35. Contracts: Reliance Damages

>> As we discussed in the module on
expectation damages, expectation,

the benefit of the bargain,

is the preferred measure of
damages in contract cases.

But there are occasions
where it cannot be used.

In such cases, an alternative
measure of damages can be used.

One such alternative is called
the reliance measure of damages.

Whereas the goal of
expectation damages is to put

the non-breaching party in
the position she would've

been in if the contract
had been performed,

the goal of reliance damages
is to put her in the position

she occupied prior to
entering into the contract.

A legal economist would describe
the goal of reliance damages

as being to restore the injured
party to the status quo ante.

Whereas expectation damages seek to give

the non-breaching party the
benefit of her bargain,

reliance damages seek to ensure
that the non-breaching party is

economically no worse off than she

would have been had she never
entered into the contract.

Reliance damages do this by
compensating the non-breaching party

for losses suffered because she relied
on the breaching party's promises,

thereby protecting her reliance interest.

Basically, reliance damages
award the non-breaching party

her out-of-pocket expenses that

resulted from the contracts
having been breached.

Although this measure of damages
is called reliance damages and

although it seeks to protect a
non-breaching party's reliance interest,

reliance damages should not be confused
with the cause of action based

on Section 90 and often called detrimental
reliance or promissory estoppel.

There is no necessary connection between

the reliance cause of action and
the reliance measure of damages.

At the time the first
restatement was being drafted,

Williston was asked
whether an action under

Section 90 was limited to
recovery of reliance damages,

and he famously replied no.

He argued that reliance under
Section 90 was a substitute

for consideration under
classical contract doctrine,

and thus all contract remedies,
including expectation damages,

should be available to a
party who successfully

claim detrimental reliance
under Section 90.

It's worth noting that Section
90 is organized with a group of

restatement sections under the topic
heading contracts without consideration.

In other words, conceptually,

the restatement views a
successful Section 90 claim

as establishing a contract
between the parties.

Following Williston's
logic under Section 90,

a party can recover either
expectation or reliance damages.

Furthermore, reliance damages are often

claimed under a traditional
contract cause of action in

situations where the plaintiff
cannot prove she had

lost profits and so cannot
recover expectation damages.

Given that a party can recover under
either expectation or reliance damages,

but not both, it is important
that a party's attorney

calculate the amount recoverable
under each measure of damages.

Typically, the amount of damages recoverable
under the expectation measure is

greater than the amount of damages
under reliance because typically,

expectation damages include
both lost profits and

out-of-pocket costs while reliance
damages don't include lost profits.

But again, if recovery of lost profits

is impossible to prove or too speculative,

the reliance measure of damages may be
more favorable for the injured party.

Second Restatement Section 349

sets out the formula for
determining reliance damages.

Costs made in preparation for performance
or in performance of the contract,

less any loss the breaching
party can prove with

reasonable certainty
the injured party would

have suffered if the
contract had been performed.

Because the focus is on the expenditures
made by the non-breaching party,

some courts will say that
the reliance measure of

damages is determined by the injured
party's out-of-pocket costs.

Pop's Cones v. Resorts in the case book is

an example of a party
seeking reliance damages.

Recall in that case,

Resorts kept assuring Pop's
Cones that they would

sign a contract leasing Pop's
retail space in the casino.

At Resorts urging,

Pop's did not renew his current lease,

but rather put all of his
equipment into storage

in anticipation of
reopening in the casino.

When Resorts pulled out of
the deal at the last moment,

Pop's brought suit under Section 90.

In that suit, the court
tells us Pop's did not

seek specific performance
of the lease with Resorts.

Why would I want to continue
in a relationship with

such a two-phase business partner?

Anyway, it also did not seek what the
court called speculative lost profits.

If the lost profits had
not been speculative,

Pop's could have sought to recover
them under expectation damages.

Instead, Pop's sought to recover

only its reliance damages,
including storage costs,

costs of retaining an attorney to
negotiate the lease, moving expenses,

and the difference between
what it was paying for

its original lease and

the higher amount that it had
to pay under the new lease.

