Source: https://h2o.law.harvard.edu/collages/1933
Timestamp: 2019-04-26 14:46:31+00:00

Document:
1. Alderson refers to certain types of cases as being governed by a "conventional rule." His reference to "breaches . . . in the nonpayment of money" is to the line of cases going back to Robinson v. Bland (see the Introductory Note to this section); the reference to "not making a good title to land" is, of course, to Flureau v. Thornhill. A third "conventional rule" that Alderson might have referred to was the contract and market rule of Gainsford v. Carroll, supra p. 1129. So far as protection of the expectation interest is concerned, do these several rules, which had become established by the time Alderson wrote, seem more or less restrictive than the formula that Alderson proposed in Hadley?
2. It appears to have been Alderson's view that cases involving the application of a "conventional" rule like those just mentioned fall under the second branch of the formula announced in Hadley v. Baxendale, since the parties in such cases "must be supposed to be cognizant" of the special rule governing their transaction. This implies that the "special circumstances" to which the second branch of the rule refers include juridical as well as natural facts. If so, it would seem, the rule in Hadley v. Baxendale can have no more than a residual application, covering only whatever ground is left uncovered by existing (and subsequently established) rules of a more specialized sort.
The economic rationale of contract damages is nicely illustrated by the famous rule of Hadley v. Baxendale that the breaching party is liable only for the foreseeable consequences of the breach. Consider the following variant of the facts in that case. A commercial photographer purchases a roll of film to take pictures of the Himalayas for a magazine. The cost of development of the film by the manufacturer is included in the purchase price. The photographer incurs heavy expenses (including the hire of an airplane) to complete the assignment. He mails the film to the manufacturer but it is mislaid in the developing room and never found.
Compare the incentive effects of allowing the photographer to recover his full losses and of limiting him to recovery of the price of the film. The first alternative creates little incentive to avoid similar losses in the future. The photographer will take no precautions, being indifferent as to successful completion of his assignment or receipt of adequate compensation for its failure. The manufacturer of the film will probably not take additional precautions either; the aggregate costs of such freak losses are probably too small to justify substantial efforts to prevent them. The second alternative, in contrast, should induce the photographer to take precautions that turn out to be at once inexpensive and effective: using two rolls of film or requesting special handling when he sends in the roll to be developed.
The general principle illustrated by this example is that where a risk of loss is known to only one party to the contract, the other party is not liable for the loss if it occurs. This principle induces the party with knowledge of the risk either to take any appropriate precautions himself or, if he believes that the other party might be the more efficient loss avoider, to disclose the risk to that party and pay him to assume it. In this way incentives are generated to deal with the risk in the most efficient fashion.
This principle is not applied, however, where what is unforeseeable is the other party's lost profit. Suppose I offer you $40,000 for a house that has a market value of $50,000, you accept the offer but later breach, and I sue you for $10,000, my lost profit. You would not be permitted to defend on the ground that you had no reason to think that the transaction was such a profitable one for me. Any other rule would make it difficult for a good bargainer to collect damages unless he made disclosures that would reduce the advantage of being a good bargainer — disclosures that would prevent the buyer from appropriating the gains from his efforts to identify a resource that was seriously undervalued in its present use. The Hadley principle is thus confined, and rightly so, to "consequential" damages, i.e., damages unrelated to the profit from the contract.
The one case where application of the Hadley principle could produce an inefficient result in a setting of consequential damages is that of monopoly. If the film manufacturer in our variant of the facts of Hadley had a monopoly of film, he could use the information the photographer would have to disclose in order to shift the risk of loss to him to discriminate against the photographer in the price charged for the film more effectively than he otherwise could; the information would indicate that the photographer's demand for the film was far less elastic than that of the amateur photographers who comprise the great bulk of the manufacturer's customers (why would it indicate this?). This use of the information would discourage risk shifting in some cases where the manufacturer was in fact the superior risk bearer.
Is Posner right to define consequential damages as "damages unrelated to the profit from the contract"? How is Posner's hypothetical case involving the sale of a house different from Hadley v. Baxendale?

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