Compensatory damages 

     A.  Introduction

     A short excerpt from California Supreme Court Justice Stanley Mosk's dissenting opinion in Freeman & Mills, Inc. v. Belcher Oil Co. offers a concise and informative introduction to the subject of damages for breach of contract. 

      [The difference in purpose between tort and contract law] has its greatest practical significance in the differing types of damages available under the two bodies of law. "Contract damages are generally limited to those within the contemplation of the parties when the contract was entered into or at least reasonably foreseeable by them at that time; consequential damages beyond the expectations of the parties are not recoverable." (Applied Equipment Corp., supra, 7 Cal. 4th at p. 515.)   Damages for emotional distress and mental suffering, as well as punitive damages, are also generally not recoverable. (Id. at p. 516.) "This limitation on available damages serves to encourage contractual relations and commercial activity by enabling parties to estimate in advance the financial risks of their enterprise." (Id. at p. 515.) "In contrast, tort damages are awarded to compensate the victim for injury suffered. [Citation.] 'For the breach of an obligation not arising from contract, the measure of damages ... is the amount which will compensate for all the detriment proximately caused thereby, whether it could have been anticipated or not.' (Civ. Code, § 3333.)" (Applied Equipment Corp., supra, 7 Cal. 4th at p. 516.) Both emotional distress damages and punitive damages are, under the proper circumstances, available to the tort victim.

     Tort and contract law also differ in the moral significance that each places on intentional injury. Whereas an intentional tort is seen as reprehensible--the deliberate or reckless harming of another--the intentional breach of contract has come to be viewed as a morally neutral act, as exemplified in Justice Holmes's remark that "[t]he duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it--and nothing else." (Holmes, The Path of the Law (1897) 10 Harv. L.Rev. 457, 462.) This amoral view is supported by the economic insight that an intentional breach of contract may create a net benefit to society. The efficient breach of contract occurs when the gain to the breaching party exceeds the loss to the party suffering the breach, allowing the movement of resources to their more optimal use. (See Posner, Economic Analysis of Law (1986) pp. 107-108.) Contract law must be careful "not to exceed compensatory damages if it doesn't want to deter efficient breaches." (Id. at p. 108.)

     The most common remedy for breach of contract is an award of money damages to compensate the injured party.  Typically, the damages awarded are intended to restore the aggrieved party to the economic position it anticipated from performance of the contract.  This measurement protects the expectation interest of the aggrieved party and therefore is also referred to as a benefit of the bargain measure of damages.  See, e.g., UCC 1-106(1).  Damages for breach of contract do not generally compensate for other injury, such as emotional distress, as we see in Erlich v. Menezes, involving a particularly egregious breach of a contract to build the Erlich's "dream home."  But see R.2d Contracts 353. 

      The sum necessary to protect the expectation interest of the aggrieved party may consist of several components, as indicated in R.2d Contracts 347:  the loss in value to the injured party resulting from the breach (sometimes referred to as direct damages or general damages); other loss flowing from the breach that the breaching party had reason to foresee, such as lost profits, personal injury, or property damage, referred to as "consequential damages;" and a variety of types of expenses that an injured party might incur as a result of the breach, referred to as "incidental damages."  The amount awarded from these losses and expenses must be reduced, however, by loss that the injured party has avoided in consequence of the breach and expenses that the injured party has saved in consequence of the breach.  Without that reduction, damages would put the injured party in an economic position better than anticipated from performance of the contract.  

     Consider the following example.  Suppose that you earn income by hauling discarded furniture, wood, and other items from residences.  After contracting to purchase a used truck for your business for $20,000, the seller breaches by refusing to deliver the truck.  Thereafter you acquire a comparable truck from another seller for $22,000 (known as a "covering" purchase).  Your lost value, established by the covering purchase, is $22,000.  But you have also avoided loss of $20,000, the amount not paid to the first seller because of the breach.  Thus, your damages would be the difference between the cover price and the contract price, i.e. $2,000.  See UCC 2-713.  Perhaps those are all the damages suffered.  Alternatively, you may also have lost several week's business by virtue of the delay in your acquiring a truck.  The profits lost would be "consequential damages,"  recoverable under the circumstances identified in UCC 2-715(2)(a) if the amount of those lost profits can be established with reasonable certainty.  In addition, you may have paid a used truck broker a fee to expedite your covering purchase.  That fee would be one type of "incidental damages."  See UCC 2-715(1). 

