Optimal Delegation and Decoupling in the Design of Liability Rules

Abstract

Calabresi and Melamed began a scholarly revolution by showing that legal entitlements have two readily distinguishable forms of protection: property rules and liability rules. These two archetypal forms protect an entitlement holder's interest in markedly different ways—via deterrence or compensation. Property rules protect entitlements by trying to deter others from taking. Liability rules, on the other hand, protect entitlements not by deterring but by trying to compensate the victim of nonconsensual takings. Accordingly, the compensatory impetus behind liability rules focuses on the takee's welfare—making sure the sanction is sufficient to compensate the takee. The deterrent impetus behind property rules, however, focuses on the potential taker's welfare—making sure the sanction is sufficient to deter the taker. Thus, disgorgement and prison terms exemplify traditional property rule remedies, while expectation and other compensatory damages fall squarely within the liability rule camp. Viewing liability rules as a distinct category of entitlement allowed Calabresi and Melamed to identify a missing category in the way courts resolved nuisance disputes. Consider the classic, if somewhat idealized, nuisance dispute between a single "Polluter" and a single "Resident" who is discomforted by the pollution. Prior to One View of the Cathedral, courts traditionally chose from among three categories of judgment: Rule 1: the court issues an injunction against the Polluter; Rule 2: the court finds the Polluter has created a nuisance but permits pollution to continue provided the Polluter pays damages; or Rule 3: the court finds the Polluter has not created a nuisance and permits pollution to continue without restriction.