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 {\bf   Tortious Interference  with Contracts: Why Punish It?   }  \\

 



May 5, 2004 \\



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Eric Rasmusen \\



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{\it Abstract}



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 Transaction costs do not justify   the doctrine of tortious  interference with contract. Better reasons are malice, judgement-proofness, and foreseeable court error.



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\noindent \hspace*{20pt} Indiana University Foundation Professor, Department of Business Economics and Public Policy, Kelley School of Business, Indiana University, BU456, 1309 E.  10th Street, Bloomington, Indiana, 47405-1701. Office: (812) 855-9219.  Fax: 812-855-3344 Erasmuse@indiana.edu.   \\ 

 Mypage.iu.edu/$\sim$erasmuse, Mypage.iu.edu/$\sim$erasmuse/papers/tortious-rasmusen.pdf.



\noindent

 I thank  Tillman Klumpp for   comments and  Yacheng Sun for research assistance.



 



\newpage



\noindent {\bf 1.  Introduction}



 Consider the following three hypotheticals:



 

\begin{quotation} 



{\it  Tort. } Injuror deliberately heckles a performance in Victim's theatre out of pure malice, causing damage of  \$10   to Victim.  What damages  should the court require Injuror to pay to  Victim? 



\end{quotation}  





\begin{quotation}



 {\it Contract.  } Promisor breaches a contract in which he promised to perform in Victim's theatre,    causing damage of  \$10   to Victim.   What damages should the court require  Promisor to pay to  Victim? 



\end{quotation}

 



  

 \begin{quotation}



 {\it Tortious Interference with Contract.  } Promisor breaches a contract in which he promised to perform in Victim's theatre,    causing damage of  \$10   to Victim.  Promisor does this because Inducer, who was aware of the contract, made him a better offer to perform that night.   What damages  should the court require Promisor and Inducer  to pay to  Victim?



\end{quotation}  

\newpage



 



Section 766 of the {\it Second Restatement of Torts } defines the tort of interference with contract as follows:



 

\begin{quotation}



One who intentionally and improperly interferes with the performance of a contract (except a contract to marry) between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract.



 \end{quotation}

 

   Previous articles (McChesney, Long, Gergen, Myers) are vague as to what the remedies are, which is the crux of the matter. Clearly, punitive damages are available in tort, unlike in contract. Questions I still need to answer are:



1. Can Victim collect compensatory damages from both Promisor and Inducer, for double compensation overall?



2. Can Victim ask for restitution damages--- the gain to Inducer  from his wrongful conduct?



 \newpage



 What about efficiency? Four explanations   have been attempted.





\noindent 

1. Court error (Bevier)





\noindent

 2. Transaction costs (McChesney)









\noindent

 3. Malice



\noindent

 4. Judgement-Proofness (Landes-Posner, bondage cases of the  1900 South)  



 \newpage



 \noindent 

{\it The Information Story } 



 

 



(1) Nature chooses the Victim's  investigation cost, $x \geq 0$, using the density $f(x)$ (denote the cumulative probability by $F(x)$).  



(2) The Victim pays $x$ if he wishes  and learns which one of a    large population of possible performers  with  average value $v=a$ actually has the higher value $v=a+b$.  



(3) The Victim chooses a performer with whom to negotiate. 



(4) The Victim and the chosen  Performer bargain to choose a performance price $p_1$, which will be  either $p_1=a$ (if $v$  is unknown) or some $p_1$ in the interval $(a, v)$.



(5) If the  Inducer chooses to induce breach, the Inducer and the Performer bargain to choose a performance  price $p_2$ in the interval  $(p_1, v)$.



(6) If the Inducer induced breach, the  court forces the Inducer to pay damages of $d$ to Victim. 



(7) If the Inducer did not induce breach, the  Performer may breach anyway. The court then forces him to pay expectation damages to Victim, which are zero  in this case because $p_1>a$. 









\noindent 

{\it  Payoffs:}  

The   Victim's payoff is $v-p_1$ if no breach occurs, minus $x$ if he discovered $v$ in advance.  If the contract is breached, his payoff is  $d$, or $d-x$ if he discovered $v$ in advance. 



The Performer's payoff is the price he gets (either $p_1$ or $p_2$).



The Inducer's payoff is  0 if no breach occurs. Otherwise, it is $v - p_2 -d$. 



  



\newpage



 The first-best solution would maximize the sum of the payoffs of Victim and Performer.\footnote{xxx Maybe change these to Payer, Performer, and Inducer.}  Without investigation, the Victim would choose the Performer randomly, so in expectation $v=a$ and the sum of the payoffs is $a$. With investigation, the Victim would choose the high-value Performer,  so $v= a+b$ and the sum of the payoff is $a+b-x$. Clearly, investigation should occur if $b>x$ and not otherwise. Thus, the overall expected social payoff is 

$$

  a+    \int_0^b (b-x) f(x) dx

$$

 

  If damages are high, there will be no breach.   The Victim will forecast the value of $p_1$, which is the result of bargaining between him and the Performer.  He will choose to pay $x$ if $a+b - p_1 >x$, so 

$$

  a+   \int_0^{b+ (a  -p_1) }  (b-x) f(x) dx,     

$$

 which is smaller than in the first-best, since $a<p_1 $. 



This will happen if the Inducer's breaching payoff is negative, which happens if $a+b - p_2 -d <0$. Thus, the critical level of damages is $d^*=a+b - p_2$. 



 If damages are lower than $d^*$, breach will occur if $p_1 >a$, because the Inducer will then deduce that $v = a+b$.  The Victim's payoff from investigation would be $d$, so he will investigate if $d>x$. This yields a social payoff of



 $$

  a+    \int_0^d (b-x) f(x) dx  .

$$



 If $d<a+b-p_1$, then welfare is lower with the Inducer's breach than otherwise.  This is so, in particular, if damages are zero--expectation damages. 



 \newpage

 

 



 \noindent 

{\bf The Investment Story }  



   

 



(1) The Victim invests $x$ in the project, adding $f(x)$ to the base value of $a$ so that the value becomes $v=a+f(x)$.  



(2) The Victim and the  Performer bargain to choose a performance price $p_1$ in the interval $[a, a + f(x)]$.



(3) If the  Inducer chooses to induce breach, the Inducer and the Performer bargain to choose a performance  price $p_2$ in the interval  $[p_1, v]$.



(4) If the Inducer induced breach, the  court forces the Inducer to pay damages of $d$ to Victim. 



(5) If the Inducer did not induce breach, the  Performer may breach anyway. The court then forces him to pay expectation damages to Victim, which are zero  in this case because $p_1>a$. 









\noindent 

{\it  Payoffs:} The Performer's payoff is the price he gets (either $p_1$ or $p_2$). 



The   Victim's payoff is $v-p_1-x$ if no breach occurs.  If the contract is breached, his payoff is  $d-x$.



The Inducer's payoff is  0 if no breach occurs. Otherwise, it is $v - p_2 -d$. 



 

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