Chapter 14 – Remedies
14.3 Legal Remedies: Damages
Damages are a common legal remedy used to compensate the non-breaching party for the harm caused by the breach. The aim of awarding damages is to put the injured party in the position they would have been in if the contract had been performed, insofar as money can accomplish this. The promisee, also called the non-breaching party, has the right to damages (a money award) in a breach of contract action if that is required to make her whole, unless the contract itself or other circumstances suspend or discharge that right. Six types of damages are discussed below.
Compensatory Damages
Compensatory damages are damages paid (i.e. money) to directly compensate the non-breaching party for the value of what was not done or not performed under the contract. Compensatory damages are based on the expectation interest and aim to put the non-breaching party in the position they would have been in if the contract had been performed as promised. In other words, compensatory damages are calculated to cover the actual financial loss suffered by the non-breaching party due to the breach of contract. For example, if you hired someone to paint a room in your house for $500, and that person breached the contract, your damages would be the difference between $500 and the cost of the replacement painter. If the new painter got $750, then damages would be $250. Yet, the calculation is frequently difficult, especially when the performance is a service that is not easily duplicated. If Rembrandt breached a contract to paint your portrait, the loss could not be measured simply by inquiring how much Van Gogh would charge to do the same thing. Nevertheless, in theory, whatever net value would ultimately have been conferred on the non-breaching party is the proper measure of compensatory damages.
Since the non-breaching party usually has obligations under the contract also, a breach by the other party discharges his duty to perform and may result in savings. Or he may have made substitute arrangements and realized at least a partial profit on the substitution (because the substitution cost less). Or, as in the case of the builder, he may have purchased goods intended for the job that can be used elsewhere. In all these situations, the losses avoided—savings, profits, or value of goods—are subtracted from the losses incurred to arrive at the net damages. The non-breaching party may recover his actual losses, not more. Suppose an employer breaches a contract with a prospective employee who was to begin work for a year at a salary of $35,000. The employee quickly finds other, similar work at a salary of $30,000. Aside from whatever he might have had to spend searching for the job (incidental damages), his compensatory damages are limited to $5,000, the difference between what he would have earned and what he is earning.
Lost volume can be a troublesome problem in calculating damages. This problem arises when the non-breaching party, a supplier of goods or services, enters a second contract when the buyer repudiates. The question is whether the second contract is a substituted performance or an additional one. If it is substituted, damages may be little or nothing; if additional, the entire expectation interest may be recovered. For example, an automobile dealer contracts to sell a car in inventory. Shortly before the deal is closed, the buyer calls up and repudiates the contract. The dealer then sells the car to someone else. If the dealer can show that he could have sold an identical car to the second purchaser regardless of what the first purchaser did, then the second sale stands on its own and cannot be used to offset the net profit recoverable from the first purchaser. The factual inquiry in lost volume cases is whether the non-breaching party would have engaged in the second transaction if the breach had never occurred.
Incidental Damages
In addition to compensatory damages, the non-breaching party may recover incidental damages. Incidental loss includes expenditures that the non-breaching party incurs in attempting to minimize the loss that flows from the breach. Incidental damages are the direct and immediate costs incurred as a result of a breach of contract. Examples of incidental damages may include expenses related to finding a replacement for the non-performing party, such as additional shipping costs, storage fees, or travel expenses. To arrange for substitute goods or services, the non-breaching party might have to pay a premium or special fee to locate another supplier or source of work. These premiums or fees are part of the damages calculation.
Consequential Damages
Consequential damages are damages that are not directly caused by the breach, but rather arise as a consequence of the breach. They are typically more remote and indirect than incidental damages. Consequential damages may include lost profits, lost business opportunities, and other economic losses that result from the non-performance of a contract. The key difference between incidental and consequential damages is the degree of proximity between the damage and the breach. Incidental damages are more closely connected to the breach and are therefore easier to quantify, while consequential damages are more remote and may be more difficult to calculate. These are damages incurred by the non-breaching party without action on his part because of the breach. Consequential damages are also sometimes referred to as indirect or special damages.
