Wenqing Liao

Th e Application of the Th eory of Effi cient Breach in Contract LawA Comparative Law and Economics Perspective

Ius Commune Europaeum

ISBN 978-1-78068-356-0D/2015/7849/133NUR 822

© 2015 IntersentiaCambridge – Antwerp – Portlandwww.intersentia.com | www.intersentia.co.uk

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Wenqing Liao

Th e Application of the Th eory of Effi cient Breach in Contract Law A Comparative Law and Economics Perspective

Intersentia Publishing Ltd.Sheraton House | Castle ParkCambridge | CB3 0AX | United KingdomTel.: +44 1223 370 170 | Email: mail@intersentia.co.uk

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ACKNOWLEDGEMENTS

Four and half years ago when I was sitting in the library of Peking University, I only had an initially unshaped idea that I was going to write a thesis about the theory of effi cient breach. Th en I came to Maastricht, one of the oldest cities in the Netherlands and started a fantastic journey to become a PhD researcher. Aft er four years, the results of my research have fi nally turned into a book: “Th e Application of the Th eory of Effi cient Breach in Contract Law, A Comparative Law and Economics Perspective”. I realise that the completion of this book would never been possible if I did not have supports and help from many individuals and organizations.

First, I would like to send my acknowledgement to my supervisors− Prof. Michael Faure and Dr. Niels Philipsen− and their families− Hui (Michael’s wife) and Tony (Michael and Hui’s son) as well as Lili (Niels’ wife), Timo and Mika (Niels and Lili’s sons). When I just started my PhD, I actually did not have a clear picture in my mind about what exactly I should do in the coming four years. Michael and Niels guided me step by step to build the structure of a doctorate thesis and to write every paragraph of each chapter. Th ey read every word of my writings, gave feedbacks frequently and even corrected linguistic errors and punctuation mistakes. In addition to being the supervisors of my PhD research, Michael and Niels gave me a lot of emotional supports and social supports. I was one of the frequent visitors to their houses during all kinds of events (weekends, festivals and birthdays), where I received not only tasty food but also greetings, accompanies and encouragement.

I also feel very grateful to the professors and other researchers who have provided various useful information and suggestions to me when I was writing my thesis. I have many thanks to Dr. George Zhou who helped me to better understand my topic and to search correct information about English law. He was also sitting at the reading committee of my thesis and showed his patience when reading and commenting my thesis. My gratitude also goes to other members of my assessment committee, including Prof. Jan Smits, Prof. Jacques Herbots and Dr. Caroline Cauff man. Th ey gave me plenty of pertinent comments and suggestions, which have touched the fundamental problems in both contract law and economic analysis of law. Th ose comments helped me to improve my research. In addition, I want to express my gratefulness to Prof. Chang Peng’ao from the Law School of Peking University. He did not only supervise my master

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thesis, but also became a friend of me, providing me advises regarding my work and my life.

In the last four years, as a PhD researcher, I shared a lot of pleasures with my colleagues in the law faculty of Maastricht University. Specially, my acknowledgement goes to Dr. Jing Liu, who is my colleague, offi cemate and a close friend. Our friendship started from 2011 when I just arrived at Maastricht without fi nding any accommodation and since then she has been treating me as her younger sister by off ering me with tasty food, nice gift s, valuable suggestions and countless times of accompanies. In the law faculty, I have a long list of names, which I will never forget in my whole life. Th ey are Kevine Kindij, Ancui Liu, Bo Chen, Catalina Goanta, Grace Gan, Huizhen Chen, Jiangqiu Ge, Junping Liu, Jie Wang, Julia Pedraza Laynez, Mengxing Lv, Mengmeng Shi, Mark Kawakami, Mehdi Piri Damagh, Kelly Shang, Laura Tilindyte, Liuhu Luo, Rosa Ristawati, Sarah Schoenmaekers, Sascha Hardt, Taotao Yue, Tianxiang He, Tian Lv, Jaqueline Albino, Tobias Heldt, Viorelia Gasca, William Bull, Xiahong Chen, Xiaowei Yu, Xi Chen, Xuesong Li, Yaojing Peng, Yuan Gao, Yang Gao, Yu Zhao, Yu Yan, Guang Shen and Zamira Xhaferri. We attended seminars and conferences together, had drinks and dinners now and then, and also celebrated some festivals together. Being in the same faculty for four years, we are not only colleagues with each other, but also friends in the end. Another group of people in the law faculty, to whom I should always remember is our secretary, including Yleen Simonis, Elke Hundhausen, Chantal Kuijpers, Marina Jodogne, Marijo Mullers and Marlies Lijten. Th ey are the people who deal with all kinds of detailed things for me and for every member in METRO, from scheduling every meeting to arranging the publication of PhD thesis. Whenever there is an issue on my hand, their offi ce door is always open, with warm smile on their faces and timely help for me.

