15.5: Limitations on Contract Remedies

LEARNING OBJECTIVES

1. Understand that there are various rules that limit recovery for the nonbreaching party in a contract case.
2. Know how these concepts serve to limit contract remedies: foreseeability, mitigation of damages, certainty of damages, loss of power of avoidance, election of remedies, and agreement of the parties.

Limitations on Remedies

The purpose of contract remedies is to place the nonbreaching party, as nearly as possible, in the position he or she would have occupied had the contract been performed. But remedies are not unlimited. Both legal and equitable remedies are subject to restrictions that ensure fairness, prevent double recovery, and maintain predictability in the law.

The principal limitations are: foreseeability, mitigation of damages, certainty of damages, loss of the power of avoidance, and election of remedies.

Foreseeability

Definition and Rule.
The doctrine of foreseeability operates as a limitation on consequential damages. Consequential damages—losses that do not flow directly from the breach but arise because of the nonbreaching party’s special circumstances—are recoverable only if they were reasonably foreseeable to the breaching party at the time of contracting.

This principle comes from the famous English case Hadley v. Baxendale (1854), which established that damages must either:

1. Arise naturally from the breach (the kind of loss that ordinarily results from such a breach), or
2. Have been within the contemplation of both parties at the time of contracting (special circumstances communicated to and understood by both).

Losses outside these categories are considered too remote and cannot be recovered.

Purpose of the Rule.
The foreseeability requirement serves to:

• Protect fairness. It prevents breaching parties from being blindsided by liability for extraordinary losses they could not have anticipated.
• Promote efficiency. It encourages contracting parties to disclose special circumstances so risks can be priced into the bargain or addressed with special terms.

Applications and Examples.

• General damages (direct). If a supplier fails to deliver materials on time and the buyer must purchase substitutes at a higher price, the increased cost is a direct and foreseeable loss.
• Consequential damages (special). If the supplier’s failure causes the buyer’s factory to shut down and lose profits, those losses are recoverable only if the supplier knew, at the time of contracting, that timely delivery was critical to production.
• Case example – Hadley v. Baxendale. The carrier delayed in delivering a broken mill shaft for repair. The mill lost profits while shut down, but the court denied recovery because the carrier had not been told that the mill would remain idle until the shaft was returned.

Modern Applications.
Courts still apply Hadley’s rule today, distinguishing between:

• Direct damages: Always recoverable if proven (e.g., cost of cover, lost contract price).
• Consequential damages: Recoverable only if foreseeable at the time of contracting.

Example: A software vendor breaches a contract to deliver a program on time. The buyer claims lost profits from a missed product launch. Unless the vendor knew about the launch and its importance, those profits are not recoverable as consequential damages.

Limitations.

• Foreseeability is assessed at the time of contracting, not at the time of breach.
• The burden of proof is on the nonbreaching party to show that the damages were foreseeable.
• Even foreseeable consequential damages may be denied if they are speculative (tying foreseeability to the certainty doctrine).

Summary.
The doctrine of foreseeability is the central limitation on consequential damages. It ensures that recovery is limited to losses the breaching party could reasonably have anticipated, balancing fairness to the breaching party with protection for the injured party’s legitimate expectations.

Mitigation of Damages

Definition and Rule.
The doctrine of mitigation requires that the nonbreaching party take reasonable steps to reduce or avoid further loss resulting from the breach. The law will not permit damages to accumulate needlessly when the injured party could have reasonably minimized the harm. If the nonbreaching party fails to mitigate, the damages recoverable will be reduced accordingly.

Purpose of the Rule.

• Fairness. It prevents the injured party from recovering losses that could have been avoided with reasonable effort.
• Efficiency. It encourages both parties to act in a commercially reasonable manner after breach, reducing waste and discouraging strategic behavior.

Applications in Contract Law.

