The Questionable Ascent of Hadley v. Baxendale

Barry E. Adler

Berkeley Olin Program in Law & Economics, Working Paper Series from Berkeley Olin Program in Law & Economics

Abstract: The venerable case of Hadley v. Baxendale serves as the prototype for default rules designed to penalize, and thus encourage disclosure by, an undesirable contractual counterpart. Penalty-default analysis is now widely accepted as a plausible approach to the issues presented by incomplete contracts. The ambition of this article is to challenge and refine the accepted wisdom. The article demonstrates that the structure of penalty-default theory as derived from Hadley rests on a faulty implicit premise. The premise is that damages from breach of contract are certain. In fact, damages are stochastic. Consequently, the standard penalty-default model of Hadley overlooks the potential incentive of a party to conceal information even though the party is subject to a penalty-default rule. This incentive, which is shown to exist in other contexts, may greatly complicate the evaluation of a default rule’s efficacy. Thus, a lawmaker may have reason to be skeptical of her ability to identify an efficient penalty-default rule, the seeming simplicity of Hadley notwithstanding.

Date: 1999-07-01
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