Teaching Assistants: Victor Goldberg on Lost (Volume) in America

This is the fourth in our series of posts on Victor Goldberg's second volume of collected essays on contracts law, Rethinking the Law of Contract Damages (RLCD).  Links to previous posts on the first volume, Rethinking Contract Law and Contract Design (RCL), can be found here.  Today's post covers the third chapter of RLCD, which is about the lost volume seller under the UCC's § 2-708(2).

Lost volume profits permit a seller to recover damages when, because it has sufficient inventory to meet demand, it cannot effectively mitigate.  But for buyer's breach, the logic goes, seller would have had two sales instead of one.  According to the estimable White and Summers, this is the remedy on which "all right-minded people would agree."  Not so, says Professor Goldberg.  The remedy should be the price that buyer would pay for an option to terminate/cancel.  Where there is no deposit paid and market conditions have not changed, the default rule should be zero damages, absent progress payments, which Professor Goldberg would treat as a series of nested options (RLCD 47).  

Rather than thinking in terms of lost volume, Professor Goldberg asks what a buyer would pay for an option to purchase.  The hotter the market for the goods, the more expensive the option should be, but lost volume profits create the opposite effect.  If it is easy for the seller to fill its inventory, presumably because the market for the goods is slack, the buyer has to pay a high price for breach.  But if no substitute goods are available, perhaps because the goods are much sought after and hard for the seller to obtain, the price for the option is low.  Lost volume recovery sets the price for the option that is not just wrong; it is backwards (RLCD 51). 

In some cases, the parties set their option price through a non-refundable deposit.  But courts have set aside such negotiated liquidated damages in favor of the lost volume remedy (RLCD 51-52).  The lost profits calculation also might also be wildly and arbitrarily different, depending on whether the seller is vertically integrated with the manufacturer (RLCD 52).

Overall, Professor Goldberg uses case law to illustrate three general themes.

(1) Lost volume recovery sets an excessive implied option price for breach.  In Teradyne Inc. v. Teledyne Indus., Inc., for example, the court treated buyer as paying $76,000 for the option to buy a test system for an additional $22,000 (RLCD 53).  In Empire Gas Corp. v. American Bakeries Co., the court ordered American Bakeries to pay 38% of the contract price for conversion units when there was a competitive market for the goods, and the reasonable option price would have been zero (RCLD 67).

(2) Courts ignore explicit option prices.  In Trienco Inc. v. Applied Theory, Inc., the court did not have an explicit option price to work with, but seller had demanded a 20% deposit on previous, similar deals and 10% on the transaction at issue.  The court awarded lost volume recovery in an amount closer to 50% of the contract price (RLCD 55).   In R.E. David Chemical Corp. v. Diasonics, Inc., the court would have invalidated as a penalty a $300,000 liquidated damages clause, but it imposed $450,000 in lost volume damages (RLCD 56).  An even more outlandish result was avoided in Rodriguez v. Learjet, Inc. only because Learjet was only interested in recovering its $250,000 in liquidated damages, rather than the $1.8 million in lost volume profits that the court was poised to award (RLCD 56-57).

(3) Courts sometimes grant lost profits even when seller has an adequate remedy.   In an unpublished California case, Lam Research Corp. v. Dallas Semiconductor Corp., the court treated the seller of specially-manufactured goods as a lost volume seller, even though it could not re-sell after buyer repudiated and seller had to cannibalize the goods for use in other products.   An action for the price under §2-709 would have provided an adequate remedy (RLCD 59-61).   In Nederlandse Draadindustrie NDI V.V. v. Grand Pre-Stressed Corp., the court granted lost volume recovery when simple contract vs. market damages would have been appropriate.  The result was an award of damages amounting to 35% of the contract price instead of 6-10% (RLCD 61-62).  Jewish Federation of Greater Des Moines v. Cedar Forest Products Co. is another case where a court awarded lost profits for a specialty item, notwithstanding seller's ability to reuse the components of the specialty item on other products.  The result was to allow seller to keep a $53,000 deposit on a $214,000 product.   The trial court had limited the remedy to $13,000 in incidental damages (RLCD 62-63).  The Montana Supreme Court upheld a $2 million jury verdict in Bitterroot Int'l Sys., Ltd. v. Western Star Trucks,Inc.  The jury was asked whether the repudiation of a five year freight-hauling and logistics service agreement implicated the lost-volume doctrine, and it concluded that it did.  On what basis the jury so concluded is hard to reconstruct from the opinion (RLCD 63-64).

Professor Goldberg proposes various fixes. Courts have generally made sense of UCC § 2-708(2) by ignoring its final clause.  Professor Goldberg thinks the better approach is to follow the statute and read it to apply only when the buyer breaches after the seller has begun production, leaving the seller with partially completed goods.  Moreover, here as elsewhere, Professor Goldberg favors allowing parties to specify their own remedies, with the UCC remedies provisions proving only defaults.  Buyers could then protect themselves against lost volume damages, which can function as a penalty for breach, with express language disclaiming liability for any lost profits.  But a couple of the cases discussed in the chapter involve large commercial transactions to which the parties committed themselves without a written agreement.  In such circumstances, it is important to have default rules that make sense.   

Professor Goldberg concedes that his approach, conceptualizing damages as a remedy for the exercise of an option to terminate or cancel a contract, does not work in every situation.  He does think it provides a better mechanism for calculating damages in the lost volume context. (RLCD 68)

If case anyone is vaguely interested in the joke inserted in my title, here's the trailer to the 1985 comedy in question

Below are links to previous posts on RLCD and the first post links to post posts on RCL:

Teaching Assistants: Victor Goldberg, Volume II, An Introduction

Teaching Assistants: Victor Goldberg on Valuation of the Contract as an Asset

Teaching Assistants: Victor Goldberg on The Golden Victory