     For a variety of reasons it may be inappropriate or simply not feasible to calculate damages that protect the expectation interest.  In such cases, courts might award nominal damages (e.g. $1.00) or might turn to one of two alternative measures of damages:  (1) a reliance measure that compensates the injured party for expenditures made in reliance on the contract, thereby returning the injured party to the economic position that it would have occupied had no contract been entered (see R.2d Contracts 349), or, (2) a restitutionary measure that compensates the injured party for any benefit conferred by the injured party on the breaching party pursuant to the contract, returning the breaching party to the economic position that it would have occupied had no contract been entered (see R.2d Contracts 373).  Typically, compensatory damages resulting from an application of a reliance or restitutionary measure of damages will be less than damages resulting from application of an expectation measure of damages.   In unusual cases, an application of a restitutionary measure will result in damages greater than application of an expectation measure, and in such cases the injured party may seek the restitutionary measure. Sullivan v. O'Connor, a classic case involving unsatisfactory results from plastic surgery on a nose, and Chicago Coliseum Club v. Dempsey, involving famous heavyweight boxing champion Jack Dempsey, discuss application of a reliance measure.  United States v. Alternon Blair, Inc., in which a subcontractor sought restitution from a breaching contractor on a losing contract, is an illustration of  the restitutionary measure.  Do not confuse the restitutionary measure of damages for breach of contract with restitution as a theory of liability independent from contract.  See Commentary.Restitution.  

     Compensatory damages, however measured, are a default term of contracts (although some contracts include language that parrots the measure of damages that the default term would otherwise supply).  The default term is subject to the contrary agreement of the parties.  An agreement between the parties establishing a measure of damages for breach is known as a "liquidated damages" clause.   Such clauses typically state a dollar figure, or a formula for deriving a dollar figure, of damages.  ("Liquidated," used in this and other contexts, means known or readily ascertainable by mathematical calculation; "unliquidated" means the opposite.)  We explore the limits that courts impose on the enforceability of such clauses.  The parties may also agree to other terms that alter the remedies that otherwise would be available, including a term stating facts that might influence a court to order specific performance or issue an injunction, a term limiting or excluding consequential damages, or a term specifying remedies (such as repair or replacement of defective goods) in lieu of damages. See UCC 2-719. We also explore these types of terms. 

     The following diagram may help you visualize the concepts.  

     In the absence of a liquidated damages clause, recovery of compensatory damages by an aggrieved party is subject to three general limits:  (1) the aggrieved party may not recover consequential damages for loss that the breaching party, at the time the contract was made, did not forsee or have reason to foresee as a probable result of breach (R.2d Contracts 351 and U.C.C. 2-715(2)(a)); (2) the aggrieved party may not obtain damages for loss that might reasonably have been avoided (R.2d Contracts 350); and, (3) the aggrieved party may not obtain damages that it cannot prove with reasonable certainty (R.2d Contracts 352).  We explore each of these limitations. 

     Supplementary reading:  Farnsworth, 12.1-12.3, 12.8-12.20; White & Summers, Chapters 6 & 7. 

     B.  Calculating damages using an expectation measure

     Calculating damages using the expectation measure frequently perplexes students.  For some, part of the difficulty may be math anxiety.  Part of the difficulty also derives from both the variety of types of contracts (e.g. sale of goods, sale of land, employment, construction, license of intellectual property) and the variety of contexts in which breach may occur.  For any bilateral contract, there are at least four general variables to consider in applying the expectation measure:  the identity of the breaching party (e.g. seller or buyer, employer or employee, real property owner or construction contractor, licensor or licensee); the timing of the breach (before or during the breaching party's promised performance); the nature and severity of the breach (e.g. did the contractor use defective drywall or simply install the wrong color toilet in the children's bathroom?); the response to the breach by the aggrieved party (either continuing or undertaking its own performance or discontinuing or not undertaking its own performance). 

