Would more polluters be deterred if they might be forced to disgorge their gains rather than pay damages based on harm? Would fewer promises be broken if contract breach might lead to disgorgement rather than expectation damages? And would such effects depend on how often disgorgement is awarded? Controversies arising from recent common law innovations,
as well as shifting regulatory strategies,
have centered on questions like these about the impact of expanding the use of disgorgement.
There may seem to be an easy answer: More disgorgement means more deterrence. After all, it is said to be an “extraordinary” remedy,
reserved for times when a tougher deterrent than ordinary harm-based damages proves necessary.
Tellingly, courts have viewed it as too harsh a remedy even when the express aim of liability is to prevent misconduct.
It is “strong medicine” to be used “sparingly,”
we were reminded last year when the Supreme Court sanctioned Nebraska for siphoning off river water belonging to Kansas.
In academic parlance, we sometimes say that the threat to take away a wrongdoer’s net gains goes beyond optimal deterrence to achieve complete deterrence,
and courts seem to agree.
But wait. Consider for a moment just how delicate an incentive this remedy really creates: Someone who expects to disgorge her net gain knows that her act will be neither gainful nor costly; it will be a wash.
She will break even. To fully persuade her not to act, then, other costs beyond disgorgement itself must finish the job.
Litigation costs or opportunity costs might do it. But the remedy itself only places her on the fence—a precarious point of equipoise, from which she can tip either way.
Our usual rhetoric hides this fact because the way we speak about disgorgement often conflates the remedy itself with the trappings of its usage, implicitly piling on extra nonremedial costs.
As a result, the conventional discourse has also lulled us into overlooking how we might embrace disgorgement’s equipoise effect and use it to good advantage.
This Essay will suggest ways for courts and regulators to do so. Its primary aim, however, is to develop a theoretical point—a logical implication of the equipoise effect: Substituting disgorgement for any other remedy, part of the time, can emulate the incentive effect of using that other remedy all of the time.
To see this more vividly, imagine meeting the founder of a tech start-up in the Bay Area. Suppose that she expects to be held liable for patent infringement if she uses a certain technology without license.
Also suppose that patent remedies are designed such that a prospective infringer might have to disgorge her net profits (thus breaking even), or alternatively, might have to pay compensation for harm to the patentee (thus keeping her profits while also paying for the patentee’s loss).
Anticipating this uncertain mix of potential remedies, the start-up founder should be expected to make the same decision as if she faced only the harm-based damages with certainty. If her profits from infringing would exceed the compensation she would have to pay, then it is worthwhile for her to infringe—whether she expects to enjoy that net gain for sure, or only with some probability. Likewise, if her profits would fall short of the compensation she would have to pay, then it is not worthwhile for her to infringe—whether she faces that net loss for sure, or only with some probability.
The underlying logic is simple. Some chance of breaking even, but otherwise enjoying a net gain, is still a net gain overall. Some chance of breaking even, but otherwise suffering a net loss, is still a net loss overall. Thus, the occasional possibility of having to disgorge profits instead of paying compensation should leave an actor’s decision unchanged relative to a standard compensatory regime.
The possible substitution of disgorgement dilutes her incentives—but thanks to the equipoise effect, her incentives continue to point her toward the same decision.
This theoretical observation cuts across the standard debates. Those who bristle at the notion of efficient breach or optimal deterrence have long urged the greater use of disgorgement as a way to increase deterrence.
Meanwhile, their opponents favor the usual harm-based damages, pointing to the familiar behavioral benefits of forcing actors to internalize the harms they cause.
But both views are incomplete.
As we have just seen, the logic of the equipoise effect implies that a court or a public enforcer may be able to substitute disgorgement some of the time, in place of harm-based damages, without altering the overall effect on behavior. To put it more generally, if the actor is uncertain about whether the remedy she must pay will be disgorgement or harm-based damages, then the resulting incentive effect emulates that which results from facing harm-based damages for sure. This may be welcome news for those favoring harm internalization, but disappointing for those promoting disgorgement as the sure path to stronger deterrence.
Internalizing harm is not the only aim, moreover, that can be emulated in this way. The underlying logic extends to other incentives that the law may seek to create by imposing remedies, including complete deterrence.
Furthermore, such flexibility in switching between remedies may also ease the tradeoffs with nondeterrence concerns in a given case, such as distributional effects or certain notions of justice.
In theory, at least. Part I details three ideal conditions for the underlying logic of emulation to work. Much of the analysis that follows will examine departures from these conditions. It is worth noting here, however, two conditions that are not required: First, nothing about the underlying logic requires that the harms and the gains be similar in value. The logic works not because gains are serving as a proxy for harms, but because of the equipoise effect. Second, the logic does not rely on the use of a liability test for predetermining which acts should be deterred.
Part II develops one particular application for this logic, showing how such a substitution strategy can be used to work around a common problem for courts and regulators—the fact that harm-based damages can often be hard to measure. A typical response in the law of remedies has long been to resist counting certain types of losses in compensatory damages;
the result is systematic underdeterrence. But an alternative solution, enabled by the equipoise effect, is to substitute disgorgement when harm-based damages are biased or hard to assess.
Such an approach may be more attractive for certain public enforcement actions in which societal harm may be hard to prove, individual compensation may not be a pressing concern,
and setting accurate incentives is a pressing concern.
Part III turns to the various additional costs that often do push an actor from equipoise over to complete deterrence, including litigation costs, reputation costs, and opportunity costs. Such costs are fairly obvious, and the analysis will not belabor them; rather, it focuses on how such costs might alter the effectiveness of the proposed substitution strategy. It also addresses the complications that arise when a plaintiff is allowed to choose between pursuing a harm-based or a gain-based award.
Several limitations of scope are worth noting at the outset. First, as this Essay focuses on deterrence, it will not delve into the vast trove of ex post distributional concerns and expressive purposes that have traditionally animated much of the law of restitution and unjust enrichment.
Second, in the contracts context, the analysis will focus only on the breach-or-perform decision.
Third, most of the exposition will assume that the infringing act causes harm with certainty,
and that liability is sure to follow,
although the analysis will also illustrate how the core idea can be applied in cases of imperfect enforcement.
Tradeoffs abound in the terrain to be explored—the aims of compensation and procedural justice compete with the aim of deterrence, errors of one kind compete with errors of another, and courts and enforcers must make do with imperfect information or else fail to act. If at times this Essay’s exposition suggests a theoretical neatness, it is only for clarity’s sake and should not be read as making easy assumptions about reality.
And it goes without saying that other reasons to use or eschew disgorgement may conflict or coexist with those introduced here.
I. Equipoise and Equivalence
For the listener, who listens in the snow,
And, nothing himself, beholds
Nothing that is not there and the nothing that is.
