Development of The Theory
According to Black's Law Dictionary, efficient breach theory is "the view that a party should be allowed to breach a contract and pay damages, if doing so would be more economically efficient than performing under the contract."
The first statement of the theory of efficient breach appears to have been made in a law review article by Robert Birmingham in "Breach of Contract, Damage Measures, and Economic Efficiency", 24 Rutgers L.Rev. 273, 284 (1970) ("Repudiation of obligations should be encouraged where the promisor is able to profit from his default after placing his promisee in as good a position as he would have occupied had performance been rendered"). The theory was named by Charles Goetz and Robert Scott, "Liquidated Damages, Penalties, and the Just Compensation Principle: A Theory of Efficient Breach", 77 Colum.L.Rev. 554 (1977).
Efficient breach theory is associated with Richard Posner and the Law and Economics school of thought. It has been used to defend the traditional common law rule that a non-tortious breach of contract cannot be remedied by punitive damages and penal damages (unreasonably excessive liquidated damages that are seen as a punishment for breach rather than a means to fairly compensate the other party). Such penalties would discourage efficient breach, and therefore "efficient" behavior, which would be undesirable for society as a whole. Posner explains his views in his majority opinion in Lake River Corp. v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985).
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