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The consequences of overstating fuel economy.

I. Introduction

This essay examines a recent case involving contract law with applied law and economic analysis. The principles of contract law can be brought to the fore by examining different variations of breach of contract. In particular, the essay looks at the consequences of Hyundai Motor Co. overstating the fuel efficiency of its Hyundai Elantra. The purpose of the essay is not merely to determine the appropriate compensation owed by a company to consumers for overstating the fuel economy of a vehicle, as in the factual case at hand. Rather, the essay illustrates various economic doctrines and norms by applying them to different fictionalized variations of the actual Elantra case. Fictionalized accounts are noted as such. The series of customized Elantras presented throughout the essay are fictional vehicles capable of figuratively transporting the reader into the realm of economic analysis of contract law.

Hyundai Motor Co. advertised that its Elantra model cars get 40 highway miles per gallon (MPG) as part of its "Save the Asterisk" campaign, while in reality the Elantra only gets 35 highway MPG (Ramstad 2012). Upon discovery of the error, Hyundai Motor Co. apologized for "procedural errors," claiming that human error led to the incorrect calculation (Ramstad 2012). This particular vehicle is part of a larger controversy being investigated by the EPA. The issue of overestimating fuel economy also includes Ford Motor Company's Ford C-Max hybrid and Toyota Motor Company's Prius V (White 2012), but only the Elantra is considered herein. In this essay, appropriate damages for breach of contract by Hyundai will be explored in cases where the breach was intentional as well as in cases of unintentional breach. Depending on the specific scenario, losses may or may not be recoverable. The essay also explores a variety of ways to calculate damages. Ultimately, damages should function to make the customers whole, as if the purchased Elantra got 40 MPG.

Prior to addressing hypothetical scenarios, readers may wish to learn more about the resolution of the actual case. Facing class-action lawsuits covering those purchasers suffering unanticipated lower fuel economy, Hyundai Motor Co. voluntarily offered, by way of settlement, a variety of options to purchasers of the 2012 Elantra (and other models and model years with similarly distorted fuel-economy boasts). Besides receiving an apology from Hyundai Motor Co., purchasers have been invited to choose one of several options: (1) a lump-sum payment, expected to average $353 across consumers; or (2) a debit card in the amount of loss due to inferior fuel economy (after reporting actual mileage to the local Hyundai dealership), plus an additional 15% for "inconvenience;" or (3) a dealership credit for repairs/service equal to 150% of the lump-sum payout under option (1); or (4) a credit toward the purchase of a new Hyundai (or Kia, as Hyundai Motor Co. owns about a one-third stake in Kia Motors) in the amount of 200% of option (1Hirsh 2014). In a separate but not unrelated action, Hyundai Motor Co. has rolled back its claim concerning the 2012 Elantra fuel economy by two MPG, to 38 MPG, issuing other rollbacks as well for various 2012 and 2013 models (EPA 2014).

II. Contract Existence

In the realm of contract law, in order to examine possible damages from an inaccurate MPG report, it is important to first establish whether a contract exists. One doctrine governing contract existence is the notion of consideration (Posner 2011:123-25). Consideration has two components: true exchange and well-defined terms. In the case of Hyundai, there is true exchange of money for a car and there are well-defined terms including the date of sale and the sale price. Among the terms are that the car will get 40 MPG, and there are specified and implied warranties that extend well into the future. Therefore, a contract exists (as opposed to a momentary spot transaction in the market).

III. Intentional Breach

Prior to the initial sale of the vehicle, suppose Hyundai has an option of producing either Elantra model X or Y. Suppose that X has a platinum input that guarantees 40 MPG while Y uses a silver input and will not necessarily achieve 40 MPG. The cost of producing X is $11,000 per car while the cost of producing Y is $5,000 per car. To simplify matters, suppose Hyundai knows consumers are willing and able to pay $25,000 and $20,000 for each model respectively. Furthermore, assume X has a pollution cost of $2,000 per car, but Y (being less fuel efficient) has a pollution cost of $5,000 per car. These costs and their implications are outlined in Table 1 below:
Costs and Implications of Producing Models X and Y

