Hidden Recovery Opportunities in Commercial Litigation: Consequential Damages

July 1, 2019

Article, ABA GP Solo eReport, July 2019

The following scenario is common: A buyer purchases equipment from a seller. The purchase order includes a warranty and a consequential damages limitation clause. The buyer expects to avoid consequential damages through the device of the repair-and-replace remedy.

After delivery, the machines do not work, and the buyer asks for repairs under the warranty. The seller repeatedly promises to fix the equipment, but the machines are never repaired. The time period under the warranty ends, and the seller refuses a refund.

Now the buyer files a lawsuit for breach of contract, seeking the amount of the purchase order plus all business losses that are causally related to the equipment failure. This includes buying replacement equipment, using hand labor instead of machines, and lost return on investment caused by the delay in production. These damages are all considered consequential and should be recovered to make the buyer whole.

The seller inevitably responds that damages were contractually limited to the amount of the purchase order. It might surprise you to learn that the buyer can recover consequential damages, even when it explicitly agreed to limit these damages in the contract. Here’s why:

A warranty is a significant inducement to a buyer. The buyer purchased the equipment because of the safeguard of the warranty. The buyer also agreed to a consequential damages limitation because of the safeguard of the warranty.

The buyer is particularly vulnerable to the seller’s bad faith once the buyer has given up all rights to consequential damages. The buyer expects to avoid consequential damages through the device of the repair and replace remedy. If the seller then creates consequential damages by willfully failing to perform the expected repair and replace remedy, the buyer ought not to be bound by the exclusion. (“When to Apply the Doctrine of Essential Purpose to an Exclusion in Consequential Damages: An Objective Approach,” 25 Duguesne L.Rev. 551, 554 n. 11 (1988), cited by New York State Elec. & Gas Corp. v. Westinghouse Elec. Corp., 564 A.2d 919 (Pa. Super. 1989))

A buyer is entitled to consequential damages because the warranty failed in its essential purpose (IdGen. Instrument Corp., F. W. Sickles Div. v. Pennsylvania Pressed Metals, Inc., 366 F. Supp. 139 (M.D. Pa. 1973)).

Many courts will also hold that under the Uniform Commercial Code, the consequential damages clause is “unconscionable” when it prevented the buyer from an adequate remedy. Put another way, the damages limitation operated in an unconscionable manner after the contract’s formation (Tokyo Ohka Kogyo America, Inc., v. Huntsman Propylene Oxide, LLC., 35 F.Supp.3d 1316 (Dist. of Or. 2014); U.C.C. § 2–719 cmt. 3):

[A] court should attempt to discern the essential purpose of the exclusive or limited remedy when it was first agreed-upon by the parties, i.e., the bargain of the parties with respect to their allocation of risks and remedies, and the court should not concern itself with whether the agreed-upon limitation on remedy was wise, fair, or oppressive at the time of contract formation, but simply ask what was the limitation’s essential purpose at that time. (Id.)

In the above hypothetical, the equipment never worked. The seller was repeatedly notified and promised to repair. In the end, the machines were not repaired, and no refund was provided. The warranty and consequential damages clauses failed in their essential purpose. Therefore, the buyer was entitled to large consequential damages.

A party who suffers a loss due to a breach of contract generally has a duty to make reasonable efforts to mitigate his losses (Ecksel v. Orleans Constr. Co., 519 A.2d 1021, (1987)). The burden is on the breaching party to show how losses could have been avoided (Id.).

In the above hypothetical, the seller must present a viable alternative that buyer could have taken to mitigate its damages. The seller would not offer a refund. But let’s assume the buyer could sell the faulty equipment for scrap value at 30 percent of the fair market value of the original purchase order. The seller will argue that the buyer should have done so to mitigate its losses.

The buyer should argue this would not have reasonably mitigated its damages. After all, the buyer purchased replacement equipment, paid additional labor expenses, and suffered lost return on investment from delay. Recovering these large consequential damages truly makes the buyer whole. Under the law, the seller did not meet its burden to show a realistic alternative the buyer could have taken to avoid these consequential damages.

Employing the above arguments can mean the difference between receiving a small partial recovery or being awarded significant consequential damages well above the value of the purchase order. While case law is state-specific, all venues no doubt follow these same trends.

Have you had a similar experience? Please share your thoughts: dberlin@weisberglawoffices.com

Commercial litigation attorney David Berlin is a problem solver for businesses of all sizes, navigating contractual disputes and litigation strategy. He can be reached at dberlin@weisberglawoffices.com or 484/432-1073.