Aft er I came to Europe, I was lucky to know a large group of new friends, owing to whom I did not feel lonely and homesick any more. Th ose friends include Zhenglong Sun, Ao Rong, Ai Li, Chan Huang, Haiyan Li, Haokun Liu, Hua Zhang, Hong Wei, Lotte Chin Kon Sung, Jinjin Zhao, Jun Hou, Qian Qu, Sheng Zhong, Shuang Zhou, Shilpi Bhattacharya, Li You, Min Lin, Mary Ma, Maik Peeters, Wei Zhao, Wenzhao Qiao, Xun Xiao, Yuzhe Li, Yu Rao, Jie Zhou and so on. Because of them, I have the possibility to taste Sichuan hot pot, Cantonese Dim Sum, Indonesia food and Chinese Barbeque even in the Netherlands. Among the above Chinese friends, I have my special thanks to Zhenglong Sun. His accompany has added a lot of pleasure to my life in Europe and his encouragement has lighted my hopes when I was in my hardest time. On the other side of the world right in China, I have my closest friends who are always standing beside me, such as Jianxing Luo, Sisi Wu, Li Jiang, Fan Zhang, Xuewen Fu, Yang Zhao, Yan Fang, Yan Liu, Yiyun Zhang and so on. Th e physical distance between them and me has not aff ected our friendship. Whenever I need help from anyone of them, a simple message or a call is enough for me to reach a hand immediately.

In addition to the above-mentioned people, there are some institutes and entities that have supported both of my research and my life in Europe. I have my gratefulness to the

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Chinese Scholarship Commission and the Chinese Embassy in the Netherlands. Without the funding provided by the Chinese Scholarship Commission, I could neither have the opportunity to conduct my PhD research nor have a proper life. Owing to the support of the Chinese embassy, the life in the Netherlands became much easier because I always felt that my country is standing behind me. In addition, I want to express my gratitude to the law faculty of Maastricht University, which has provided me with opportunities to work in my own offi ce, to enjoy nice coff ees every day, to attend the Ius Commune research school, to present in diff erent workshops and most importantly to defend my thesis.

In the end, I owe my gratefulness to my mother Daolan Huang and my father Chengliang Liao. Th eir support always gives me suffi cient motivation to move on and never to give up.

Wenqing LiaoMaastricht

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CONTENTS

Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viiList of Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviiList of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xix

Chapter 1.Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12. Research Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43. Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

3.1. Law and Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83.1.1. Application of the Economic Analysis of Law . . . . . . . . . . . . . . . . . . 83.1.2. Effi ciency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93.1.3. Transaction Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

3.2. Comparative Law and Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.2.1. Choosing Legal Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143.2.2. Choosing the Topics to be Compared . . . . . . . . . . . . . . . . . . . . . . . . 15

4. Structure of the Th esis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Chapter 2.Economic Analysis of Contract and Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

1. Economic Analysis of Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171.1. Voluntary Transactions and Effi ciency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171.2. Contract Formation: Negotiating Over the Uncertainty . . . . . . . . . . . . . . . 18

1.2.1. Th e Problem of Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191.2.2. Contract Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