                         Model X               Model Y

Cost of Production       $11,000               $5,000
Cost of Pollution        $2,000                $5,000
Revenue from Consumers   $25,000               $20,000
(Revenue--Cost           $25,000 - $11,000 =   $20,000 - $5,000 =
  of Production)
Profit                   $14,000               $15,000
(Revenue--Cost           $25,000 - $13,000 =   $20,000 - $10,000 =
  of Production--
  Cost of Pollution)
Value to Society         $12,000               $10,000

Therefore, the total value of each X to society is $12,000 (i.e., the revenue minus the costs of production and pollution) and total value of each Y to society is $10,000. It is more efficient for Hyundai to produce model X, but Hyundai's profit is greater from producing model Y. Hyundai decides to make and market the Y Elantra as part of its "Save the Asterisk" campaign, despite knowing that the Y model is not likely to actually achieve 40 MPG. Now, suppose customers notice the difference and sue for damages based on the contract for 40 MPG. The court may rule specific performance, breach with damages, substantial performance or discharge the contract without assessing money damages.

Specific Performance

A specific performance ruling would require the contract to be completed as originally agreed upon. Hyundai would need to take back the cars and install the platinum piece thereby assuring the car achieves 40 MPG. Suppose it would cost Hyundai $10,000 per car to recall and install the platinum pieces, and the loss to each customer for a 35 MPG performance is $5,000. Specific performance would cost Hyundai $10,000 but only provide a $5,000 benefit. Also consider the high administration and transaction costs society would incur. The total social cost ($10,000 plus administration costs to oversee implementation) exceeds the $8,000 total social benefit (difference in pollution costs plus benefit to consumers), so specific performance is not efficient in this circumstance.

Posner (1979) holds that a contract should not be enforced through specific performance if the cost of enforcement exceeds the gain from enforcement. Meanwhile, Kronman (1979b: 183-87) asserts that specific performance is primarily useful when a good passes the "uniqueness test;" in a case of a unique good or service, specific performance is more efficient than awarding money damages when money damages involve a high calculation cost (most typically due to a court having to assess a value that is highly subjective to one or both of the parties). However, an Elantra is not a unique good because it has a developed market and close substitutes. Therefore, the works of both authors support the finding that specific performance in this case would be inefficient.

Breach with Damages

The court's second option, breach with damages, would allow the customers to keep the car that was originally purchased and force Hyundai to compensate the customers $5,000 each (this is the loss to each customer as defined above). Assuming that damages can be calculated at reasonable cost, they should be set at exactly $5,000 or the amount that would make the customer whole. If damages were to be set above $5,000, there would be an opportunity for extortion. (1) On the other hand, if damages are set below $5,000, consumers will not trust advertising and the number of car purchases would decline. (2) In any context in which intentional breach is contemplated, the ideal would be to achieve the principle of "efficient breach," meaning breach if and only if breach is efficient. (3)

A ruling of breach with damages in the amount of $5,000 may not be perfectly efficient because consumers may not get compensated for any subjective value they might attach to being more environmentally friendly (Kronman 1979b: 186). Determining such a subjective value would have high transaction costs. It cannot be assumed that a consumer's subjective value is incorporated into the sale price and is therefore compensated as part of the $5,000 in damages. A consumer might buy a car with better fuel economy solely in order to save money from using less gas.

Substantial Performance and Foreseeability

As Posner (2011:167) points out, "Product performance may depend on the consumer's tastes, which may not be known to the producer." For example, suppose a customer pays $25,000 for a battleship grey Elantra. When the car is delivered, it is steel grey. Because of the incorrect shade, the consumer sues for breach of contract, strategically hoping for a ruling of specific performance. Repainting the car will cost $1,200. Armed with a ruling of specific performance, the buyer could indicate a willingness to instead accept the incorrect color in exchange for a price concession of, say, $ 1,000. The consumer has an incentive to inflate the value he or she attaches to the car's color shade as an opportunistic ploy to obtain a large price concession. Therefore, a court would rule substantial performance (Posner 2011:166-67) has occurred and so deny the consumer recovery for any alleged loss due to slight color variation, either through the consumer opportunistically exploiting a specific performance ruling or more directly through a court ruling of money damages. The "grey area" in this hypothetical scenario can be compared to the case Jacob & Youngs Inc. v. Kent, (4) where substantial performance was ruled. Both in the hypothetical case and in Jacob & Youngs Inc. v. Kent, a ruling of substantial performance avoids the court having to attempt to estimate subjective loss amounts in setting money damages or, more importantly, giving a party the opportunity to extort additional gains through ex post opportunism via a specific performance ruling.

