Overview of Contract Damages
Typical in most contract disputes, the question of liability and damages must be separately addressed. Liability relates to whether a party is responsible for and accountable for a particular loss or harm. Damages, on the other hand, is the amount or measure of compensation for an injury, loss or harm suffered by a particular party. The term "damages" encompasses a wide range of recovery for virtually any loss, whether tangible or intangible, caused by the non-performance of a contract.
For contracts, damages can be characterized into two types: general and special. General damages are those that are either a direct result of the breach of contract or those arising under the law. Special damages go beyond the general damages and are typically not available unless the parties to the contract are aware of the circumstances that has resulted in the harm or injury. As the case of Bombay Supply Association Ltd v. Hargovind Khorana demonstrates, general damages are those damages such as, for example, damages that may be expected in the normal course of things, or generally understood to be common occurrences arising out of the breach. These damages should ordinarily be anticipated by both parties during the formation of the agreement. For this reason, general damages are referred to as "expected" or "contemplated" damages. On the other hand , special damages, although they may be an extended consequence of the breach, arise outside the normal scope of events for which parties may reasonably have contemplated when entered into the agreement.
Unlike damages to tort, which are primarily aimed at punishing the tortfeasor, the primary aim of monetary damages for breach of contract is to compensate the innocent party or the party suffering the breach. A party suffering a loss arising out of the breach shall recover damages for loss suffered as a result of such breach. As discussed in the case of Indian Ice Cream Manufacturers Association v. Union of India, it is usually difficult to expect damages for loss of profits or loss of production capacity in the normal course of events. Thus, such damages are considered a special type of damage falling within the ambit of special damages. In the case of Bombay Supply Association Ltd v. Hargovind Khorana, the Court further defined special damages as those damages which arise from a particular set of circumstances that are outside the public obligations and duties of the party suffering a loss. Such damages can be expected if the range of foreseeable consequences in event of a breach of contract would include such loss. For such damages to be recoverable, they must have been in the contemplation of both parties.
The Role and Purpose of Compensatory Damages
At its core, compensatory damages are designed to put the non-breaching party in the same position it would have been in, had the contract not been breached. Put a different way: compensatory damages are intended to cover the actual loss suffered by the injured party. This is usually accomplished by placing a monetary value on any losses the aggrieved party has suffered, and then awarding damages in such amount.
Compensatory damages can take various forms. For example, if a building contractor fails to follow certain specifications as to materials, and as a result, the building suffers major damage, compensatory damages might include a payment for the cost of correcting the contractor’s errors. On the other hand, if the building was to be used as a warehouse, and the contractor has instead built it to use as a barn, the appropriate award may be a figure to account for the difference in resale value of the building in its current form vis-a-vis how it would have been sold, had it been built per the original specifications.
The Meaning of Consequential Damages
Consequential damages are types of damages that result from the breach of a contract. Unlike compensatory damages, which are meant to replace what was lost because of the breach in order to put the non-breaching party in the position they would have been in had the breach never occurred, consequential damages go above and beyond compensatory damages.
There are many different types of consequential damages. When the non-breaching party litigates the breach of a contract, they may seek to receive these damages in order to compensate them for any losses suffered due to the breach. One example of this is lost profits recovered by the non-breaching party if the breaching party’s actions resulted in the non-breaching party’s inability to sell their own products or services. Usually, an injury sustained by the non-breaching party because of the breach has to be proven to be foreseeable in order for them to be recovered through consequential damages.
A Primer on Punitive Damages
Most damages awarded in contract disputes are compensatory, as discussed above; however, there are certain situations where a party may recover punitive damages. Punitive damages help punish the breaching party and deter future misconduct. Even when a party has intentionally breached an express provision of their contract, the courts will rarely award punitive damages in breach of contract cases. However, if that breach was done with fraud, malice, oppression or was done intentionally with a wrongful purpose, then the court may grant punitive damages.
Parties should note that contractual claims brought against fiduciaries like doctors and lawyers are typically not dismissed even with a punitive damages claim, so long as the pleading does not allow the court to treat breach of contract claims as malpractice claims. A recent case out of the Northern District of FL, Wicked Dolphin Distillery, LC v. MicroShiner LLC, N.D.Fla.,2013.WL 7092294, is a good illustration of this distinct exception.