1.3. Problems in Contracts without Legal Interference . . . . . . . . . . . . . . . . . . . . 211.3.1. Problems of Opportunism and Distrust . . . . . . . . . . . . . . . . . . . . . . 21

1.3.1.1. Opportunism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211.3.1.2. Distrust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221.3.1.3. Insuffi ciency of Market Mechanisms . . . . . . . . . . . . . . . . 23

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1.3.2. Th e Problem of Incomplete Contracts . . . . . . . . . . . . . . . . . . . . . . . . 241.3.2.1. Hypothesis of a Complete Contract . . . . . . . . . . . . . . . . . 241.3.2.2. Reality: Incomplete and Imperfect Contracts . . . . . . . . . 25

2. Economic Function of Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262.1. How Does a Court apply Contract Law in a Contract Case? . . . . . . . . . . . . 272.2. Contract Law and Rational Behaviour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

2.2.1. Standard Behaviour Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282.2.2. Illustration of the Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

2.3. Economic functions of contract law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302.3.1. To Deter Ineffi cient Opportunism and Increase Guarantee to

Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312.3.2. To Fill the Gaps in Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 322.3.3. To Disambiguate Contract Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . 322.3.4. To “Regulate Contracts” through Mandatory Rules . . . . . . . . . . . . 33

3. Economic Analysis of Contract Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343.1. A Binding Contract and the Justifi cation for its Enforceability . . . . . . . . . 343.2. What is a Valid Contract? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 353.3. Enforcement of a Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

4. An Introduction to Economic Analysis of contract remedies . . . . . . . . . . . . . . . . 374.1. Basic hypothesis: Remedy as an Incentive . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

4.1.1. Promisor’s Behaviour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384.1.2. Promisee’s Behaviour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394.1.3. How Do Remedy Rules Shape the Parties’ Incentives . . . . . . . . . . . 39

4.1.3.1. Assumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394.1.3.2. Th e Complicated Reality . . . . . . . . . . . . . . . . . . . . . . . . . . 40

4.2. Basic Hypothesis: Remedy Rules as Default Rules . . . . . . . . . . . . . . . . . . . . 415. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Chapter 3.Effi cient Breach in Law and Economics Th eory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

1. What is the Effi cient Breach Th eory? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451.1. Why Do People Breach? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451.2. Defi nition of Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

1.2.1. Th e Concept of Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461.2.2. Traditional Th eories of Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . 48

1.2.2.1. Kaldor-Hicks Effi ciency . . . . . . . . . . . . . . . . . . . . . . . . . . . 481.2.2.2. Just Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481.2.2.3. Incentive to Breach Effi ciently . . . . . . . . . . . . . . . . . . . . . . 49

2. Hypothesis of Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 492.1. Analysis of Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 492.2. Formulate the Ideal Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

3. Models of Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513.1. Unfortunate Contingencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

3.1.1. Th e Increased Performance Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

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3.1.2. Solutions to the Problem of Increased Cost . . . . . . . . . . . . . . . . . . . 533.1.2.1. Breach and Full Compensation . . . . . . . . . . . . . . . . . . . . . 543.1.2.2. Re-negotiations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543.1.2.3. Specifi c Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

3.2. Fortunate Contingencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 553.2.1. Another Off er . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 553.2.2. A Higher Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 563.2.3. Reactions to a Fortunate Contingency . . . . . . . . . . . . . . . . . . . . . . . 58

3.2.3.1. Breach and Compensation . . . . . . . . . . . . . . . . . . . . . . . . . 593.2.3.2. Re-negotiations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

4. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Chapter 4.A Re-Examination of the Optimal Rule to Enhance Effi ciency . . . . . . . . . . . . . . . . . . 63

1. Th eoretical Framework of Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 641.1. Shavell Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 651.2. Th e Remedy Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

1.2.1. Party-designed Remedies, Default Remedies and Mandatory Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

1.2.2. Choosing the Optimal Default Remedy . . . . . . . . . . . . . . . . . . . . . . 672. Traditional Idea: Promote Effi cient Breach through Expectation damages . . . . . 693. What may Infl uence Effi ciency? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