Consider an example of a business that contracts with a shipping company to deliver goods to its customers. The shipping company fails to deliver the goods to customers on time, and as a result, the business incurs losses. In this scenario, incidental damages might include the cost to the business of storing the goods while waiting for them to be picked up and delivered by the shipping company, or the cost of hiring another shipping company to deliver the goods instead. Consequential damages, on the other hand, might include the lost profits the company suffered as a result of the delayed delivery, or the cost of losing customers who were unhappy with the late delivery and decided to take their business elsewhere. So, incidental damages are the direct costs incurred as a result of the breach, such as storage or shipping fees, while consequential damages are the indirect losses that result from the breach, such as lost profits or lost business opportunities.
Foreseeability is an important factor in determining whether consequential damages are recoverable in a legal case. In general, a party can only recover consequential damages that were foreseeable at the time the contract was entered into. If the consequential damages were not foreseeable at the time of the contract, then they may not be recoverable. For example, if the shipping company in the example above failed to deliver goods on time and, as a result, the business lost a major client, the lost profits from that client might be recoverable if it was foreseeable that the late delivery could lead to the business suffering the loss of the client. On the other hand, if the loss of the major client was not foreseeable at the time of the contract, then the damages associated with this loss would not be recovered as consequential damages. In sum, if the damages were foreseeable, then they may be recoverable, but if they were not foreseeable, then they may not be recoverable.
Case 14.1
EBWS, LLC v. Britly Corp., 928 A.2d 497 (Vt. 2007)
REIBER, C.J.
The Ransom family owns Rock Bottom Farm in Strafford, Vermont, where Earl Ransom owns a dairy herd and operates an organic dairy farm. In 2000, the Ransoms decided to build a creamery on-site to process their milk and formed EBWS, LLC to operate the dairy-processing plant and to market the plant’s products. In July 2000, Earl Ransom, on behalf of EBWS, met with Britly’s president to discuss building the creamery.…In January 2001, EBWS and Britly entered into a contract requiring Britly to construct a creamery building for EBWS in exchange for $160,318.…The creamery was substantially completed by April 15, 2001, and EBWS moved in soon afterward. On June 5, 2001, EBWS notified Britly of alleged defects in construction. [EBWS continued to use the creamery pending the necessity to vacate it for three weeks when repairs were commenced].
On September 12, 2001, EBWS filed suit against Britly for damages resulting from defective design and construction.…
Following a three-day trial, the jury found Britly had breached the contract and its express warranty, and awarded EBWS: (1) $38,020 in direct damages, and (2) $35,711 in consequential damages.…
…The jury’s award to EBWS included compensation for both direct and consequential damages that EBWS claimed it would incur while the facility closed for repairs. Direct damages [i.e., compensatory damages] are for “losses that naturally and usually flow from the breach itself,” and it is not necessary that the parties actually considered these damages. [Citation]. In comparison, special or consequential damages “must pass the tests of causation, certainty and foreseeability, and, in addition, be reasonably supposed to have been in the contemplation of both parties at the time they made the contract.”
…The court ruled that EBWS could not recover for lost profits because it was not a going concern at the time the contract was entered into, and profits were too speculative. The court concluded, however, that EBWS could submit evidence of other business losses, including future payment for unused milk and staff wages.…
At trial, Huyffer, the CEO of EBWS, testified that during a repairs closure the creamery would be required to purchase milk from adjacent Rock Bottom Farm, even though it could not process this milk. She admitted that such a requirement was self-imposed as there was no written output contract between EBWS and the farm to buy milk. In addition, Huyffer testified that EBWS would pay its employees during the closure even though EBWS has no written contract to pay its employees when they are not working. The trial court allowed these elements of damages to be submitted to the jury, and the jury awarded EBWS consequential damages for unused milk and staff wages.
