Business Law I Final Preparation Chapter 16 - Breach of Contract and Remedies

Burke v. 401 N. Wabash Venture, LLC

The U.S. court of appeals affirmed the district court's decision that enforced the liquidated damage agreement permitting the developer to retain the plaintiff's deposit.

Mance v. Mercedes-Benz USA

The U.S. district court held that the arbitration clause was enforceable and granted Mercedes-Benz's motion to compel arbitration.

What are liquidated damages?

Under certain circumstances, the parties to a contract may agree in advance to the amount of damages payable on a breach of contract. These damages are called liquidated damages. To be lawful, the actual damages must be difficult or impracticable to determine, and the liquidated amount must be reasonable in the circumstances.5 An enforceable liquidated damages clause is an exclusive remedy even if actual damages are later determined to be different from the liquidated damages.

What are the 3 types of performance of a contract?

(1) complete performance, (2) substantial performance (or minor breach), and (3) inferior performance (or material breach). A breach of contract occurs if one or both parties do not perform the duties as specified in the contract.

What are compensatory damages for a construction contract?

A construction contract arises when the owner of real property contracts to have a contractor build a structure or do other construction work. The compensatory damages recoverable for a breach of a construction contract vary with the stage of completion of the project when the breach occurs. A contractor may recover the profits he or she would have made on the contract if the owner breaches the construction contract before construction begins. Example RXZ Corporation contracts to have Ace Construction Company build a factory building for $1,200,000. It will cost Ace $800,000 in materials and labor to build the factory for RXZ. If RXZ Corporation breaches the contract before construction begins, Ace can recover $400,000 in "lost profits" from RXZ as compensatory damages. Example Entel Corporation contracts to have the Beta Construction Company build a factory building for Entel for $1,200,000. It will cost Beta Construction Company $800,000 to construct the building. Thus, Beta Corporation will make $400,000 profit on the contract. Beta begins construction and has spent $300,000 on materials and labor before Entel breaches the contract by terminating Beta. Here, Beta can recover $700,000, which is comprised of $400,000 lost profits ($1,200,000 − $800,000) plus $300,000 expended on materials and labor. The $700,000 of compensatory damages will make Beta Construction Company "whole." If the builder breaches a construction contract either before or during construction, the owner can recover the increased cost above the contract price that he or she has to pay to have the work completed by another contractor. Example Ethenol Corporation contracts to have the Sherry Construction Company build a factory building for Ethenol for $1,200,000. Just before Sherry Construction Company is to begin work, it breaches the contract by withdrawing from the project. Ethenol seeks new bids, and the lowest bid to construct the building is $1,700,000. Here, Ethenol can recover $500,000 in compensatory damages from Sherry Construction Company ($1,700,000 [new contract price] − $1,200,000 [Sherry Construction's original price]).

What is a penalty?

A liquidated damages clause is considered a penalty if actual damages are clearly determinable in advance or if the liquidated damages are excessive or unconscionable. If a liquidated damages clause is found to be a penalty, it is unenforceable. The nonbreaching party may then recover actual damages. Example Rent-to-Own Store is a store that rents furniture to individuals who are usually poorer, and these individuals take title to the furniture after having paid the cost of the furniture (which is often overpriced with high interest rates). Mable, an elderly person who is poor, has rented and purchased a living room set, a dining room set, and a bedroom set from Rent-to-Own Store. Mable rents a flat-screen television from Rent-to-Own Store and signs a contract that states that if Mable falls more than 3 months behind in her television payments, Rent-to-Own Store can recover all of the furniture she had previously purchased from the store as liquidated damages. This is an example of a liquidated damages clause that is a penalty and that would not be enforced.

What is inferior performance?

A material breach of a contract occurs when a party renders inferior performance of its contractual obligations that impairs or destroys the essence of the contract. There is no clear line between a minor breach and a material breach. A determination is made on a case-by-case basis. Where there has been a material breach of contract, the nonbreaching party may rescind the contract and seek restitution of any compensation paid under the contract to the breaching party. The nonbreaching party is discharged from any further performance under the contract.2 Alternatively, the nonbreaching party may treat the contract as being in effect and sue the breaching party to recover damages. Example A university contracts with a general contractor to build a new three-story classroom building with classroom space for 1,000 students. The contract price is $100 million. However, the completed building cannot support more than 500 students because the contractor used inferior materials. The defect cannot be repaired without rebuilding the entire structure. Because this is a material breach, the university may rescind the contract, recover any money that it has paid to the contractor, and require the contractor to remove the building. The university is discharged of any obligations under the contract and is free to employ another contractor to rebuild the building. However, the building does meet building codes so that it can be used as an administration building of the university. Thus, as an alternative remedy, the university could accept the building as an administration building, which has a value of $20 million. The university would owe this amount—$20 million—to the contractor.

