Teaching Assistants: Victor Goldberg on the New Business Rule

This is the thirteenth 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 twelfth chapter of RLCD, in which Professor Goldberg addresses the question of lost profits, especially in the context of new businesses. 

Ever the iconoclast, Professor Goldberg here rejects both the per se rule that new businesses cannot recover lost profits and the "modern" approach that treats the new business issue as merely a matter of proving lost profits with reasonable certainty.  The latter approach is faulty because it fails to consider opportunity costs. Professor Goldberg returns to the Kenford case, previously discussed here, which involved a failed plan to build a domed stadium in Buffalo, to illustrate a first category of new business cases. Kenford should not have been able to recover lost profits on the planned stadium because he retained the capital and he could have used it to make the same profits through similar investments. (RLCD, 228-30)

The relevant question in cases such as Kenford is not whether the stillborn project would have made money but whether it would have made more money than the next best alternative. For such cases, the per se rule that new businesses cannot recover lost profits makes sense. (RLCD, 231) Plaintiff has spent no money in reliance on the project going forward; they are free to invest in other opportunities.  Case law examples show that there is a danger of overcompensating non-breaching parties. Moreover, the litigation costs involved in such cases constitute waste, as the court should know going in that the non-breaching party has no claim to lost profits, given opportunity costs. (RLCD 232-39) In some of these cases, there is partial reliance, and in such cases an award of reliance damages is appropriate. (RLCD 233-37) 

Professor Goldberg discusses one case that illustrates "an important qualification to the argument."  That is where a plaintiff brings specific assets to a project and the expected returns would be positive. (RLCD 237-39) I'm not sure why this qualification would not have application in some of the other cases that Professor Goldberg discusses. After all, assets might not be tangible.  They might be a skill set particularly suited to a new business venture.

For example, a franchisee who wants to exploit a new opportunity within the same franchise has unique expertise relevant only to the that franchise, and franchise agreements limit the locations available for new franchises.  Sure, the disappointed franchisee could use the same start-up capital to invest in a different venture. But the entire point of the new business rule is that new business ventures are uncertain, while a plaintiff can use the franchisor's own feasibility study, supplemented by evidence from comparable units of the same franchise, to establish the likely success of the abandoned franchise opportunity.  

Cases involving the licensing of intellectual property are different, because the licensor has already invested in the project.  Absent a liquidated damages provision or some other limitation on damages, the licensor should be entitled to recover its lost profits. (RLCD, 230) These cases seem to fit squarely into Professor Goldberg's exception allowing recovery of lost profits where the plaintiff brings specific assets to the project.  In the IP cases, plaintiffs incur costs in developing the intellectual property and getting it to the point where it is marketable. (RCL 241) Courts err in deciding these cases by requiring proof of lost profits with "reasonable certainty."  From Professor Goldberg's perspective, that is not the issue.  Rather the damage is based on a future stream of earnings from an investment already made. (RLCD, 243) That seems right, but I don't follow why a court is not nonetheless required to establish what that future stream of earnings would be with reasonable certainty, as it would with any claim to harm from a breach of contract. Professor Goldberg's alternative seems to involve a battle of the experts (RLCD, 244), and that too seems right, except that a court would still have to determine whether the expert reports provided sufficient evidence for a jury to determine with reasonable certainty what damages plaintiff had suffered.

A third category of lost profits on a new business venture arises when a project is delayed.  Here, the lost profits might raise Hadley problems. (RLCD, 230) In such cases, Professor Goldberg thinks the cases should be resolved according to his preferred "tacit assumption" version of Hadley.  In such cases, profits lost due to delay may not be difficult to compute. They may, however, be barred under Hadley or under a contractual allocation of risk. (RLCD, 245-48) Cases involving defective rather than delayed performance are similar, except that here Professor Goldberg would again bring to bear the opportunity cost principle (RLCD, 248-51)

Finally, there are cases in which buyer repudiates a long-term contract.  Here, Professor Goldberg argues that seller should recover lost profits as direct damages, but only if market conditions have changed. (RLCD, 230) If market conditions have not changed, the opportunity costs principle comes into play.  If market conditions have changed, then there ought to be recoverable lost profits, and just because it will be difficult to determine what they are does not mean that damages should be zero because any attempt at determination would be speculative. (RLCD, 251-52)

Ultimately, courts should be less concerned with speculative damages in new business cases.  Either there are no damages because of the opportunity cost principle or there are damages, which can be ascertained, unless they are precluded under the Hadley rule or through contractual limitations on damages. (RLCD 253)

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
Teaching Assistants: Victor Goldberg on Lost Volume in the UK
Teaching Assistants: Victor Goldberg on Mitigation
Teaching Assistants: Victor Goldberg on the Middleman's Damages
Teaching Assistants: Victor Goldberg on Sub-Sales in the UK
Teaching Assistants: Victor Goldberg on Jacob and Youngs v. Kent
Teaching Assistants: Victor Goldberg on Victoria Laundry
Teaching Assistants: Victor Goldberg on Consequential Damages in the U.S.
Teaching Assistants: Victor Goldberg on Consequential Damages in the UK