Private Law Theory

ABSTRACT
The economic theory of contracts treats the rule of Hadley v Baxendale as the paradigmatic example of a penalty default rule: a rule deliberately not wanted by the majority of contracting parties, conceived for the sole purpose of forcing the informed party to disclose private information through opt-out. This article argues that this account – by now classic in the law and economics literature – fails to capture the rule’s actual structure. The analysis shows that Hadley does not operate as a damages-limiting rule that parties can escape only through an express opt-out. On the contrary, it is internally articulated into two modules: an ordinary standard module, which covers foreseeable damages without any activity by the parties, and an extended module, which is triggered as soon as the promisee communicates his special circumstances to the promisor. Communication is sufficient to obtain this extension; the parties need not include an opt-out clause in the contract. The two readings diverge in the case in which the promisee has communicated his special circumstances but the contract is silent as to the scope of liability. On the traditional law and economics reading, absent an opt-out clause the special damages are not recoverable; on the reading proposed here they are, because communication alone triggers the rule’s extended module. In this situation American courts do award the special damages, and it is therefore the modular account that explains what the courts do.

Baffi, Enrico, Modular Default Rules: Hadley v Baxendale and the Theory of Contractual Defaults (June 9, 2026).