What are consequential damages?

A nonbreaching party can sometimes recover consequential damages, or special damages, from the breaching party. Consequential damages are foreseeable damages that arise from circumstances outside a contract. To be liable for consequential damages, the breaching party must know or have reason to know that the breach will cause special damages to the other party. Example X-Mart, a major retailer, contracts with Mattel, a major manufacturer of toys, to purchase one million of the new "G.I. Barbie Dolls" produced by Mattel at $20 per doll. X-Mart plans to sell these dolls in its stores nationwide at $50 per doll, and Mattel is aware that X-Mart intends to resell the dolls. The popularity of Barbie Dolls guarantees that all the dolls purchased by X-Mart will be sold. If Mattel breaches this contract and fails to deliver the dolls to X-Mart, X-Mart cannot purchase the dolls elsewhere because Mattel holds the copyright and trademark on the doll. Therefore, X-Mart can recover the lost profits on each lost sale as consequential damages from Mattel—that is, the difference between the would-be sales price of the dolls ($50) and the purchase price of each doll ($20), or $30 lost profit per doll. In total, X-Mart can recover $30 million in consequential damages from Mattel ($50 − $20 = $30 × 1,000,000).

What are nominal damages?

A nonbreaching party can sue a breaching party to a contract for nominal damages even if no financial loss resulted from the breach. Nominal damages are usually awarded in a small amount, such as $1. Cases involving nominal damages are usually brought on principle. Most courts disfavor nominal damages lawsuits because they use valuable court time and resources. Example Mary enters into an employment contract with Microhard Corporation. It is a 3-year contract, and Mary is to be paid $100,000 per year. After Mary works for one year, Microhard Corporation fires Mary. The next day, Mary finds a better position at Microsoft Corporation, in the same city, paying $125,000 per year on a 2-year contract. Mary has suffered no monetary damages but could bring a civil lawsuit against Microhard Corporation because of its breach and recover nominal damages ($1).

Intentional Interference with Contractual Relations

A party to a contract may sue any third person who intentionally interferes with the contract and causes that party injury. The third party does not have to have acted with malice or bad faith. This tort, which is known as the tort of intentional interference with contractual relations, usually arises when a third party induces a contracting party to breach a contract with another party. The following elements must be shown: A valid, enforceable contract between the contracting parties Third-party knowledge of this contract Third-party inducement to breach the contract A third party can contract with the breaching party without becoming liable for this tort if a contracting party has already breached the contract, and thus, the third party cannot be held to have induced a breach of the other parties' contract. Example A professional football player signs a 5-year contract to play football for a certain professional football team. Two years into the contract, another professional football team, with full knowledge of the player's contract with the other team, offers the player twice the amount of money that he is currently making to breach his contract and sign and play with the second football team. The player breaches his contract and signs to play for the second team. Here, the second team intentionally interfered with the player's contract with the first team. The first team can recover tort damages—including punitive damages—from the second team for the tort of intentional interference with a contract.

What is specific performance?

An award of specific performance orders the breaching party to perform the acts promised in a contract. The courts have the discretion to award this remedy if the subject matter of the contract is unique.7 Specific performance is available to enforce land contracts because every piece of real property is unique. Works of art, antiques, and items of sentimental value, rare coins, stamps, heirlooms, and the like, also fit the requirement for uniqueness. Most other personal property does not. Example On September 1, Won-Suk enters into a contract to purchase a house from Geraldine for $1 million. The closing date is set for November 1. On November 1, Won-Suk brings the money to the closing, but Geraldine does not appear at the closing and thereafter refuses to sell the house to Won-Suk. In this case, because each piece of real estate is considered unique, Won-Suk can bring an action of specific performance against Geraldine and obtain a court judgment ordering Geraldine to sell the house to Won-Suk. Specific performance of personal service contracts is not granted because the courts would find it difficult or impracticable to supervise or monitor performance of such a contract. Example A concert hall contracts with a famous rap artist to hold a series of concerts. Later, the rap artist refuses to perform. Here, the concert hall cannot require the rap artist to perform because it is a personal service contract. The concert hall could, however, sue to recover any payments it has made to the rap artist and recover any damages that it may have suffered because of the breach.