In the above hypothetical situation, suppose the purchaser indicates that the color is to be battleship grey, but for some idiosyncratic reason the color shade sought is a major concern: if the correct shade is not used in production, the consumer genuinely will suffer a loss of $1,000. An example might be a film producer who has arranged an intricate scene that will fail in the absence of just the right color scheme and colored car. If a specific monetary damages amount for any slight deviation from the requested color shade is not included in the original contract, recovery for the loss will be denied

under the Foreseeability Doctrine. (5) The customer has a duty to disclose what is at stake if the color is not battleship grey. The so-called duty to disclose simply means that recovery for a loss will be denied in the absence of disclosure. In this case, the $1,000 amount must be declared in advance. Because it is not ordinary knowledge that a different shade of grey makes a $1,000 difference to a customer, the actual knowledge of the customer must be monetized and written into a liquidated damages clause of the contract with that particular customer. Short of this insertion, the $1,000 loss, although real, is not recoverable under the Foreseeability Doctrine. The seller needs to be informed of special circumstances in advance to make an informed decision about whether a separate production run will be required with accompanying additional cost or, indeed, if the contract should be entered into at all.

Fraud and Disclosure

Another scenario to consider would be if the purchased car got zero MPG; in other words, a case of fraud, where: "The liar makes a positive investment in manufacturing and disseminating misinformation. This investment is wasted from a social standpoint, so naturally the law does not reward him for his lie" (Posner 2011:139). Legally, the seller has a duty to disclose if the car does not run. If the seller does not disclose the information, it is an actionable omission. Just as an empty box of chocolates cannot be sold without disclosure (Posner 2011:141), if there are no piston rings in the car's engine the customer should not need to look under the hood. Rather, that information must be disclosed.

The economic rationale for disclosure is that if information were free or extremely inexpensive for one of the parties to acquire, it would be a waste of resources for the other party to acquire the same information (Kronman 1979a: 114). For example, without disclosure rules, the buyer might hire a mechanic to determine why the car does not run. Meanwhile, Hyundai knows this information at no cost. Products that tend to require disclosure are those that are infrequently purchased and expensive, and those where the flawed characteristic is not ascertainable without handling or not necessarily discoverable with repeated use (Posner 2011:141). All of these conditions are true in an automobile purchase. Therefore, the company must disclose if the car gets zero MPG to prevent overinvestment in information discovery.

What should one make of a situation in which a car is purported to get 40 MPG, yet actually only gets 35, or 38, or 39.99 MPG? Does that constitute fraud? One aspect without which fraud is not present is materiality: the difference between what is claimed as true and what is actually true must be a material difference, meaning a difference of substance/importance (American Bar Association Model Jury Instructions, 1996). Thus, 40 versus 39.99 MPG does not constitute fraud, especially when a reasonable person would know that individual driving characteristics easily explain any .01 difference between stated and actual MPG. A five MPG difference between claimed and actual MPG, however, certainly may be material, especially when viewed in terms of total cost associated with use of the automobile over its lifespan. Ultimately, materiality is for a judge or jury to decide in a given case.

IV. Unintentional Breach

A breach of contract may occur not by intentional choice, but for reasons beyond the control of the parties. These include: (a) a mutual mistake; (b) an unforeseen change in circumstances that makes completion of the contract impossible; or (c) a cross-purpose mistake. Additionally, another case involving foreseeability will be explored. In all four cases, risk assignment guides the court's ruling.

Kronman (1979a: 115) asserts that in cases of mistake the losses incurred from a breach of contract should be borne by the least cost avoider of the mistake. This person is the more informed and/ or more diversified party. As previously discussed, assigning risk to the more informed party will avoid the costs to society of duplicated information gathering, whereas assigning risk to the more diversified party reduces the quantum of risk and risk-associated costs. (6) With the risk spread across a broad portfolio of contracts, there is less marginal risk to the risk-bearing party overall.

Mutual Mistake

Assume Hyundai decides to produce the higher quality model X with the platinum input (from the Intentional Breach section), but an engineer accidentally used a multiplier of 0.1 instead of 0.01 somewhere in his calculations to determine MPG. This mistake yields a calculation of 40 MPG, and the customer purchases what he and Hyundai believe is a 40 MPG car. The inaccuracy is unknown until the EPA receives complaints and investigates, whereupon the human error is discovered. (7) Mutual mistake is also evident in the case of Sherwood vs. Walker. (8) The questions that arise in both cases are: should the contract be completed; and if not, which party should pay damages?