This Part develops the core theoretical point of this Essay. It begins by explaining how the incentive effect of any remedy can be emulated by a probabilistic mix of that remedy and disgorgement, inducing the actor to make the same choices—a situation we might call “choice equivalence.” It then articulates three ideal conditions for choice equivalence and details the consequences of departures from each of these conditions. The exposition thus begins at a high level of abstraction, before Part II turns to a set of potential applications.
A few preliminary notes are in order: The terms “disgorgement” and “gain-based damages” will be used interchangeably throughout this Essay to mean an amount of damages that removes the marginal net gains (or marginal net savings) relative to the actor’s best alternative noninfringing course of action.
In general, the exposition will speak as if the actor faces a binary choice between not acting (and thus incurring no gains, no harm, and no liability) and acting (and thus incurring gains, harm, and the costs of liability).
This setup naturally suits strict liability contexts, including contract breach;
it can also be adapted to fit a simplistic version of a negligence regime.
A. Choice Equivalence
To fix ideas, let us label as the “primary” remedy whatever the law has set up as the default remedy in a given context. This shift to a more general terminology is purposeful: Although much of the discussion thus far has focused on compensatory damages or expectation damages, the logic elaborated here extends beyond harm-based damages.
First, suppose that a certain primary remedy will cause a net loss for the actor whenever it is ordered, because the remedy will cost her more than she will gain from the act that creates the liability. Examples might be heavy criminal fines, civil penalties, or punitive damages. If the actor anticipates facing this primary remedy with certainty, then she expects a net loss; she is completely deterred. But now suppose instead that the actor expects some chance of paying disgorgement in lieu of this primary remedy. Thus she faces some chance of breaking even (due to disgorgement) and otherwise a net loss (due to the primary remedy). Overall, she still faces an expected net loss; again, she is deterred.
Illustration—Fraud. The consumer protection agency seeks to completely deter sellers of herbal supplements from making fraudulent claims. In many cases, the agency applies civil penalties that exceed the seller’s profits resulting from the fraud; but sellers know that sometimes, for idiosyncratic reasons, the agency will instead seek only the disgorgement of those profits. The incentive effect of this probabilistic mix of remedies is still complete deterrence; even though sellers will sometimes break even, overall they expect a net loss.
The same logic applies if the primary remedy is one that leaves the actor with a net gain. An example might be a lenient civil fine. If the actor anticipates facing such a primary remedy with certainty, then she will not be deterred; she will have an incentive to act. But suppose instead that the actor expects some chance of paying disgorgement in lieu of this primary remedy. Thus she expects some chance of breaking even (due to disgorgement) and otherwise a net gain (due to the primary remedy). Again she is not deterred, as overall she still faces an expected net gain from the act.
Many common remedies work in both directions, of course. They are designed to tip the actor sometimes in favor of acting and sometimes against acting, depending on whether the actor’s gains will exceed the cost of the remedy. An example might be compensatory damages or a carefully calibrated regulatory fee. By the same logic as the prior scenarios, the overall incentive effect of such a primary remedy can be emulated by a probabilistic mix of that remedy and of disgorgement. This was illustrated in the patent remedies scenario in the Introduction;
it is restated in slightly more general terms here.
Illustration—Reasonable Royalty. Imagine an intellectual property statute that is designed to allow infringement when the user is willing to pay a reasonable royalty, but to deter infringement when the user is unwilling to pay that amount.
When the accurate amount of a reasonable royalty can be proved, the court will award that amount as damages; when the amount is difficult to prove, however, the statute permits the court in its discretion to award instead a disgorgement of profits attributable to the infringement.
If the user is uncertain which course the court will take—and thus anticipates some chance of paying the royalty but otherwise disgorging profits—then the user faces incentives that mimic the effect of a regime where the award is always the royalty.
The simple logic at work can be expressed more formally as follows: Suppose the actor faces the primary remedy—call it r—with probability p, but otherwise faces disgorgement. If the actor chooses to act, she will enjoy a gain of g. Thus, the actor faces some chance p of ending up with (g – r), but otherwise breaks even, and so she has a positive incentive to act if p(g – r) > 0. This reduces to (g – r) > 0 for p > 0, which means that she has a positive incentive to act if her gains will be greater than the primary remedy and if she expects some positive chance of facing the primary remedy. Notice that (g – r) > 0 is also the condition for her to have a positive incentive to act if she were to face the primary remedy with certainty. Likewise, she would be deterred if p(g – r) < 0, which reduces to (g – r) < 0 for p > 0.
Thus, whether the actor faces the probabilistic mix of remedies or only the primary remedy, the resulting incentive effects are equivalent in the sense that they will induce the same choice.
The ideal conditions for such emulation are detailed below. But before moving on, it is worth emphasizing that the underlying logic is not limited to contexts in which the primary remedy is some form of harm-based damages. Notice that in the fraud illustration above, the primary remedy being emulated is punitive; the aim (and the result) is complete deterrence. And in the intellectual property illustration, the primary remedy being emulated is a court-determined price; depending on the regulatory scheme, such a price may or may not reflect the harm done.
For practical reasons, however, most of this Essay will focus on contexts in which the typical primary remedy is some form of harm-based damages, such as expectation damages or compensatory damages. The next section thus turns our focus to the special case of emulating harm internalization.
B. Harm Internalization
Torts and contracts damages are normally harm-based measures—compensatory damages and expectation damages, respectively.
These harm-based damages create incentives that are conventionally thought to promote efficient choices. In torts, we say that harm internalization serves optimal deterrence,
and in contracts, we say that it provides efficient incentives for the breach-or-perform decision.
For these reasons, this Essay gives extra attention to choice equivalence when the primary remedy is damages based on harm.
Illustration—Chemical Spill. Cyana, Inc., is a manufacturer that transports Chemical X on train lines running through major urban areas. One of Cyana’s train cars is leaking and will spill chemicals on the next leg of its journey. Cyana expects to be held strictly liable for the spill. The standard remedy is compensatory damages, but suppose that if the court deems the harm to be too difficult to measure, the court may instead require Cyana to disgorge its savings from not replacing the leaky car on that trip. Facing this uncertainty, is Cyana more likely to replace the leaky car than if it faced compensatory damages for sure?
The answer is no. If Cyana’s savings fall short of the harm caused by the spill, then it will choose to replace the car. This will occur even if there is a chance the court will require disgorgement of its savings, because Cyana still anticipates some remaining chance of suffering a net loss from having to pay compensation. Likewise, it will not replace the car if its savings exceed the harm.
Note that this illustration assumes a strict liability regime. Nothing in the underlying logic relies on any liability threshold, such as the prebalancing of harm and gains in the Learned Hand version of negligence. Among other things, this means that the logic can be applied to contract breach.