     The fourth variable, the response to the breach by the aggrieved party, merits additional comment.  At common law, an uncured material breach of obligations under a bilateral contract relieves the aggrieved party of its remaining obligations of performance.  See Commentary.Breaches that discharge duties of counter-performance.  If the aggrieved party does not perform its remaining obligations, its damages (referred to in R.2d Contracts 236 and 243 as damages for total breach) may well be different than if the aggrieved party chooses to perform its remaining obligations (referred to in R.2d Contracts 236 as damages for partial breach).  Damages for total breach may be different than damages for partial breach because an aggrieved party that does not perform its remaining obligations may avoid costs it otherwise would have incurred and may avoid loss it otherwise would have suffered. 

     In the charts that follow, this commentary provides examples for the calculation of the expectation measure of damages in the context of two types of contracts, a contract for the sale of goods, governed by UCC Article 2, and a general contractor's contract with a land owner for the construction or renovation of a residence.  While the expectation measure of damages was developed at common law long before the enactment of the UCC, and applies to breach of any kind of contract, application of the Article 2 remedy sections to some sample problems is a useful way to illuminate the expectation measure of damages as well as good practice in developing your skills in use of the Commercial Code.  I offer a look at the construction contract because calculation of damages in that context is frequently difficult for many students.  Problem.Dispute.Expectation measure asks you to apply the expectation measure of damages to contracts for the sale of goods and to several other types of contracts.  

     Contract for the sale of goods.   Assume that buyer contracts to purchase an automobile from seller for $20,000.  Thereafter, either buyer or seller may breach.  In the event of breach, the aggrieved party is entitled to the damages identified in the following charts.  Values in the fourth column are hypothesized.  I elaborate and consider variations and subtleties elsewhere in the materials.  Where the aggrieved party performs its own obligations and is thus seeking only damages for partial breach (a phrase that is not used in Article 2), I so note in the first column.  Be sure to study the cited sections carefully to understand how the language of each is designed to restore the aggrieved party to the economic position that it had anticipated from performance of the contract.    

Seller of automobile breaches

Buyer breaches and seller is not an automobile dealer

Buyer breaches and seller is an automobile dealer

     Contract for construction or renovation of residence.   Assume that land owner contracts with general contractor for construction or renovation of a residence for the contract price of $250,000.  As in the examples above, either the land owner or the contractor may breach and the timing and nature of the breach may vary.  Assume that there is no consequential or incidental damage (as there would be, for example, if the contract called for construction of an apartment building and the contractor's delayed or defective performance resulted in a loss of rents to the land owner).  Recall also that the party aggrieved by the breach may respond in different ways: it may continue its own performance notwithstanding the breach (claiming only damages for partial breach) or it may terminate the contract and refuse any further performance of its own obligations (claiming damages for total breach).  Where the aggrieved party performs its own obligations and is thus seeking only damages for partial breach, I so note in the first column. Values in the middle columns are hypothesized. 

General contractor breaches

Owner breaches

Formulas adapted from Farnsworth, 12.9 - 12.10.

Damages for total breach  = loss in value  + other loss (assume $0 in examples below)  - cost avoided - loss avoided - progress payments received from owner

Damages for partial breach = loss in value + other loss (assume $0 in examples below)

Where "loss in value"  =  amount promised by the owner that the owner has not yet paid; "cost avoided" =  estimated cost to complete construction (not given below), or =  original estimated costs of entire project less costs incurred before breach, and "loss avoided"  =   compensation from alternative use of same resources (e.g. unused lumber)

Equivalent alternative formula for total breach:  Damages = anticipated profit + costs incurred before breach + other loss (assume $0 in examples below) - loss avoided - progress payments received from owner.              

