Contracts Quick Tip: Expectation Damages

Questions about expectation damages arise frequently on law school exams and on the bar exam. Even if math isn’t a favorite subject, keeping a few basic principles in mind will help you analyze an expectation-damages question thoroughly.

Expectation damages are the default form of money damages in contract law. Put differently, if a party breaches a contract, courts usually award expectation damages to the injured party unless there is a reason that expectation damages are inappropriate.

When analyzing any expectation-damages issue, keep the goal of these damages in mind. Expectation damages seek to place the injured party in the position he would have been in had the contract been fully performed. 

Any expectation-damages analysis will therefore involve a comparison of 2 alternate universes: (1) what would have happened had the contract been fully performed and (2) what actually happened in light of the breach. Usually, there’s a difference between those 2 universes for the injured party. Expectation damages seek to make up that difference.

The Second Restatement of Contracts uses a 3-part formula that is helpful to analyze most fact patterns. Under the Restatement, an injured party’s expectation damages are

The first 2 parts of the calculation add up the injured party’s losses. The third part of the calculation subtracts from that amount any savings the injured party actually made, or reasonably could have made, by not having to perform. Let’s look at each part of the calculation in more detail.

First, an injured party’s expectation damages include the loss in value of the other party’s performance. In a fact pattern, the main sources of information for this first part of the calculation are facts about the contract and facts about what performance, if any, the breaching party actually rendered. 

For example, consider a contract in which a homeowner agreed to pay a contractor to remodel her bathroom for a total of $15,000. The homeowner made 2 progress payments of $5,000 each but then repudiated the contract. The loss in value to the contractor of the homeowner’s performance is $5,000 ($15,000 due if fully paid minus $10,000 actually paid).

Second, the Restatement formula adds any other losses caused by the breach, including incidental or consequential damages. In a fact pattern, information about what happened to the injured party after the breach will help you analyze any issue of incidental or consequential damages. 

Incidental damages are those that arise in the ordinary course of events from the breach. Incidental damages are not particular to the specific injured party; rather, they are losses that any party would suffer following a breach. Incidental damages are generally recoverable as expectation damages. 

For example, consider that the contractor in our earlier example was forced to rent a truck on short notice for $500 to remove his equipment from the home following the homeowner’s repudiation. Anyone in the contractor’s position would likely have had to do the same following the homeowner’s repudiation. Therefore, the $500 is recoverable as incidental damages.

Unlike incidental damages, consequential damages are particular to the injured party. Consequential damages arise out of the injured party’s particular or special circumstances and are recoverable only if the breaching party knew or should have known of these circumstances.

For example, consider that the contractor was forced to turn down a more lucrative job building a gazebo because the homeowner had already booked his time for the bathroom remodel. However, the homeowner did not know that the contractor had refused other work as a result of her project. May the contractor recover the amounts he could have made on the gazebo project from the homeowner? No. Because these losses are particular to the contractor, they are consequential damages. The contractor may recover these losses only if the homeowner was aware of the contractor’s special circumstances that gave rise to them. Here, the homeowner was not aware, so the losses from having turned down the gazebo work are not recoverable. 

Third, the Restatement subtracts any amounts that the injured party actually saved by not having to perform or that he reasonably could have saved without undue risk, burden, or humiliation. This third part of the calculation acknowledges that an injured party may not recover for losses that could have reasonably been avoided. In other words, the injured party must mitigate his losses.

In a fact pattern, look for information about what steps, if any, the injured party took or reasonably could have taken to mitigate his losses in analyzing this third part of the expectation-damages calculation.

In our running example, consider that the contractor was able to book a new job on short notice that filled the remaining work time in the bathroom remodel. The new job paid just $700. The amount the contractor earned on the new job would be subtracted from his total losses.

Putting all 3 parts of the calculation together, we see that the contractor’s expectation damages are (1) $5,000 (the loss in value of the performance that the homeowner should have rendered), plus (2) $500 (the contractor’s incidental damages from renting the truck on short notice), minus (3) $700 (the losses the contractor avoided by not having to perform under the contract with the homeowner), or $4,800.

If we compare the contractor’s 2 universes, the contractor would have earned $15,000 for the bathroom remodel had the homeowner fully performed. In fact, the contractor actually earned $10,200 ($10,700 in earnings from the homeowner and the new job, minus $500 spent on the truck). Expectation damages cover the difference between the 2 universes, or $4,800 ($15,000 minus $10,200).

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