Posner (2011) develops separate conclusions in addressing the question of mutual mistake in Sherwood v. Walker and the general doctrine itself. In the case of Sherwood v. Walker, Posner (2011:121) asserts that the parties had the same understanding of what the contract was. (9) Hence, the sale should have gone through because the seller was in a position to obtain information at a lower cost than the buyer, and the buyer took on risk (Poser 2011:129). Following that approach, Hyundai is in the lower cost position to discover that the car does not actually get 40 MPG. Therefore, Hyundai should pay damages equal to $5,000 such that the customer achieves the expected benefit from owning a 40 MPG car. Meanwhile, if the subject of a contract turns out to be something other than what was agreed upon, the contract should be invalid (Posner 2011:129). An example would be if the contract outlined the terms of trade for an orange and the orange turned out to be an apple. In that case, the purchaser might not be able to use an apple as well as he would be able to use an orange, although they are both fruits. Perhaps the purchaser was trying to make orange juice because he was allergic to apple juice. An apple would not suffice! Applying this logic to the Hyundai case, the highest valued user of a 40-MPG car might not be the highest valued user of a 35-MPG car.

Unforeseen Change

Another case of unintentional breach can occur when circumstances arise out of either party's control that make contract completion impossible. Both Kronman (1979a) and Posner (1979) address impossibility. Suppose Hyundai decides to produce model X (using the platinum input), begins marketing and takes orders for the X model at $25,000 each. Subsequently, before production starts, the tariff on platinum is raised such that its use as an input becomes cost prohibitive. This is similar to the case of Gobel v. Linn where the original contract could not be completed and a new one was established. (10) In both the hypothetical case and Gobel v. Linn, a contract modification must occur as commercial impossibility (bankruptcy) precludes completion of the original contract in its original terms. Hyundai contacts those holding purchase contracts and informs them that they can walk away from the original contract for sale or receive a car with inferior gas mileage for the same $25,000 or pay $35,000 to get a car that achieves the rated 40 MPG. Any buyer that goes through with the sale would be unable ex post to (depending on the option selected) decline to pay the additional $10,000 or sue for damages due to receiving a car that achieves less than 40 MPG. An exception may occur if Hyundai acted in bad faith by "courting" bankruptcy (Posner 2011:125).

Now suppose instead that the tariff increase will not be ruinous to Hyundai, but merely expensive, turning what would have been profitable transactions into unprofitable ones. Hyundai's other operations and sales are profitable enough to ensure firm survival despite losses on the model X sold for $25,000. In this situation Hyundai's performance will not be excused, nor should it be. As the party that has more information and is more diversified (as explained earlier in the essay), Hyundai is held responsible for paying damages: Hyundai has more information regarding the likelihood of tariff changes because it imports many of its inputs; Hyundai is also the more diversified party because it sells multiple models. Therefore, if a contract is established and the customer sues, Hyundai should be ordered to pay $5,000 in damages to make the customer whole.

Finally, if Hyundai in the face of a tariff increase were to choose deliberately to switch to model Y (silver input) from model X (platinum input), thereby reducing fuel economy, and attempted to conceal the fact from consumers, Hyundai would be engaged in a fraudulent, intentional breach, despite having no control over the tariff change. In this set of circumstances, the analysis presented earlier in the discussion of intentional breach would apply.

Cross-Purpose Mistake

Another unintended breach can occur in the case of a cross-purpose mistake, wherein consideration is lacking because there are not well-defined contract terms. Recall the two parts of consideration that must be present for there to be a contract, namely true exchange and well-defined terms. Dnes (2005, 100-101) carefully distinguishes between cross-purpose mistake and mutual mistake. The famous example of a cross-purpose mistake comes from Raffles v. Wichelhaus (11) where two ships with the same name had different delivery dates. A cross-purpose mistake also occurred in the more recent case of Konic International Corp. v. Spokane Computer Services, Inc. (12) As these two cases show, in a cross-purpose mistake, often the terms are not well defined because the parties believe the terms are different things!