On appeal, Britly contends that because there is no contractual or legal obligation for EBWS to purchase milk or pay its employees, these are not foreseeable damages. EBWS counters that it is common knowledge that cows continue to produce milk, even if the processing plant is not working, and thus it is foreseeable that this loss would occur. We conclude that these damages are not the foreseeable result of Britly’s breach of the construction contract and reverse the award.…
[W]e conclude that…it is not reasonable to expect Britly to foresee that its failure to perform under the contract would result in this type of damages. While we are sympathetic to EBWS’s contention that the cows continue to produce milk, even when the plant is closed down, this fact alone is not enough to demonstrate that buying and dumping milk is a foreseeable result of Britly’s breach of the construction contract. Here, the milk was produced by a separate and distinct entity, Rock Bottom Farm, which sold the milk to EBWS.…
Similarly, EBWS maintained no employment agreements with its employees obligating it to pay wages during periods of closure for repairs, dips in market demand, or for any other reason. Any losses EBWS might suffer in the future because it chooses to pay its employees during a plant closure for repairs would be a voluntary expense and not in Britly’s contemplation at the time it entered the construction contract. It is not reasonable to expect Britly to foresee losses incurred as a result of agreements that are informal in nature and carry no legal obligation on EBWS to perform. “[P]arties are not presumed to know the condition of each other’s affairs nor to take into account contracts with a third party that is not communicated.” [Citation] While it is true that EBWS may have business reasons to pay its employees even without a contractual obligation, for example, to ensure employee loyalty, no evidence was introduced at trial by EBWS to support a sound rationale for such considerations. Under these circumstances, this business decision is beyond the scope of what Britly could have reasonably foreseen as damages for its breach of contract.…
In addition, the actual costs of the wages and milk are uncertain.…[T]he the milk and wages here are future expenses, for which no legal obligation was assumed by EBWS, and which are separate from the terms of the parties’ contract. We note that at the time of the construction contract EBWS had not yet begun to operate as a creamery and had no history of buying milk or paying employees. See [Citation] (explaining that profits for a new business are uncertain and speculative and not recoverable). Thus, both the cost of the milk and the number and amount of wages of future employees that EBWS might pay in the event of a plant closure for repairs are uncertain.
Award for consequential damages is reversed.…
Case questions
- Why, according to EBWS’s CEO, would EBWS be required to purchase milk from adjacent Rock Bottom Farm, even though it could not process this milk?
- Surely it is well known in Vermont dairy country that dairy farmers can’t simply stop milking cows when no processing plant is available to take the milk—the cows will soon stop producing. Why was EBWS then not entitled to those damages which it will certainly suffer when the creamery is down for repairs?
- Britly (the contractor) must have known EBWS had employees that would be idled when the creamery shut down for repairs. Why was it not liable for their lost wages?
- What could EBWS have done at the time of contracting to protect itself against the damages it would incur in the event the creamery suffered downtime due to faulty construction?
Nominal Damages
Nominal damages are symbolic in nature and are awarded when a contract has been technically breached, but no actual loss has been suffered by the non-breaching party. These damages are typically a small amount, such as $1, and serve as recognition that a breach occurred even though it did not result in significant harm. In a case where there has been a breach of contract, courts can award nominal damages when the losses associated with the damages are trivial or when losses associated with the damages are speculative and cannot be proven.
In the shipping contract situation above, if the delay in the delivery of the shipped goods did not result in any quantifiable loss to the business, a court may award nominal damages. This would be a very small symbolic amount that would reflect that the business was wronged by the shipping company’s breach of their contract. Nominal damages might also be awarded if the business is unable to provide evidence of the exact amount of damages it suffered as a result of the delayed delivery of the goods by the shipping company. The court may find that the damages suffered by the company are speculative and therefore uncertain. Damages are speculative when it is difficult to quantify the exact financial harm suffered by the non-breaching party, or when it is unclear whether the damages claimed can be directly attributed to the breach of contract. So, the court might award nominal damages to reflect that the business was wronged but could not prove precisely how it incurred damages.
Liquidated Damages
Liquidated damages refer to a predetermined amount of money that a party agrees to pay in the event of a breach of contract. This amount is typically agreed upon and specified in the contract at the time the contract is formed. Liquidated damages are often used in contracts where it may be difficult to calculate the actual damages that would result from a breach of contract. Liquidated damages may also be used in situations where it makes more sense to designate an amount of damages in advance of a breach, as a way to minimize disputes over damages and potential litigation between contracting parties. It’s important to note that the liquidated damages clause must be reasonable and proportional to the harm that may result from a breach, or it may be deemed unenforceable by a court. Liquidated damages cannot be used to punish a party for breaching by requiring the payment of damages far in excess of what the law would otherwise allow. In our shipping company example, the contract could specify that the shipping company must pay the business $100 for every day beyond the agreed-upon delivery date that the goods remain undelivered. That means if the goods are delivered three days late, the shipping company would have to pay the company $300 in liquidated damages. If you have a cell phone contract, you likely have a liquidated damages clause in that contract, which you might be calling an ‘early termination fee.’ Courts will enforce a liquidated damages provision as long as the actual amount of damages is difficult to ascertain and the sum is reasonable in light of the expected or actual harm. If the liquidated sum is unreasonably large, the excess is termed a penalty and is said to be against public policy and unenforceable.
