32. Contracts: Expectation Damages

>> The question of whether a party has

breached the contract and
is liable for damages

is separate from the question of

what amount of damages
that party ought to pay.

The Second Restatement sets out
the three basic measures of

damages in section 347: Expectation,

Reliance, and Restitution.

In this module, we will
discuss expectation damages,

and in the next two modules,

we will discuss reliance and restitution.

Expectation damages are the gold
standard for measuring contract damages.

The goal of expectation damages is to

put the party in the
position it would've been,

if the contract had been fully performed.

That is, to give the non-breaching
party the benefit of the bargain.

This measure of damages protects
the party's expectation interest.

Section 347 of the Second
Restatement sets out

the fairly basic formula for
computing expectation damages,

which contains four elements.

The loss in value caused by the breach,

plus other losses,

minus costs avoided,

and loss avoided by the
non-breaching parties,

not having to complete its performance of

the rest of the contract after breach.

Determining loss in value is a
very fact-specific undertaking.

The Restatement does not set out

a specific formula for
computing loss in value.

Section 348 of the
Restatement does set out what

it calls two alternatives
to loss in value.

But this is a little
misleading because these are

really specialized
examples of loss in value.

For instance, where the breach has
caused a delay in the use of property,

the loss in value to the properties owner

can be determined by the
rental value of the property.

Similarly, where the breach consists of
defective or unfinished construction,

loss in value to the owner of the building

under construction can be determined

by either the diminution in value or
the cost of completing performance.

Although most courts say that the cost of

completing performance is
the preferred measure.

However, we do have the
Jacob and Youngs v. Kent

case where Cardozo says
the loss to the homeowner

caused by the contractors' failure
to use reading pipe can be

determined either by the diminution in

market value of the home
without reading pipe,

which was nothing is the difference
between the two types of pipe

cost no diminution in the
market value of the home,

or by the cost of tearing out the wrong
pipe and installing reading pipe,

which would've been extremely expensive.

The court chooses diminution in value
was the appropriate measure of damages.

There are other ways of articulating
the expectation measure of damages.

Some think these alternative
ways of articulating

expectation damages make more intuitive
sense than the restatement formula.

Where a seller has breached by refusing to

convey something purchased
by the other party,

such as goods,

the measure of damages set
out in UCC Section 2-713 is

sometimes expressed as
the difference between

the contract price and the market
price at the time of the breach,

plus other loss but minus expenses saved.

If the contract price for
a widget is $100,000,

but the market price at the
time the breaching seller is to

deliver the widget is $110,000,

the disappointed buyer
will be awarded $10,000.

This is because, in order to purchase
another widget on the market,

the buyer will have to spend $110.000.

The buyer may also have incidental
or consequential damages.

For example, if the breaching
seller was located near to

the buyer and the buyer originally
intended to pick up the widget himself,

but as a result of the breach,

he has to have the substitute
widgets shipped from out of state,

the buyer will also be able to recover
the additional shipping costs.

Even if the buyer decides not to
purchase a substitute widget,

we would still want to award

the disappointed buyer the
benefit of his bargain.

If the seller perform the contract,

the buyer would've spent $100,000,

but he would've received
a widget worth $110,000.

Given the breach, the buyer doesn't
have to spend the $100,000.

Nonetheless, he should receive the
profit he would've made or $10,000.

To point out the obvious,

if the contract price is higher than

the market price at the time
the seller is to perform,

the disappointed buyer will
have suffered no damages,

or at best, nominal damages.

If the contract price was $110,000 but
the market price is only $100,000,

the seller's breach
actually saved the buyer

from losing $10,000 on the transaction.

The buyer has no reason to go to court.

He should send the seller
a thank you note instead.

Conversely, when the seller
is the injured party,

if the contract price is $110,000
and the market price has dropped to

$100,000 between the time of contracting
and the time of performance,

we would award the seller
the difference or $10,000.

This is because the seller's profit came
from wisely entering into a contract

at a price that is above

the market price at the time the
seller has to deliver the goods.

The seller sold the widget to the
breaching buyer for $110,000,

thereby making a profit of
$10,000 over the market price.

Presumably, if the seller
tries to resell the widget,

he would only get the
market price of $100,000.

To give the seller the
benefit of his bargain,

we have to award him the extra $10,000.

This method of computing
expectation damages

can also be used with real estate.

The Ray v. Eurice Brothers case in the
case book gives an example of this.

In that case, the Rays
hired Eurice Brothers

to build them a house for $16,300.

Eurice Brothers was held to
have breached the contract.

To put the raise in the position,

they would've been and have the
defendant perform the contract,

the Rays need to have spent
$16,300 for the house.

In fact, it costs the Rays

$22,293.40 to have a different
company build the house.

Thus, the court awarded them

the difference between the
contract price and what

they actually spent or $5,993.40.

In construction contracts where
the builder is the damaged party,

the expectation measure of
damages is often expressed as

the builder's net profit plus

the builder's unreimbursed costs
at the time of the breach.

If the builder was to be
paid $150,000 to build

a home and its total costs
were going to be 130,000,

he stood a net profit of $20,000.

Suppose the owner wrongfully
terminates the contract at

a time when the builder has
already incurred $90,000 in costs,

and the owner has made
installment payments of $75,000.

Under this formula,

the builder should recover his net profit,

$20,000, plus his unreimbursed
costs or $35,000.

It's a good idea to double-check
your understanding of

expectation damages by using more
than one formula, if possible.

The results should be identical
no matter which formula you use.

To use the restatement formula
in the above hypothetical,

you would perform the
following computation.

The damages are the sum
of the loss in value,

which would be the total
contract price, $150,000,

minus what the owner has already paid,

which was $75,000,

for a net loss in value of $75,000.

Plus other loss.

There were no other consequential
damages in this hypo,

minus the costs avoided,

which would be the total costs of
$130,000 minus costs already incurred,

which were $90,000 or a total
of $40,000 in costs avoided.

That is costs that the builder will not

have to incur due to the owner's breach.

Minus loss avoided, which would be 0

as this was a profitable
contract for the builder.

Using the restatement formula,

the builders should
recover the sum of $75,000

minus $40,000 or $35,000 in damages.

Expectation damages will provide
the non-breaching party with

compensation for the
lost profits you would

have earned if the contract
had been performed.

But there are instances where the
non-breaching party either cannot prove what

the lost profits would have
been to the required degree

of certainty or would not have,

in fact, earned any profits.

That is, at the end of the contract,

the non-breaching party would have
either broke even or lost money.

The next two modules on
the reliance measure of

damages and the restitution
measure of damages

discuss alternative ways of measuring

damages when expectation
damages are not available.