Suppose the Elantra and the Electra are both for sale. As previously stated, the Elantra gets 40 MPG and sells for $25,000. Meanwhile, suppose that the Electra only gets 20 MPG (what a creative marketing scheme), but also sells for $25,000. A customer comes in and says he would like to purchase the "E" car. The new salesman, unfamiliar with the differences between the two models, brings out the Electra and the customer pays $25,000. After owning the car for a month, the customer returns to the dealership complaining the car is not getting 40 MPG. The car salesman points out that the customer asked to purchase the "E" car, not the "Elantra." If the customer brings suit in this case, the judge may find that consideration was not present because there was no meeting of the minds and therefore no well-defined terms. In this case, the contract would be discharged.

The Foreseeability Doctrine

Another way for a judge to determine if losses are recoverable is to use the Foreseeability Doctrine, which holds that a loss is recoverable if and only if it is reasonably foreseeable (Posner 2011:159). Although it was not the first such case, Hadley v. Baxendale (13) is an example of the application of the Foreseeability Doctrine. In order to establish if a loss is reasonably foreseeable, two kinds of knowledge must be considered: common knowledge and special knowledge. Common knowledge is ordinary knowledge (e.g., a red light means stop), and the contracting parties will be assumed (i.e., imputed) to hold such knowledge whether or not it is actually possessed. The cost of conducting ordinary business would be needlessly increased if the conventions of ordinary business had to be reviewed freshly in every ordinary context, so the parties are held to a standard of possessing what is thought to be ordinary common knowledge. In contrast, special (extraordinary) knowledge is sometimes in play. An example of extraordinary knowledge would be that a certain store is closed on Tuesday mornings. Typically, if a delivery were going to be made, it would be assumed that stores are open on weekday mornings, unless otherwise specified. Here a legal burden is put on the party possessing the special knowledge, which must actually be conveyed if an associated loss is to be recoverable, since the other party could not otherwise become aware of the special knowledge at reasonable cost. Thus, there is one Foreseeability Doctrine (a loss is recoverable when reasonably foreseeable), but two tests of it (foreseeability is at hand if either it concerns common knowledge, whether or not actually possessed, or if it concerns special knowledge that was actually conveyed). The Foreseeability Doctrine works toward optimal conveyance of information and risk/responsibility assignment. (14)

To illustrate the doctrine, assume the customer above bought an Elantra instead of an Electra and bet her neighbor $100,000 that her car would get 40 MPG. Then, the customer loses the bet and seeks damages. The court can use the Foreseeability Doctrine to decide if the losses are recoverable. The imputed knowledge is that the car gets 40 MPG as advertised. If, in reality, it gets 35 MPG, the $5,000 loss incurred from the lost five MPG is recoverable. Meanwhile, the $100,000 bet is special knowledge that was not actually disclosed by the customer. Therefore, the $100,000 is not a recoverable loss.

In order to support this conclusion, the court might use Tullock's (1979:24) idea of "resolution by analogy," (15) or Holmes' (1979:30) idea of "construction" (16) to work out what the parties would have said if the event had been considered. In this case, the court would conclude that Hyundai would not have agreed to the contract if the $ 100,000 bet had been disclosed and a model Y Elantra had been sold to the customer. The company only sells the car for $25,000, and logically Hyundai would only agree to take on the risk if it were certain that the car would actually get 40 MPG in the bet context. To assure the performance, Hyundai would stipulate certain track conditions, specify the gasoline octane level, assign a specific representative to do the driving and take other extraordinary measures. All such measures would involve additional costs to Hyundai, so one would expect there to be added consideration (i.e., a higher sale price). Absent such stipulations and added consideration, the 40-MPG clause of the implicit contract is arguably unenforceable; certainly the $100,000 loss associated with an undisclosed bet is not recoverable.

Holmes (1979) also advances the idea that not every circumstance must be written into a contract because that would be prohibitively expensive. Suppose that the customer was suing for damages not because of a bet she made, but because her Elantra was not getting 40 MPG while she was speeding around her neighborhood towing a yacht on a trailer. When she brings suit, Hyundai argues it should not need to advertise that the Elantra gets 40 MPG only when there are four seats occupied by persons weighing less than 200 pounds each, no more than 100 pounds in the trunk, the operator drives the speed limit, the car is not towing a boat, the car is not traveling uphill the whole way, the car's tires are actually inflated, etc. There appears to be no end to the number of necessary provisos needed if such obviously inappropriate, excessive disclosure were required. In this case, Judge Holmes would likely find that Hyundai only owes $5,000 in damages.