What are compensatory damages for an employment contract?

An employee whose employer breaches an employment contract can recover lost wages or salary as compensatory damages. If the employee breaches the contract, the employer can recover the costs to hire a new employee plus any increase in salary paid to the replacement. Example EBM Corporation enters into a written contract to employ Mohammad as a chief financial officer of the company for 3 years at a salary of $30,000 per month. Before Mohammad starts work, EBM informs Mohammad that his employment is terminated. This is a material breach of the contract. If Mohammad is unable to find a comparable job, Mohammad can recover $1,080,000 (36 months × $30,000) as compensatory damages.

What is injunction?

An injunction is a court order that prohibits a person from doing a certain act. To obtain an injunction, the requesting party must show that he or she will suffer irreparable injury if the injunction is not issued. Example A professional basketball team enters into a 5-year employment contract with a basketball player. The basketball player breaches the contract and enters into a contract to play for a competing professional basketball team. Here, the first team can obtain an injunction to prevent the basketball player from playing for the other team during the remaining term of the original contract.

What is anticipatory breach?

Anticipatory breach (or anticipatory repudiation) of a contract occurs when a contracting party informs the other party in advance that it will not perform the contractual duties when due. This type of material breach can be expressly stated or implied from the conduct of the repudiator. Where there is an anticipatory repudiation, the nonbreaching party's obligations under the contract are discharged immediately. The nonbreaching party also has the right to sue the repudiating party when the anticipatory breach occurs; there is no need to wait until performance is due.3

What are compensatory damages?

Compensatory damages are intended to compensate a nonbreaching party for the loss of the bargain. In other words, they place the nonbreaching party in the same position as if the contract had been fully performed by restoring the "benefit of the bargain." Example Lederle Laboratories enters into a written contract to employ Wei as a chief operations officer of the company for three years, at a salary of $20,000 per month. After one year at work, Lederle informs Wei that her employment is terminated. This is a material breach of the contract. If Wei is unable to find a comparable job, Wei can sue Lederle Laboratories and recover $480,000 (24 months × $20,000) as compensatory damages. However, if after six months of being unemployed Wei finds a comparable job that pays $20,000 per month, Wei can recover $120,000 from Lederle (6 months × $20,000) as compensatory damages. In these examples, the damages awarded to Wei place her in the same situation as if her contract with Lederle had been performed. The amount of compensatory damages that will be awarded for breach of contract depends on the type of contract involved and which party breached the contract. The award of compensatory damages in some special types of contracts is discussed in the following paragraphs.

What are compensatory damages for sale of a good?

Compensatory damages for a breach of a sales contract involving goods are governed by the Uniform Commercial Code (UCC). The usual measure of damages for a breach of a sales contract is the difference between the contract price and the market price of the goods at the time and place the goods were to be delivered.4 Example Revlon, Inc. contracts to buy a piece of equipment from Greenway Supply Co. for $80,000. Greenway does not deliver the equipment to Revlon when it is required to do so. Revlon purchases the equipment from another vendor but has to pay $100,000 because the current market price for the equipment has risen. Revlon can recover $20,000 from Greenway—the difference between the market price paid ($100,000) and the contract price ($80,000)—in compensatory damages.

What is a disclaimer of consequential damages?

Consequential damages are often disclaimed in a sales or license agreement. This means that the breaching party is not responsible to pay consequential damages. Disclaimer of consequential damages is lawful in most instances. Example A student installs a new software program on his computer that is licensed from a software company. The license price was $100. The software was installed, but it was defective. The software causes files in the computer, including the student's class notes, Ph.D. dissertation, and other valuable information, to be deleted. These were the only copies of the files. The student suffers a loss by having his only copies of these important materials to be deleted because of the newly installed software. These losses are consequential damages. However, the software license contains a disclaimer stating that the licensor is not liable for consequential damages. Therefore, the student cannot recover monetary damages for his consequential damages. The student can recover $100 in compensatory damages, however, for the license price he paid for the defective software.

