Contract drafters and reviewers sometimes get confused about what constitutes “consequential damages” excluded by a limitation of liability. A federal district court recently proposed this recap, with extensive citations:
Defendant’s brief frequently discusses foreseeability, and it is true in some sense that predictability is relevant to determining whether damages naturally flow from a breach and are considered direct or indirectly result and are considered consequential.
But that definition has never been very instructive for analyzing particular damages, and foreseeability is the limit of all contract damages, not the distinction between direct and consequential damages.
Rather than turning on foreseeability, the difference between direct and consequential damages depends on whether the damages represent (1) a loss in value of the other party’s performance, in which case the damages are direct, or (2) collateral losses following the breach, in which case the damages are consequential.
Direct damages refer to those which the party lost from the contract itself—in other words, the benefit of the bargain—while consequential damages refer to economic harm beyond the immediate scope of the contract.
So direct damages are the costs of a plaintiff getting what the defendant was supposed to give—the costs of replacing the defendant’s performance.
Other costs that the plaintiff may not have incurred if the defendant had not breached, but that are not part of what the plaintiff was supposed to get from the defendant, are consequential.
Even this more developed definition is not precise, so it is important to remember that the goal of contract interpretation is to give effect to the parties’ intent and that the primary guide to determining their intent is the actual language of the agreement.
Jay Jala, LLC v. DDG Construction, Inc., No. 15-3948, slip op. at 3-5 (E.D. Pa. Nov. 1, 2016) (partially granting defendant’s motion for summary judgment on damages) (emphasis and extra paragraphing added, internal quotation marks and extensive citations omitted).
The Jay Jala court’s formulation has some appeal; I’m mulling over how it might relate to a different test articulated by the Texas supreme court in a number of cases, such as one from 2012:
Direct damages are the necessary and usual result of the defendant’s wrongful act; they flow naturally and necessarily from the wrong…. Consequential damages, on the other hand, result naturally, but not necessarily. …
Arthur Andersen & Co. v. Perry Equip. Corp., 945 S.W.2d 812, 816 (Tex. 1997), quoted in El Paso Marketing, L.P. v. Wolf Hollow I, L.P., 383 S.W.3d 138, 144 (Tex. 2012) (internal quotation marks and footnote omitted, alterations by the El Paso Marketing court, emphasis added).
Hmm … if I had to litigate a consequential-damages case, and I had to choose between the Jay Jala court’s recap and the Texas supreme court’s Arthur Andersen test, I suspect that the Texas definition might provide a brighter line, one that could well be easier for the jury to use in deciding the case.