15.3: Legal Remedies- Damages (Monetary)

LEARNING OBJECTIVES

1. Understand what is meant when it is said that damages are a legal remedy (as opposed to an equitable remedy).
2. Understand the names and purposes of the six types of remedies.
3. Know when liquidated damages will be allowed.
4. Recognize the circumstances that might allow punitive damages.

Overview

The promisee—whom we will hereafter refer to as the nonbreaching party—has the right to recover damages, or a money award, whenever the other party breaches the contract, unless the contract itself or other circumstances suspend or discharge that right. Monetary damages are sums of money paid by one party to the other and are considered a legal remedy.

Historically, this distinction stems from the development of the English legal system. Courts of law were originally limited to granting monetary relief. If a petitioner sought something other than money—such as an order compelling performance or undoing a contract—recourse had to be made to a separate system of equity. In practice, this meant two different sets of courts, procedures, and remedies.

Although today the institutional separation between law and equity no longer exists, the distinction is still recognized. A judge may be described as “sitting in law” when awarding damages, or “sitting in equity” when granting remedies such as injunctions, rescission, restitution, or specific performance. Many modern cases involve claims for both legal and equitable remedies.

We begin, as the common law did, with the legal remedy of damages.

Types of Damages

There are six different types of damages: compensatory, incidental, consequential, nominal, liquidated, and (sometimes) punitive.

Compensatory Damages

Definition and Purpose.
Compensatory damages are paid to directly compensate the nonbreaching party for the value of what was not done or performed. Their purpose is to place the nonbreaching party in the position they would have occupied had the contract been performed.

Measuring the Loss.
Sometimes calculating compensatory damages is straightforward. For example, if a builder would have earned a $10,000 profit on a $100,000 house, and the owner wrongfully cancels, the builder’s expectation interest is $10,000. In other cases, courts look to the reasonable cost of obtaining a substitute performance. If a service can be replaced, the measure of damages is the cost of hiring someone else to perform.

However, the calculation is often difficult, especially when the service is unique and not easily duplicated. If Rembrandt breached a contract to paint your portrait, the loss cannot be measured simply by asking what Van Gogh would charge. Nevertheless, the proper measure remains whatever net value would ultimately have been conferred on the nonbreaching party. Similarly, an author whose publisher breaches a book contract may recover lost royalties (if ascertainable) and the measurable value of her lost reputation and publicity.

Deductions for Savings and Substitutions.
Because the nonbreaching party is usually discharged from further obligations, a breach often results in cost savings. The nonbreaching party may:

• Avoid expenses they otherwise would have incurred,
• Make substitute arrangements and realize partial profits, or
• Repurpose goods purchased for the breached contract.

These avoided losses must be deducted from the damages calculation. The rule is that the nonbreaching party recovers only net losses, not more.

Example: An employer breaches a contract to hire a worker at $35,000 for one year. The employee quickly finds similar work for $30,000. Aside from incidental damages (such as job search costs), compensatory damages are limited to $5,000—the difference between the contract salary and the replacement salary.

The Lost Volume Problem.
A special issue arises when the nonbreaching party is a supplier of goods or services who enters a second contract after the first buyer repudiates. The question is whether the second contract is a substitute performance or an additional one.

Example: An automobile dealer contracts to sell a car. Before delivery, the buyer repudiates. The dealer then sells the same car to another buyer. If the dealer can show that he would have sold a car to the second buyer even if the first buyer had performed, then the second sale is not a substitute—it is additional. In that case, the dealer is entitled to recover the full expectation interest from the first buyer, since the breach deprived him of one sale.

The key inquiry in lost volume cases is whether the nonbreaching party would have made the second sale even if no breach had occurred.

Incidental Damages

In addition to compensatory damages, the nonbreaching party may also recover incidental damages. These are the reasonable costs and expenses incurred while attempting to minimize losses caused by the breach. They are tied to the nonbreaching party’s duty to mitigate damages.

Common examples include:

• Paying a premium to obtain substitute goods or services quickly,
• Covering brokerage fees or special charges to secure a new supplier,
• Incurring transportation, storage, or inspection costs for substitute goods,
• Spending extra money on advertising or recruiting to replace a lost contract or employee.

Illustration: Suppose a seller fails to deliver goods on time, forcing the buyer to purchase replacements from another source at higher shipping costs. The additional shipping charges are incidental damages. Similarly, if an employer breaches a contract, and the employee must spend money on travel or job-placement services to find a new position, those costs may be recovered as incidental damages.

Consequential Damages

A consequential loss is addressed with consequential damages (sometimes called special damages). These are damages that do not flow directly from the breach itself but arise from the particular circumstances of the nonbreaching party. Unlike incidental damages, they occur without any additional action by the nonbreaching party.

Examples include:

• Property damage: If Ralph installs plumbing incorrectly and the toilet leaks, damaging the floor, the downstairs ceiling, and the rug, he is liable for those additional losses.
• Lost profits: If a repair company fails to fix a manufacturer’s machine on time, and the manufacturer loses sales as a result, the repair company may be liable for those lost profits.
• Personal injury or property damage: If a seller provides a defective machine that injures the buyer or damages property, the seller may be responsible for those losses as consequential damages.