Implied Covenant of Good Faith and Fair Dealing

Contracts usually are enforced based on the express terms of the contract. However, some states permit a court to imply a covenant called the covenant of good faith and fair dealing in certain types of contracts. Under this implied covenant the parties to a contract are not only held to the express terms of the contract but are also required to act in good faith and deal fairly in all respects in obtaining the objective of the contract. This covenant of good faith and fair dealing is usually implied in contracts where the parties have a special relationship that involves a fiduciary duty. Contracts between insurance companies and insureds, publishing agreements between publishers and authors, and employment contracts are often included under this implied covenant. A breach of the implied covenant of good faith and fair dealing is a tort for which tort damages are recoverable. A court can award punitive damages for the breach if the circumstances warrant. Breach of the implied covenant of good faith and fair dealing is often referred to as the tort of bad faith. Example An automobile owner (called the insured) has an automobile insurance policy with an insurance company that provides for the payment of up to $200,000 for medical expenses, pain and suffering, and other injuries incurred by anyone who is injured if the insured causes an automobile accident. The insured driver causes an automobile accident whereby he seriously injures another driver. The other driver incurs medical expenses of $100,000 and will suffer permanent injuries because of the accident. The injured party sues the insured and his insurance company for $1 million to recover damages for medical expenses, future medical expenses, and pain and suffering. The injured party makes an offer to the insurance company whereby he will accept the automobile insurance policy limit of $200,000 in exchange for releasing the insurance company and the insured of any future liability. This is often done to settle a case quickly and to avoid the risks of going to trial. Although this is a reasonable settlement offer, the insurance company refuses to settle. The case goes to trial and the jury awards the injured party $1 million. The insurance company pays the policy limit of $200,000, leaving an $800,000 judgment for the insured to pay. If the insured has any assets, they will have to be used to pay the judgment. If the insured does not have the ability to pay, he might have to file for bankruptcy. The insured sues his insurance company, alleging that the insurance company breached the implied covenant of good faith and fair dealing by refusing to settle the lawsuit within the policy limits. Under these facts, the jury awards the insured $800,000 in compensatory damages and $2 million in punitive damages against the insurance company based on its bad faith in handling the claim. The implied covenant of good faith and fair dealing is an evolving area of the law.

What are equitable remedies?

Equitable remedies are available if there has been a breach of contract that cannot be adequately compensated through a legal remedy. They are also available to prevent unjust enrichment. The most common equitable remedies are specific performance, reformation, and injunction, which are discussed in the following paragraphs.

What is mitigation of damages?

If a contract has been breached, the law places a duty on the innocent nonbreaching party to make reasonable efforts to mitigate (i.e., avoid or reduce) the resulting damages. The extent of mitigation of damages required depends on the type of contract involved. If an employer breaches an employment contract, the employee owes a duty to mitigate damages by trying to find substitute employment. The employee is only required to accept comparable employment. The courts consider factors such as compensation, rank, status, job description, and geographical location in determining the comparability of jobs. Example Edith is employed by Software Inc., a software company located in the Silicon Valley of California, as a software manager. Her contract is for 3 years at $200,000 per year. If Software Inc. terminates Edith after one year, she is under a duty to mitigate the damages that would be owed to her by Software Inc. If Edith finds a job as a software manager at another software company located in the Silicon Valley for the same salary, she is required to take the job. However, if Edith finds a job at a similar salary as a sales manager in the Silicon Valley, or if she is offered a job as a software manager at the same salary at a software company in Los Angeles, California, or if she is offered a job as a software manager at a company in the Silicon Valley but at a salary of $120,000 per year, she is not required to accept any of these job offers because they are not comparable jobs. If an employee who has been dismissed improperly accepts a job that is not comparable, the employee can sue the prior employer for damages. Example Andrew is employed as a chief financial officer of Financial Company in New York City for a salary of $200,000 per year on a 3-year contract. His employer terminates Andrew with 2 years left on the contract. Andrew accepts employment as a financial analyst at a new employer that pays $150,000 per year. Andrew can sue his prior employer Financial Company and recover $100,000 ($50,000 difference in salary per year for 2 years).

What is arbitration of contract disputes?

Many contract disputes are heard and decided by the court system. In the contract area, however, some contract disputes are heard and decided through arbitration. Arbitration is a nonjudicial, private resolution of a contract dispute. An arbitrator, not a judge or jury, renders a decision in the case. Most arbitration agreements stipulate binding arbitration, that is, the arbitrator's decision cannot be appealed to the courts. Arbitration occurs if the parties have entered into an arbitration agreement, either as part of their contract or as a separate agreement. Many consumer and business contracts contain arbitration clauses. Examples Credit card agreements, mortgages, sales contracts, automobile leases, employment contracts, electronic contracts, and software licenses often contain arbitration clauses. The U.S. Congress has enacted the Federal Arbitration Act,8 which promotes the arbitration of contract disputes whether the dispute involves federal or state law. The U.S. Supreme Court has upheld the act's national policy favoring arbitration and the enforcement of arbitration agreements.9

What is complete performance?

