Please follow the directions
Answer Questions 1 through 6 based on the scenario in the “Theory to Practice” section, and complete the following in your response:
- At the end of the scenario, BTT states that it is not interested in distributing Chou’s new strategy game, Strat. Assuming BTT and Chou have a contract, and BTT has breached the contract by not distributing the game, discuss what remedies might or might not apply.
- Explain your answers and refer to Section 7-6 in Ch. 7 for support.
At the bottom you will find Ch 7 section 7-6 in highlighted in blue
Theory to Practice
Big Time Toymaker (BTT) develops, manufactures, and distributes board games and other toys to the United States, Mexico, and Canada. Chou is the inventor of a new strategy game he named Strat. BTT was interested in distributing Strat and entered into an agreement with Chou whereby BTT paid him $25,000 in exchange for exclusive negotiation rights for a 90-day period. The exclusive negotiation agreement stipulated that no distribution contract existed unless it was in writing. Just three days before the expiration of the 90-day period, the parties reached an oral distribution agreement at a meeting. Chou offered to draft the contract that would memorialize their agreement. Before Chou drafted the agreement, a BTT manager sent Chou an e-mail with the subject line “Strat Deal” that repeated the key terms of the distribution agreement including price, time frames, and obligations of both parties. Although the e-mail never used the word contract, it stated that all of the terms had been agreed upon. Chou believed that this e-mail was meant to replace the earlier notion that he should draft a contract, and one month passed. BTT then sent Chou a fax requesting that he send a draft for a distribution agreement contract. Despite the fact that Chou did so immediately after receiving the BTT fax, several more months passed without response from BTT. BTT had a change in management and informed Chou they were not interested in distributing Strat.
- At what point, if ever, did the parties have a contract?
- What facts may weigh in favor of or against Chou in terms of the parties’ objective intent to contract?
- Does the fact that the parties were communicating by e-mail have any impact on your analysis in Questions 1 and 2 (above)?
- What role does the statute of frauds play in this contract?
- Could BTT avoid this contract under the doctrine of mistake? Explain. Would either party have any other defenses that would allow the contract to be avoided?
- Assuming, arguendo, that this e-mail does constitute an agreement, what consideration supports this agreement?
Ch 7 section 7-6
The law provides certain relief for aggrieved parties that suffer losses as a result of another party’s breach of contract. These relief mechanisms are collectively referred to as remedies. Recall the distinction discussed in Chapter 1 between remedies at law and remedies in equity. For many contracts, the remedy at law will be money damages awarded by the court to the nonbreaching party. This is simply a legal mechanism for compelling the breaching party to compensate the innocent party for losses related to the breach. In a contract claim, money damages are primarily limited to (1) compensatory (also called direct) damages, (2) consequential damages, (3) restitution, and (4) liquidated damages.15
15Two other forms of civil damages recognized as a remedy at law are punitive damages (intended to deter conduct and/or punish a wrongdoer) and nominal damages (a breach exists, but no actually damages were suffered). However, these forms of damages are rare in contracts cases.
Compensatory damages cover a broad spectrum of losses for recovery of actual damages suffered by the nonbreaching party. These damages are an attempt to put the nonbreaching party in the same position she would have been in if the other party had performed as agreed. This includes such sums as out-of-pocket damages and even potential profits that would have been earned if performance had occurred. For example, BigCo. hires LowPrice to prepare BigCo.’s tax returns and financial statements in time for BigCo.’s shareholders meeting on March 1 for a fee of $5,000. On February 15, the principal of LowPrice notifies BigCo. that she cannot prepare the returns because she decided to switch careers and shut down the tax practice. BigCo. must then hire HighPrice to prepare the documents. Because of the short time line, HighPrice charged a fee of $12,000. BigCo. is entitled to recover the difference between the price actually paid ($12,000) and the price that would have been paid if LowPrice had performed ($5,000) as originally agreed. Thus, BigCo. is entitled to $7,000 as compensatory damages (plus any additional out-of-pocket costs related to locating and hiring a new accounting firm).