1. Employment contracts. If an employee is wrongfully discharged, he must make reasonable efforts to find comparable employment. If he refuses a substantially similar job, the wages he could have earned are deducted from his damages.
2. Sales of goods. Under the Uniform Commercial Code, a buyer whose seller fails to deliver goods must attempt to “cover” by purchasing substitute goods at a reasonable price. Similarly, a seller whose buyer repudiates must attempt to resell the goods to another purchaser.
3. Construction contracts. If an owner breaches by refusing to allow construction to proceed, the contractor must stop work and avoid unnecessary expenses; continued performance after repudiation cannot be charged to the breaching party.

Examples.

• Employment: Alice is wrongfully fired from her $50,000/year job. She quickly finds similar employment at $45,000/year. Her damages are $5,000—the difference between the contracts—rather than the full $50,000.
• Goods: A buyer contracts to purchase grain at $2 per bushel. The seller repudiates, and the buyer reasonably covers by purchasing from another supplier at $2.20 per bushel. The buyer can recover the $0.20 difference per bushel as damages. If the buyer made no effort to cover despite available alternatives, damages might be limited.
• Construction: A contractor is hired to build a house. Midway through, the owner repudiates. The contractor cannot continue construction and claim the full contract price; instead, he must stop work and seek damages for the work performed and lost profits.

Limitations.

• The nonbreaching party must act reasonably, not perfectly. The law does not require extraordinary effort, excessive expense, or undue risk.
• The duty to mitigate does not require the injured party to accept employment or substitute performance that is inferior or substantially different.
• What counts as “reasonable” is judged case by case, in light of industry standards and practical realities.

Connection to Damages.

• Compensatory damages are reduced by the amount of loss avoided through reasonable mitigation.
• Incidental damages (such as expenses in arranging substitute goods or services) are recoverable precisely because they are part of the mitigation process.

Summary.
The mitigation doctrine limits damages by requiring the nonbreaching party to take reasonable steps to reduce the harm from breach. It balances the right to be compensated with the obligation to avoid unnecessary loss.

Certainty of Damages

Definition and Rule.
Damages for breach of contract must be proven with reasonable certainty. Courts will not award damages that are speculative, conjectural, or based on guesswork. The nonbreaching party bears the burden of showing, with reliable evidence, the existence and extent of the loss.

This rule does not require mathematical precision but does require a solid factual basis. If damages cannot be measured with sufficient certainty, the claim will fail.

Purpose of the Rule.

• Fairness. Prevents breaching parties from being saddled with excessive or imaginary liability.
• Predictability. Ensures that contract damages are grounded in evidence and can be reasonably anticipated.
• Encouragement of recordkeeping. Incentivizes parties to document performance, expenses, and profits so that losses can be proven if breach occurs.

Applications in Contract Law.

1. Lost profits of established businesses. Courts may award lost profits where the business has a reliable track record and records to prove what profits would have been.
2. Lost profits of new businesses. Traditionally, courts refused to award lost profits for new ventures, viewing them as too speculative. Modern courts sometimes allow recovery if the plaintiff can present credible market data, expert testimony, or evidence of comparable businesses.
3. Service contracts. Damages for loss of unique services are recoverable if the value of those services can be reasonably measured (e.g., the cost to hire a substitute performer).

Examples.

• Established business: A clothing retailer contracts with a supplier for holiday merchandise. The supplier breaches. The retailer can prove, based on past years’ records, that holiday sales would have generated $50,000 in profits. Those profits are recoverable as damages.
• New business: A startup restaurant sues for lost profits when its supplier fails to deliver equipment on time. Without a sales history, damages may be denied as speculative—unless the owner can present reliable market studies or evidence of comparable restaurants.
• Speculative claims denied: A software developer claims $5 million in “brand recognition losses” after a contract breach but provides no reliable measure of such losses. The claim would be rejected under the certainty doctrine.

Limitations.

• Courts draw a line between uncertain damages (where the fact of damage cannot be proven) and uncertain amounts (where the fact of damage is clear, but the exact sum is difficult to calculate). Only the former bars recovery.
• Where damages are clearly established but hard to calculate precisely, courts often allow recovery of a reasonable estimate based on available evidence.