V. Damage Calculation

Although previously it was assumed that the cost of non-performance to the customer is $5,000, there are a variety of ways to calculate the amount that will make customers whole. Assume there are 900,000 customers. Suppose there has been a breach, and suspend the assumption that cost of breach to any customer is $5,000. Hyundai could use actual numbers or estimated numbers to calculate damages.

Actual Damages

In order to award actual damages, Hyundai would need to monitor how many miles each customer drives each day and where each customer purchases gas. Additionally, Hyundai could compensate its customers in a variety of time intervals, ranging from a daily basis to a lump sum. It would be costly and therefore inefficient for Hyundai to measure and pay each of its 900,000 customers for their exact gas use on a daily basis (this may not be true with only 10 customers). Compensating with a lump sum based on a certain time frame would also be inefficient because individuals would drive more during observation period in order to be awarded more damages. Additionally, Hyundai must consider the lost resale value because customers cannot claim their Elantras get 40 MPG. Actual damages have very high transaction costs that are likely to be prohibitively costly when there are a large number of customers to compensate.

Estimated Damages

Hyundai could also consider using estimated calculations that will have lower transaction costs but will undercompensate some customers. Using this approach, Hyundai would need to determine the average amount its customers drive as well as the average price of gas. The calculation could account for region (e.g., state, county, or town). The more detailed the breakdown, the higher the costs of acquiring information will be. Additionally, there is an issue with those inframarginal consumers who will be undercompensated. These are customers who drive more or use more expensive gas (for convenience) than the calculated average. Meanwhile, customers in the opposite situation will be overcompensated. Therefore, using estimated damages will not be perfectly efficient.

Elantra Damages

Given the above options, Hyundai actually has decided (option [2] mentioned in the Introduction) to compensate its customers with a debit card using their actual miles driven, presumably in conjunction with an average gas price determined by some regional measure. This method of compensation requires the customers to drive to a dealership to get their odometers checked, costing them time, so Hyundai adds another 15% for good measure to compensate customers for the inconvenience involved. Although still imperfect (since customers vary in opportunity cost of time), this calculation appears to be better than using average mileage in reaching approximately appropriate individual compensation levels, and it is administratively expedient. Moreover, for any consumer that finds this particular compensation scheme to be objectionable, Hyundai has provided other compensation options (reviewed in the Introduction).

VI. Brand Name Capital and Performance

Hyundai has voluntarily offered compensation to its customers to avoid costly litigation and to protect its brand name capital. A spokesman for Hyundai stated, "Fuel efficiency and trust in our customers is the most important thing" (Ramstad 2012). A company invests money in building its brand, so if its product does not perform as advertised consumers will lose confidence in the brand and will not pay for it in the future. Hyundai has attempted to protect its brand name capital through money compensation, but DeAlessi and Staaf (1994) have advanced a clever argument that even court-ordered money damages may be an inadequate remedy relative to specific performance when trademark capital is involved. The argument calls attention to consumers who, for idiosyncratic reasons, so much prefer specific performance compared to a remedy of simple money damages that they would insist on a penalty clause for nonperformance in the contract, except that contract law does not permit inclusion of a penalty clause (since the presence of a penalty clause would inhibit efficient breach and since it may cause a party to attempt to induce an inefficient breach by the other party [Posner 2011:160]). DeAlessi and Staaf (1994) find a workaround in brand name capital: if a firm fails to provide specific performance, its trademark capital suffers a loss, but the loss does not accrue as a gain to the party suffering the breach. Thus, trademark capital can assure specific performance, much like a penalty clause might if it were legal, but without the drawback of creating the potential for opportunistic or uncooperative behavior!

Despite its substantial investment in brand name capital, Hyundai has chosen to compensate rather than perform specifically by recalling its cars and refurbishing them to achieve 40 MPG. Obviously, whatever the imperfections of the compensation scheme, they pale in comparison to the costs that would be involved in achieving specific performance.