Illustration—Exclusive Sales Agreements. The manufacturer Only Toys contracts with the retail chain Costmart not to sell any of its competitors’ goods. Costmart is considering breaching by selling toys made by a competitor that are dissimilar to any product made by Only Toys. This breach would increase Costmart’s profits while only slightly reducing profits for Only Toys. Costmart anticipates that a court might award expectation damages but also might substitute disgorgement if it deems the loss of business to Only Toys too hard to measure. Is Costmart more deterred from breaching than if it faced expectation damages for sure?
Again, the same logic applies: Even if Costmart faces some chance of disgorging its profits, there is still a chance it will enjoy a net gain from breaching and paying expectation damages, so it will breach. Likewise, if the breach would hurt Only Toys more than it would benefit Costmart, then Costmart will not breach.
These illustrations may come as a relief for those who favor harm-internalizing incentives. Starting from a regime of purely harm-based damages, a shift toward the greater use of disgorgement among courts or enforcers can thus result in the same choices by the actor if the actor faces some uncertainty about whether the remedy in her individual case will be disgorgement or harm-based damages.
When complete deterrence is understood to be the law’s aim instead, however, such choice equivalence may not be so welcome.
Illustration—Breach of Trust. Frank Snepp, a former CIA analyst, wrote a tell-all memoir about the fall of Saigon. The Supreme Court required him to disgorge his profits from the book—a remedy that the dissent condemned as “Draconian.”
In justification, the majority sounded the alarm of deterrence.
After all, Snepp had breached a nondisclosure agreement with the CIA, and disgorgement “is tailored to deter those who would place sensitive information at risk.”
But the Court’s opinion also appears to hint that, had the harm to the government been more readily quantifiable, harm-based damages might have been appropriate.
Let’s suppose that future whistleblowers read the opinion as suggesting that harm-based damages, rather than disgorgement, might be awarded in some instances. The resulting incentives—of facing some chance of paying compensation instead of disgorgement—would serve optimal deterrence and thwart complete deterrence.
C. A Class of Regulatory Alternatives
A fuller appreciation of choice equivalence may help to expand our regulatory imagination. This section presents two further ways of seeing how the probabilistic mixing of remedies defines a class of regulatory alternatives whose incentive effects can induce the same choices as full harm internalization.
First, recall the classic reason for harm internalization: to make the actor take into account the harms she causes to others, just as she naturally takes into account her own gains. (Think of a pollution tax, the archetypal example.) Internalizing both harms and gains serves optimal deterrence.
So far, so familiar.
Now, notice that the point is really to have the actor weigh those harms and gains in equal measure—but not necessarily in full measure. The potential polluter will make the efficient choice if she is weighing harms against gains, both at full value. But she will make the same choice if she is weighing them both at 2/3 of their true values.
And she will also do so if she is weighing them both at only 1/2 of their true values. Any such combination is choice equivalent to any other.
Full internalization, then, is just one of many choice-equivalent regulatory approaches. A more general class of approaches involves matching partial internalization with the same degree of partial self-interest. Leveling down an actor’s self-interest (by decreasing her prospective gains through some use of disgorgement) can complement our usual strategy of leveling up her concern for others’ harm (by increasing her prospective costs through some use of harm-based damages) as a way to serve optimal deterrence.
Illustration—Chemical Spill. Suppose that the chemical company, Cyana, anticipates a 2/3 chance that the court will award compensatory damages and a 1/3 chance that the court will order disgorgement of its savings from not replacing the leaky car. This remedial mix dilutes Cyana’s self-serving motivations, because it is less sure to enjoy the savings. Meanwhile, it also raises Cyana’s internalization of harms, because it may have to pay harm-based damages. Because Cyana now weighs both its savings and the harms at 2/3 of their values, it makes the same choices as if it faced compensatory damages for sure.
Another way of appreciating why such alternatives are choice equivalent draws on an insight that contracts scholars have long noticed. As Professors Charles Goetz and Robert Scott put it, “In order to maintain the efficiency value of [a damages] rule, however, it is only necessary that some minimal amount of benefits are retained by the breacher in order to induce him not to perform.”
In other words, any damages amount that falls between the promisee’s value and the promisor’s cost (but is not equal to the promisor’s cost) should serve efficient breach, just as standard expectation damages would. Professor Avery Katz has similarly suggested that “it may be optimal to split the difference” between expectation damages and the promisor’s cost.
To see the connection with the analysis above, we can interpret such intermediate values as naturally leveling up and leveling down in just the right proportions.
Likewise, we can interpret the probabilistic mixing of expectation damages with disgorgement as setting expected damages for the breaching party somewhere in between the cost to the promisor and the value to the promisee.
We can then extend the underlying intuition beyond the contracts context: For a given actor, if the gains from acting are greater than the harm, then any expected damages amount falling between the harm and the gains (but not equal to the gains) must be less than the gains. And so the actor’s ex ante incentive will be to act. But if the harm is greater than the gains, then any expected damages amount falling between the harm and the gains (but not equal to the gains) must be greater than the gains. And so the actor is deterred. These choices are equivalent to those the actor would make if he faced harm-based damages for sure.
This intuition also readily applies to settlements. If the actor expects to settle in the shadow of a probabilistic mix of remedies, and thus anticipates paying a settlement price equal to the expected value of that mix, such an expectation sets incentives that are choice equivalent to an expectation of settling at a price equal to compensation for harm.
D. Ideal Conditions
Noticing the possibility of choice equivalence is only step zero of the analysis. The accuracy of such emulation depends on certain ideal conditions. In some contexts they will not be especially demanding. But reality will also often depart from the ideal, sometimes irretrievably. This section identifies three ideal conditions as well as the possible departures that may pose the greatest challenges.
1. Use of the Primary Remedy. — The first ideal condition is that the gain-based remedy must not be used exclusively. This may seem a trivial condition because if no other remedy is involved, then there is no use for the equivalence concept. Yet there are subtle ways in which this condition may fail. For example, suppose that although the courts are mixing remedies as a general matter, the actor somehow knows ex ante that the particular court it will face will substitute disgorgement in this case.
This first condition then fails because disgorgement would be the only remedy relevant to the actor’s incentives. For remedial mixing to matter, the actor needs to face uncertainty ex ante about whether a future court will order disgorgement or the primary remedy in its case.
Note what this condition does not say. It does not demand that the primary remedy be used much more often than the gain-based remedy. The actor must perceive some chance that the primary remedy will be used, but that is all. In theory, choice equivalence can occur even if the primary remedy is only ordered relatively rarely.
Illustration—Chemical Spill. Recall that Cyana is deciding whether to replace a leaky train car carrying Chemical X. Suppose that it anticipates only a 1/5 chance that the courts will award compensatory damages and a 4/5 chance that the courts will order disgorgement. Its incentives are still choice equivalent to harm internalization alone.