Loss of Power of Avoidance

Definition and Rule.
The remedy of rescission (or avoidance) allows a party to cancel a contract and be restored to their precontract position. However, the power to avoid a contract can be lost if the injured party, after learning of the grounds for avoidance, affirms the contract, delays too long, acts inconsistently with avoidance, or if third-party rights intervene. Once the power of avoidance is lost, the party is limited to other remedies, such as damages.

Purpose of the Rule.

• Fairness. Prevents a party from holding the contract in suspense, deciding later whether to affirm or avoid based on changing circumstances.
• Certainty and stability. Ensures that contracts are either enforced or set aside in a timely manner, giving both parties clarity about their obligations.
• Protection against opportunism. Stops an injured party from reaping benefits under the contract and then later attempting to avoid it when convenient.

Ways the Power of Avoidance May Be Lost.

1. Affirmation or ratification. If the injured party continues to perform, accepts benefits, or otherwise indicates intent to abide by the contract after discovering grounds for rescission, the right to avoid is lost.
2. Unreasonable delay. A party who waits too long to exercise avoidance may be deemed to have elected to affirm.
3. Acts inconsistent with avoidance. Taking actions inconsistent with rescission—such as reselling goods or substantially altering them—can extinguish the power to avoid.
4. Intervening rights of third parties. If property passes into the hands of an innocent third party, the right to avoid may be cut off.

Examples.

• Fraudulent inducement: A buyer discovers misrepresentation but resells the goods rather than rescinding. By affirming, the buyer loses the right to avoid.
• Minor’s contract: Michelle, age 17, sells her watch to Betty Buyer. Upon reaching majority, Michelle ordinarily could disaffirm. But if Betty sells the watch to an innocent third party before Michelle disaffirms, Michelle cannot recover it from the third party.
• Bad check: Salvador sells his car to Bill Buyer, who pays with a bad check. If the check bounces, Salvador could rescind by returning the check and reclaiming the car. But if Bill sells the car to Pat Purchaser before the check bounces, Salvador cannot reclaim it from Pat, who acquired good title. (Some exceptions apply, but the general rule protects innocent third-party purchasers.)
• Delay in rescission: A party induced into a contract by duress waits years before seeking rescission. The delay bars avoidance.

Limitations.

• Courts require rescission to be sought promptly once grounds are known.
• Rescission may be denied under the clean hands doctrine if the party seeking it has acted inequitably.
• Intervening third-party rights often cut off avoidance, especially where the third party is a good-faith purchaser for value.

Election of Remedies

Definition.
The doctrine of election of remedies addresses situations in which the nonbreaching party may appear to have two or more remedies available for the same breach. Where those remedies are mutually exclusive, the law may require the injured party to choose one and forgo the others.

Purpose.
At its core, the doctrine seeks to prevent double recovery—that is, compensating the injured party more than once for the same loss.

At Common Law

Traditionally, common law courts applied the doctrine of election of remedies strictly. A defrauded party was required to elect promptly upon discovering the fraud.

• Rule. The defrauded party could either:
  1. Rescind the contract, returning both parties to their precontract position, or
  2. Affirm the contract and seek damages for the fraudulent misrepresentation.

But the party could not do both.

• Example: Buyer purchases real estate from Seller for $300,000. Seller fraudulently represents that water is available. Buyer spends $60,000 drilling wells before giving up and sues Seller for $360,000 (return of purchase price plus drilling costs). Under the traditional rule, Buyer would not recover the $360,000 because rescission should have been elected upon discovery of fraud. Instead, Buyer could recover only $60,000 in damages (Merritt v. Craig, 746 A.2d 923 (Md. 2000)).
• Criticism. The doctrine has been widely criticized as overly rigid. Courts and commentators argue that it focuses too much on labels and technicalities, sometimes undercompensating victims while protecting wrongdoers. As one court put it:

  “A host of commentators support elimination of the election of remedies doctrine. A common theme is that the doctrine substitutes labels and formalism for inquiry into whether double recovery results in fact. The rigid doctrine goes to the other extreme, actually resulting in the under compensation of fraud victims and the protection of undeserving wrongdoers.”
  — Head & Seemann, Inc. v. Gregg, 311 N.W.2d 667 (Wis. App. 1981).