Once again, we see that a Verizon Wireless™ service agreement includes a liquidated damages clause:
If your line of service has a contract term and you cancel that line, or if we cancel it for good cause, during that contract term, you’ll have to pay an early termination fee. If your contract term results from your purchase of an advanced device, your early termination fee will be $350, which will decline by $10 per month upon completion of months 7–17, $20 per month upon completion of months 18–22, $60 upon completion of month 23 and will be $0 upon completion of the contract term. For other contract terms, your early termination fee will be $175, which will decline by $5 per month upon completion of months 7–17, $10 per month upon completion of months 18–22, $30 upon completion of month 23 and will be $0 upon completion of your contract term.
Case 14.2
Watson v. Ingram, 881 P.2d 247 (Wash. 1994)
JOHNSON, J.
…In the summer of 1990, Wayne Watson offered to buy James Ingram’s Bellingham home for $355,000, with a $15,000 [about $36,500 in 2024 dollars] earnest money deposit.…
Under the agreement, the entire amount of the purchase price was due in cash on or before December 3, 1990.…The agreement required Watson to pay a $15,000 earnest money deposit into escrow at Kelstrup Realty, and provided that “[i]n the event of default by Buyer, earnest money shall be forfeited to Seller as liquidated damages, unless Seller elects to seek actual damages or specific performance. Lastly, the agreement contained a provision entitled “BUYER’S REPRESENTATIONS,” which stated, “Buyer represents that buyer has sufficient funds available to close this sale in accordance with this agreement, and is not relying on any contingent source of funds unless otherwise set forth in this agreement”.…
On November 10, 1990, Watson sent a written proposal to Ingram seeking to modify the original agreement. The proposed modification would have allowed Watson to defer paying $54,000 of the $355,000 sale price for between 6 and 12 months after the scheduled December closing date. In exchange, Ingram would receive a second lien position on certain real estate Watson owned.
According to Ingram, the November 10 proposal was the first time he realized Watson did not have financing readily available for the purchase of the house. Ingram notified Watson on November 12, 1990, that he would not agree to modify the original agreement and intended to strictly enforce its terms. Ingram was involved in a child custody suit in California and wanted to move to that state as soon as possible.…[Further efforts by Ingram to sell to third parties and by Watson to get an extension from Ingram failed.]
In September 1991, Ingram finally sold the house to a third party for $355,000, the same price that Watson had agreed to pay in December 1990.
Ingram and Watson each sought to recover Watson’s $15,000 earnest money held in escrow. On December 4, 1990, Ingram wrote to Kelstrup Realty, indicating he was entitled to the $15,000 earnest money in escrow because Watson had defaulted. In January 1991, Watson filed this action to recover the earnest money, alleging it amounted to a penalty and Ingram had suffered no actual damages.…
The trial court found the earnest money “was clearly intended by both parties to be non-refundable” if Watson defaulted and determined $15,000 was “a reasonable forecast by [Ingram and Watson] of damages that would be incurred by [Ingram] if [Watson] failed to complete the purchase”. The court entered judgment in favor of Ingram for the amount of the earnest money plus interest. The court also awarded Ingram his attorney fees pursuant to the parties’ agreement. The Court of Appeals, Division One, affirmed. Watson now appeals to this court.
This case presents a single issue for review: whether the parties’ contract provision requiring Watson to forfeit a $15,000 nonrefundable earnest money deposit is enforceable as liquidated damages. Liquidated damages clauses are favored in Washington, and courts will uphold them if the sums involved do not amount to a penalty or are otherwise unlawful. [Citation] To determine whether liquidated damages clauses are enforceable, Washington courts have applied a 2-part test from the Restatement of Contracts.…Liquidated damages clauses are upheld if the following two factors are satisfied:
First, the amount fixed must be a reasonable forecast of just compensation for the harm that is caused by the breach. Second, the harm must be such that it is incapable or very difficult of ascertainment.