3.1. Th e Profi ts Based Effi ciency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 713.1.1. Th e Profi ts in a Sales Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 713.1.2. Th e Models of Profi ts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

3.2. Just Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753.2.1. A Buyer’s Loss from Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

3.2.1.1. Expectation Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 763.2.1.2. Reliance Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 773.2.1.3. Loss of Restitution Interest . . . . . . . . . . . . . . . . . . . . . . . . 77

3.2.2. Th e Indiff erence Principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 773.3. Transaction Costs under Diff erent approaches to resolve disputes . . . . . . 79

3.3.1. Types of Transaction Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803.3.2. Hypothesis of Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

3.4. Risk Preference? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 823.4.1. People’s Attitude toward Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 823.4.2. Risk and Contract Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

4. Critiques on the Effi cient Breach Doctrine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 844.1. Economic Critique . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

4.1.1. Problems in the Economic Basis of Effi cient Breach . . . . . . . . . . . . 854.1.2. Weakness in the Compensatory Damages . . . . . . . . . . . . . . . . . . . . 85

4.2. Moral Concern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 875. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

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Chapter 5.Alternative Remedies and Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

1. Specifi c Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 901.1. What is Specifi c Performance? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

1.1.1. Literal Performance & Equivalent Performance . . . . . . . . . . . . . . . 901.1.2. Origin of the Dichotomy: A Liability Rule Remedy &

A Property Rule Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 911.1.3. An Introduction to the Comparison between Specifi c

performance and Expectation Damages . . . . . . . . . . . . . . . . . . . . . . 921.2. Comparison in the Model of Contracts to Produce Goods . . . . . . . . . . . . . 93

1.2.1. Th e Higher Surplus Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 931.2.2. Th e Indiff erence Principle Standard . . . . . . . . . . . . . . . . . . . . . . . . . 94

1.2.2.1. Can Expectation Damages really Fully Compensate the Promisee? . . . . . . . . . . . . . . . . . . . . . . . . 95

1.2.2.2. Can Specifi c Performance really Fully Compensate the Promisee? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

1.2.3. Th e Transaction Cost Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 971.2.4. Risk-aversion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

1.3. Comparison in the model of Contracts to convey goods . . . . . . . . . . . . . . 1021.3.1. Th e Higher-Surplus Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1021.3.2. Th e Indiff erence Principle Standard . . . . . . . . . . . . . . . . . . . . . . . . 1041.3.3. Th e Transaction Cost Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1051.3.4. Risk-aversion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

1.4. Result of Comparison: Will Breach be Optimal to Promote Effi ciency? . . 1071.4.1. Approaches to Achieve an Effi cient Result . . . . . . . . . . . . . . . . . . . 1071.4.2. Effi cient Remedy and Effi cient Breach . . . . . . . . . . . . . . . . . . . . . . . 107

1.4.2.1. Contracts to Produce Goods . . . . . . . . . . . . . . . . . . . . . . 1071.4.2.2. Contracts to Convey Goods . . . . . . . . . . . . . . . . . . . . . . . 108

2. Monetary Remedies Defi ned by Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082.1. An Introduction to Restitution, Reliance Damages and Disgorgement . . 109

2.1.1. Defi nition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1092.1.2. Eff ects of Damages Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

2.2. Comparison among Diff erent Damage Rules’ Abilities to Achieve Effi ciency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

3. Contract Damages Stipulated by the Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1143.1. Debates over the Effi ciency of Liquidated Damages and Penalty Clause . . . 115

3.1.1. A Distinguishing Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1153.1.2. A Unifi ed Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

3.2. Will Damage Stipulation Enhance Effi ciency? . . . . . . . . . . . . . . . . . . . . . . 1213.2.1. Damage Stipulation and Effi cient Breach . . . . . . . . . . . . . . . . . . . . 1223.2.2. Concerns about Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . 1243.2.3. Risk Allocation through the Damage Stipulation . . . . . . . . . . . . . 126

4. Implications from Effi cient Breach Doctrine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1275. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

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Chapter 6.Effi cient Breach and European Union Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . 131