Under the UCC

The Uniform Commercial Code (UCC) rejects the strict election of remedies doctrine. Instead, remedies are cumulative, meaning that a nonbreaching party may pursue multiple remedies so long as they do not result in double recovery.

• Section 2-703(1): “Whether the pursuit of one remedy bars another depends entirely on the facts of the individual case.”
• Section 2-721: Specifically provides that in cases of fraud, neither rescission of the contract, nor return or rejection of goods, bars a claim for damages or other remedies permitted under the UCC.

Application: A buyer may rescind a fraudulent sales contract, return the goods, and still pursue damages for losses caused by the fraud. The flexibility of the UCC reflects a modern approach that prioritizes fairness over formalism.

Tort versus Contract

Sometimes the same conduct gives rise to both a breach of contract claim and a tort claim. In these cases, the injured party may face a practical choice between suing in tort or contract.

Considerations include:

1. Statute of limitations. Contract actions often have longer limitation periods than tort actions.
2. Allowable damages. Tort claims may permit punitive damages or compensation for pain and suffering, which are generally unavailable in contract.
3. Expert testimony. In some contract cases, expert testimony may be unnecessary, while it would be required in a tort action.
4. Insurance coverage. Insurance policies typically exclude intentional torts. Framing a claim in contract may increase the likelihood of recovery under the breaching party’s insurance.

Example: A physician promises that surgery will be risk-free but performs negligently, scarring the patient. The patient could sue in tort (medical malpractice) or in contract (breach of warranty). The choice may depend on the kinds of damages sought, the statute of limitations, and insurance coverage.

Legal versus Extralegal Remedies

Finally, even where legal remedies are available, parties may elect not to pursue them in court. Litigation can be disruptive, expensive, and damaging to ongoing relationships, especially in commercial contexts. Businesspeople often prefer to settle disputes privately, renegotiate contracts, or even overlook smaller breaches rather than bring suit.

The decision whether to sue is ultimately strategic and personal, balancing legal rights with practical, financial, and relational considerations. Lawyers may advise, but clients decide.

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KEY TAKEAWAY

There are several limitations on the right of an aggrieved party to get contract remedies for a breach besides any limitations fairly agreed to by the parties. The damages suffered by the nonbreaching party must be reasonably foreseeable. The nonbreaching party must make a reasonable effort to mitigate damages, or the amount awarded will be reduced by the damages that could have been avoided. The party seeking damages must be able to explain within reason how much loss he has suffered as a result of the breach. If he cannot articulate with any degree of certainty—if the damages are really speculative—he will be entitled to nominal damages and that’s all. There are circumstances in which a party who could have got out of a contractual obligation—avoided it—loses the power to do so, and her remedy of avoidance is lost. Not infrequently, a person will enter into a contract for services or goods that contains a limitation on her right to damages in case the other side breaches. That’s all right unless the limitation is unconscionable. Sometimes parties are required to make an election of remedies: to choose among two or more possible bases of recovery. If the remedies are really mutually exclusive and one is chosen, the aggrieved party loses the right to pursue the others. And of course a person is always free not to pursue any remedy at all for breach of contract; that may be strategically or economically smart in some circumstances.

EXERCISES

1. When one party to a contract breaches, what duty, if any, is then imposed on the other party?
2. A chef who has never owned her own restaurant sues a contractor who failed to finish building the chef’s first restaurant on time. She presents evidence of the profits made by similar restaurants that have been in business for some time. Is this good evidence of the damages she has suffered by the delay? To what damages is she entitled?
3. Rebecca, seventeen years and ten months old, buys a party dress for $300. She wears it to the junior prom but determines it doesn’t look good on her. She puts it in her closet and forgets about it until six months later, when she decides to return it to the store. Is she now entitled to the remedy of rescission?
4. What is the difference between rescission and restitution?
5. Why are parties sometimes required to make an election of remedies?