Awarding Damages for Breach of Contract
| Publication year | 2017 |
| Pages | 20 |
| Citation | Vol. 86 No. 9 Pg. 20 |
Colin Quinn and Brendan Quinn
INTRODUCTION
When awarding damages for a breach of contract, the intent is to place the non-breaching party in the position he or she would have been had the breach never occurred. While numerous types of damages can result from a breach, they are generally classified into two categories. The first category, direct damages, are those which flow directly from the breach itself. The second category, consequential damages, refer to the economic harm that is beyond the immediate scope of the contract. In other words, they are secondary losses arising from circumstances particular to the specific contract or parties involved. Kansas courts generally limit consequential damages to what was reasonably within the contemplation of both parties as the probable result of the breach.[1] To be recoverable, therefore, consequential damages must have been foreseeable or contemplated by the parties at the time of entering into a contract.
While the definitions appear straightforward, it is often difficult to determine which category certain damages fall under, and courts considering this issue have not created a bright-line test to clearly distinguish the two categories. Appreciating the distinction between direct and consequential damages, however, can prove to be critical for several reasons. First and foremost, design and construction contracts often include a provision that waives consequential damages, giving the parties an opportunity to classify certain types of damages. However, the contracting parties may have different or conflicting ideas as to what constitutes a “consequential” damage. Whether a certain type of damage is contractually and properly waived may depend on how the damage is classified. Second, while consequential damages are within the contemplation of the parties at the time a contract is executed, the amount of the damages awarded can be quite significant. Indeed, consequential damages are often the largest damages in a dispute. Because they can involve such large sums of money, consequential damages are often the focal point of contention in settlement negotiations, mediation, arbitration, and litigation.
This article addresses the following key points to assist the practitioner’s understanding of consequential damages: (1) the prerequisites to a successful recovery; (2) recover-ability of business expenses incurred indirectly from a breach; (4) the effect of contractual waivers of consequential damages; and (5) defenses and avoidances of incurring consequential damages.
Pre-Requisite to any Consequential Damages Recovery: Foreseeability and Reasonable Degree of Certainty
The concept of consequential damages dates all the way back to the mid-19th century from the watershed case of Hadley v. Baxendale, which came from the Exchequer Court of England.[2] The facts of the case are simple. The Plaintiffs, owners of a four mill, were forced to temporarily shut down due to one of its components breaking down. Plaintiffs contracted with the defendants to transport the component to its original manufacturer so a replacement part could be crafted. Plaintiffs informed the defendants’ clerk that the mill was currently inoperable, and the replacement component needed to be sent immediately. The delivery of the component, however, was delayed “by some neglect”[3] of the defendant, causing the mill to be shut down longer than anticipated. As a result, plaintiff sued to recover damages for both loss of business opportunity and loss of profits they would have earned had the component been delivered on time. Defendants contended that the damages were too remote to recover. The jury ultimately returned a verdict for the Plaintiffs. The Exchequer Chamber reversed the jury’s decision, explaining that in a breach of contract action, an injured party may only recover those damages that are:
[F]airly and reasonably [] considered either arising naturally, i.e., according to the usual course of things…or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.
On the basis of this decision, courts have set forth the foundation to distinguish between direct and consequential damages. Likewise, Kansas courts have long followed the Hadley rule that, regardless of the damages incurred by a party, those damages must have been reasonably foreseeable at the time the parties entered into the contract.[4]
While it may seem simple to argue that most, if not all, types of damages can be considered “foreseeable” at the time a contract is entered, that is not always the case. For instance, the case of MLK, Inc. v. University of Kansas,[5] presents a typical, yet unsuccessful, claim by a contractor against an owner for recovery of certain consequential damages as a result of the owner’s breach of contract. In that case, the University of Kansas and MLK entered into a construction contract for the renovation of a scholarship hall on campus. The contract was a lump sum fee of $497,532 for the completion of the work. The contract stated “the date of beginning and the time for completion as specified in the Contract of the work to be done hereunder are ESSENTIAL CONDITIONS of this Contract.”[6]
During the course of the project, MLK requested extensions of the completion date due to weather-caused delays, which KU rejected. As a result, MLK was unable to meet the project completion date. KU terminated the contract on August 15, 1991 and withheld over $50,000 from MLK’s final payment application. MLK brought a claim for breach of contract against KU. In addition to direct damages, MLK made claims for loss of bonding capacity, loss of reputation, and lost profits. The total damages claimed by MLK was $3,587,816.81 (on a contract originally worth less than $500,000).
MLK claimed $431,000 annual lost profit damages from late 1991 through late 1994; $36,417 per month during that same time frame for costs necessary to restore its reputation; costs related to an IRS debt of $70,000 and a default on an SBA loan for $109,750, and reimbursement for any payments made to its surety. MLK’s damages expert estimated gross profits which far exceeded any profits earned by MLK in the preceding years. Additionally, the expert presented inconsistent methods as to how he came to his conclusions, a fact easily exploited by KU. The district court ruled that MLK’s claims for lost profits were too speculative and that the contractor had failed to meet its burden of proof.[7] The appellate court affirmed this ruling.
Following the rule set forth in Restatement (Second) of Contracts § 351 (1979), the district court granted summary judgment denying MLK’s claim for loss of bonding capacity, primarily because the loss was not foreseeable. The court’s ruling was primarily based on MLK’s failure to present sufficient evidence showing that KU had any special knowledge regarding MLK’s bonding capabilities. In fact, the evidence showed that MLK had actually been sued and terminated by its surety for unrelated projects. As a result, the court found that MLK could not carry its burden to prove that its damages for alleged loss of bonding capacity flowed from its contract with KU.
The MLK case provides significant insight for attorneys cognizant of the difficulties associated with recovering consequential damages for a few reasons. First—and at the outset of any project—if a certain asset is particularly critical to the success of your client’s ongoing business (such as your client’s bonding capacity, business reputation, or dependent revenue stream from other projects), ensure that the fact is expressly set forth in the contract itself. This could prevent a significant headache in the future if the parties are forced to litigate the nature and amount of damages. In the event your client does end up litigating this issue, ensure that your expert witnesses are precise and consistent in their testimony. Be able to present a unified and logical theory as to why, specifically, your client’s damage claim is foreseeable, flows naturally from the defendant’s breach, and can be lent credibility by a discerning jury. That will bolster your argument that the consequential damages claimed were foreseeable by the opposing side at the time the contract was executed.
Loss of Energy, Financing and Administrative Costs—Business Expenses which should Not have been Incurred
Inevitably, a client will ask that you seek not only their direct contractual damages, but will want to know if they can recover for other expenses actually incurred which would not have otherwise incurred but for the breach of the opposing party. Examples include extended storage costs, extended on-site and office overhead, and extended general conditions. Given the proper facts, many of these categories of damages can be recovered in a construction defect claim.
In State ex rel. Stovall v. Reliance Ins. Co.,[8] the state fled suit against its contractor, several subcontractors, and the contractor’s surety regarding apparent failures with an underground thermal piping system installed by the contractor for a prison in Butler County. The state’s mechanical contractor installed a direct-bury pipe with poured-in-place insulation. Shortly after the contractor completed its work, prison staff began to notice that heat was escaping from various points throughout the system. The state abandoned the earthen-trench system and, instead, installed a concrete trench system and attempted to place the entire cost onto the various defendants. For reasons immaterial to this article, the court held that...
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