Like constructing a building, performance on many contracts occurs in phases. As time passes, the promisor sinks more costs into performance and less expenditure remains. For phased performance, we show that optimal liability for the breaching party decreases as the remaining costs of completing performance decrease. In brief, efficiency requires a decreasing liability contract. To implement such a contract, we recommend deducting past expenditure on incomplete performance from liability. We

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... w that progress payment contracts, which are commonplace in some industries, are materially equivalent to decreasing liability contracts. Our analysis should prove useful for elucidating progress payment contracts and for drating and litigating contracts. Abstract Like constructing a building, performance on many contracts occurs in phases. As time passes, the promisor sinks more costs into performance and less expenditure remains. For phased performance, we show that optimal liability for the breaching party decreases as the remaining costs of completing performance decrease. In brief, efficiency requires a decreasing liability contract. To implement such a contract, we recommend deducting past expenditure on incomplete performance from liability. We show that progress payment contracts, which are commonplace in some industries, are materially equivalent to decreasing liability contracts. Our analysis should prove useful for elucidating progress payment contracts and for drafting and litigating phased contracts. Like constructing a building, performance on many contracts occurs in phases. As time passes, the promisor sinks more expenditure into performance and less expenditure remains. Unless the parties specify otherwise in the contract, the breaching party in a phased contract is liable under positive law for the entire losses suffered by promisee because of breach, subject to some well-known limitations. 1 This default rule, however, often produces inferior incentives. We analyze how liability for breach should ideally change through the phases of a contract. We show that deducting past expenditures from liability often improves incentives. The following example illustrates our analysis.