What is an Orphan instance and why is it bad?
An orphan instance is a type class instance for class C and type T which is neither defined in the module where C is defined nor in the module where T is defined.
Type class instances are special in that they don't have a name and cannot be imported explicitly. This also means, that they can not be excluded explicitly. All instances defined in a module A are imported automatically when importing A. This applies recursively to all modules imported by A.
Say you want to make use of a type class instance in your module, then you must import both the class and the type directly, or you must import modules which itself import at some point the class and at some other point the type. If there is a non-orphan instance, you automatically get the instance imported. This way the compiler can restrict the set of modules to look for an instance if you want to apply it. So the problem is partially an efficiency problem, but this is not all.
Say you want to define an alternative instance to an existing instance. This is a bad thing, since if two instances for the same class/type pair are in scope, then you cannot describe in Haskell 98 which instance to use. If you want to use multiple instances for the same class/type, you have to ensure, that they are never imported together in a module somewhen. It is almost impossible to assert that, or put differently, it would reduce the composability of libraries considerably.
Actually, non-orphan instances can avoid definition of multiple instances. For defining an instance you have to import the class and the type and then you will automatically have the according non-orphan instances imported, too. If you want to define a new instance then the compiler will reject it immediately.