VII. Conclusion

Hyundai invested in trademark capital through its "Save the Asterisk" campaign but did not deliver specific performance (Ramstad 2012). Upon discovering the "procedural errors" in its MPG calculations, Hyundai opted for a breach-with-damages approach to remedy its mistake. This leads to the question; Under what circumstances do we want specific performance? The company will not pursue the specific performance option when specific performance is overwhelmed by other considerations. Often, these considerations are the associated transaction costs and administration costs (Kronman 1979b). In the particular hypothetical case involving a superior platinum component part, the transaction costs involved in collecting all of the Elantras and installing the proper part ($10,000) outweigh the benefit of specific performance ($8,000). In the factual case, the costs of achieving specific performance apparently are similarly prohibitive. Therefore, although the company has invested in trademark capital, there was not specific performance. Rather, Hyundai has offered voluntary compensation for breach of contract in order to minimize the cost of maintaining its reputation while delivering to its customers the approximate expected value from owning a Hyundai Elantra that gets 40 MPG. Although there is in fact only one actual case involving the Hyundai Elantra, customized hypothetical versions of the case drove the excursion through the economics of contract law.


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Ramstad, Evan and Ramsey, Mike. "Hyundai Surrenders 40 MPG Claims." Wall Street Journal Retrieved November 2, 2012 (http://online.wsj .com/article/SB 10001424052970204712904578 094412515725112.html).

Sherwood v. Walker. 66 Mich. 568; 33 N.W. 919; 1887 Mich. LEXIS 525. LexisNexis Academic. Web. 20 Dec. 2012.

Tullock, Gordon. 1979. "The Logic of the Law." Pp 35-47. The Economics of Contract Law. Ed. Kronman, Anthony T. and Posner, Richard A. New York, NY: Basic Books Inc.

White, Joseph B. "Hitching the New Small Wagon to Better Fuel Efficiency." Wall Street Journal 24 Dec. 2012. New York Ed.: Dl. Retrieved December 24, 2012 ( SB 1000142412788732490720457818756038305 9762.html).

Corey Beck, College of the Holy Cross, Class of 2013. E-Mail:

David Schap, Professor, Department of Economics, College of the Holy Cross, Worcester, MA 01610. E-Mail: Phone: (508) 793-2688

The authors express thanks to the anonymous referee for helpful comments.


(1.) Extortion can occur when damages exceed the amount that would make the customer whole. The problem with extortion is twofold. The first problem arises if a payment is made because of a threat of contract completion. The customer might bribe the other party to breach the contract and not complete it. Such a payment would occur if contract completion would make the purchaser worse off relative to breach and money damages. The threat always exists that the company might complete the contract and the consumer will be relatively undercompensated. The second problem is that transaction costs will inevitably increase as a result of the opportunity for extortion and related strategic bargaining (Posner 2011:143).

(2.) The more general principle is that if consumers will not be compensated adequately for the failure of a contract, they will either not enter into contracts at all or will increase the time spent and detail in negotiating contracts (Posner 2011:150). In the instant case, the lack of trust in advertising would manifest itself as a decline in future demand for cars in the Hyundai product line, which implies a lower future equilibrium price and lower equilibrium quantity transacted in the future. Viewed from this perspective, Hyundai's payment of $5,000 in damages mitigates its reputational loss and associated profitability decline.

(3.) Posner (2011:149-158) explains how setting damages appropriately in cases of intentional breach establishes precedent that guides parties in the future to choose to breach a contract only in circumstances in which breach frees resources to flow to a higher valued use.

(4.) In Jacob & Youngs Inc. v. Kent, Jacob & Young's Inc. did not install the correct brand of pipes into the defendant's walls when building his home. The contract called for Reading pipe to be installed. As a result of oversight by a subcontractor, Jacob & Young's Inc. used Cohoes pipe. According to the opinion of the court, the pipe used was of very similar quality. However, Kent refused to pay the remainder of the fees for the construction and Jacobs & Young's Inc. filed suit. The court found that the action of taking out the pipe and replacing it with Reading pipe would be inefficient. The court ruled that the brand of pipes installed within walls did not need to be changed after the installation was complete.

(5.) The Foreseeability Doctrine in part requires any extraordinary knowledge to be disclosed for losses associated with that information to be recoverable. The full implications of the Foreseeability Doctrine are considered a bit later in this essay.

(6.) For example, suppose that two parties bet on the outcome of a coin flip. The winning party gains the entire bet while the losing party gets zero. Party A is involved in only one coin flip and consequently will get the entire bet or nothing; the two extremes. Meanwhile, party B is involved in this bet and 99 other similar bets. Consequently, party B will get something closer to a 50/50 payout across all bets. Therefore, party B should be assigned the risk because the standard deviation, which is the standard measure of risk, is lower.

