Imagine the following scenario: your company licenses software that is used in the industrial manufacturing industry. One of the companies that uses your software changes the safety instructions displayed upon login, and as a result an accident occurs that causes serious injuries among workers. Are you liable for the harm caused? Another way to think about this question, is: even though you did not write or edit the safety instructions, could you have foreseen this harm?
Most people have a strong gut reaction to scenarios such as this. And that gut reaction is usually: no! The surprising fact is that, at least for now, the answer is uncertain. The Supreme Court will weigh in on this issue later this year.
This example deals with liability in tort law, and not contracts, but a similarly difficult question arises in the context of contracts: the consequences of a breach of contract can be far-reaching, devastating, and unpredictable. Who is responsible? Or rather, when you are in breach of contract, do you have a good idea of where your liability ends?
There are multiple examples of this dilemma. Someone is late in delivering tiles to a buyer, and that buyer consequently gets fired from his subcontracting job. Someone manufactures a defective piece of equipment and the defect causes a death or serious injury. You breach a contract with one person, and cause significant economic harm to a third person as a consequence.
Long story short: everyone is responsible for the consequences of their breach of contract. Within reason. Determining what is reasonable is not straightforward, however.
Damages can consists of all or some of the following:
Types of Damages
This is a monetary amount awarded to a plaintiff to compensate him for the losses suffered as a result of the material breach of contract. It can consist of expectation damages, intended to provide the injured party with the value that he or she expected to receive from the contract had it not been breached.
It can also be consequential, or indirect damages (also referred to as special damages). This is a monetary amount intended to reimburse the innocent party for any other, indirect damages suffered as a result of the breach of contract (loss of profit, for example)
This is damages provided for and specified in the contract itself. This means that both parties had determined, during contract negotiation or later by means of a contractual amendment, the appropriate amount that each would owe if the contract were to be breached in the future.
Punitive damages are awarded with the intent to punish the breaching party. They are almost never granted in contract cases, but might be granted in instances where a breach of contract overlaps with the commission of a tort.
Liability for Special Damages
Courts use two approaches to determine liability for indirect, or special, damages. The first is to establish whether the damages flows from the breach. This means, in essence, determining whether the damage in question would have occurred if the breach had not taken place.
The second is whether or not the damage had been foreseeable or could have been foreseen by the parties by the time they entered into the contract. Here, courts differ in their approach. Some will determine whether or not it reasonable to expect a party to have foreseen the damage in question (the answer to that is alarmingly indeterminate), or they will inquire whether the party could actually have foreseen it.
If it is found that the damage flows from the breach, and could or should have been foreseen, the result is liability for special damages. This will include any loss of profits that the other party suffered from your breach, or any liability that he/she now has toward third parties. In short: it can be a large amount.
Of course, sound legal and business practice is to never breach a contract. However, breaches of contract occur even where parties have the best intentions.
The risk is that you might be held liable for far-reaching consequences of that breach. Or, alternatively, you might suffer far-reaching consequences as a result of another party’s breach and wish to recover your losses. In both cases, not knowing what special damages might consist of is problematic. So, how to make life more predictable?
Spend time, and invest money, in carefully drafting your contracts. Try to have contracts that provide for liquidated damages in appropriate cases. Be sure to consider the possible consequences (even indirect) of a breach of contract and plan for them when negotiating.
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