we attempt in this paper to analyze systematically the effects and the efficiency of this limitation on contract damages. We study two alternative rules: the limited liability rule of Hadley, and an unlimited liability rule. Our analysis focuses on the effects of the alternative rules on two types of decisions: buyers' decisions about communicating their valuations of performance to sellers; and sellers' decisions about their level of precautions to reduce the likelihood of nonperformance. We identify the efficient behavior of buyers and sellers. We then compare this efficient behavior with the decisions that buyers and sellers in fact make under the limited and unlimited liability rules. This analysis enables us to provide a full characterization of the conditions under which each of the rules induces, or fails to induce, efficient behavior, as well as the conditions under which each of the rules is superior to the other.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3696.

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Date of creation: May 1991
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Publication status: published as Journal of Law, Economics, and Organization, Vol. 7, No. 2, pp. 284-312, Fall 1991.
Handle: RePEc:nbr:nberwo:3696

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Cited by:
  1. Luca Anderlini, Leonardo Felli, & Andrew Postlewaite, . "Should Courts Always Enforce What Contracting Parties Write?," Working Papers, Georgetown University, Department of Economics gueconwpa~03-03-29, Georgetown University, Department of Economics.
  2. De Geest, Gerrit, 2013. "N problems require N instruments," International Review of Law and Economics, Elsevier, Elsevier, vol. 35(C), pages 42-57.
  3. Surajeet Chakravarty & W. Bentley MacLeod, 2009. "Contracting in the shadow of the law," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 533-557.
  4. Steven Shavell, 2003. "On the Writing and the Interpretation of Contracts," NBER Working Papers 10094, National Bureau of Economic Research, Inc.
  5. Liu, Zhiyong & Avraham, Ronen, 2012. "Ex ante versus ex post expectation damages," International Review of Law and Economics, Elsevier, Elsevier, vol. 32(4), pages 339-355.
  6. Surajeet Chakravarty & W. Bentley MacLeod, 2006. "Construction Contracts (or “How to Get the Right Building at the Right Price?”)," CESifo Working Paper Series 1714, CESifo Group Munich.
  7. Isabel Marcin & Andreas Nicklisch, 2014. "Testing the Endowment Effect for Default Rules," Working Paper Series of the Max Planck Institute for Research on Collective Goods, Max Planck Institute for Research on Collective Goods 2014_01, Max Planck Institute for Research on Collective Goods.
  8. Miceli, Thomas J. & Sirmans, C. F., 1995. "An economic theory of adverse possession," International Review of Law and Economics, Elsevier, Elsevier, vol. 15(2), pages 161-173, June.
  9. Zervogianni, Eleni, 2004. "Remedies for damage to property: money damages or restitution in natura?," International Review of Law and Economics, Elsevier, Elsevier, vol. 24(4), pages 525-541, December.
  10. repec:dgr:uvatin:2011017 is not listed on IDEAS
  11. Hviid, Morten, 1996. "Default rules and equilibrium selection of contract terms," International Review of Law and Economics, Elsevier, Elsevier, vol. 16(2), pages 233-245, June.

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