Cyana will thus make the same choice, whether it expects a 1/5 chance of compensatory damages or a 2/3 chance (as in the earlier illustration). Notice that this also means it will make the same choice even if it miscalculates the chances (say, if the true chance is 2/3 but Cyana guesses 1/5).
Thus, in theory, the actor’s choice will not depend on how often the gain-based remedy will be used. Even if the primary remedy’s influence is greatly diluted, it will still point the actor in the right direction.
2. Accuracy of the Primary Remedy. — A second ideal condition becomes relevant if the actor is uncertain ex ante about the value of the primary remedy. In such a case, emulation requires that the actor anticipate that the expected value of the primary remedy, when it is awarded, reflects the primary remedy’s expected value were it always awarded. (This condition is obviously met when the primary remedy has only one possible value—for example, if there is a fixed fine, or if the actor knows ex ante the amount of damages that will be assessed.
Illustration—Chemical Spill. Suppose Cyana does not know exactly how much harm will result from the spill, but knows the range of the possible extent of harm. Cyana also believes that courts tend to award compensatory damages when harm turns out to be at the higher end of the range, but tend to substitute disgorgement when harm turns out to be at the low end. Due to this perceived selection bias, Cyana’s incentives are choice equivalent to damages based on higher-than-average harm.
The result is that Cyana faces incentives that are more deterrent than those that would result were the courts always awarding compensatory damages. In essence, the remedial mix in this case is emulating a biased sample from the range of potential compensatory damages, rather than a representative sample. How effectively courts or enforcers can make use of such substitution—or how readily they might fail—will often turn on this issue of selection bias.
Perfect emulation is not always a good thing, however. What if harm-based damages are sometimes badly distorted—for instance, by gross mismeasurement or by doctrines that artificially limit recovery? As Part II will detail, a more strategic use of the equipoise effect may then be in order. Courts and public enforcers might instead co-opt the mechanism of selection bias, using it to counteract such distortions.
3. Accuracy in Erasing Gains. — The third condition may be called the “no leftover incentives” condition. The substitution of disgorgement dilutes two competing incentives in equal measure: the net gains from the act and the legal disincentives for the act due to the primary remedy. If these are the only incentives at work, then there is no problem. But if the actor has other incentives that fall outside the reach of disgorgement, then those incentives are not diluted. Instead, by comparison, they will loom large.
What might such leftover incentives be? Most commonly, there may be costs of acting that are not offset in the disgorgement award.
Although disgorgement aims to remove only net gains—and thus implies offsetting of the actor’s costs—this offset may be imperfect. Some noneconomic costs might not be quantifiable. Or a court might omit opportunity costs or the cost of capital (though courts have recognized the need to offset both kinds of costs and have found ways to do so).
To put it in more abstract terms, a court might fail to accurately assess the marginal net gain (or marginal net savings) relative to the actor’s best noninfringing alternative course of action.
Moreover, an actor might also have favorable incentives that disgorgement will not reach—for example, longer-term economic gains not yet evident or not provable to the court or enforcer.
Illustration—Breach of Trust. Consider a case like that of the former CIA analyst, Frank Snepp.
In calculating the profits that such an author must disgorge, a court might fail to offset the value of the time he spent writing the book, which could have been spent writing a different book. Or the court may be unable to account for the emotional impact of either criticism or acclaim for being a whistleblower.
The presence of such leftover incentives are, in a sense, an error in valuing the net gains to be disgorged, resulting in a failure to reach true equipoise in the first place. Such errors create distortions of a peculiar sort. The more the primary remedy is used relative to disgorgement in the remedial mix, the less the chance that these leftover incentives will make a difference in the actor’s decision.
This sliding-scale effect tempers a well-known peril of mismeasuring gains. As Professors Mitchell Polinsky and Steven Shavell observed, one disadvantage of relying on a gain-based remedy alone for setting incentives is that even a slight underestimation of the actor’s gains can result in a failure to deter acts whose harms greatly exceed their benefits, because a purely gain-based remedy does not force the actor to internalize any of the harm, no matter how large.
But in the present context, harm-based remedies are mixed with the gain-based remedies, and thus the chances of such a harsh consequence are diminished in two related ways. First, the influence of an error in measuring gains is reduced because the actor does not expect disgorgement to be used all the time. Second, in this mixed scheme, actors do internalize harm (if only partially) and therefore cannot entirely ignore the possibility of causing great harm.
E. Information Demands
At this point, it may seem that information costs must be quite high for the effective use of choice equivalence. Undoubtedly, in some contexts, such an approach will be infeasible or wasteful due to information costs. Most obviously, good information about the right amount of gains to be disgorged may be unavailable. But without minimizing such concerns, a few favorable points should be noted.
1. What Is Not Required. — First, recall that the actor does not need to know exactly how often one remedy will be substituted for the other, because whatever mix she imagines will still induce the right choice (if choice equivalence holds).
Conveniently, this also means that courts and public enforcers need not guess what exact probabilistic mix the actor might be expecting; nor do they need to convey the exact probabilities to the actor. What the actor needs to perceive (and all that courts or enforcers need to convey), in theory, is uncertainty about whether the remedy in a specific case will be disgorgement or the primary remedy.
Second, choice equivalence does not require calculating both harm-based damages and gain-based damages in a given case. Indeed, it allows the substitution of gain-based damages when harm is hard to measure, as Part II will detail.
And when harm-based damages are awarded, there is no need to calculate gains.
2. Negligence or Strict Liability? — One favorable quality of choice equivalence may be useful to consider in deciding between a negligence regime and a strict liability regime. The relative merits of these regimes have been studied in an extensive literature raising many complications that cannot be fully considered here,
but it may still be worth noting a fairly basic way for choice equivalence to enter into the calculus.
Illustration—Chemical Spill. Judge Richards is deciding whether Cyana’s chemical spill should be treated under negligence or strict liability, a question of first impression. She recognizes that in some such cases the full extent of harm may quickly become evident, while in other cases harm will be underestimated because future harm is unknown or not provable. How should this potential for errors in measurement affect her decision?
If the negligence test depends on information about harm, as the Hand formula does,
Judge Richards may sensibly decide that the law should favor a strict liability regime in which compensatory damages are awarded only when they can be reliably measured, while disgorgement is substituted otherwise. (As we have seen, this approach is choice equivalent to a regime of reliably measured compensatory damages.) The disadvantage of using a negligence test that relies on harm assessment, in contexts where harm is often hard to measure, is that doing so risks introducing errors at both the liability and the remedies stages.
By avoiding distortions at both stages, a strict liability regime with strategic substitution may well better serve the aim of harm internalization.
