Teaching Assistants: Victor Goldberg on Tacit Assumptions and Consequential Damages

This is the seventh in a series of posts on Victor Goldberg's work.  Today's post is about Chapters 8-10 of his book, Rethinking Contract Law and Contract Design (RCL).  Links to other posts follow this post.

Site of the dramatic events in Hadley

Everybody hates the tacit assumption doctrine, except for New York State (sort of), three of the Law Lords in The Achilleas, Oliver Wendell Holmes, and Professor Goldberg.  The doctrine is an alternative to the dominant rule on consequential damages (from Hadley v. Baxandale) that such damages must be within the contemplation of the parties at the time they entered into the contract.  The tacit assumption seeks to determine whether it would be commercially reasonable to assume that the damages at issue were an unspoken assumption of the parties.  Professor Goldberg points out that tacit assumptions abound in modern contracts law, as evidenced by courts’ welcoming attitude to extrinsic evidence relating to course of performance, course of dealing, and usage of trade.  We seem to assume that damages are different, but this is an unreasoned sentiment (RCL, 87-90).  

In general, Professor Goldberg proposes two situations in which the parties might provide for the recovery of consequential damages in negotiated contracts.  The first would be based on the gross negligence or willfulness of the non-breaching party.  He justifies this exception to the general limitation on consequential damages in terms of the tradeoff between flexibility and reliance discussed in Chapter 2: “For innocent mistakes the onus is on the buyer to protect itself,” Professor Goldberg maintains, but they should not have to protect themselves against behaviors by the seller “outside the buyer’s reasonable expectations” (RCL, 93-94).  The second exception is where parties stipulate in advance to the seller’s liability for foreseeable consequential damages, as they might do in the context of a long-term relationship like those between suppliers of auto parts and the automobile manufacturers (RCL, 94-95).

Albright-Knox Art Gallery, Buffalo, NY

Professor Goldberg next, in Chapter 9, covers Kenford Company v. Erie County through five rounds of litigation that spanned two decades.  A $500 million claim ultimately yielded a $10 million verdict based on what the court styled reliance damages, but there were a lot of interesting twists and turns along the way.  The case involved what now seems like a quixotic scheme to build a domed stadium in Buffalo for the Bills that might also house a baseball team looking for a new venue.  The Washington Senators and the New York Yankees were both potential future tenants.  The author of the scheme was Edward Cottrell, operating through the Kenford Company, who owned the land on which the stadium was to be built.  The basic deal was that Kenford would loan a parcel of land to Erie County for the purposes of building the stadium. In exchange, he would get a 40-year lease of on the stadium and profit from management fees and from enterprises he would build on the surrounding property.  The deal fell through when construction estimates for the stadium greatly exceeded estimates.  The County backed out, and Cottrell was unable to secure financing without the County’s support (RCL, 97-101).  The parties seemed never to have contemplated such an eventuality, and their five-page contract covering everything but the management agreement gave the courts little to work with.

As the husband of a proud daughter of the City of Good Neighbors, I was intrigued by the possibility that a domed stadium for the Bills might also be enough to entice the Yankees to leave the Bronx for Erie County.  If George Costanza could be part of the Yankees organization, why not the city of Buffalo?  Unfortunately, even though the Yankees were up for sale for a mere $12 million, Buffalo failed to lure them to the Queen City of the Lakes, as its attempt sailed wide right.

From Professor Goldberg’s perspective, the courts made myriad mistakes in their approach to damages.  They treated the damages from the breach of the management contract as consequential damages when they were in fact direct damages.  The management contract was the consideration for the donated land, and so the question should have been value of that land (perhaps $200,000) and not some speculative $58 million estimate that Cottrell’s experts had concocted (RCL, 108-09).  In their approach to lost profits, the New York Court of Appeals applied the new business rule, which turns on the speculative nature of estimates of a new venture’s potential profitability.  The new business rule might make sense.  However, as Professor Goldberg points out, the reason, at least in cases like Kenford should not turn on the speculative nature of the damages but on the economics concept of opportunity costs.  The question is not what profits the new business would have generated but the extent to which those profits exceeded those of an alternative venture into which the non-breaching party could have invested its resources (RCL, 108).  Professor Goldberg regards all of Kenford’s extravagant claims of lost profits with a jaundiced eye.  If the deal was so lucrative, why was Kenford unsuccessful in securing financing (RCL, 100)?  Whence came Kenford’s expert opinion that the company would have made $140 million by buying “a baseball franchise at its fair market value” (RCL, 109)? 

