Friday, May 04, 2007

What's Wrong With Inducing Breach of Contract? (2)

I see my fatwa against the tort of inducing breach of contract has not won universal acceptance. Obviously, if this state of affairs is allowed to continue, the terrorists will have won. In hopes of attaining greater oneness, I propose to do an "economic analysis" of the relative merits of a rule allowing parties to a contract to sue 3rd parties that interfere.

For those who did not have the benefit of a U of T legal education, and might be getting a bit nervous at this point, I should hasten to explain that an "economic analysis of law" does not require the use of calculus or graphs or the investigation of empirical reality in any way. That stuff is all really hard, and if we knew how to do it, we wouldn't have gone to law school. What we will do might better be called "intuitive cost-benefit analysis," but that doesn't sound as good. We take each rule (no liability for inducing breach of contract without the use of illegal means; liability for inducing breach of contract even if the means are not otherwise illegal) and add actual costs under each rule with incentive costs. Incentive costs will be taken as the value of the exchanges that would occur in a transaction-cost-free universe and those that actually occur in the world with these rules. Whichever rule has the lower total costs (determined by intuition and thought-experiment, naturally) wins.

In tribute to the pre-1985 DC Universe continuity, we will call the world with an inducing breach of contract tort in addition to an unlawful interference with contractual relations tort Earth 1. The Pithlord-preferred reality with just an unlawful interference tort will be Earth 2.

OK, let's get started. Suppose that on Earth 1 and Earth 2, all judgments can be enforced and legal process is costless and error free. (Also, Wonder Woman and Superman are married, and Lex Luthor is Clark Kent's best friend.) Assuming as well that a defendant in an inducing breach of contract action has a claim over against the actual contract-breaker, then Earth 1 and Earth 2 will be equally efficient. The incentives will be the same because anyone worried about being sued for IBC will know that they can always recover against the actual breaching party.[1] Let's suppose Batman agrees to sell the bat cave to Hawkman, and Green Lantern is thinking of making a better offer. On Earth 2, Hawkman couldn't sue Green Lantern, so Green Lantern's incentives won't be affected, but on Earth 1, Green Lantern will still know that if Hawkman ever sues him, Batman will indemnify him, so the rule will still have no effect on his behaviour. On the other hand, Batman won't break his deal unless he is willing to compensate

Making things a bit more realistic, let's say the legal process is somewhat costly and prone to the occasional error. (And Luthor is a Republican.) Earth 1 and Earth 2 still won't be that different. It would almost never pay Hawkman to sue Green Lantern in IBC because it will always be cheaper and easier to make a case against Batman, the breaching party. All Hawkman has to show against Batman is that he had a contract, that Batman didn't perform and that Hawkman has suffered damage as a result. Against Green Lantern, he has to prove all these things, and the other elements of inducing breach of contract, as well. Who needs the grief? But if no rational agent sues in IBC, then all rational agents know this, and the incentives don't change.[2] Some inefficient contractual breaches will occur when it just won't be worth the innocent party's while to expend litigation costs and take the risk of legal error. So some incentive costs will exist, but they won't be higher on either Earth.

The existence of a cause of action in Inducing Breach of Contract becomes important when its possible that some contract breachers will be judgment proof. If Green Lantern tempts Batman into breaching his contract with Hawkman, but the Wayne estate turns out to already be heavily leveraged and insolvent, then Hawkman could be out of luck if Batman was the only one he could sue. Green Lantern might be the only deep pocket left. So on Earth 1, alleged inducers will sometimes be sued.

Obviously, Earth 1, with the tort of inducing breach of contract, has higher litigation costs.

On Earth 2, all the incentive for controlling the risk that a party to a contract will not be able to pay damages in the event of breach will be on the other party to the contract. On Earth 1, that incentive will be lessened somewhat, but there will be an incentive for people who might be considered "inducers" to do the same. I think it's fair to say that due diligence/risk management costs will therefore be higher on Earth 1, leading to fewer otherwise-efficient transactions. This is especially the case because it is easier to define and control risk when you have a contract with someone. So, again, Earth 1 is a less efficient place.

There will be a greater deterrence of breaches of contract on Earth 1 than on Earth 2. This will be a good thing sometimes (since the existence of litigation costs and errors and judgment-proofedness means that some inefficient breaches will occur on both Earths), but not always (efficient breaches will be more thoroughly deterred). Because of risk aversion and legal error, some potentially valuable interaction between Green Lantern and Batman won't happen on Earth 1, even though it would not have led to breaches of contract. Let's call the incentive effects here a wash.

The result is that Earth 2, without a tort of inducing breach of contract, is closer to the Coasian ideal of efficiency than Earth 1, with such a tort.

[1] If there isn't a claim over, then the Earth 1 will just plain suck in commercial efficiency. The disincentive to engage in inefficient breaches of contract will be less than it should be since at least some plaintiffs will sue in IBC instead, leaving the breacher off the hook. Also, socially-beneficial activity that could be considered IBC will be deterred.

[2] The existence of legal error complicates things somewhat. If there is uncertainty about the outcome of Hawkman's case, both Batman and Green Lantern might be tempted to contribute towards a settlement for less than the full amount, providing Hawkman with an incentive to sue Green Lantern, and therefore affecting everyone's ex ante incentives.

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