If, however, the negligence test is based on a different method for setting the standard of care that does not involve assessing harms, then a strict liability regime with strategic substitution may have less of an informational advantage, or may even have a disadvantage. At the liability stage, of course, such a negligence test still demands more information than strict liability.
But at the remedies stage, the presence of a negligence test might relieve some need for accuracy in setting the level of damages.
Then again, it might not,
in which case the informational advantage goes more clearly to a strict liability regime with strategic substitution.
II. Using Equivalence
The logic of choice equivalence points to a tantalizing “worry-free” possibility: Courts or public enforcers may be able to substitute disgorgement for other damages or sanctions, on occasion, without needing to worry about throwing off future actors’ ex ante choices. This Part focuses on one application of this remedial flexibility—as a way to work around problems of measurement in awarding harm-based remedies such as compensatory or expectation damages. The following analysis will also suggest why using a probabilistic mix of harm-based and gain-based damages might even serve the aims of harm internalization better, in some circumstances, than using solely harm-based damages.
Before proceeding, let us make a mental note of two limitations. First, the actor’s gains may also be hard to measure in some contexts.
For clarity’s sake, the exposition here will assume that accurate measurement of the marginal net gains or marginal net savings to be disgorged is feasible—but of course that is not always so.
Second, substitution plainly sacrifices the aim of accurate compensation for those injured parties who do end up with a disgorgement award. Some such parties might recover more than the harm they suffered, and some might recover less. A substitution strategy may thus be more attractive to a public enforcer who is not bound to seek compensation for harm. It may be less appealing for contexts, including private disputes, in which accurate case-by-case compensation may be valued for reasons
other than deterrence.
This limitation may make the substitution strategy unpalatable in some contexts.
A. The Problems of Measuring Harm
At times it can be fiendishly hard to award accurate damages based on harm. Think of inchoate harms or future harms. And then there are subjective or idiosyncratic harms, including some emotional harms. Even some economic harms, such as lost profits or market prices when no market exists, may call for sophisticated guesses.
The usual common law approaches to such measurement problems range from tolerating guesswork to awarding nothing at all. If a court decides that the amount of damages cannot be shown with “reasonable certainty,” then the award may end up being zero—even when the harms are very real.
This constraint operates in both the contracts and torts contexts.
To take a textbook example, in Freund v. Washington Square Press, the high court of New York determined that a playwright could not recover lost royalties from his publisher who breached by refusing to publish his book, because the value of those royalties, “while theoretically compensable, was speculative.”
Freund’s lost royalties were a future harm and so he was able to provide “no stable foundation for a reasonable estimate of royalties he would have earned had defendant not breached its promise to publish.”
He therefore recovered only nominal damages.
B. A Substitution Strategy
These travails suggest a reason for courts or public enforcers to make use of choice equivalence by substituting disgorgement when harm-based damages are difficult to measure or would be distorted relative to the true extent of harm.
In some contexts, courts have already experimented with substituting gain-based damages when harms are hard to prove or calculate; they have usually done so when the measure of an actor’s gains can plausibly serve as a proxy measure for the plaintiff’s harm.
But we can do better than that. The strategy of substitution suggested here is enabled by the equipoise effect; it does not rely on any closeness in value between gains and harms. Thus, its use is not confined to such cases. Gains and harms often differ greatly in value and cannot be justified as proxies for one another. Yet if choice equivalence is possible, substitution may nonetheless serve the aims of harm internalization.
Illustration—Noncompete Agreements. Layton signed a noncompete agreement with his former employer Adz, a company selling advertisements in study guides it gives away to law students. Layton then formed his own company copying the Adz business model anyway. Finding Layton liable for breach, a court might estimate harm-based damages based on the value of the new company’s profits, as an approximation, on the theory that Adz could have earned as much.
Yet even if the new company was actually far more (or far less) profitable than Adz, gain-based damages can still be useful as part of a substitution strategy if the conditions for choice equivalence can be met.
In fact, when the shortcomings of harm-based damages are severe, a substitution strategy might not only be serviceable for inducing a harm-internalizing effect, but also superior. The reason is that it may be better to emulate more accurate incentives by using a strategy of substitution, than to create distorted incentives by relying directly on biased harm-based damages.
Illustration—Patent Damages. A patent-holding company, Luce, owns the patent for a one-click interface feature that is used in a variety of software.
Suppose that M-Soft is found to have infringed on Luce’s patent based on a similar feature found in M-Soft’s personal calendar software.
Setting compensatory damages based on a reasonable royalty may require the court to estimate the licensing price that the parties would have agreed to before the infringing use occurred. This task is fraught with guesswork at each step.
In the face of such uncertainty, courts have sometimes resorted to arbitrary fictions, much to the consternation of scholars and practitioners.
If choice equivalence holds, however, a substitution strategy becomes a possible alternative; courts can replace such fictional awards with disgorgement, while continuing to order the standard remedy when it is more readily assessed with accuracy.
Several principles should guide courts and enforcers when applying such substitution strategies. These guidelines, which correspond to the ideal conditions for choice equivalence articulated in Part I, can be organized into two categories: Those that relate to the problems of accuracy in representing true harm, and those that relate to the problems of accuracy in erasing gains.
1. Guidelines as to Harm. — Recall that in situations where the actor does not know how much harm the contemplated act will cause, it is important to avoid conveying a perception of selection bias in the substitution strategy. This corresponds to the second ideal condition described above, that substitution occur in such a way that the actor will perceive that the expected value of the primary remedy when it is used reflects the primary remedy’s expected value were it used all the time.
In the present application, however, we are considering the complication that the primary remedy itself might be inaccurate or distorted. As a result, the proper aim is a modified principle: Substitution should be used in such a way that the expected value of the harm-based damages when they are awarded reflects the act’s true average harm.
In considering how this principle might be implemented, it is useful to consider two types of situations: (1) when harm-based damages are generally accurate on average, though sometimes hard to prove, and (2) when harm-based damages are likely to be biased—that is, distorted relative to true harm.
If the actor faces uncertainty about the extent of harm her act will cause and harm-based damages are generally accurate on average, then the court or public enforcer should substitute disgorgement in such a way that the actor will not expect the chances of substitution to correlate with the extent of the realized harm.
Illustration—Patent Damages. Consider again the patent dispute between Luce and M-Soft. Imagine now that M-Soft has not yet infringed, but is contemplating doing so. It is uncertain how many infringing units it can sell. It does know that in infringement litigation, the reasonable royalty may be hard for a court to determine. It expects that some courts will substitute disgorgement when faced with such a difficulty, while the remaining courts will award royalty rates that are correct on average.