It is worth noting that it's unclear why

Pop's Cones did not seek
expectation damages,

given that the new tenant to
which Resorts rented the space in

this casino was also a TCBY yogurt shop,

proving lost profits may have
been relatively simple by

subpoenaing the new tenants
profit and loss records.

Let's return to the last part of
Section 349 under reliance damages.

The injured party recovers
its expenditures minus

any loss the injured party would have

suffered if the contract
had been performed.

In a sense, this clause creates

an affirmative defense
for the breaching party.

If the breaching party can prove
with reasonable certainty that

the contract was a loser for the
non-breaching party, that is,

the injured party would have
lost money on the deal,

the amount of that loss
will be subtracted from

any damages based on the injured
party's out-of-pocket costs.

Why is that? Courts hate to
award windfalls in contract law.

Even under expectation damages,

the injured party is
entitled only to be put in

as good a position as it would've been
and if the contract had been performed.

The injured party is not entitled
to be put in a better position.

If the contract proved to be a
losing deal for the injured party,

he would not have recovered
all of his costs.

That's what it means to
have a losing contract.

If the injured party
would not have recovered

all his costs had the
contract been performed,

he should not be entitled to recover

those costs when the contract
is breached by the other party.

To allow such a recovery would put him in

a better position than if the
contract had been performed.

In other words, it would give them
a windfall. Here's an example.

Suppose a builder enters into a contract
to construct a road for $100,000.

The builder estimated that it would
cost $90,000 to build the road,

so it anticipated earning
10,000 in profit.

But the land where the road was to be
built was more swampy than expected,

requiring more filtered than anticipated.

To keep things simple, let's assume
the builder cannot invoke any of

the excuse doctrines such as a
mistake to rescind the contract.

In fact, it cost the builder
$105,000 to build the road.

Now assume the other party breaches
the contract by refusing to pay.

Under the expectation measure of damages,

the builder would only be entitled
to the contract price or $100,000.

Because that would not cover his costs,

the builder might try instead to

recover under the reliance
measure of damages.

If reliance damages only took account of

the injured party's costs and
awarded the builder $105,000,

he would be better off than if the
breaching party had actually perform

the contract and the builder had
received the contract price of $100,000.

This would give them a windfall,

which contract law abhors.

To avoid the windfall,

the breaching party is entitled to
prove that the contract was a loser.

If that is proven, the court will
subtract the builder's loss, $5,000,

from its costs, $105,000,

and awarded only $100,000.

Note that this amount does
not put the builder back in

the position it was in before
it entered in the contract.

To do that, a court would have
had to give the builder $105,000.

Courts justify limiting
reliance damages to costs

minus loss by saying that the $5,000
loss was not caused by the breach.

Rather it was caused by the
builder's own miscalculations.

In this hypothetical, the
builder's recovery would be the

same under either expectation
or reliance damages,

but that's not always the case.

Let's consider another hypo
to show the difference.

Pop Kings, a band that has
been around for five years,

decides it's time for
them to go on the road.

They hire a manager, Slick,

to arrange concert dates for them.

Under the management contract,

the band advances the
manager $10,000 to put down

payments on performance spaces during
the tour and to make hotel reservations.

They also spend $2,000 on publicity
materials such as posters and advertising.

A week before the tours to begin,

Slick is arrested for selling
drugs and the band discovers that

he used their $10,000 to buy
illegal drugs for resale.

In fact, Slick failed to arrange

any concert dates and it's
too late to do so now.

Assume Slick has substantial assets

and the band sues him
for breach of contract.

If the band could prove that
they would have earned $30,000

in profits from the concert tour
after all expenses were paid,

including the $10,000 advance
and the $2,000 in advertising,

they would recover $42,000 under
the expectation measure of damages.

That's what it would take to put them
in the position they would've been in,

had Slick fully performed the contract.

Another way to say this is that

$42,000 represents the loss
in value of the contract.

That is the amount that would have covered

the bands expenses plus
pay them their profit.

However, if they cannot prove lost
profits with reasonable certainty,

they could fall back on the
reliance measure of damages,

which would allow the band to recover

their out-of-pocket expenses or $12,000,

the $10,000 advance and the
$2,000 they paid in advertising.