Most contracts are discharged by the complete performance, or strict performance, of the contracting parties. Complete performance occurs when a party to a contract renders performance exactly as required by the contract. A fully performed contract is called an executed contract. Tender of performance, or tender, also discharges a party's contractual obligations. Tender is an unconditional and absolute offer by a contracting party to perform its obligations under the contract. Example Ashley, who owns a women's retail store, contracts to purchase a lot of high-fashion blue jeans from a manufacturer for $75,000. At the time of performance, Ashley tenders the $75,000. Ashley has performed her obligation under the contract once she tenders the $75,000 to the manufacturer. The manufacturer tenders the jeans to Ashley when required to do so and Ashley accepts the jeans. There is a complete performance of the contract.

What is reformation?

Reformation is an equitable doctrine that permits the court to rewrite a contract to express the parties' true intentions. Reformation is usually available to correct clerical errors in contracts. Example A clerical error is made during the typing of a contract, and both parties sign the contract without discovering the error. If a dispute later arises, the court can reform the contract to correct the clerical error to read as the parties originally intended.

What is rescission and restitution?

Rescission is an action to undo a contract. It is available where there has been a material breach of contract, fraud, duress, undue influence, or mistake. Generally, to rescind a contract, the parties must make restitution of the consideration they received under the contract.6 Restitution consists of returning the goods, property, money, or other consideration received from the other party. If possible, the actual goods or property must be returned. If the goods or property have been consumed or are otherwise unavailable, restitution must be made by conveying a cash equivalent. The rescinding party must give adequate notice of the rescission to the breaching party. Rescission and restitution restore the parties to the positions they occupied prior to the contract. Example Pralene's Store contracts to purchase $1,000,000 of goods from a clothing manufacturer. Pralene's pays $100,000 as a down payment, and the first $200,000 worth of goods are delivered. The goods are materially defective, and the defect cannot be cured. This breach is a material breach. Pralene's can rescind the contract. Pralene's is entitled to receive its $100,000 down payment back from the manufacturer, and the manufacturer is entitled to receive the goods back from Pralene's.

What is substantial performance?

Substantial performance occurs when there has been a minor breach of contract. In other words, it occurs when a party to a contract renders performance that deviates slightly from complete performance. The nonbreaching party may try to convince the breaching party to elevate its performance to complete performance. If the breaching party does not correct the breach, the nonbreaching party can sue to recover damages by (1) deducting the cost to repair the defect from the contract price and remitting the balance to the breaching party or (2) suing the breaching party to recover the cost to repair the defect if the breaching party has already been paid. Example Donald Trump contracts with Big Apple Construction Co. to have Big Apple construct an office building for $100 million. The architectural plans call for installation of 3-ply windows in the building. Big Apple constructs the building exactly to plan except that it installs 2-ply windows. There has been substantial performance. It would cost $5 million to install the correct windows. If Big Apple agrees to replace the windows and does so, its performance is elevated to complete performance, and Trump must pay the entire contract price. However, if Trump has to hire someone else to replace the windows, he may deduct this cost of repair of $5 million from the contract price of $100 million and remit the difference of $95 million to Big Apple. If Trump had already paid the $100 million and Big Apple refuses to install the proper windows, Trump can sue and recover the $5 million.

Alba v. Kaufmann

The appellate court, as a matter of law, granted the Albas' motion for summary judgment and ordered Kaufmann specifically to perform the real estate contract.

What are torts associated with contracts?

The recovery for breach of contract is usually limited to contract damages. A party who can prove a contract-related tort, however, may also recover tort damages. Tort damages include compensation for personal injury, pain and suffering, emotional distress, and possibly punitive damages. Generally, punitive damages are not recoverable for breach of contract. They are recoverable, however, for certain tortious conduct that may be associated with the nonperformance of a contract. The major torts associated with contracts are intentional interference with contractual relations and breach of the implied covenant of good faith and fair dealing.

What are monetary damages?

Where there has been a breach of a contract, the nonbreaching party may recover monetary damages from a breaching party. Monetary damages are available whether the breach was minor or material. Monetary damages are sometimes referred to as dollar damages. Several types of monetary damages may be awarded. These include compensatory, consequential, liquidated, and nominal damages.