1. An Introduction to European Union Sales Contract Law . . . . . . . . . . . . . . . . . . . 1321.1. Europeanization of Private Law and Contract Law . . . . . . . . . . . . . . . . . . 1321.2. Structure of EU Sales Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136

2. General Rules about Sales Contract, Breach and Remedies . . . . . . . . . . . . . . . . . 1392.1. Sales Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1392.2. Seller’s Breach and Buyer’s Remedy in General . . . . . . . . . . . . . . . . . . . . . . 1392.3. Damages rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142

2.3.1. General Measurement of Damages . . . . . . . . . . . . . . . . . . . . . . . . . 1422.3.2. Limits on Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144

2.4. Agreed Damages: Liquidated Damages and Penalty Clauses . . . . . . . . . . 1473. Application of the Effi cient Breach Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148

3.1. Rules in the effi cient Performance Zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1493.1.1. Specifi c Performance, Substitutive performance . . . . . . . . . . . . . . 1493.1.2. A Grey Zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

3.2. Rules in the Effi cient Breach Zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1523.2.1. Unexpected Contingencies in EU Contract Law . . . . . . . . . . . . . . 1523.2.2. Reactions to Contracts within the Effi cient Breach Zone . . . . . . 157

4. Limits of Effi cient breach in EU Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1614.1. EU Measures as Optional Instrument Cross-border Sales . . . . . . . . . . . . 1614.2. Dispute Resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

5. Economic Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1625.1. Th e Seller’s Incentive to Perform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1625.2. Th e Seller’s Incentive to Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

6. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Chapter 7.Effi cient Breach and Re-Negotiation in English Sales Law . . . . . . . . . . . . . . . . . . . . . 167

1. Introduction to English Sales Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1672. General Rules about Sales Contract, Breach and Remedies . . . . . . . . . . . . . . . . . 171

2.1. Sales Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1712.2. Seller’s Breach and Buyer’s Right to Specifi c Performance . . . . . . . . . . . . 1722.3. Damage Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176

2.3.1. Compensation and the Measurement of Loss . . . . . . . . . . . . . . . . 1762.3.1.1. Th e Prima Facie Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1762.3.1.2. Substitute Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . 1782.3.1.3. Cost of Cure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1792.3.1.4. Available Market Does not Exist . . . . . . . . . . . . . . . . . . . 180

2.3.2. Restrictions to Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1812.3.2.1. Damage Limitation Rules . . . . . . . . . . . . . . . . . . . . . . . . . 1822.3.2.2. Sub-sales Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1832.3.2.3. Purchase for Self-use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183

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2.4. Agreed Remedy: Liquidated Damages and Penalty Clauses . . . . . . . . . . . 1843. Application of the Effi cient Breach Model regarding Unexpected

Contingencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1873.1. English Law Doctrines in Relation to the Effi cient Breach Zone . . . . . . . 187

3.1.1. Frustration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1883.1.1.1. Th e goods have perished . . . . . . . . . . . . . . . . . . . . . . . . . . 1883.1.1.2. Illegality of the Contracts . . . . . . . . . . . . . . . . . . . . . . . . . 1913.1.1.3. Events covered by Force Majeure Clauses . . . . . . . . . . . 1913.1.1.4. Other Impossibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192

3.1.2. Hardship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1943.2. Rules in the Effi cient Breach zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

4. Economic Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1964.1. A Seller’s Incentive to Perform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1964.2. A hypothetical Case: the Forward Issue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1974.3. Controversy over the Introduction of Punitive Damages . . . . . . . . . . . . . 198

5. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199

Chapter 8.Applying the Effi cient Breach Doctrine to Chinese Commercial Sales Law . . . . . . 201

1. Introduction to Chinese Sales Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012. General Rules on Sales Contracts, Seller’s Breach and Buyer’s Remedies . . . . . 212

2.1. Sales Contracts and Buyer’s Remedies in General . . . . . . . . . . . . . . . . . . . 2122.2. Continuing Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214

