Teaching Assistants: Victor Goldberg on Lost Volume in the UK

This is the fifth 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 fourth chapter of RLCD, which is about the lost volume problem as handled in courts in the United Kingdom.

This short chapter does not really break new ground in terms of Professor Goldberg's larger arguments.  He merely provides more examples of the outrageous results that proceed from courts in two separate jurisdictions making what he regards as the same mistake.  Paraphrasing Lord Hoffman in The Achilleas, Professor Goldberg posits that damages in contracts cases ought not yield absurd results.  Requiring parties to pay damages well in excess what they would have paid for the option to breach, as lost volume profits often do, renders the resulting contract absurd (RLCD, 69-70).  For this reason, sophisticated parties frequently contract around the lost volume remedy (RLCD, 70).

Professor Goldberg discusses three cases involving car sales.  The basic rule, as discussed in the cases and the treatises, is that a dealer can collect lost profits when it had adequate inventory to meet demand.  In such cases, the courts reason, but for the breach, the dealer would have sold one more car and so it is entitled to its lost profits.  It recovers nothing when it had just enough cars to meet demand such that the breach made no difference.  In Professor Goldberg's view, "The lost volume seller framing gets it backward. It sets the option price high the the market is slack and low (or zero) when the market is tight" (RLCD 71-72)  This is so because in a tight market, the dealer would not be able to get cars from the manufacturer and so could not recover lost profits.  In the end, in this context the lost volume remedy sets an option price that is unknown to the buyer, almost certainly too high and "perverse" because backwards.  The alternative would be to make the option  price explicit by asking the buyer to pay a non-refundable deposit (RLCD, 77).

In B2B cases, lost profits are harder to calculate -- they should be the difference between the contract price and the but-for costs.  Lost volume damages can result in ridiculous amounts of damages.   In a research-intensive business, lost profits could exceed 50% of the contract price.   Imagine that a software developer offers a just-completed product for sale for $100,000.  The buyer reneges, and the software developer finds a new buyer.  If the product is delivered electronically, but-for costs approach zero, and lost volume damages would be $100,000, more or less.  Again, this is an absurd result (RLCD, 69-70).  But it is the result ordered in a number of English cases.  In In re Vic Mill, and Hill & Sons v. Edwin Showell & Sons, Lim., cases from the World War I era, courts awarded lost volume profits so long as seller had the capacity to meet all demand (RLCD, 78-80).  

English courts also applied the lost volume doctrine in the equipment rental context.  Both cases involved liquidated damages provisions.  In one case, the damages provision was set aside as a penalty, but on appeal, the court imposed lost profits damages calculated as the liquidated damages adjusted for depreciation and other costs.  In the second case, the court upheld a liquidated damages provision set at 50% of the contract price because it was not excessive in relation to damages based on a lost-volume theory (RLCD, 81-84).  Professor Goldberg would have struck the latter liquidated damages clause because it was in a consumer lease, and it seems unlikely that the defendant was on notice of the clause.  I'm surprised that Professor Goldberg does not delve into potential conceptual problems in applying the lost volume sales concept in the context of leases.  

Finally, in Sony Computer Entertainment UK Ltd. v. Cinram Logistics , UK, Ltd, there was no breach.  Rather, defendant was responsible for warehousing and distributing memory cards for Sony's Playstation.  It conceded liability for allowing the memory cards to be diverted.  The question was whether damages should be the cost to Sony of the lost cards (£56,246) or or the lost profits Sony could have gotten had it been able to sell not only these cards but other cards that it had in inventory sufficient to meet demand (£187,989).  Professor Goldberg argues that the lost volume analysis make no more sense in this context than it does its "natural habitat".  The smaller figure is the only one that makes any sense (RLCD, 84-86).

Concluding his section on lost volume profits, Professor Goldberg pleads to put this wayward doctrine out of its misery.  His argument for why it is wrong may also explain its longevity: courts impose lost profits damages because they think that the breaching party ought to pay for the harm that they caused.  This is the wrong way to approach contracts damages.  Rather, courts can and should ask what a buyer would pay for the option to breach.  Parties sometimes provide an easy answer to that question through liquidated damages clauses or through non-refundable deposits.  But courts, enamored of lost profits, too often ignore such devices, resulting in penalties that can be far harsher than the ones they routinely strike down (RLCD 86-87).

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

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