Consequential damages compensate the nonbreaching party for foreseeable indirect losses not covered by compensatory damages. An aggrieved party is entitled to recover consequential damages if the damages are caused by unique and foreseeable circumstances beyond the contract itself. In order to recover consequential damages, the damages must flow from the breach (i.e., the damages were a consequence of the breach). For example, in the BigCo.–LowPrice case above, suppose that LowPrice had breached on the day before the tax returns were due and that BigCo. needed the tax returns as documentation for a bank loan on that day. Because the tax returns were not ready until one month after the due date, the bank charged BankCo. a delay fee and then raised the interest rate on the loan. These costs to BankCo. are related to the unique circumstances (tax returns needed on a certain date) and are foreseeable (assuming LowPrice had reason to know of the bank loan).
The rules that limit damages for which a nonbreaching party may recover were set out in Hadley v. Baxendale,16 a landmark case on consequential damages that has been followed almost universally by U.S. courts. The case involved Hadley, a 19th-century mill owner, who was forced to cease operations due to a broken crankshaft. The mill owner sent the shaft out for repairs by hiring Baxendale to deliver the shaft to a repair shop in another city. Baxendale had no reason to know that the mill was shut down and, in fact, it was common practice in the industry for mill owners to have a back up shaft for just such an occasion. Baxendale delayed delivery of the shaft and this resulted in additional days of shutdown for the mill and, thus, lost profits for Hadley. Hadley sued Baxendale for the lost profits as consequential damages. The court ruled in favor of Baxendale because Hadley had not shown that a reasonable person could have foreseen Hadley’s ongoing damages. Because Hadley had not actually communicated the unique circumstances, Baxendale was not liable for the damages related to the delay.
16156 Eng. Rep. 145 (1854).
Restitution is a remedy designed to prevent unjust enrichment of one party in an agreement. In the event that one party is in the process of performing the contract and the other party commits a material breach, the nonbreaching party is entitled to rescind (cancel) the contract and receive fair market value for any services rendered. For example, BuildCo. contracts with WidgetCo. to build a new warehouse for WidgetCo.’s inventory. One-third through the construction, WidgetCo. fails to make its payments on time and, therefore, materially breaches the contract. BuildCo. rescinds the contract and in a lawsuit against WidgetCo., BuildCo. may recover restitution equal to the fair market value of the work performed.
Liquidated damages are damages that the parties agree to ahead of time. In some cases it may be very difficult to determine actual damages, so parties may agree at the time of the contract that a breach would result in a fixed damage amount. Liquidated damages provisions are commonly used in license agreements (such as a software-user’s license) whereby the parties agree, for example, that a breaching party will pay $10,000 in the event of a breach caused by one party making unauthorized copies of the software. In order to be enforceable, courts have held that liquidated damage clauses must be directly related to the breach and be a reasonable estimate of the actual damages incurred (i.e., damages cannot be excessive so as to penalize the breaching party).
Although the usual remedy for a breach of contract is money damages, there are some instances where money damages are insufficient to compensate the nonbreaching party or when one party was unjustly enriched at the other party’s expense. In these cases, a court may grant equitable relief. This relief comes primarily in the form of (1) specific performance, ( 2) injunctive relief, or (3) reformation.
Specific performance is a remedy whereby a court orders the breaching party to render the promised performance by ordering the party to take a specific action. This remedy is only available when the subject matter of the contract is sufficiently unique so that money damages are inadequate.17 Therefore, specific performance is rarely available in a sale of goods case unless the goods are rare (such as a coin collection) or distinctive (such as a sculpture) where the buyer cannot reasonably be expected to locate the goods anywhere else.
17Restatement (Second) of Contracts, § 359.
One of the most common circumstances where specific performance is awarded is in a real estate contract. Most courts consider each parcel of land to be sufficiently unique to trigger specific performance as a remedy. For example, Andrews agrees to sell Baker an office building in 30 days. At the closing where conveyance of the title is to take place, Andrews breaches the agreement by refusing to sell the building. In this case, Baker cannot be completely compensated for the breach because Baker chose that building for its location, convenience, accessibility, appearance, and other important factors. Baker contracted for a unique parcel of real estate and is entitled to the benefit of the agreement for the same parcel. The court will require Andrews to perform as promised by conveying the property to Baker. If, however, Andrews has already sold the property to a good faith buyer, then Baker may only be awarded money damages as a remedy.
