Introduction and Expectation Damages

Introduction and Expectation Damages

Terms:


Expectation Damages:
Compensation awarded to the party harmed by a breach of contract for the loss of what he reasonably anticipated from the transaction that was not completed. In other words, expectation damages is compensation that tries to place the harmed party in the position he would have been in had the breach not occurred.


Once you have determined that a valid contract has been established and that there has been a breach of that contract, you must decide what remedy the damaged party will receive for the breach.

On the other hand, if no contract has been formed, you must determine whether or not one party benefited from his contact with the other party and whether or not the party who provided the benefit should be repaid for the benefit he provided.

There are two kinds or remedies in contract law:

  1. damages, which are monetary awards and
  2. specific performance, which is where the court orders the breaching party to actually perform on the contract.

As far as damages go, there are three different kinds:

  1. expectation damages,
  2. reliance damages and
  3. restitution.

We will cover reliance damages and restitution in the next subchapter.

Expectation Damages

Expectation damages are usually applied when compensating a victim of a breached contract and they are awarded in order to place the harmed party in the position he would have been in had the breach not occurred. For example:

Sunshine offers to sell Squeeze Me one thousand bushels of oranges for $5 per bushel to be delivered on April 1st. Squeeze Me agrees. On March 31st, the price of oranges reaches $9 per bushel and, the next day, Sunshine refuses to deliver the oranges to Squeeze Me. Squeeze Me is now the victim of a breach of contract. The court, in order to put Squeeze Me in the position they would have been in had Sunshine not breached, will award expectation damages. In this case, expectation damages will be measured by taking the market price of the oranges, $9 per bushel, and subtracting from it the contract price, $5 per bushel. Therefore, given the market price of oranges, Squeeze Me would have had $9,000 worth of oranges had Sunshine not breached. Taking the $9,000 value of the oranges and subtracting the $5,000 that Squeeze Me would have paid for the oranges, expectation damages will come to $4,000.

There are, however, limitations on expectation damages which were established by the famous case of Hadley v. Baxendale, 156 Eng. Rep. 145 (Ex. Ch. 1854).

In Hadley, the crank-shaft in a mill broke and the mill owner had to send the crank-shaft to the manufacturer so that the manufacturer could make a new one. The mill owner and the courier that he used to send the crank shaft entered into a contract under which the courier promised that he would deliver the crank-shaft to the manufacturer the next day. However, the courier breached his contract and did not deliver the crank-shaft for several days. The mill owner sued the courier for the lost profits he would have made had the crank shaft been delivered to the manufacturer on time. The court ruled that the miller could not recover the lost profits. The court said that, in such a case, the injured party could recover for damages that followed naturally from the breach but that special damages could only be recovered if those special damages were “in the contemplation” of both parties at the time the contract was made.

Based on the Hadley ruling, there is a distinction in modern contract law between general damages arising from a breach and special damages that are unique to the injured party. General damages, as we mentioned, are the damages that naturally flow from a breach but are not linked to the particular circumstances of the harmed party. These damages are never barred under the Hadley rule because the entire purpose of expectation damages is to compensate the harmed party for the general damages he has suffered. For example:

Sunshine offers to sell Squeeze Me one thousand bushels of oranges for $5 per bushel to be delivered on April 1st. Squeeze Me agrees. On March 31st, the price of oranges reaches $9 per bushel and, the next day, Sunshine refuses to deliver the oranges to Squeeze Me. Squeeze Me is now the victim of a breach of contract and the court, in order to put Squeeze Me in the position they would have been in had Sunshine not breached, will award expectation damages. In this case, Squeeze Me is recovering for the general damages they suffered as a result of Sunshine’s breach. If we were to change the names of the parties in this example and change the product that was being exchanged and change the contract price and market value of the object, the example would look different but the general principle would remain the same; the injured party is recovering for the general damages that it suffered due to the breach. Again, these kinds of damages are never barred under Hadley because they are the textbook definition of what expectation damages are.

However, special damages are damages that result due to the injured party’s individual circumstances and these damages are limited under Hadley. Accordingly, the injured party can recover for these special damages only if, at the time the contract was made, the breaching party either knew or should have known that these damages would probably result from his breach. For example:

AgraTech is a company that invents and markets equipment used by food manufacturers. On March 25th, AgraTech and Squeeze Me enter into a contract under which Squeeze Me buys a new industrial sized juicer from AgraTech for $10,000 and AgraTech agrees to deliver the juicer on April 1st. This new juicer can juice oranges twice as fast as any other juicer on the market and Squeeze Me needs this juicer in order to be able to produce enough juice to meet the demands of its customers. AgraTech does not deliver the juicer until May 1st. Because there is no comparable juicer on the market, Squeeze Me is unable to buy one somewhere else. As a result of AgraTech’s breach, Squeeze Me is unable to meet its customers’ orders and ends up losing a number of their clients to other juice companies. If AgraTech either knew or should have known of Squeeze Me’s special circumstances and that Squeeze Me would lose considerable business if the juicer was not delivered on time, Squeeze Me can recover its lost profits as special damages. However, if AgraTech neither knew nor should have known of Squeeze Me’s special circumstances, AgraTech will only be liable for the general damages stemming from the breach.