If M-Soft estimates the chances that the court in its case will substitute disgorgement to be 1/3, no matter how many units of the software have been sold, then choice equivalence is possible. But choice equivalence fails if M-Soft expects courts to be more likely to use substitution if it has sold, say, 1,000 units than if it has sold 1,000,000 units.
Note that this does not require the court or public enforcer to choose between the remedies randomly or haphazardly. What is important is that the actor does not perceive ex ante that the courts’ criteria for substitution will be correlated with the realized harm. For obvious reasons, it may be quite difficult for a court or a public enforcer to actively impress upon future actors that it is following such a guideline. It may be more plausible for the nature of uncertainty on the actor’s part to satisfy this independence condition.
In the second type of situation, in which actors face uncertainty about the extent of harm, and harm-based damages may be artificially distorted relative to the realized harm, courts or enforcers can use selection bias to counteract such potential distortions. For instance, they can substitute disgorgement instead of awarding the distorted harm-based awards. Again it is essential for the actor to perceive no correlation between the extent of realized harm and the likelihood of substitution, even while the actor understands that disgorgement will replace the distorted harm-based damages. For example, in the M-Soft illustration, the approach may work if M-Soft understands that courts will substitute disgorgement whenever the calculation of reasonable royalties would be distorted by the application of pricing fictions, but also that the chances of such distortions (and hence the chances of substitution) turn on factors unrelated to the number of units sold.
2. Guidelines as to Gains. — Next, recall the ideal condition that the court or enforcer should aim as closely as possible for true equipoise when assessing the disgorgement award.
That is, it should be sure to remove the actor’s net gains as accurately and fully as possible—including offsetting the actor’s full range of costs. This is what we have called the “no leftover incentives” condition.
Notably, the very fact of substitution amplifies the problem that departures from this condition create for choice equivalence: Because substitution dilutes the influence of harm-based damages, such extraneous costs (as well as any leftover favorable motives) will loom larger—and may at times overwhelm the remaining influence of the diluted incentives.
Meeting the “no leftover incentives” condition may be difficult or infeasible when some of the actor’s costs or raw gains are intangible, idiosyncratic, or not yet apparent because they will accrue in the future.
Opportunity costs may also be hard to measure, even if courts are familiar with the need to account for them.
Part III will elaborate on particular difficulties with some such costs and touch on potential solutions.
C. Public and Private Enforcement
The substitution strategy may be both more feasible and more attractive in public enforcement actions than in private disputes. Certain public enforcers may have leeway to seek penalties based on gains in lieu of penalties based on harm. Unlike a court with private plaintiffs before it and a specific harm to remedy, such a public enforcer may have no strong reason to tie penalties to harm except to set a desired level of deterrence.
And as we have seen, a substitution strategy may serve just as well, or better, for optimal deterrence.
1. Imperfect Private Enforcement. — Public enforcers may be able to use choice equivalence to fill gaps in deterrence left by incomplete private enforcement, especially in cases with multiple victims.
For example, suppose that an act has affected a large group of consumers, and the public enforcer estimates that the harm-based damages being pursued by private plaintiffs will likely only cover a certain proportion (say 1/10) of the total harm. Rather than pursuing supplemental sanctions based on the harms suffered by the absent victims, the public enforcer may instead peg its sanctions to 9/10 of the actor’s gains.
As explained above, this combination of private damages worth 1/10 of the harms and public sanctions worth 9/10 of the gains can emulate the incentive effect of a set of penalties worth the full amount of harm.
Illustration—Food Safety. Suppose an agricultural produce company sells spinach. For one full year, the company neglects to inspect the spinach for bacteria before sending it to market. The FDA estimates that one hundred people became seriously ill due to consuming the company’s spinach that year. Only ten of those victims file suit, and they reach confidential settlements. In setting regulatory sanctions against the company, the FDA aims to make up the gap in harm-internalizing incentives. The direct way to do so is to assess penalties that capture the harm suffered by the ninety missing victims. But if the agency does not have reliable measures of harm, it can nonetheless achieve choice-equivalent incentives by fining the company an amount based on 90% of the company’s net gains (that is, its savings from neglecting inspections during that year).
Likewise, if the public enforcer is solely responsible for setting deterrence for the actor, then it may choose to apply sanctions that combine a harm-based measure (covering the known victims) with a gain-based measure for the remaining share.
Illustration—Food Safety. In the case of the bad spinach, suppose that none of the one hundred victims comes forth to seek compensation. The FDA is able to identify only ten specific victims to evaluate their actual harms. The agency might then set purely harm-based penalties by extrapolating from these known harms. Or instead, the agency could set choice-equivalent incentives by assessing penalties equal to those known harms (representing 10% of total harm) plus 90% of the company’s net gains.
The use of such fractional disgorgement is not inconceivable, especially in negotiated agreements such as consent decrees.
Even courts may be willing to use their equitable powers to award combination remedies that are partly based on harms and partly on gains. As the Supreme Court noted in the recent interstate water dispute, “disgorgement need not be all or nothing.”
The majority further explained that “if partial disgorgement will serve to stabilize a compact by conveying an effective message to the breaching party that it must work hard to meet its future obligations, then the Court has discretion to order only that much.”
Indeed, the Court ordered partial disgorgement in addition to a conceded award of full compensation.
2. Imperfect Public Enforcement. — Suppose now that violators face only a 1/3 chance of being detected and sanctioned. Thus, they expect to pay for the harm done only 1/3 of the time. The usual multiplier solution is to assign total damages (in cases when the violation is detected) that are worth three times the amount of harm. For example, if the victims themselves collect full compensation, then a public enforcer may step in with supplemental sanctions that are double the compensation.
Again, substitution is possible: Instead of supplementing the compensatory award with a further harm-based penalty, the public enforcer may seek a gain-based penalty—in this case, double disgorgement instead of double compensation. These combinations are choice equivalent; both generate optimal deterrence.
Illustration—Food Safety. Consider again the case of the bad spinach. Suppose all one hundred injured victims sue for compensation. Yet the FDA also knows from experience that in similar cases, the originating source of tainted produce is discovered only 1/3 of the time and thus, only 1/3 of such incidents will result in compensation. The agency might make up for the deterrence gap by assessing further penalties amounting to twice the compensation that is won. But a choice-equivalent approach is to set penalties equal to twice the company’s net gains instead.
The reason is familiar by now, even if the configuration of remedies is slightly different: Agricultural producers know they will face a 1/3 chance of paying double disgorgement—an expected penalty of 2/3 of gains—along with the existing 1/3 chance of paying compensatory damages.
Thus, a public enforcer wishing to apply supplemental sanctions can choose to seek either compensation or disgorgement as the basis for such sanctions, achieving the same deterrent effect either way.
And it is not hard to imagine that a public enforcer might be better able to establish the amount of the actor’s gains than the victims’ harms,
or that the agency may prefer one or the other approach for institutional reasons.