Specific performance is also an appropriate remedy in a narrow category of personal services contract where the parties agree that a specific individual will perform the services, and the individual possesses a unique quality or expertise central to the contract. For example, if Marcel contracts with Constantine to paint Marcel’s office lobby in whitewash and Constantine breaches, a court would not consider specific performance as an option because the work is not specialized enough. On the other hand, if the Marcel–Constantine contract requires that Constantine paint a special mural on the wall, that would be sufficiently unique as to qualify for specific performance.
A court order to refrain from performing a particular act is known as injunctive relief.18 In the Andrews–Baker office building contract, suppose that Andrews promises to sell the building to Baker in 30 days. Baker learns that Andrews is intending to breach the contract and sell the building to Dominguez for a higher price. In this case, both money damages and specific performance are inadequate because Baker still wants the building instead of compensation for the breach. Baker will ask the court to issue an injunction that would prevent the sale of the building to Dominguez as an equitable remedy consistent with the notion of putting the aggrieved party in the same position as if the other party had performed as agreed.
18The concept of injunctive relief is covered in more detail in Chapter 4, “Resolving Disputes: Litigation and Alternative Dispute Resolution.”
When the parties have imperfectly expressed their agreement and this imperfection results in a dispute, a court may change the contract by rewriting it to conform to the parties’ actual intentions. This contract modification is called reformation. For example, suppose in the Andrews–Baker building contract above, that Andrews’ real estate broker mistakenly placed the decimal in the price making it $10,000 instead of the parties agreed upon price of $100,000. At the closing, Baker gives Andrews the check for $10,000 and refuses to pay any more, citing the price on the contract. So long as there was a sufficient basis for believing the parties intended the price to be $100,000, a court may simply reform the contract. Andrews may then show that Baker breached the contract and request specific performance as an additional remedy.
Avoidance and Mitigation of Damages
The law imposes an obligation on the parties in a contract to take appropriate steps in order to avoid incurring damages and losses. So long as a party can avoid the damages with reasonable effort, without undue risk or expense, she may be barred from recovery through a lawsuit. The rule preventing recovery for reasonably avoidable damages is often called the duty to mitigate.19 For example, Leonardo contracts with NewCo. to design a new office building for NewCo. Midway through the design planning process, NewCo. changed its management, notified Leonardo that it believes that the design contract is invalid, and ordered them to stop work. Despite this, Leonardo continues the design process, submits the final work product to NewCo., and demands payment in full. In this case, it is likely that a court will not allow Leonardo to recover for any damages occurring after the NewCo. stop order. Once Leonardo learned of NewCo.’s claim, he had an obligation to avoid any further damages incurred by his failure to stop the work even if NewCo.’s stop order breached the contract.
19Restatements (Second) of Contracts, § 350.
Managers may encounter a mitigation of damages issue when dealing with employees who claim that their employer breached an employment contract. If an employee has been wrongfully terminated, for example, that employee has a duty to seek new employment (of similar type and rank) if available in order to avoid damages resulting from the alleged breach by the employer.
Concept Summary: Damages
- For a breach of contract, courts will award monetary damages to the nonbreaching party to remedy the loss suffered by nonperformance.
- Monetary damages can be (1) compensatory—direct losses from nonperformance; (2) consequential—indirect but foreseeable losses from nonperformance; (3) restitution—losses equal to the amount that the breaching party has been unjustly enriched by the nonbreaching party; or (4) liquidated—losses of a predetermined value according to the contract.
- Equitable relief is given when the monetary damages are insufficient; it takes the form of (1) injunctive relief, (2) specific performance, or (3) reformation.
- The duty to mitigate is the nonbreaching party’s obligation to avoid excessive or unnecessary damages through reasonable efforts or else be barred from recovery for those avoidable costs of nonperformance.