The Reliance Interest in Contract Damages

A Failure To Reconcile Contract Damages: The Reliance Interest

A Review Of L. Fuller And W.R. Jr. Perdue ‘The Reliance Interest In Contract Damages’

The damages doctrine came under particular focus by Fuller and Perdue, (for ease I will hereby refer to just Fuller) whom are believed to have stimulated the twentieth century discussions much further than that which had previously existed, even though this resulted in much criticism. It has been subject to much dissection as commentators seek to unravel the policy that surrounds the juristic intervention. For many commentators the article is viewed to be the starting point for much of the ensuing scrutiny around the vindication of contractual interests in the law of damages. It appears that successive efforts have either accepted or elaborated lines of argument on the bases of attempting to present an alternative approach in response. Thus the article has become a point of reference, not however, for its underlying argument. The rationale for the article being cited in a great deal of the material, is much a result of providing a digestible version of the claim that the purposes underlying contract enforcement are in fact multiple and complex. Fuller can be accredited in achieving a successful descriptive analysis, if nothing else.

Introduction

It is the purpose of this essay to assess the ‘radical’ application of Fuller’s underlying argument, that reliance should be the interest that is protected, and demonstrate that this fails to reconcile with the purpose of contracting, that being of receiving performance. In contradiction to Fuller’s proposition, it was made sufficiently clear by the courts in Robinson v Harman where it was stated that the usual measure of recovery is the expectation measure. The purpose of such an award is to project ‘the plaintiff into a world of post-contractual fulfillment defined by means of a substitutive damages award.’ I will begin by summarising Fuller’s article and then provide reasoning as to why the reliance interest does not protect and ensure that the purpose of contracting is upheld. I will then ensue to criticise the impact of the reliance theory on contractual theory.

Commentary And Summary

As identified by Craswell ‘Fuller and Perdue’s article made a number of significant contributions, and it therefore resists easy summary’; though I will attempt to provide the reader with an understanding of the focus of the article (part one of supplies most of Fuller’s theory, whilst part two is rather an appendix supporting the theory). A significant point to note is the exposition of the three interests (restitution, reliance and expectation) by the article, which were placed into an ascending hierarchy by the level of importance to be accorded to the interest in the normative case. It is these interests which have developed to be the cornerstone of the articles importance.

Fuller observes the accepted view that damages are to act as compensation for the plaintiff’s loss, it is necessary to find actual loss rather than a ‘metaphorical statement’ of loss. What Fuller must be ignorant of is that there is no compensable loss in his expectation interest. Fuller endeavors to justify the reason why he believes the expectation interest to not have characteristics of a compensatory nature. Most academics have justified their disagreement with this point by stating that ‘the essence of contract is performance’, which as an interest, is compensable. This reasoning is easily justified on the bases that the plaintiff has failed to receive performance from the defendant which he contracted to obtain.

It is suggested in the article that if one is to proceed to award damages for the loss of expectation, then we move ‘from the realm of corrective justice to that of distributive justice’. Thus Fuller claims the availability of such, should therefore be reduced. Accordingly a reliance basis should take prominence. The reasoning is suggestive that to establish a claim for compensation there must have been loss through reliance of entering into the contract, which if not recovered by the plaintiff will leave him in a position worse than that if he had not contracted. It is accepted that this should set the minimum award available in an award of damages, but it cannot take prominence or form the main basis of recovery.

Fuller’s objections to the expectation measure are premised on the accepted idea that damages are to be solely compensatory, and fail’s to correctly conclude that damages should also be concerned as protecting the interest that results from the primary purpose of contract. He states that the expectation measure to act as compensatory ‘seems . . . a queer kind of compensation.’ Thus the underlying theme is that if damages are going to be compensatory then they must be predicated on a different basis to that of the expectation measure. Hence damages awarded on the basis of reliance have a greater moral justification. The article having decisively questioned the basis of the expectation principle as the fundamental principle of compensation concludes that the reliance interest has a greater rational for protection than the expectation interest as this award will correct an ‘unjust loss by the non-breacher.’

Fuller does not acclaim that the awarding of expectation damages is completely erroneous; he appreciates that in cases they are justified, especially in a commercial context. It is however incorrect to state that a contract obtains a different status in a commercial context. The purpose of a contract is always the same; it is the importance and potentially economic significance that differs. Hence it is unquestionable that the interest obtained is the same no matter what context the contract is placed.

Fuller attempts to reason that the reliance interest is defined in such broad terms that losses incurred through placing reliance upon contracting becomes recoverable. Essentially by defining reliance in these terms, indirectly provides protection to the performance interest that is obtained in contracting. Such a broad approach to the definition is debatable. The position that is taken in defining the reliance interest may stand to inherently dis-credit his own underlying argument of simply protecting the reliance interest.