2.2.1. Th e priority of Continuing Performance . . . . . . . . . . . . . . . . . . . . 2142.2.2. Alternative Execution in Chinese Law . . . . . . . . . . . . . . . . . . . . . . 216

2.3. Damages Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2182.3.1. Th e Complementary Function of Monetary Damages . . . . . . . . . 2182.3.2. Measurement of Damages: Expectation Damages . . . . . . . . . . . . 220

2.3.2.1. Market Price Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2212.3.2.2. Limits of Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223

2.3.3. Th e Case of Punitive Damages in Sales of Commodity Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2252.3.3.1. Th e pre-conditions for Awarding Punitive Damages . . 2272.3.3.2. Th e Amount of Punitive Damages . . . . . . . . . . . . . . . . . 230

2.4. Liquidated Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2323. Applicati.on of the Effi cient Breach Model in relation to an Unexpected

Contingency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2353.1. Unexpected Contingencies in Chinese Law . . . . . . . . . . . . . . . . . . . . . . . . . 236

3.1.1. Force Majeure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2363.1.2. “Change of Circumstances” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2373.1.3. “Impossibility and Impracticability” . . . . . . . . . . . . . . . . . . . . . . . . 239

3.2. Rules within the Effi cient Breach Zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

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4. Economic Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2434.1. Will Chinese Law Encourage Effi cient Performance and Deter

Ineffi cient Breach? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2434.1.1. Th e Remedy System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2434.1.2. Th e Mechanism of Punitive Damages in Chinese Law

regarding Sales of Houses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2454.2. Will Chinese Law Encourage Effi cient Breach? . . . . . . . . . . . . . . . . . . . . . . 246

5. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

Chapter 9.A Comparative Law and Economics Analysis of Effi cient Breach in English Law, EU Law and Chinese Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249

1. How does Contract Law Motivate Performance within the Effi cient Performance Zone? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2501.1. Th e Role of Specifi c Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2511.2. Th e Price for Breach: the Damage Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2541.3. Substitutive Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2571.4. Party-agreed Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260

2. How Does the Law Discourage Wasteful Performance in the Effi cient Breach Zone?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2632.1. Where is the Boundary? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2632.2. Ways to Achieve Non-Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268

2.2.1. Refusal of Granting Specifi c Performance & Award of Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268

2.2.2. Encouragement of Renegotiation . . . . . . . . . . . . . . . . . . . . . . . . . . . 2742.2.3. Modifi cation by a Th ird Party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278

3. Explanations for the Diff erences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2813.1. Th e Role of Contract. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2823.2. Legal Culture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2843.3. Is One Legal System more Effi cient than Others? . . . . . . . . . . . . . . . . . . . . 285

4. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286

Chapter 10.Concluding Remarks and Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . 289

1. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2891.1. Summary of Research Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2891.2. Summary of Each Chapter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291

1.2.1. Part I. Th eoretical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2911.2.2. Part II. Comparative Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293

2. Suggestions for Developing An Effi ciency-enhancing Contract Law System . . 2982.1. Remedy Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2982.2. Effi cient Breach Zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300

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3. Limitations and future Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3013.1. Limitations of Th is Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3013.2. Effi cient Breach Th eory: A Developing Topic. . . . . . . . . . . . . . . . . . . . . . . . 302

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305Table of legislation and European or international instruments . . . . . . . . . . . . . . . . . . . 333Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337Valorization Addendum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341

xvii

LIST OF ABBREVIATIONS

CCL Contract Law of the People’s Republic of ChinaCESL Directive on Common European Sales Law Directive COM (2011) 635

fi nalCISG Convention on Contracts for the International Sales of GoodsCPC Communist Party of People’s Republic of ChinaCPL Civil Procedure Law of the People’s Republic of ChinaDCFR Draft Common Frame of Reference of European Private LawECL Th e Economic Contract Law of the People’s Republic of ChinaFECL Law of the People’s Republic of China on Economic Contracts Involving

