Liability Risks

• Author: Robert J. Spjut
• Pages: 225-243

9

Liability Risks

LIABILITY HAZARDS

An obligee who expects to realize a specified amount of value from a

transaction will expect compensation at least in that amount from its

obligor when the latter’s breach causes an unsuccessful outcome and

loss of such value. If, at contract formation, the extent of those damages

cannot be determined because conditions and contingencies are

unknown at that time, then the compensation that the obligee may

expect remains to be determined until the conditions are known and

the contingencies have occurred; the damages are uncertain. When

such damages are known, whether at contract formation or later, the

applicable law may not allow the obligee to recover all its losses. Such

damages are irrecoverable. At contract formation, the hazard to the

obligee is the uncertainty of the damages it may recover for breach

and the losses it may be unable to recover under applicable legal rules.

Uncertainty is also a hazard to an obligor, because at contract formation

it may be unable to determine the amount of its potential liability. The

law also may allow the obligee to recover damages that the obligor did

not anticipate could be awarded for breach of contract. The hazards to

the obligor are damages that are uncertain or unexpectedly recoverable.

225

Inadequate and Excessive Compensation

The relief to which a party is entitled under the applicable law may

fall short of or exceed that party’s expectations. The relief falls short

of expectation when the value of the relief available to a party injured

by a breach of contract is less than the value it expected to realize and

would have realized had the transaction been successfully completed. For

example, in the textbook case Hadley v. Baxendale,1 the owners of a flour

mill in Gloucester lost five days’ revenue because the carrier delayed

delivery of their broken crank shaft to engineers in Greenwich but were

not entitled to compensation for their lost profits, having not made the

carrier aware that their mill was shut down until a new crank shaft was

delivered. The owners were not entitled to compensation for value they

expected to but did not realize because the operations resumed five days

later than expected. The hazard to the mill owners was the limitation on

the damages they could recover from the carrier for breach; the risk was

the chance that they might suer those losses.

The relief exceeds a defaulting party’s expectation when the value

of the relief available to a party injured by a breach of contract exceeds

the losses the defaulting party expected the injured party to incur as a

result of its default. For example, if, in Hadley v. Baxendale, the carrier

had been held liable for the mill’s lost profits, the mill owners would

have received compensation for losses the carrier did not expect the

mill owners to incur had the transaction been unsuccessful. The hazards

are the discrepancies between the rules that determine the damages

to which the injured party is entitled and either its expectations as to

damages it should recover or the defaulting party’s expectations as

to the damages for which it should be liable. The hazards occur when the

parties crystallize their expectations about such damages.

Uncertainty

At contract formation, the parties may or may not have sucient

information to forecast the losses that will likely result from an obligor’s

breach of contract. If a party has sucient information, it should have

reasonable certainty about the defaulting obligor’s liability. Such obligor

should be able to understand the extent of its potential liability and

1 9 Exch. 341, 23 L. J. (Ex.) 179, 23 L.T. (O.S.) 69, 18 Jur. 358, 2 W.R. 302, 2 C.L.R. 517, 17

Digest (Repl.) 91 (1854).

Counterparty Risks

226