A has a contract to sell coal to B, at $10 a ton, delivery June 1. On April 1, A tells B that it will not perform. On April 1, the contract price for June 1 coal is $12. On June 1, the spot price turns out to be $11. Does the law have any reason to induce B to cover at the April futures price rather than the June spot price?

-- Anonymous, October 25, 1998

Answers

You guys have the right answer, but I don't think the right reason yet.

On April 1st, what is the best estimate of the price on June 1?

-- Anonymous, October 27, 1998

The law DOES have a reason to induce B to cover at the April futures price. April 1 is the date that A will look to cover the loss of their futures conract that has been breached. If they wanted to simply wait until June to buy the coal, they never would have entered into the original futures contract. A obviously has some interest in obtaining a futures contract (so that they will have security etc) and they have the right to obtain another one at the time of the breach. The only way that they can adequately cover the breach would be to allow A to be as well off as they would have been had the contract not been breached. -j.dhuyvetter

-- Anonymous, October 25, 1998

I agree with Jessica. When the contract was signed, parties agreed on $10. Now, on April 1, when the contract is breached, the price is $12. If B still wants to buy coal, he must do so at a price $2 more expensive. On June 1, the price is still more expensive, although only by $1. B should probably cover his loss on April one and then sue for damages for $2/ton. If, however, he does not cover his loss and buys the spot price on Juen 1, I think the court would still award damages of $1/ton. On either date, the market value is greater than the contract value so that victim of the breach suffers as a result of the breach and damages are appropriate.

-- Anonymous, October 25, 1998

It seems to me the court wants B to cover on April 1 to minimize potential damages and disputes. In this hypo, the price went down, and in a relatively trivial way. Who really cares whether the suit is for $1/ton or $2/ton, as either way A makes good B's losses? What the court doesn't want is for B to look at the breach as an opportunity for speculation on coal prices, knowing the court will inflict any losses on A.

For example, say on June 1 the spot price is $15. Now B is going to complain to the court that A should have to pay them $5/ton. But if the price plummets to $5/ton, B is laughing all the way to the bank. No risk, possible profit. The court wants B to cover immediately to avoid these sorts of games.

-- Anonymous, October 26, 1998

response to is there a reason

on april 1, the best estimate of the price on june 1 is the april 1 future price.

i see it in these terms: one good is called "futurecoal", which is coal to be delivered on june 1 purchased at any date prior to june 1. another good is "presentcoal", which is coal purchased on the coal market, not on the futures market, on june 1.

the good that was contracted for was "futurecoal". If plaintiff covers with "presentcoal" at the june 1 spot price, he is simply not buying the same good, so he has not covered at all.

the only way in which B can get his coal as a cover for the breached contract is by buying it at the future price for june 1 at no matter what price. and that is the only way for the court to tell that he has followed the terms of the contract and has not tried to speculate.

so the reason for the court to induce b to cover at the future price at the moment of the breach is

that was the good contracted for. avoidance of the speculative game.

one also needs to consider that the good B wanted was not necessarily coal, but the future on the coal. so if he still wants to get a future, he needs to get it when it is such, and not when the fulfillment date has come. a future can be five years down the line: the court has an easier time by just having the promisee buy at the actual time of breach.

many more words than were needed. fair enough.

-- Anonymous, October 27, 1998

Hi,

we were having an impromptu discussion about this question, and here's what we came up with:

The reason to ask B to cover at the April futures price rather than get the June spot price is to facilitate efficient breach by A.

Assume that A and B both know the April market price for a futures contract for coal on June 1 ($12). If A knows that the law requires B to cover as soon as the breach occurs, A will know how much damages he will have to pay B when he breaches ($2). Assuming A is rational, he will not breach unless it's efficient--i.e. he gets an offer which is higher than $12, say $14 from C. Everybody will be better off through the breach: B gets $2 from A, which makes him as well off as if contract had been performed, A gets $2 more than he would've gotten, and C, who is so desparate for coal that he's willing to pay a high price for it, gets the coal. If the law allows B to not buy the coal until June 1, A will not know in April when he can breach efficiently, even if he gets an offer ($14 from C) that's much higher than his contract price with B. The price might go down, as in Prof. Lessig's hypothetical, in which case the breach would be efficent. But the price might also go up to $16, in which case A would be worse off because of the breach. In addition, this uncertainty might also cause A to not breach at all, depriving C, who REALLY wants the coal, of something that is of more "value" to him than to B.

That's probably longer than it had to be.... Hope it's coherent. (Obviously this explanation doesn't take into account at all the social/moral harm of breaching. Although we can come up with a hypothetical about C really needing the coal in April to keep his little children warm as opposed to B who need the coal in June to do something frivolous, in which case we'd really want to allow A to breach.)

Ayn, Baxter, and Tawen

-- Anonymous, November 02, 1998