Foreign InterestGPCL Th e General Principles of Civil Law of the People’s Republic of ChinaNPC National People’s CongressPCR People’s Republic of ChinaPECL Principles of European Contract LawProp. CESL a Proposal for a Regulation for Common European Sales LawSGA Th e Sales of Goods Act 1893SGA 1979 Th e Sales of Goods Act 1979SPC Supreme People’s Court of the People’s Republic of ChinaTCL Th e Law of the People’s Republic of China on Technology ContractsTEC European Union Treaty Establishing the European CommunityTFEU Treaty on Functioning of the European Union;UPICC UNIDROIT Principles of International Commercial Contracts 1994.

xix

LIST OF TABLES

Table 1. Economic Surplus from a Voluntary Transaction . . . . . . . . . . . . . . . . . . . . . . . . . 18Table 2. Irrational Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36Table 3. Each Party’s Reservation Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57Table 4. Ex-ante and Ex-post Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66Table 5. Th e Model of Profi ts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74Table 6. Indiff erence Principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78Table 7. Surplus of Each Party if Y1 is Lucky . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93Table 8. Surplus of Each Party if Y1 is Unlucky . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94Table 9. Impact of Remedies on Ex-ante Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . 100Table 10. Types of Ex-post Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100Table 11. Surplus of Each Party under Expectation Damages . . . . . . . . . . . . . . . . . . . . . 102Table 12. Surplus of Each Party under Specifi c Performance . . . . . . . . . . . . . . . . . . . . . . 103Table 13. Eff ect of Diff erent Damage Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111Table 14. Each Party’s Surplus when Z3 Bids a Low price . . . . . . . . . . . . . . . . . . . . . . . . . 112Table 15. Each Party’s Surplus when Z3 Bids a High Price . . . . . . . . . . . . . . . . . . . . . . . . 112Table 16. Th e Hypothesis of an Effi cient Penalty Clause . . . . . . . . . . . . . . . . . . . . . . . . . . 121Table 17. Resources of EU Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138Table 18. Articles in EU Contract Law regarding a Buyer’s Remedy . . . . . . . . . . . . . . . . 141Table 19. Cumulation of Remedies under EU Contract Law . . . . . . . . . . . . . . . . . . . . . . 141Table 20. Th e Rule of Expectation Damages in EU Contract Law . . . . . . . . . . . . . . . . . . 142Table 21. Market Price or Alternative Price in EU Contract Law . . . . . . . . . . . . . . . . . . 143Table 22. Th e Foreseeability Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145Table 23. Th e Contributory Negligence Rule and the Mitigation Rule in EU . . . . . . . . 146Table 24. Th e Term Loss in EU Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146Table 25. Liquidated Damages in EU Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148Table 26. Unreasonable Delay in Requesting Specifi c Performance under EU

Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150Table 27. Substitutive Performance in EU Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . 151Table 28. Th e Rules regarding the Grey Zone in EU Contract Law . . . . . . . . . . . . . . . . . 152Table 29. Th e Conditions for Excuse in EU Contract Law . . . . . . . . . . . . . . . . . . . . . . . . 153Table 30. Th e Conditions for an Exceptional Change of Circumstances in EU

Contract Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155Table 31. Restrictions to Specifi c Performance in EU Contract Law . . . . . . . . . . . . . . . . 156

xx

List of Tables

Table 32. Consequence of Force Majeure in EU Contract Law . . . . . . . . . . . . . . . . . . . . . 158Table 33. Obligation to Re-negotiate in EU Contract Law . . . . . . . . . . . . . . . . . . . . . . . . 159Table 34. Unavailability of Specifi c Performance in EU Contract Law . . . . . . . . . . . . . . 160Table 35. Sources of English Sales Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171Table 36. Typical Forms of Commercial Sales in English Law . . . . . . . . . . . . . . . . . . . . . 172Table 37. Timing Point for Assessment in English Law . . . . . . . . . . . . . . . . . . . . . . . . . . . 177Table 38. Sources of Sales Contract Law in China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210Table 39. Time for Assessing the Market Price From a Comparative Perspective . . . . 255Table 40. Award of Specifi c Performance from a Comparative Perspective. . . . . . . . . . 271Table 41. Award of Damages in Comparative Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 272