The question before this court is whether this test is to be applied as of the time of contract formation (prospectively) or as of the time of trial (retrospectively). We have previously held, the “[r]easonableness of the forecast will be judged as of the time the contract was entered”. [Citations]
In contrast, a prior Division One opinion relied upon by Petitioner held the reasonableness of the estimate of damages and the difficulty of ascertainment of harm should be measured as of the time of trial, and earnest money agreements should not be enforceable as liquidated damages if the non-breaching party does not suffer actual damage. [Citations]
We…adopt the date of contract formation as the proper timeframe for evaluating the Restatement test. The prospective approach concentrates on whether the liquidated sum represents a reasonable prediction of the harm to the seller if the buyer breaches the agreement, and ignores actual damages except as evidence of the reasonableness of the estimate of potential damage.
We believe this approach better fulfills the underlying purposes of liquidated damages clauses and gives greater weight to the parties’ expectations. Liquidated damages permit parties to allocate business and litigation risks. Even if the estimates of damages are not exact, parties can allocate and quantify those risks and can negotiate adjustments to the contract price in light of the allocated risks. Under the prospective approach, courts will enforce the parties’ allocation of risk so long as the forecasts appear reasonable when made. [Citations]
In addition to permitting parties to allocate risks, liquidated damages provisions lend certainty to the parties’ agreements and permit parties to resolve disputes efficiently in the event of a breach. Rather than litigating the amount of actual damages, the non-breaching party must only establish the reasonableness of the agreement. The prospective approach permits parties to rely on their stipulated amounts without having to precisely establish damages at trial. In contrast, if the reasonableness of the amount is judged retrospectively, against the damage actually suffered, the “parties must fully litigate (at great expense and delay) that which they sought not to litigate.” [Citation].
Petitioner argues the prospective approach treats buyers unfairly because it permits sellers to retain earnest money deposits even when the seller suffers no actual damage, and this violates the principle that contract damages should be compensatory only. He further contends that by evaluating parties’ liquidated damages agreements against actual damages established at trial, courts can most effectively determine whether such agreements were reasonable and fair.
We disagree. As this court has previously explained, “[w]e are loath to interfere with the rights of parties to contract as they please between themselves [Citations] It is not the role of the court to enforce contracts so as to produce the most equitable result. The parties themselves know best what motivations and considerations influenced their bargaining, and, while, “[t]he bargain may be an unfortunate one for the delinquent party,…it is not the duty of courts of common law to relieve parties from the consequences of their own improvidence…” [Citations]
The retrospective approach fails to give proper weight to the parties’ negotiations. At the time of contract formation, unpredictable market fluctuations and variations in possible breaches make it nearly impossible for contracting parties to predict “precisely or within a narrow range the amount of damages that would flow from breach.” [Citations]. However, against this backdrop of uncertainty, the negotiated liquidated damages sum represents the parties’ best estimate of the value of the breach and permits the parties to allocate and incorporate these risks in their negotiations. Under the prospective approach, a court will uphold the parties’ agreed upon liquidated sum so long as the amount represents a reasonable attempt to compensate the non-breaching party. On the other hand, if the reasonableness of a liquidated damages provision is evaluated under a retrospective approach, the parties cannot confidently rely on their agreement because the liquidated sum will not be enforced if, at trial, it is not a close approximation of the damage suffered or if no actual damages are proved.…
Having adopted the date of contract formation as the proper timeframe for evaluating the Restatement test, the Restatement’s second requirement loses independent significance. The central inquiry is whether the specified liquidated damages were reasonable at the time of contract formation.…
We also agree with the Court of Appeals that in the context of real estate agreements, a requirement that damages be difficult to prove at trial would undermine the very purposes of the liquidated damage provision: “certainty, assurance that the contract will be performed, and avoidance of litigation”. [Citation] It would “encourage litigation in virtually every case in which the sale did not close, regardless of whether the earnest money deposit was a reasonable estimate of the seller’s damages.” [Citation]
In sum, so long as the agreed upon earnest money agreement, viewed prospectively, is a reasonable prediction of potential damage suffered by the seller, the agreement should be enforced “without regard to the retrospective calculation of actual damages or the ease with which they may be proved”. The prospective difficulty of estimating potential damage is a factor to be used in assessing the reasonableness of the earnest money agreement…
The decision of the Court of Appeals is affirmed.
