CONTRACT DISPUTES – TYPES OF DAMAGES, PART I: RETURN OF DRAW THE LAW

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So the contract has been broken and you have gone through all the prior posts on this subject matter: ADR is not working, the threat of nonpayment won’t get the other side to perform, and theystopped talking to you. So you are left with a lawsuit to try and recover, but what can you recover in terms of damages? Today’s post is all about the types of damages that you may be awarded in a breach of contract lawsuit. So seeing as Draw the Law has been a long vacation, let’s dive right into it.

General: Damages

In general, damages are awarded in a lawsuit to the party that brings a claim and successfully makes that claim under the facts of the case. The most typical type of award is money.  The rules vary based on the type of the claim, and as exemplified by the recent ruling in the Apple v. Samsung case the assessment of damages can be complicated (see the sheet the presiding juror had to fill out here).  If you are curious how the breakdown of that patent infringement case came out here is a helpful link.

For today’s discussion, I am only focusing on a breach of contract claim.  There are other claims and types of damages, which I will follow-up with in Part II, but for today it is all about the other party did not live up to what was in the agreement and what it will cost the other party for breaking its promise.  Therefore, the most common damages we are concerned about are compensatory, consequential, and liquidated.
 

The Most Common: Compensatory

Compensatory (also called expectation) damages are the most commonly awarded in a breach of contract suit. The concept is simple: what amount of money would put the nonbreaching party in the position it would have been if the breaching party had performed under the contract?  The rationale behind it could not be more simple as well, we want to give the nonbreaching party the benefit of the bargain, therefore we make the breaching party pay for not living up to the promise.

Example: Let’s say Ron accountant contracts with Annabel web marketer and consultant to do his web marketing and drive his SEO up for fifty-hours at a favorable rate of $50.00 an hour for 1-month. Therefore, he owes her $2,500 for her web marketing services.  If Ron breaches the agreement, Annabel would expect $2,500 as her compensatory damages, which is the economic loss she suffered.

Now, let’s reverse the situation, if Annabel breaks the contract and Ron has to get a new web marketer. To replace her and the new person costs $70.00 an hour for a total amount of $3,500. In this case, Mavis would owe Aaron $1,000. Why?  It is the difference from the benefit of their bargain, $2,500 and the amount he had to spend to deal with her breach, $3,500.  Therefore, a $1,000 from her would put him in the position of the original bargain where he was only going to pay to Annabel $2,500.

It’s clear that if he breaches he should compensate her $2,500. If she breaches, he would still pay out $2,500 because that was in the original bargain, but to get him that benefit she compensates him the difference he had to pay the new guy, $1000.

 

What Flows from the Breach: Consequential

Consequential damages are what would be received from all the harm caused by the breach in the contract.  One way to understand this concept is think that the original breach as the starting point of the damages (compensatory), but as many of you business owners know you order product and services in-turn to drive your own business goals. You order parts to build machines, you use web marketers to deliver your message, etc . . .  in order to make a profit.  If there is a delay in your goods or services you are expecting it causes more loss down the line.  These losses stemming from the breach are consequences of the breach, thus they are the consequential damages.

Example: Let’s continue with Aaron and Mavis as the example situation.  Aaron has told Mavis that he needs her services because he will be rolling out new services, in time for filing income tax returns, and he knows these service will generate an additional $3,000 in revenue. If Mavis breaches, and Aaron cannot announce his message on services in time, she will owe in addition to the compensatory damages, $3,000.00 in consequential damages.

In a nonbreaching situation the consequence of increased SEO means increased revenue for him. In a breaching situation his inability to market means he loses out on sales, which is the consequence of her not performing.

 

Built-in: Liquidated

Liquidated damages is a very simple concept, what is the the amount of money built into the contract in the event of a breach?  That amount represents liquidated damages.

Example: Aaron and Mavis agree that Aaron’s assessment that he will receive $3,000 in additional revenue thanks to the new web marketing campaign over a 30-day period.  Therefore, Aaron makes Mavis agree to a damages clause, stating each day late from the day she is to deliver is $100.00 a day. Therefore, if she is delayed in implementing the web marketing campaign by 5 days, she owes Aaron $500.00 in liquidated damages as stated in the agreement.

 

Last Word: Limiting Damages

With consequential damages and the ability to build in some sort of formula into a written agreement there is definitely a way to limit damages for a breach.  This is sometimes an effective tool in allowing parties to purposefully breach and pay a known quantity for breaching.  In addition, with consequential damages no party wants to be responsible for everything that happens if they fail to live up to the agreement.  Contractors are keenly aware of this as someone who installs your electricity, water, and the like does not want to be on the hook for loss goods that need be refrigerator, damaged carpets from leaky points, and other nightmarish scenarios.  So usually, there is a warranty in the contract that specifically excludes consequential damages.

The way damages are calculated are always of concern in a business deal because you always should have in the back of your mind, what if this doesn’t work out or what if something more lucrative comes along, should I breach?  If you have a firm calculation it might pay to breach the contract and pay the damages or in negotiating you feel that the value of the benefit is too low or too high based on the risk of a breach.  As always, seek expert help or outside information when calculating for these things.
 
[author] [author_image timthumb=’on’]http://www.alohastartups.com/wp-content/uploads/2011/09/RyanKHew.png[/author_image] [author_info]I am a practicing attorney in Honolulu, HI helping small businesses with their transactional and compliance needs. Contact Me Today: Web| 808.944.8400 @RKHewEsq Ryan K. Hew, Attorney At Law[/author_info] [/author]

*Disclaimer: This post discusses general legal issues, but does not constitute legal advice in any respect. No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction. Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.