Purpose Of Contract And The Reliance Interest

Contract and promises are valuable because we appreciate the consequences of such. We contract in order to gain surety in the other parties’ performance, and thus impose secondary obligations to ensure the primary obligation is enforced. Application of the reliance theory does not ensure parties perform; it acts merely to compensate, akin to an action in tort. A purpose of contract law must truly be to provide security to those parties whom contract and proceed on the basis of forming a legal relationship. A failure to protect the purpose of the relationship places redundant a substantial part of contract theory, thus the argument presented by Fuller has exorbitant consequences for contract.

Parties to a contract place reliance upon a contract, because the parties believe they have formed a contract. Consequently, at some point both parties must be aware that the other party is promising to perform, this is the result of forming a contract. It follows that a party does not place reliance upon a contract unless the party is aware that they have formed that contract. Therefore, reliance only occurs when parties’ believe that they have become obligated to perform. It thus follows that a plaintiff will not simply seek compensation for their reliance when the plaintiff has placed reliance upon performance. Reliance is correspondingly secondary to performance.

If it is accepted that the basis upon which we contract is that of reliance, then we are surely contracting to simply receive damages. Parties become no longer concerned with receiving performance, which ‘is a conception of contract foreign to English law’. Thus the purpose for which we have contracted becomes seemingly pointless and the consequences of this are that we move to a Holmesian view of contract.

Contract law damages thus needs to reflect the benefit of contracting. There is an inescapable link between the remedial right and the legal right (being performance), which if it is accepted to be the case, damages should pertain to the equivalence of performance. Thus once a contract is formed both parties can place reliance upon obtaining performance or compensation to the equivalent of performance, not simply to the extent of their reliance, which is only a secondary result of forming a contract. The primary purpose is the ability to receive the other parties’ performance, if this is not the case, then parties forming a contract do not need to expect performance. On the basis of this theory, contracting parties can place reliance upon a contract irrespective of the question of performance. From this we move to question the purpose of a wholly executory contract, if performance is not to be expected, and performance cannot be obtained by some other method.

It emerges that Fuller’s main concern of awarding expectation damages is the inclination to overcompensate and the moral implications of such. However, one is inclined to conclude that ‘the primary function of the contractual remedies is to induce performance of the contractual obligations [and this is most likely to be obtained where] the sanction for breach imposes costs on the promisor greater than the cost of performing the obligations’.

The Substantive Tensions Of The Theory

As has been noted above, many critics have disagreed with the theory that is presented. Through questioning the implication of the theory it will demonstrate the uncertainty of such a theory. Most commentators would agree, the nature of protection given to a contract through the awarding of damages is not independent of the interest that the plaintiff obtains in the formation of a contract, they are justifiably connected. It is therefore, inexplicable to suggest that damages are subordinate to the interest that is obtained in contract. An award of damages operates as a substitute to the interest that is obtained in the contract. As has been discussed above, if the performance interest is accepted then adjudication of a damages award must be associated, and cannot be discerned and analysed upon a moral basis.

The reasoning which gives rise to further issues in the argument, is that contracting creates an entitlement (e.g. right) upon the formation of a valid binding contract and it follows that this entitlement should be protected. If no protection is accorded to such, then we result to actually render contractual theory, which is premised on the notion of being able to acquire damages as a substitute for breach of non-performance, redundant. The result of the reliance theory is that it becomes no longer necessary to consider the purpose for which the contract was formed, but merely result in considering the basis of damages as distinct from the entitlement. The reason for this is that reliance losses are made outside of the actual contract between the parties, but to calculate reliance losses, the losses made outside of the contract have to be investigated.

The consequence of a reliance based doctrine is that a contract entitles the promisee to damages to this extent, and also that the contractual obligations will only be enforceable when there has been reliance. This creates a quandary of when to determine appropriate reliance, and the well known rule from the case of Hadley v Baxendale seeks to limit the recovery on such a basis. The law therefore moves to a position to impose contractual obligations upon the parties when it determines there has been reliance. We therefore move from a position of parties making contracts on a voluntary basis which are determined by the parties’ consent, to a position where the law imposes duties when reliance has been placed upon the contract. Thus we no longer need mutual assent.

It follows from the above, that an obligation to give reliance damages can arise merely as a result of representations of a promissory nature. As a result of asserting that claims should proceed on the basis of reliance removes the need for establishing a counter promise. The reliance itself will become the counter promise. Consequently, we succumb to a position of reformulating an established basis of contract law. This is a wholly unsatisfactory position. Court’s cannot simply assess cases based on the reliance that a party gives to a promise. This would involve looking at each case upon its own facts to determine, presumably subjectively, whether there has in the case been reliance (not just of a fictitious nature), and thus allow a reliance based recovery. This is unlikely to be a position favoured, as it will result in potentially removing the consistency in application of legal principles which the law strives to achieve.