Case questions
- What does the court here mean when it says that liquidated damages clauses allow the parties to “allocate and incorporate the risks [of the transaction] in their negotiations”?
- Why is it relevant that the plaintiff Ingram was engaged in a child-custody dispute and wanted to move to California as soon as possible?
- What, in plain language, is the issue here?
- How does the court’s resolution of the issue seem to the court the better analysis?
- Why did the plaintiff get to keep the $15,000 when he really suffered no damages?
- Express the controlling rule of law out of this case.
Punitive Damages
Punitive damages are those awarded for the purpose of punishing a defendant in a civil action. These damages are meant to punish the breaching party for their behavior rather than to compensate the injured party. They are proper in cases in which the defendant has acted willfully and maliciously and are thought to deter others from acting similarly. Punitive damages are more common in cases of intentional torts (civil wrongs) rather than breach of contract. Since the purpose of contract law is compensation, not punishment, punitive damages have not traditionally been awarded, with one exception—when the breach of contract is also a tort for which punitive damages may be recovered. Punitive damages typically awarded in tort claims when the tortfeasor’s behavior is malicious or willful (reckless conduct causing physical harm, deliberate defamation of one’s character, a knowingly unlawful taking of someone’s property), and some kinds of contract breach are also tortious. For example, when a creditor holding collateral as security under a contract for a loan sells the collateral to a good-faith purchaser for value even though the debtor was not in default, he has breached the contract and committed the tort of conversion; punitive damages may be awarded, assuming the behavior was willful and not merely mistaken. But in the shipping company example that we’ve used throughout this section, punitive damages would not be available absent some indication of willfully tortious conduct on the part of the shipping company.
Punitive damages are not fixed by law. The judge or jury may award at its discretion whatever sum is believed necessary to redress the wrong or deter like conduct in the future. This means that a richer person may be slapped with much heavier punitive damages than a poorer one in the appropriate case. But the judge in all cases may remit (reduce) some or all of a punitive damage award if he or she considers it excessive.
Activity 14B
Debate
Punitive damages are rarely available in breach of contract actions. Because contract breaches often result due to sound business decisions, contract law focuses on compensatory rather than punitive remedies. But not everyone that enters a contract is a business making a business decision. Sometimes, contracting is personal. Take, for example, a couple planning a wedding reception that contracts with their dream venue. While the original couple has the date and event secured by a contract, a celebrity contacts the venue looking for the same date, but will only book if no other events are held at the venue so as to secure privacy. The celebrity offers to pay well more than the original couple is able to pay. The venue breaches the contract with the original couple. The venue knows it will only pay compensatory damages and will be able to do so easily with the extra income from the celebrity event. The couple, on the other hand, has now been thrust into an incredibly stressful situation as they were counting on having their reception already planned. Now, they have to explore alternatives, inform their guests, re-plan the day to fit the new venue, and perhaps will have their event at a location they do not love. This is not an arm’s length transaction from the vantage point of the couple.
- Should punitive damages be made available in contract actions more frequently? If so, what legal standards should be applied to the availability of punitive damages.
- Should the law be more focused on discouraging breach and if so would allowing for punitive damages be a step in the right direction?
- Are there other reforms that you would recommend aimed at discouraging breach?
Check your Understanding
1) the money awarded to one party because of an injury or loss caused by another party; and 2) the harm an injured party suffers because of another party's wrongful conduct
money awarded to compensate plaintiffs for harm they've suffered
the direct and immediate costs incurred as a result of a breach of contract
damage or injury that does not directly and immediately result from a wrongful act, but is a consequence of the initial act
being such as may be reasonably anticipated
a small amount of money awarded to the plaintiff in a civil lawsuit when a judge or jury finds that the plaintiff has suffered a legal wrong but is not awarded compensatory damages
an amount of money agreed upon by both parties that a party who breaches the contract will pay to the other party
damages awarded in a lawsuit as a punishment and example to others for malicious, evil or particularly fraudulent acts
a wrongful act that causes injury