     Note that the damages do not take account of time, effort or the emotional impact of seeking a remedy, nor do they compensate the aggrieved party for the costs of litigation.  State statutes typically provide for the recovery of some costs of litigation, including filing and motion fees, videotaping or transcription of depositions, and jury fees (see, e.g. Cal. Code Civ. Pro. 1033.5).  However, under the so-called "American rule" on attorney's fees, a party aggrieved by breach of contract will not generally be entitled to recover the major cost of litigation, its attorney's fees, absent a provision in the contract or a provision in a statute (often a consumer protection statute) so providing.  Accordingly, the value of a claim for breach of contract will often be somewhat less than the amount that will truly restore the aggrieved party to the economic position that it had anticipated from full performance.  Because of these uncompensated losses, even an undisputed and liquidated claim for breach of contract will often be settled for less than the expectation measure of damages.  

     Supplementary reading:  Farnsworth 12.8 - 12.11; White & Summers, Chapters 6 & 7.

     C.  Enforcement of remedies

     As suggested above, an action for breach of contract may lead to a judgment for specific performance or a judgment for damages for the aggrieved party.  The judgment is, in effect, the court's statement that a party is or is not entitled to the remedy or remedies requested in the lawsuit.  Often the breaching party will comply with the terms of the judgment.  Sometimes the breaching party will appeal or may negotiate a settlement with the aggrieved party (threatening appeal as leverage).  Typically the judgment may be enforced (as described below) pending the conclusion of an appeal unless the appellant posts a bond or other form of security assuring the appellee of payment or other performance of the judgment in the event of an unsuccessful appeal.  If successful on appeal, the judgment will be reversed or at least the case will be remanded for further proceedings.  If unsuccessful on appeal, the breaching party has bought some time. 

     Absent an appeal, or after an unsuccessful appeal, the breaching party may file bankruptcy.  Bankruptcy is governed by federal law and to a significant extent preempts state law.  The filing of a bankruptcy triggers an "automatic stay" (i.e. an automatic injunction) that, among other things, at least temporarily prohibits the aggrieved party from taking any action whatsoever (including phone calls, letters, or additional judicial proceedings) to enforce the judgment.  Depending upon the type of bankruptcy case filed and upon other circumstances, that prohibition may become permanent, the liability of the breaching party under the judgment may be permanently discharged, and the breaching party may have to pay little or nothing on the judgment.  Your client, whether aggrieved by an alleged breach of contract or the party alleged to have breached a contract, needs to know the dramatic potential effect of bankruptcy on a judgment in advance of the (sometimes lengthy and expensive) dispute resolution necessary to obtain the judgment.  Knowledge about the effects of bankruptcy can often help facilitate resolution of a dispute (contract, tort, or otherwise) short of extensive litigation and you thus owe your clients a fundamental understanding of the effects of bankruptcy.  Federal bankruptcy law is the subject of an upper division course at most law schools.

     Absent either an appeal or a bankruptcy filing, the breaching party may simply not comply with the terms of the judgment, sometimes out of spite but often because of insufficient resources.  But a judgment, which is no more than an official statement of that to which a party is entitled, is not self-executing.  Accordingly, the aggrieved party must take additional action to enforce the judgment. 

     If the judgment calls for specific performance, the party seeking to enforce the judgment must bring a motion for contempt, seeking sanctions (including fine or imprisonment) for failure to comply with the judgment.  If the judgment calls for the payment of money, the party seeking to enforce the judgment can cause a sheriff (or other "levying officer") to seize and sell assets of the judgment debtor (the person against whom the judgment was entered, e.g. the breaching party) and pay the proceeds of the sale to the judgment creditor (the person in whose favor the judgment was entered, e.g. the aggrieved party) in satisfaction of the judgment.  Absent sufficient assets (some of which state laws makes exempt from the enforcement process), the judgment debtor is judgment proof and the judgment makes but an attractive document for framing.  For a fuller description of this and other procedures for enforcement of a money judgment, see Commentary.Enforcement of a money judgment.  Your client also needs to know in advance of dispute resolution the often cumbersome and frustrating process of enforcing a judgment against a party who does not voluntarily comply with its terms.