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Thursday, November 18, 2004

A better approach to teaching damages

Syracuse_l_rev_1 The various formulas by which courts purportedly calculate damages can be difficult to teach and confusing to students.  In a forthcoming article in the AALS Contracts Newsletter, Jake Barnes (Seton Hall) and Debbie Zalesne (CUNY) offer a new and improved solution: the "surplus-based" approach to damages.  The article is a handy guide; the theory is set out in an upcoming article in the Syracuse Law Review.

Click the link below for the full text.

Teaching Damages with the
Surplus-Based Approach

David W. Barnes
Seton Hall University School of Law

Deborah Zalesne
CUNY School of Law

We teach our students that all the rules for calculating damages can be summarized in one rule:

When another’s performance does not conform to the contract, an injured party may recover damages as measured by that party’s lost surplus, which is the difference between anticipated surplus and actual surplus.

Because this approach readily lends itself to preparing a list of types of benefits realized and costs suffered as the result of another’s breach, it appeals to students. It is not just mechanical. Because it emphasizes the goal of contract damage rules (putting the injured party in the position the party would have occupied had there been no breach), it focuses students’ attention on the underlying theory. It substitutes for or explains the damage rules in UCC Article 2 and the Restatement and always gives equivalent results.

The only new concept is that of "surplus," which is analogous to "profit" for a business but applies to consumers as well:

An injured party’s anticipated surplus is the difference between the benefit that party would have received as a result of the contract (anticipated revenue) and cost that party would have incurred in relation to the contract had the contract been fully performed (anticipated cost).

An injured party’s actual surplus is the difference between the benefits that party received (actual revenue) and cost that party incurred (actual cost) as a result of the parties’ performances under the contract or from substitute performance arranged by the injured party.

A student only needs to list and organize the various benefits and costs anticipated (those that would be been realized or incurred if the contract had been performed) and actual benefits received and costs incurred in some format like the one in the accompanying table, which shows calculations for a variety of cases. Of course students need to understand that each category is limited by well-known requirements that losses are compensable only to the extent that: (a) the injured party could not have avoided them using reasonable methods; (b) they are reasonably foreseeable in the ordinary course of events or as a result of special circumstances the parties had reason to know; and (c) the fact of the loss and the amount of the loss are provable with reasonable certainty.

The surplus-based approach works for every imaginable case. Consider, for example, a case in which a buyer breaches and the seller sues for lost profits plus costs incurred, such as in Cesco Manufacturing Corp. v. Norcross, Inc., 391 N.E.2d 270 (Mass. App. 1979). In that case, the seller contracted to sell 1,000 customized greeting card display racks for $100,000. After the seller incurred $15,000 of the $50,000 in production costs anticipated, the buyer breached. There was no actual market or salvage value for the unfinished goods. Under the surplus-based rule, the seller’s damages are as follows: Anticipated Surplus, $50,000, equals Anticipated Revenue ($100,000 contract price) less Anticipated Cost ($50,000). Actual Surplus, -$15,000, equals Actual Revenue ($0) less Actual Cost ($15,000). Damages, $65,000, equal Anticipated Surplus ($50,000) minus Actual Surplus (-$15,000). An award of $65,000 provides $15,000 to repay costs incurred plus $50,000 in anticipated surplus.

Where lost profits are too speculative, the surplus-based rule treats anticipated benefits and anticipated costs as equal. For example, in Security Stove & Manufacturing Co. v. American Railway Express Co., 51 S.W.2d 572 (Mo. Ct. App. 1932), a shipper of a stove not delivered on time to an exhibition had incurred $801.50 in charges, fares, hotel bills, wages, and rentals. The court did not award lost profits because they were too speculative. Reliance measure presumes no loss, so anticipated revenues and costs are each treated as equal to $801.50. There was no actual revenue and actual costs were $801.50, resulting in a damage award of $801.50.

Damages for a lost volume seller can also be calculated using the surplus-based rule. In Neri v. Retail Marine, 285 N.E.2d 311 (N.Y. 1972), for example, a buyer deposited $4,250 on a $12,587 boat. The retailer/seller anticipated $10,008 to buy the boat from the manufacturer and prepare it for sale, but also spent $674 to store, maintain and insure the boat after the buyer breached. Seller resold to a third party for same price. The court calculated the seller’s damages without consideration of the resale because the seller was a lost volume seller. Under the surplus-based rule, the seller’s damages are as follows: Anticipated Surplus equals Anticipated Revenue ($12,587 contract price) less Anticipated Cost ($10,008), which comes to $2,579. Actual Surplus equals Actual Revenue (payment of $4,250) less Actual Cost ($0 performance cost, because that cost is associated with the resale, plus the breach-related cost of $674), which comes to $3,576. The Lost Surplus, -$997, is Anticipated Surplus ($2,579) minus Actual Surplus ($3,576); money is payable to the breaching buyer.

Finally, consider a case where an aggrieved buyer seeks damages after a breaching seller has only partly performed. In Pittsburgh Coal Co. v. Northy, 123 N.W. 47 (1909), a seller contracted to sell 1,300 tons of coal to a buyer for $2.45/ton. The buyer intended to resell for $4/ton. The seller delivered 937 tons, which buyer resold as intended. Buyer’s anticipated benefit was $5,200 and anticipated cost was $3,185. Actual revenue was $3,748 and actual cost was $2,295.65. Anticipated surplus less actual surplus (damages) is $562.65.

Case Name

Anticipated

–– Anticipated

–– Actual

+ Actual

Damages

and Type

Benefits

Costs

Benefits

Costs

Equal

Cesco

(lost profits + costs incurred)

$100,000.00

$ 50,000.00

$ 0.00

$ 15,000.00

$ 65,000.00

Security Stove

("reliance"; uncertain profits)

$ 801.50

$ 801.50

$ 0.00

$ 801.50

$ 801.50

Neri

(resale, lost volume)

$ 12,587.00

$ 10,008.00

$ 4,250.00

$ 674.00

$ (997.00)

Pittsburgh Coal

(seller's part performance)

$ 5,200.00

$ 3,185.00

$ 3,748.00

$ 2,295.65

$ 562.65

This table (above) is based on the general formula that comes from the general rule: Damages = Anticipated Surplus – Actual Surplus, which directly compares the injured party’s position before and after breach. Anticipated Surplus equals Anticipated Benefits less Anticipated Costs. Correspondingly, Actual Surplus equals Actual Benefits less Actual Costs. An equivalent approach is: Damages = (Anticipated Benefits – Actual Benefits) – (Anticipated Costs – Actual Costs), which is an easy approach for cases where a buyer or seller arranges a substitute transaction (cover/resale) or additional costs are imposed by the other’s breach of contract or warranty.

Because this approach is so organized and consistent from case to case, it is easy for students to learn. It is also a good way for students to check whether their calculations using traditional approaches are correct. For more illustrations of the computations, see David W. Barnes & Deborah Zalesne, The Shadow Code, 56 S.C. L. Rev. (forthcoming 2004). For a complete discussion of the theoretical reasons for adopting this "surplus-based" approach to contract damages, see David W. Barnes & Deborah Zalesne, A Unifying Theory of Contract Damages, 55 Syracuse L. Rev. (forthcoming 2005).

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