Beyond Ex Post Expediency - an Ex Ante View of Rescission and Restitution

Table of ContentsI. Introduction 1172II. Rationale for Limiting Rescission Rights 1174III. An Ex Ante View of Rescission 1176rv. The Threat to Contractual Stability 1181V. The Right to Reject 1181VI. Conclusion 1182I. IntroductionWhy provide a remedy in restitution for breach of contract? One might imagine that a remedy in restitution only makes sense in cases where contract remedies are inadequate, or wholly absent, such as in those situations where there is no remedy at law due to a failure of formation or some technical defect.1 When something prevents an agreement from receiving adequate enforceability under contract law, restitution steps in and cleans up the mess, as it has for centuries. But what about those cases where contract provides a perfectly adequate remedy; what purpose - other than perhaps expethency, or worse, mischief - is served by allowing a party to rescind the agreement and turn to restitution as if the contract and an adequate remedy for its breach did not exist? Notwithstanding the transaction costs of pursuing the contract remedy, restitution here would seem dubious or, at best, duplicative.2We will show, however, that there is a purpose, a heretofore unappreciated economic purpose, of rescission and restitution, which manifests even where contract remedies are fully compensatory and costless to enforce.3 This is not to say that the economic argument we offer is the only or the essential function of rescission followed by restitution. In making our argument, we are fully cognizant of the fact that the remedy of rescission and restitution also often promotes the economy that previous commentators emphasized. Our principal aim is not to exclude other considerations, but rather to expand the scope of inquiry regarding rescission and restitution. Indeed, we believe that the remedy's long and pervasive existence - dating back to ancient Roman markets and likely earlier to the legal regimes of ancient Greece and Egypt - can best be understood only by appealing to its variable functions, including the one we identify.Our argument begins with the well-known proposition that when promisors breach contracts, promisees normally prefer (legal costs aside) a remedy in contract to rescission and recovery of price paid. Normally, expectation damages, the conventional remedy for breach of contract, are greater than the contract price.4 Hence, only in odd cases - cases of socalled losing contracts, where realized value of performance turns out to be less than the price - is the option to rescind and pursue restitution preferable to expectation damages.5 In these cases, when the promisor breaches, the promisee gets a lucky break; the breach rescues her from the loss by giving her a right to rescind the contract and receive the price paid. But surely, it is commonly suggested, from an ex ante perspective, "rational parties would not bargain" for such a right.6 Our argument departs from this conventional wisdom.Rational parties, we argue, would often desire a right of rescission followed by restitution even if damages were fully compensatory and costless to enforce.7 The mere threat that a promisee may rescind, even if the threat is not carried out, exerts an effect on the behavior of the promisor, encouraging her to reduce the risk of rescission by increasing the value of performance to the promisee. Parties may enlist this implied threat to increase the value of contracting.To illustrate, take a seller of goods who knows that the buyer has a right to rescind the contract if the goods are defective. …