Moral Diversity and Efficient Breach

Authors

Matthew A. Seligman, Benjamin N. Cardozo School of Law

Abstract

Most people think it is morally wrong to breach a contract. But sophisticated commercial parties, like large corporations, have no objection to breaching contracts and paying the price in damages when doing so is in their self-interest. The literature has ignored the profound legal, economic, and normative implications of that asymmetry between individuals’ and firms’ approaches to breach. To individuals, a contract is a promise that cannot be broken regardless of the financial stakes. For example, millions of homeowners refused to breach their mortgage contracts in the aftermath of the housing crisis even though doing so could have saved them tens or even hundreds of thousands of dollars. Their moral beliefs led homeowners to forgo opportunities for efficient breach that firms would have seized, thus exacerbating al-ready swelling wealth inequalities.

This Article explains this phenomenon, identifies its consequences and examines strategies to address it. Neither ex post judicial interventions (such as adjusting the remedies for breach) nor traditional ex ante regulatory interventions (such as disclosure requirements) will effectively address the problem. Instead, the most promising approach is a novel solution based on the framework of choice architecture: requiring contracts to include an express term creating an option to exit the contract and pay a fee equivalent to expectation damages. An express exit term elevates an implicit legal option into an explicit contractual option, reframing the moral choice so individuals would perceive exiting the contract as a morally permissible performance of their promise rather than a morally forbidden breaking of it. The presence of that exit term thereby aligns individuals’ perceptions of their moral obligations under the contract with sophisticated firms’ approaches to breach.

The Article concludes with new empirical evidence that demonstrates the practical impact of an exit clause. It presents the results of two experimental studies I performed that demonstrate the effectiveness of a mandatory exit clause in reducing the effects of the asymmetry between individuals and firms. Those results show that exit clauses could have substantial practical implications for the regulation of contracts in contexts like consumer and mortgage contracts.

Recommended Citation

Matthew A. Seligman, Moral Diversity and Efficient Breach, 117 Mich. L. Rev. 885 (2019).
Available at: https://repository.law.umich.edu/mlr/vol117/iss5/3