The tacit assumption doctrine arose in Round 5, as New York’s Court of Appeals attempted to calculate the lost appreciation of the lands surrounding the site of the now-defeated stadium.  The Court of Appeals seemed to adopt the tacit-assumption approach, but the assumptions of the parties were hard to discern given that the contract was only five pages long.  The Court of Appeals resorted to what Professor Goldberg terms “proof by adjective,” finding it both “irrational” and “illogical” to think that the County would have assumed the risk of Cottrell’s loss from failure of the land to appreciate in value in case the stadium never got built (RCL, 111).  And so, the Court of Appeals applies the tacit assumption doctrine in Kenford, only to find that no tacit assumption could be shown.  In later cases, the Court seemed to backtrack both from the tacit assumption doctrine and from the new business rule (RCL, 113).  Neither should have been an issue in Kenford.  Had the County only drafted a proper contract, including a termination for convenience clause and a clause making performance contingent on financing, it could have saved itself decades of litigation (RCL, 111). 

Finally, Professor Goldberg discusses the tacit assumption in the context of the House of Lords’ decision in The Achilleas.  Professor Goldberg provides a fascinating discussion of the risks involved in ship chartering.  The reliance/flexibility calculation is especially challenging in this context.  A typical charter may last six months.  During that time, the charterer will pay a fixed daily price for the use of the ship and its crew.  But timing the “last voyage” so that one can return the vessel in time can be tricky (RCL, 117-24).  As Richard Wagner put it, Wer baut auf Wind baut auf Satans erbarmen.  Well, maybe the problem is no longer wind, but the point is, sea travel involves a lot of uncertainty.  

The parties can allocate risk with careful contract language, but (no surprise here) the language of the contract governing The Achilleas was ambiguous.  Through no fault of the charterer, the ship was returned eight days late.  As a result, it arrived too late for the ship to be available for its next charterer.  In the meantime, the price had dropped, and the new charterer negotiated a 20% discount on its four-month charter.  The owner sought to recover the costs of that discount, which amounted to $1.36 million.  The charterer sought to limit damages to the daily fee it negotiated for its charter multiplied by the eight days it was late, which came to less than $160,000 (RCL, 125). 

The Lords unanimously found for the charterer.  Three Lords embraced the tacit assumption approach, attempting to ascertain the intention of the parties. It would make no sense for the charterer to assume a risk that it could not control.  The next charter might be for four months or for two years, and the rates for time charters were volatile.  Lord Rodger of Earlsferry and Baroness Hale found that the unusual market volatility at the time was an unforeseen occurrence, rendering the consequential damages too remote (RCL 127-28).

Professor Goldberg opposes the language in the Hadley canon of foreseeability or remoteness, although he harbors little hope of dislodging this formulation from the vocabulary of consequential damages jurisprudence.  In his view, it makes more sense to consider the parties’ degree of control over the outcome, and the tacit assumption approach better facilitates that analysis.  There will always be some indeterminacy under this approach, but the tacit assumption narrows the zone of indeterminacy by considering what liability risks rational actors in the position of parties would have assumed.  In The Achilleas, the owner negotiated a new charter after the first charterer had set its last voyage.  The owner controlled the timing and so it makes no sense to put the burden of liability on the first charterer, whose last voyage was delayed, as happens, for reasons beyond its control (RCL, 132).

What is remarkable about the time charter line of cases is that there is a time charter line of cases.  The last voyage problem is well known.  There are straightforward solutions.  The parties can allocate risk in a limited number of ways.  Instead, they rely on form contracts with convoluted language that leaves it up to courts to determine whether the parties allocated the risk of consequential damages or, if the court adopts the tacit assumption approach, how the parties likely would have allocated risk had they bothered to reduce their assumptions to writing (RCL, 133). 

A post on Chapter 7 (liquidated damages) is here.

A post on Chapters 5 & 6 (speculative damages) is here.

A post on Chapter 4 (lost-volume damages) is here.

A post on Chapter 3 (timing for assessing damages) is here.

A post on Chapter 2 (the flexibility/reliance trade-off) is here.

The introductory post is here.