Foreseeability: Hadley v. Baxendale

The leading case on consequential damages is Hadley v. Baxendale (1854). In this case, the Hadleys operated a flour mill in England. Their mill’s crankshaft broke, and they hired Baxendale, a carrier, to transport the shaft to an engineer for repair. Baxendale negligently delayed delivery, and as a result, the mill was shut down for several days, causing the Hadleys to lose profits.

The Hadleys sued to recover their lost profits as damages. The court, however, limited recovery. It ruled that damages for breach of contract should be those that (1) arise naturally from the breach or (2) may reasonably be supposed to have been in the contemplation of both parties at the time of contracting. Because Baxendale had not been told that the mill would remain shut down until the shaft was returned, the lost profits were not foreseeable and thus not recoverable.

This case established the modern rule of foreseeability: consequential damages are only recoverable if they were foreseeable at the time the contract was made. If the special circumstances were not communicated, the breaching party cannot be held liable for extraordinary losses.

Modern Example

Imagine a retailer who orders 1,000 custom T-shirts from a manufacturer to resell at a major music festival. The festival is a one-time event, and the retailer clearly informs the manufacturer that timely delivery is essential. If the manufacturer delivers the shirts two weeks late—after the festival is over—the retailer cannot resell them and loses significant profits. Because the manufacturer was aware of the event and its timing, those lost profits are foreseeable consequential damages and may be recovered in court.

If, however, the retailer had not told the manufacturer about the festival, the lost profits would likely be considered too remote and unrecoverable—just like in Hadley v. Baxendale.

Exclusions

Not all costs associated with a breach are recoverable. A common example is legal expenses: the costs of suing to enforce the contract are generally not recoverable as damages unless the contract explicitly provides otherwise. However, when the breach forces the nonbreaching party into litigation with a third party, those legal expenses may be claimed as consequential damages.

Business Application

To protect themselves, businesses should communicate special circumstances in writing when entering into a contract. If timely delivery, resale at a specific event, or reliance on performance for downstream obligations is critical, stating this clearly ensures that consequential damages will be considered foreseeable—and therefore recoverable—if a breach occurs.

Nominal Damages

When there has been a breach but the nonbreaching party suffers no actual loss—or cannot prove the amount of the loss—the court may award nominal damages. The purpose is symbolic: to affirm that a legal right has been violated, even if no compensable harm occurred.

Example: Ricardo contracts to buy a new car from Dealer A. Dealer A breaches, but Ricardo immediately purchases the same car from Dealer B at the same price. Ricardo has suffered no measurable loss. A court may award him nominal damages of, say, $1 or $5 to recognize the breach.

Liquidated Damages

Because damages are sometimes difficult to calculate, parties may agree in advance on a sum to be paid in the event of a breach. These agreed-upon sums are called liquidated damages.

Courts will enforce liquidated damages provisions if two conditions are met:

1. The actual damages are difficult to ascertain at the time of contracting, and
2. The liquidated amount is a reasonable estimate of the expected or actual harm.

If the amount is unreasonably large, the provision is treated as a penalty and is unenforceable as against public policy.

Example: A concert promoter contracts with a musician, including a clause that the musician will pay $50,000 if she cancels within two weeks of the show. If the promoter can show that actual losses (lost ticket sales, advertising, staffing costs) are difficult to measure and that $50,000 is a reasonable forecast of likely losses, the clause will be enforced. If the clause demanded $1 million, a court would likely strike it down as a penalty.

Punitive Damages

Punitive damages are awarded not to compensate the injured party but to punish the breaching party for willful, malicious, or fraudulent conduct and to deter others from similar behavior.

Because the central purpose of contract law is compensation, not punishment, punitive damages are generally not available for breach of contract. There is one important exception: when the breach also constitutes a tort for which punitive damages are permitted.

Examples:

• A creditor holding collateral sells it to a third party even though the debtor is not in default. This act both breaches the loan contract and constitutes the tort of conversion. If the conduct was deliberate, punitive damages may be awarded.
• If a party fraudulently induces another into a contract and then breaches, punitive damages may be available under tort law principles of fraud.

Discretion of the Court. Punitive damages are not fixed by statute. The judge or jury determines an appropriate amount based on the seriousness of the conduct and the goal of deterrence. Because punitive damages are meant to sting, wealthy defendants may face higher awards than poorer ones. However, judges have the power to remit (reduce) punitive awards that are excessive or disproportionate.

KEY TAKEAWAY

As the purpose of contract remedies is, in general, to make the nonbreaching party whole, the law allows several types of damages (money paid) to reflect the losses suffered by the nonbreaching party. Compensatory damages compensate for the special loss suffered; consequential damages compensate for the foreseeable consequences of the breach; incidental damages compensate for the costs of keeping any more damages from occurring; nominal damages are awarded if the actual amount cannot be shown or there are no actual damages; liquidated damages are agreed to in advance where the actual amount is difficult to ascertain, and they are allowed if not a penalty; and punitive damages may sometimes be allowed if the breaching party’s behavior is an egregious tort, an outrage.

EXERCISES

1. What is the difference between a legal remedy and an equitable remedy?
2. What types of remedies are there, and what purpose does each serve?
3. What must be shown if liquidated damages are to be allowed?
4. Under what circumstances may punitive damages be allowed?