3. Omitting Outliers. — Public enforcers may also be more likely to have the informational resources needed to use substitution more strategically for replacing outlier harm-based awards. If a particular enforcement action may result in harm-based penalties that are unusually low or high (for idiosyncratic reasons), the enforcer may choose instead to substitute disgorgement in that case. This can avoid creating a misimpression for future actors about the typical harm that such conduct might entail or about the harm-based penalties that might follow.
Illustration—Oil Spill. EP operates oil rigs in the Gulf of Mexico. While attempting to drill a new well, EP causes an oil spill.
An investigation finds that EP’s failure to perform a number of customary safety checks, despite warning signs of abnormal pressure in the well, caused the spill. Any of these errors alone would have been enough to cause the spill. Yet due to fortuitous and unusual seismic conditions unknown to EP at the time, the well sealed itself off without further intervention. As a result, the amount of oil released into the water was minimal—but only due to a quirk of fate.
In such an outlier case, the public enforcer may prefer to seek disgorgement of EP’s savings from underperforming its safety checks (or penalties reflecting that amount) rather than harm-based penalties. This will allow other cases, in which harm-based penalties reflect more typical levels of harm, to set the deterrence for future actors.
D. Judicial Gatekeeping
A principal limitation of substitution remains that it may be unappealing in contexts where compensation is valued for reasons other than deterrence. The uses of substitution discussed in this Part, however, have focused on contexts where the aim of accurate compensation is already compromised. It may thus be worth considering whether some of the judicial tools currently used to address such situations might be adapted to allow the use of substitution. This section briefly explores two such possibilities.
1. The “Inadequate Remedy at Law” Criterion. — Common law courts play a gatekeeping role in the use of equitable remedies, such as injunctive relief or specific performance, and there is already some degree of acceptance of disgorgement as a further equitable option. It sometimes serves as a monetary substitute for injunctive relief, most familiarly as a substitute for specific performance in the contracts context.
The traditional “inadequate remedy at law” criterion for equitable relief may thus be worth considering as a possible opening for the use of strategic substitution.
When compensatory or expectation damages are likely to fail to capture the full extent of harm, substitution can be useful for reducing underdeterrence. The problem is that this criterion would only seem available for use when harm-based damages would otherwise be too low, not too high,
unless courts are willing to read “inadequacy” broadly to include situations where damages are likely to be mismeasured in either direction.
It may also seem dissonant to use a criterion focused on the adequacy of compensation to enable the substitution of a remedy that is not pegged to compensation at all.
2. The “Reasonable Certainty” Criterion. — Another possible avenue is to adapt the existing “reasonable certainty” criterion to serve a strategy of substitution.
That is, rather than awarding no damages at all, courts could substitute disgorgement instead.
Whether such a use seems consonant with the spirit of this criterion is probably in the eye of the beholder: It might seem dissonant if one viewed the test as a defendant’s bulwark against ungrounded awards. But to the contrary, one might suggest that it is consonant to use this criterion to switch to a familiar measure of damages (disgorgement) that can be measured with more certainty in a given case—and all the more so if such substitution can displace the various distortive fictions for setting harm-based damages that might otherwise fill the vacuum.
III. Completing Deterrence?
Given the equipoise effect, if the law is aiming for complete deterrence through its use of disgorgement, then it must also rely on a variety of further costs to “complete” the deterrence. This Part addresses two sets of questions that arise from this reliance: First, how well do such costs guarantee complete deterrence? Second, how does the presence of such costs affect the theory of choice equivalence and the strategy of substitution?
A. Litigation Costs and Opportunity Costs
Litigation costs accompany all remedies. These include direct litigation expenditures, of course, which may be sizable but may also be limited if a case settles. One might also include in this category the informal sanctions or reputational losses that may result from the fact of litigation or the fact of liability.
Further costs related to litigation may include other economic or psychic costs; for example, the liable party may be loath to confer what it sees to be a windfall on a despised opponent or a rival firm. These sorts of litigation-related costs are generally not offset in the calculation of monetary awards, including disgorgement.
In practice, a so-called disgorgement award might also fail to properly offset opportunity costs or even the direct costs of the act.
Some such costs are more subtle than others: For example, consider an actor who uses an item of property without consent. This actor might have bargained for its use instead, leaving her sharing in the surplus. As some courts have acknowledged, an award that failed to account for that shared-surplus baseline would overshoot the true net gain attributable to the taking.
This sort of opportunity cost would be properly offset if the disgorgement award is valued at the actor’s marginal net gain (or marginal net savings) relative to her best alternative noninfringing action.
Some courts have intentionally ignored opportunity costs, however, apparently as a way to pile on an arbitrary amount of extra disincentive.
Similarly, a refusal to offset even the more direct and tangible costs of taking the action is sometimes a deliberate part of the remedial scheme, intended as a way to add a quasi-punitive surcharge beyond the accurate disgorgement amount.
B. A Fragile Deterrence
Extraneous costs like these are what ensure complete deterrence in many cases. The fact that some such costs will always exist might thus seem to offer a way to justify our conventional shorthand equating gain-based damages with complete deterrence.
But this is a flimsy rationalization. The most obvious reason is that possible favorable motivations, also untouched by a disgorgement award, might outweigh such costs.
Illustration—Hidden Benefits. An advertising firm breaks a contract with Client One to take a higher-paying contract with Client Two. The firm jumped at the opportunity because it has been hoping for years to build a relationship with Client Two, whose fortunes are clearly on the rise. Even if the agency must disgorge the direct profits from its breach, the longer-term economic motivations would remain. Such favorable motivations may well outweigh the leftover costs that would otherwise have served as a deterrent.
Think also of intrinsic, intangible motivations such as enjoyment or a sense of purpose. Consider again the former CIA analyst, Frank Snepp.
The Supreme Court required him to disgorge all his profits from publication—noting that the harm to the government was “unquantifiable,” that nominal damages would be “a hollow alternative, certain to deter no one,” and that punitive damages would be “speculative and unusual.”
The disgorgement solution, however, only goes so far. It does not defeat his nonfinancial motivations to write his whistleblowing book—a desire for recognition, say, or a sense of public duty. More to the point, he might still have written the book due to those motivations even if he knew that the so-called disgorgement remedy would be deliberately tweaked to fail to account for his time, effort, and opportunity costs.
It is hardly a satisfying answer, then, to say that deterrence is ensured by disgorgement because we can always assume that some further costs are sure to exist—especially as such costs might be uncalibrated and arbitrary in magnitude.
C. Effects on Choice Equivalence
Given that such costs do exist, however, how might they affect the theory of choice equivalence and the strategy of substitution? To address this question, it is useful to distinguish between two types of additional costs: those that are specific to the imposition of disgorgement and those that attend the imposition of any remedy.