(7.) This is a fanciful version of what is currently happening regarding EPA gas mileage calculations. The EPA is not without its own errors (White 2012). The EPA allows car companies to do their own MPG calculations and submit them for approval. Then, the EPA certifies these calculations. Occasionally, the EPA will audit the calculations, especially when there are consumer complaints as in the case of Hyundai (Ramstad 2012).

(8.) In Sherwood vs. Walker, Sherwood agreed to buy a cow named Rose the Second of Aberlone from Walker. At the time of the contract, both parties assumed that the cow was not pregnant and was therefore valued less than a pregnant cow. However, it was later discovered that Rose was actually pregnant so Walker refused to sell the cow as per the original contract. The court found that because there was a mutual mistake, the contract did not need to be fulfilled.

(9.) Posner uses the example that if a contract for the sale of wheat for $3 a bushel is agreed upon for a delivery date in the future, a market price of $6 on the contract's delivery date does not make the contract invalid (Posner 2011:129).

(10.) In Gobel v. Linn, the defendant argued that the beer company he represented agreed to an increased price of ice under duress. In the original contract, the plaintiff agreed to sell Gobel ice at a price of $1.75 per ton. However, due to a failure of the ice crop, Linn notified Gobel that the price had to be increased. Gobel agreed to the higher price because ice is a necessary input to maintain beer and consequently the company. After the ice was delivered, Gobel refused to pay and Linn brought suit. The court found that extraordinary circumstances rendered the first contract void. The ice company could not deliver on the original contract. It had not chosen to increase the price with the ability to fulfill the contract at the original price level (ice at $1.75 per ton). Therefore, the case was over the new contract that Gobel and Linn had both agreed to. The principle that emerged from this case is that, if events out of a party's control arise that render a contract void, new contracts that are negotiated are enforceable.

(11.) In Raffles v. Wichelhaus, the defendant agreed to buy cotton from the plaintiff that would be shipped on the boat Peerless. However, there were two ships names Peerless. The defendant expected the cotton to arrive on the Peerless in October, but the plaintiff shipped the cotton on the Peerless that arrived in December. The defendant refused to accept the cotton from the December Peerless and the plaintiff sued. The court held that the contract was for cotton delivered on a boat named Peerless so the contract was valid. However, the dissenting opinion points out that the ship Peerless was an ambiguous term. Therefore, there was no meeting of the minds and no consideration present because both parties were referencing different ships.

(12.) In Konic International Corp. v. Spokane Computer Services, Inc., Konic contracted to sell a surge protector for "fifty-six twenty" to Spokane. The employee of Spokane believed that this price meant $56.20, but the price was actually $5,620. As a result, Spokane refused delivery. When Spokane refused delivery, Konic sued for breach of contract. The court found that there was no meeting of the minds and therefore no consideration present. Spokane was not forced to take the surge protector.

(13.) In Hadley v. Baxendale, the plaintiff lost profit when his mill's crankshaft broke and was not replaced in the expected time frame. The defendant who repaired the crankshaft stated if the crankshaft was dropped off prior to noon it would be ready the next day. The plaintiff did not express the urgency (potential lost profits), but dropped off the crankshaft prior to noon expecting it to be repaired the next day. However, due to the defendant's neglect the crankshaft was not ready the next day. The court found that the defendant had no way of knowing the extent of the damages from a delay in fixing the crankshaft. Because the plaintiff did not disclose the urgency of fixing the crankshaft (which was not ordinary knowledge), the defendant was not found liable for damages related to lost profits.

(14.) Hardy (1979) points out that when a party accepts knowledge, that party accepts risk.

(15.) Resolution by analogy is one way that a judge can determine if a contract is enforceable. With this method, the judge can try to determine what the parties would have done based on what they agreed to do in a similar situation. The example that Tullock (1979:24) gives is that if a flood destroys a house, the clause addressing an unintentional fire could be applied.

(16.) Construction is the concept that Judge Holmes developed whereby a case is ruled based on what the parties likely would have built into the contract if they had foreseen the unforeseen circumstance (Holmes 1979:30).
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Author:Beck, Corey; Schap, David
Publication:American Economist
Geographic Code:1U2NY
Date:Mar 22, 2015
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