By Daniel Faizakoff, Esq. and Daniel Goldstein, Esq.
The term “damages” refers to the loss or injury sustained by a party as a result of a breach of contract or tortious act committed by another. It also refers to the sum that will be awarded by a court to the injured party as the compensation or pecuniary remedy for such loss. In a breach of contract action, pecuniary remedies can include compensatory damages, consequential damages, and liquidated damages. In certain circumstances, lost profits and punitive damages may also be recovered. This article serves to highlight the various contract damages and identify how they differ.
To recover damages in a legal proceeding, a plaintiff must first establish an invasion of a legal right by a wrongful act on the part of the defendant, resulting in a loss. However, determining whether damages should be awarded first requires a finding of liability or fault. Thus, the measure of damages is always secondary to the question of liability. In the breach of contract context, this means that a plaintiff must allege and prove the following elements prior to the adjudication of damages: (1) the existence of a contract, (2) performance of the contract by plaintiff, (3) breach by the defendant, and (4) damage resulting to plaintiff.
New York courts separate damages into: (1) “compensatory” damages, which are to compensate for the loss or injury; and (2) “punitive” damages, which are not to compensate for loss or injury, but to penalize a defendant for the offensive nature of his actions. Compensatory damages, in turn, may be subdivided into: (a) “general” or “direct” damages, which compensate for the value of the promised performance, and (b) “special” or “consequential” damages, which compensate for indirect losses incurred as a result of the breach. To illustrate these two types of damages we will examine lost profits which can, depending on the circumstances, be either direct damages or consequential damages depending on where the profits were to be earned. This distinction can mean the difference of a recovery, particularly if a liability limitation clause excludes consequential but not general damages.
II. Direct Damages
The first type of compensatory damages compensates a plaintiff for the value of the promised performance. General damages “are the natural and probable consequence of the breach” and are measured by what it would take to put the non-breaching party in the same position that it would be in had the breaching party performed under the contract as promised. The intent is to restore the injured party to the position it would have been in had the contract been fully performed. Therefore, lost profits that would have been earned by the plaintiff directly from the breaching defendant are considered to be direct or general damages. For example, if a manufacturer produces goods for a customer and the customer fails to pay for the goods, the profits that the manufacturer lost as a result of the breach are direct damages.
III. Consequential Damages
The second type of compensatory damages known as special or consequential damages, are damages that do not directly flow from the breach itself. These are described as damages “which do not arise out of the immediate transaction between the contracting parties, but which stem from losses incurred by the non-breaching party in its dealings with third parties.” An example of special or consequential damages would be lost profits that would have been earned from third parties but for the actions of the defendant. For example, a plaintiff may have contracted to have a manufacturer produce component parts to be included in the product ordered by its customer. If the manufacturer breaches his obligation to timely supply the component part, the plaintiff will not be able to fulfill the order placed by its customer and will lose those potential profits.
Consequential damages are recoverable in limited circumstances and only upon a showing that they were foreseeable and within the contemplation of the parties at the time the contract was made. In determining the contemplation of the parties at the time the contract was made courts will look to the nature, purpose, and particular circumstances of the contract known to the parties when they entered the agreement. Damages for the loss of future profits must be proven with reasonable certainty and “be capable of measurement based upon known reliable factors without undue speculation.” As a result, in our example above, it is clear that the purpose of the order of the component parts was for the inclusion of the component parts in the product to be sold to the customer by the plaintiff. The measure of damages is also certain and readily quantifiable because the goods were going to be sold for a specific price to the customer which had already ordered the goods. In contrast, damages for lost profits generally are not available for start-ups or companies in the developmental phase, because profits are difficult or impossible to prove with reasonable certainty.
IV. Liquidated Damages
Liquidated damages are damages to be paid by the breaching party to the non-breaching party that are agreed upon in advance by the contracting parties to satisfy any potential loss or injury that the parties anticipate may flow from a breach of the contract. Thus, liquidated damages are negotiated and established by contract alone. The purpose is to predetermine a sum certain that will be paid by the breaching party to the non-breaching party in the event of default and thereby establish predictability. Liquidated damage clauses are enforceable and courts will uphold them, providing that: (a) the injury or loss is uncertain or difficult to quantify at the time the contract is executed, (b) the amount bears a reasonable proportion to the actual loss sustained, and (c) the amount is structured to serve as a function of damages and not a penalty. If the liquidated damage amount is grossly disproportionate to the actual loss, or if the provision functions as a penalty, it will likely be set aside by the court.
V. Punitive Damages
Punitive damages or exemplary damages are damages intended to reform or deter the defendant and others from engaging in the conduct which gave rise to the lawsuit. Punitive damages generally are not recoverable in an ordinary breach of contract case, as their purpose “is not to remedy private wrongs but to vindicate public rights.”
Because punitive damages are usually in excess of the plaintiff’s actual loss, they are awarded only in special cases, usually under tort law, where the defendant’s conduct was “egregiously insidious.” However, courts have awarded punitive damages when the breach of contract “also involves a fraud evincing a high degree of moral turpitude, and demonstrating such wanton dishonesty as to imply a criminal indifference to civil obligations, and where the conduct was aimed at the public.”
VI. Other Types of Monetary Damages
Additional pecuniary damage classifications include: (a) incidental damages, which are reasonable expenses incurred as a result of the other party’s breach, (b) nominal damages, which are minor amounts awarded to reflect a legal recognition that a plaintiff’s rights have been violated through a defendant’s breach, and (c) and statutory or treble damages, which are damage amounts established by statute (treble damages means that the court triples the amount of compensatory damages awarded).
Additionally, a prevailing party should not forget the pecuniary remedies of attorneys’ fees and pre-judgment statutory interest. The American Rule is that parties to a lawsuit bear their own legal fees, and courts do not shift attorneys’ fees to prevailing parties. However, it is not uncommon for contracts to provide for the prevailing party’s attorneys’ fees to be reimbursed by the losing party, and these provisions are generally upheld. Further, pre-judgment interest accrues on the amount of a damages award from the time of the injury or damage to the time the judgment is entered by the court. In New York, the statutory rate is currently 9% per year. CPLR 5001[a].
VII. Equitable Remedies
Whereas legal remedies are associated with monetary damages, equitable remedies are a distinct category of damages pertaining to the court’s authority to prescribe a remedy according to the demands of the situation. While equitable remedies can be monetary in nature, such as restitution to prevent one party from being unjustly enriched, they can also take the form of non-monetary relief. The main kinds of equitable remedies available in a breach of contract action include an injunction or specific performance, contract rescission, and contract reformation. An injunction is where a court orders a party to stop acting in a certain manner. Specific performance is an order requiring a party in breach to perform their part of the bargain. In general, courts will avoid the relief of specific performance so as to not compel two quarreling sides to maintain a relationship. However, in certain situations, such as a sale of property or goods which have already been paid for, courts can and do compel the relief of specific performance.
In sum, each breach of contract action is different and unique and thus, the type of damages available to the plaintiff is dependent on the facts of the particular case. Competent counsel should always be consulted to determine what types of damages are recoverable by a plaintiff and what potential liabilities may be incurred by a defendant.