Expectation damages can only be recovered if they can be calculated to a reasonable certainty. Where damages cannot be calculated to a reasonable certainty, the injured party will only be able to recover nominal damages. (We will discuss nominal damages a little bit later).

Typically, the issue of certainty arises in cases where the damages suffered are in the form of lost profits. The general rule regarding lost profits and certainty in calculating damages is that if the injured party is an established business, lost profits are not treated as speculative because they can be estimated from past profits. Therefore, an established business will generally recover for its lost profits.

However, where the injured party is a new business so that there are no past profits with which to estimate future profits, the courts examine each case individually and, if the courts can calculate damages to a reasonable certainty, then damages will be awarded. However, in the event that courts cannot, the injured party will be awarded nominal damages only.

Finally, an injured party has an obligation to try to mitigate damages. In fact, the injured party will not be allowed to recover for any damages that could have been mitigated. There are three kinds of contracts for which the duty to mitigate generally applies:

  1. contracts for the sale of goods,
  2. employment contracts and,
  3. construction contracts.

In employment contract cases, where a boss wrongfully fires an employee, the employee has a duty to mitigate damages by looking for a comparable job. For example:

  1. On March 1st, Ramon Garcia and the Red Sox enter into a contract under which Garcia agrees to play for one season and the team agrees to pay Garcia $500,000. On March 15th, the team informs Garcia that they will not honor the contract. On March 20th, the Dodgers offer Garcia a contract to play for them for one season for $250,000. Garcia decides that he would rather sit on his couch for a season and collect damages from the Red Sox than actually have to play so he turns the offer down. In this case, Garcia will not be able to collect the full $500,000 from the Red Sox. Garcia has a duty to mitigate the damages caused by the Red Sox's breach and he had an opportunity to do so by signing a contract with the Dodgers. By refusing to mitigate his damages, Garcia is no longer entitled to the damages he could have avoided. Since he could have avoided $250,000 of the $500,000 in damages he suffered, he will only recover the $250,000 that he could not have avoided.
  2. On March 1st, Ramon Garcia and the Red Sox enter into a contract under which Garcia agrees to play for one season and the team agrees to pay Garcia $500,000. On March 15th, the team informs Garcia that they will not honor the contract. On March 20th, Garcia is offered a $50,000 contract by the Cozumel Crusaders of the Mexican semi-pro league. Garcia turns the offer down. In a suit against the Red Sox for $500,000, Garcia will be awarded the full $500,000. The duty to mitigate for an employment contract only requires the harmed party to find a comparable job. Here, Garcia was offered a job but it was not comparable to the major league job he had with the Red Sox. Thus, he is not required to take the Crusader’s offer under the duty to mitigate. See Parker v. Twentieth Century Fox, 3 Cal.3d 176 (1970).

As far as contracts for the sale of goods are concerned, the U.C.C. requires a buyer to try to find substitute goods in the event that a seller breaches. If the buyer does not try to cover, he will not be able to recover whatever damages he could have prevented by covering.

As far as construction contracts are concerned, the injured contractor is under duty to mitigate damages by not continuing to work after the party that hired him breaches the contract. For example:

Ahab hires SevenSeas, Inc., a world famous boat builder, to build him a yacht. Ahab agrees to pay $2,000,000 for the yacht. After SevenSeas incurs $100,000 in expenses buying materials and drawing up blue prints for the boat’s construction, Ahab breaches, telling SevenSeas that he will not be buying the yacht. SevenSeas continues to work on the yacht, incurring $400,000 in expenses before suing Ahab. In a suit against Ahab for $500,000, SevenSeas will only be awarded $100,000 because they had a duty to mitigate damages specifically not continuing to work once Ahab breached. See Rockingham v. Luten Bridge Co., 35 F.2d 301 (4th Cir. 1929).

Finally, please note that expenses that the injured party accumulates in trying to mitigate damages can also be recovered from the breaching party. For example:

On March 1st, Ramon Garcia and the Red Sox enter into a contract under which Garcia agrees to play for one season and the team agrees to pay Garcia $500,000. On March 15th, the team informs Garcia that they will not honor the contract. In the following weeks, Garcia accumulates $55,000 in airline and hotel expenses flying to different major league cities to try out for their teams. Garcia will be able to recover this $55,000 from the Red Sox.