Nominal Damages in Contract Breach
In certain situations where a breach of contract has occurred, but no substantial amount of loss or harm has been sustained because of it, the law intends to provide a meaningful remedy. Thus, the law also intends to require adequate proof of actual damages, and not just potential or speculative damages. When no substantial loss or harm has actually occurred, the non-breaching party may have suffered an injury that is recognized by law and for which an action will lie, but for which the loss or harm is so small that it would not be rational to incur the expense of proving it. A suit then may be maintained only to vindicate a right or claim that the law recognizes , and not to recover damages.
Such is the case with nominal damages. Nominal damages may be awarded when a breach of contract has actually occurred, but no loss or harm was actually sustained. Though some have stated that nominal damages have been reduced to a nullity by modern law in breach of contract actions, the fact is that remedial statutes and cases still recognize that an injury to an interest or right, for such reasons alone, may be small in degree, but nevertheless no less an injury for that. Therefore, where the injury is permitted to be sought, the law will acknowledge that some injury has actually occurred for which nominal damages are to be awarded if no substantial amount is recoverable.
Liquidated Damages: Assessing Pre-Agreed Damages
Liquidated damages are often included in contracts but are of importance because they will be the only recovery considered available to either party if a breach occurs. Liquidated damages are actually a form of an agreed upon damage formula where the parties agree in advance to the formula for determining what the damages would be for a specified breach of the contract. The parties also agree that this formula is acceptable to both parties and that should a breach occur, it is their clear intent that these liquidated damages are to be the sole measure of damages for that particular breach of the contract.
Liquidated damages are often found in construction contracts but also in other transactional agreements where the parties are agreeing to a damage formula based on a number of factors set forth in the agreement depending on the particular circumstances involved. A liquidated damage provision has to be fairly specific as to the damages that are being agreed to so that at the time of a breach, there is a reasonable level of certainty at the time of contract formation as to the damages which would be incurred. In other words, in order for a liquidated damage provision to be enforceable, it has to be determined at the time of the contract formation that the damages that may be incurred following a breach would be difficult to estimate. Only when the specified damages would be difficult to estimate or know at the time of contracting would the use of a liquidated damages clause be appropriate.
Mitigating Damages: Limits and Obligations
Remoteness
Damages for breach of contract are subject to a limit, in that the losses must be a reasonably foreseeable consequence of the breach at the time it was entered into by the parties. This is known as remoteness of damage, and is governed by the rule established in Hadley v Baxendale 1854, 9 Ex. 341. This rule restricts the type of loss for which a party may claim damages from all those which may be said to be a natural result of the breach or other type of wrong by permitting recovery only for those which the parties knew, or ought to have known, would have resulted from breach of contract or other type of wrong. Losses which result from a breach of contract, and which neither party had in mind when the contract was made, may therefore be too remotely connected to the contract for recovery. Damages are said to be too remote if they do not arise naturally from breach of contract but arise as an indirect result of it. The inquiry is whether the parties to the contract contemplated the damages as a probable result of the breach.
Mitigation of Damages
It is well established that the party complaining of the breach of contract must take reasonable steps to mitigate his loss, so that he cannot recover damages that he could have avoided by taking those reasonable steps. However, he is not bound to take steps which are "unreasonable", for example, involving considerable expense or effort or which would cause serious disruption to its operations. Where the innocent party fails to mitigate, the measure of damages will be assessed as at the date mitigation should have occurred, and not at the date to which it is actually taken.
Choosing the Right Damages
Negotiating and understanding the scope of damages in the context of a particular deal is critical to achieving the best balance for the contracting parties. It is important, though, to recognize that there are many forms of damages, and that damages are not uniform across different types of contracts. No one should try to create a one-size-fits-all approach to damages clauses in all contracts. In addition to the general types of damages outlined above, contracts can also provide for consequential damages, indemnification for certain types of liabilities of the indemnified party, and even exclusions of lost profits or liability for consequential or punitive damages. Parties can also negotiate for a liquidated damages provision, which may or may not be enforceable .
In preparing a contract, parties should consider a number of factors, including the nature of the transaction, the degree of sophistication of the parties and the nature of the risk of breach. A more sophisticated (or, in the case of retailers, less vulnerable) buyer may be able to negotiate a lower limit on liability, for example. More complex transactions will also present greater risks and should involve more sophisticated approaches to evaluating damages.
Litigation over damages can be expensive, and the institution of such litigation can be damaging in and of itself to a contracting relationship. Parties should make their best efforts to evaluate and negotiate the potential risks of breach at the outset of the deal, and to address the potential consequences in the contract. Recognizing the range of options available should help drafters ensure the most appropriate result.