First, note that extraneous costs specific to disgorgement may be analyzed as a form of leftover incentives or errors in assessing net gains—that is, departures from the third ideal condition, as articulated in section I.D.3. The presence of such leftover costs leads to deviations from choice equivalence, which in the context of harm internalization may translate into deviations from optimal deterrence.
(To be clear, however, this does not mean that the result is complete deterrence.) The straightforward solution is for the disgorgement award to offset such leftover costs.
Next, consider the extraneous costs that are present no matter which remedy is awarded. For example, the actor’s litigation costs will not be offset if the court awards compensatory damages or expectation damages any more than if the court awards disgorgement. (This is assuming that the so-called “American Rule” is in effect, whereby each side pays its own costs.)
Similarly, reputation costs may arise from the fact of liability, whether the remedy is disgorgement or compensation.
Even if the same such costs are present for either remedy, however, choice equivalence will be distorted. The intuition is that leftover incentives loom larger under a substitution strategy, which dilutes other relevant incentives, than under the usual harm-based damages regime. In the context of harm internalization, this asymmetry translates into a greater deviation from optimal deterrence. An actor expecting to pay harm-based damages plus such extra costs is already overdeterred.
But an actor facing the substitution strategy along with such costs will be overdeterred to a greater extent.
The ideal solution here, of course, would be to adjust both remedies to offset such extraneous costs. But if litigation costs cannot be offset when awarding compensatory or expectation damages, due to existing practice, a partial solution might be to adjust the disgorgement amount to offset litigation costs whenever the substitution occurs—that is, to make sure that at least the disgorgement component of the remedial mix is properly set. Doing so would reduce the overdeterrence to the same level as would naturally occur under the harm-based damages regime.
This is not a coincidence, but rather a straightforward application of the logic of choice equivalence.
The preceding analysis has focused on harm-based damages, but it is worth noting that the same distortions—and the same solutions—apply to the use of a substitution strategy for emulating any other primary remedy.
D. The Plaintiff’s Choice
Ensuring complete deterrence can also be accomplished by allowing the plaintiff to choose between harm-based and gain-based damages. This is a familiar structure in some areas of law—most notably, in cases of conscious wrongdoing, certain fiduciary breaches, and copyright violations.
It is well understood how allowing plaintiffs the choice can lead to complete deterrence, but the mechanism is worth reviewing briefly here as a preface to analyzing how it affects the choice-equivalence analysis and the strategy of substitution.
1. Extreme Selection Bias. — Consider the classic case of the egg-washing machine, Olwell v. Nye & Nissen Co.
At the height of World War II, when labor was in short supply, a man named Olwell discovered that the packing company next door had surreptitiously used his “Eggsact” egg-washing machine. Orwell had sold his own packing business to the company—except for this particular machine. They had used his machine without permission for three years (and rebuffed his offers to sell or rent it to them).
But it so happened that Olwell had no intention of using the machine himself during that time; nor had he sought to rent it or sell it to others.
In short, he had suffered no actual harm. Even more fortunately for him, the Washington Supreme Court used his case to make a strong statement about the plaintiff’s freedom to choose between a harm-based torts remedy and a gain-based restitutionary remedy.
Not surprisingly, he chose to pursue an award based on disgorging his neighbor’s gains.
What sorts of incentives does such a remedial structure produce for a potential tortfeasor or contract breacher? Consider an actor who does not know whether harm will exceed gains or vice versa. What she can predict is that if the harms exceed her gains, the plaintiff will choose compensatory damages, and the rest of the time the plaintiff will choose disgorgement.
Illustration—Copyright Damages. The Hawk publishing company is considering copying and selling a booklet of income tax worksheets that is extremely similar to a booklet an author named Buck has created and copyrighted. Hawk does not know whether its profits from the infringement will exceed Buck’s lost profits, but it knows that copyright law will allow Buck the option of seeking either disgorgement or compensation.
Looking ahead, the company sees no chance of a net gain, but only some chance of breaking even and otherwise a net loss. Expecting a net loss on average, the company is completely deterred—as copyright law apparently intended.
This complete deterrence effect is quite familiar.
But seeing it from the perspective of the equipoise effect does leave us with a somewhat unusual conclusion: In a sense, it is the harm-based damages that are responsible for complete deterrence.
The reason is that an extreme form of selection bias is at work.
And this selectivity, combined with the equipoise effect, is what guarantees the overall net loss. In essence, the resulting incentives are choice equivalent with harm-based damages that are sure to be greater than the actor’s gain.
2. Consequences for Legal Design. — Simply allowing the plaintiff to choose between disgorgement and compensation can thus create complete deterrence. The actor does not even need to have a good guess of how often the harms might exceed her gains. As long as she expects some chance that the harms will exceed gains, then she will be completely deterred. This is rather convenient if the law’s aim is complete deterrence.
This effect may be troubling, though, if the law’s aim is harm internalization. Is there any way to return to optimal deterrence? This question circles back to the ideal conditions articulated in section I.D. The second condition, the accuracy of the primary remedy, has failed in a spectacular way. Here the issue is not just missing the target of true harm. Now the problem is overshooting the actor’s gains.
Recognizing this distinctive mechanism introduces some conceptual clarity—but also some pessimism—in crafting workarounds. One approach is to limit the option of disgorgement to public enforcers, rather than private plaintiffs. One might sensibly assume that private plaintiffs will naturally choose whichever form of damages offers a higher amount.
While this motivation might also be true of public enforcers in some contexts, in others it might not. When public enforcers value optimal deterrence, they may instead pursue substitution in a way that emulates harm internalization. A second approach is to set boundaries on when the plaintiff should be allowed the choice—for example, by setting a liability threshold,
or by establishing prerequisites such as a finding of bad intent. This confines complete deterrence to unacceptable versions of the act, while keeping harm internalization for the more tolerable sorts.
One further observation emerges from this exploration of the equipoise effect. Recall the tech start-up founder, whom we met in the Introduction. Imagine that she anticipates having to disgorge her profits, should she infringe the patent. If that were all, she would be in equipoise. But what if she also expected some chance that the court might substitute harm-based damages instead?
This would introduce a new incentive—one requiring her to weigh gains against harms.
This shift of perspective in how we see our familiar mix of remedies also prepares us to revisit how we see harm-based damages operating alone. We can think of an award of harm-based damages as being the sum of two parts: an amount that is equal to gains, and an amount that is equal to the difference between harms and gains.
The first piece puts the actor in equipoise, and the second piece introduces a further incentive requiring her to weigh gains against harms. Look familiar? We thus arrive at another way of appreciating how harm-based damages work: They introduce a desired incentive—after first finding equipoise.