Conclusion

To put simply Fuller’s argument, he states that a greater weight of protection to be accorded upon the reliance interest, and that the expectation interest should be resided to becoming at least secondary (or redundant) when it comes to the awarding of damages. The implication of such a radical theory creates a number of theoretical difficulties in contractual doctrine and ‘given the lack of formal recognition accorded to in the evolution of contract law to the reliance interest (as Fuller concedes), nevertheless the formal standing and primacy of the expectation interest cannot so easily by elided.’

Accepting Fuller’s definition of interests, only the award of expectation damages protects the primary interest in contract. In English law the duty to perform is widely accepted to be the true contractual purpose and thus priority should be given to its protection. A result of obligations being imposed by the law renders theoretical distinctions between contractual theory and tort increasingly difficult. Contract should be seen as a distinct legal obligation and should not be enjoined with the law of torts, due to limitations that are placed upon the recovery of damages. Hence the award of the performance based measure is justified as necessary to protect the sanctity of promises. Fuller’s moral perspective on the awarding of damages will always fail to reconcile the true contractual interest with contractual damages.

Bibliography

Articles

D.W. Barnes, ‘The Net Expectation Interest in Contract Damages’ (1999) 49 Emory Law Journal 1137

R. E. Barnett, ‘The Death of Reliance’ (1996) 46 Journal of Legal Education 518

R. Birmingham, ‘Notes on the Reliance Interest’ (1985) 60 Washington Law Review 217

B. Coote, ‘Contract Damages, Ruxley, and the Performance Interest’ (1997) 56(3) Cambridge Law Journal 537

R. Craswell, ‘Against Fuller and Perdue’, (2000) 67 The University of Chicago Law Review 99

R. Epstein, ‘Beyond Foreseeability: Consequential Damages in the Law of Contract’ (1989) 18 The Journal of Legal Studies 105

D. Friedmann, ‘The Performance Interest in Contract Damages’, (1995) 111 Law Quarterly Review 628

L. Fuller and W.R. Jr. Perdue, ‘The Reliance Interest in Contract Damages’ (1936) 46 Yale Law Journal 52 and 373

D. Kimel, ‘Remedial Rights and Substantive Rights in Contract Law’, (2002) 8 Legal Theory 313

S. Macaulay, ‘The Reliance Interest and the World Outside the Law Schools’ Doors’ [1991] Wisconsin Law Review 247

M. Owen, ‘Some Aspects of the Recovery of Reliance Damages in the Law of Contract’ (1984) 4(3) Oxford Journal of Legal Studies 393

T. D. Rakoff, ‘Fuller and Perdue’s the Reliance Interest as a Work of Legal Scholarship’ [1991] Wisconsin Law Review 203

S. Stoljar, ‘Promise, Expectation and Agreement’ (1988) 47(2) Cambridge Law Journal 193

C. Webb, ‘Performance and Compensation: An Analysis of Contract Damages and Contractual Obligation’, (2006) 26 Oxford Journal Of Legal Studies 41

C. T. Wonnell ‘Expectation, Reliance, and the Two Contractual Wrongs’ (2001) 38 San Diego Law Review 53

Books

‘Contracts, Promises, and the Law of Obligations’ in P.S. Atiyah, Essays on Contract (OUP: Oxford, 1986)

‘Holmes and the Theory of Contract’ in P.S. Atiyah, Essays on Contract (OUP: Oxford, 1986)

M. Bridge, ‘Expectation Damages and Uncertain Future Losses’ in J. Beatson and D. Friedmann (Eds) Good Faith and Fault in Contract Law (Clarendon Press: Oxford 1995)

N. Cohen and E McKendrick (eds), International Studies in the Theory of Private Law: Comparative Remedies for Breach of Contract (Oregon (USA): Hart Publishing, 2005)

P. Jaffey, ‘Damages and the Protection of Contractual Reliance’ in R. Cunnington, and D. Saidov (Eds), Contract Damages: Domestic and International Perspectives, (Hart: Oxford, 2008).

D. McLauchlan, ‘Expectation Damages: Avoided Loss, Offsetting Gains and Subsequent Events’ in R. Cunnington, and D. Saidov (Eds), Contract Damages: Domestic and International Perspectives, (Hart: Oxford, 2008).

A. Ogus, ‘The Economic Basis of Damages for Breach of Contract: Inducement and Expectation’ R. Cunnington, and D. Saidov (Eds), Contract Damages: Domestic and International Perspectives, (Hart: Oxford, 2008).