Remedies - Expectation interest (including direct, incidental, and consequential damages)

Learning Outcomes

After reading this article, you will be able to explain the expectation interest as the primary measure of contract damages, distinguish between direct, incidental, and consequential damages, and apply the correct rules for calculating and limiting damages in MBE-style questions. You will also recognize the requirements for consequential damages and the duty to mitigate.

MBE Syllabus

For the MBE, you are required to understand the rules governing contract damages, especially the calculation and limits of expectation interest. This article covers:

  • The definition and purpose of expectation interest in contract law.
  • The distinction between direct (general), incidental, and consequential damages.
  • The requirements for recovering consequential damages.
  • The duty to mitigate and limits on damages.
  • The calculation of damages and common exam pitfalls.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

  1. What is the primary purpose of expectation damages in contract law?
    1. To punish the breaching party.
    2. To put the non-breaching party in the position they would have been in had the contract been performed.
    3. To restore the parties to their pre-contract positions.
    4. To compensate only for out-of-pocket expenses.
  2. Which of the following is required for a plaintiff to recover consequential damages?
    1. The damages must be foreseeable to the breaching party at contract formation.
    2. The damages must be punitive in nature.
    3. The damages must be speculative.
    4. The damages must be expressly stated in the contract.
  3. A buyer covers after a seller’s breach by purchasing substitute goods at a higher price and incurs extra storage costs. Which is true?
    1. The buyer may recover only the price difference.
    2. The buyer may recover the price difference and incidental damages.
    3. The buyer may recover only incidental damages.
    4. The buyer may recover punitive damages.

Introduction

Expectation interest is the standard measure of damages for breach of contract on the MBE. The law aims to place the non-breaching party in the position they would have occupied had the contract been fully performed. This article explains how expectation damages are calculated, the difference between direct, incidental, and consequential damages, and the limits on recovery. Understanding these distinctions is essential for answering MBE questions on contract remedies.

Key Term: Expectation Interest
The measure of damages intended to place the non-breaching party in the position they would have been in if the contract had been performed as agreed.

Types of Damages

Damages for breach of contract are generally divided into three categories: direct (general), incidental, and consequential damages.

Direct (General) Damages

Direct damages are the core of expectation damages. They compensate for the loss of the contract’s value itself—typically the difference between the contract price and the market price or the cost of cover.

Key Term: Direct Damages
Damages that flow naturally and necessarily from the breach, representing the value of the promised performance itself.

Incidental Damages

Incidental damages are reasonable expenses incurred by the non-breaching party in dealing with the breach, such as costs of finding substitute performance, storing rejected goods, or arranging cover.

Key Term: Incidental Damages
Reasonable expenses incurred in responding to a breach, such as costs of cover, inspection, storage, or transportation.

Consequential Damages

Consequential damages are losses resulting from the breach that are not the immediate result of the breach itself but arise from the non-breaching party’s particular circumstances. These are only recoverable if, at the time of contracting, the breaching party had reason to foresee them as a probable result of breach.

Key Term: Consequential Damages
Damages that do not flow directly from the breach but result from special circumstances, recoverable only if foreseeable at contract formation.

Requirements for Consequential Damages

To recover consequential damages, the non-breaching party must show:

  • The damages were caused by the breach.
  • The damages were foreseeable to the breaching party at the time of contract formation (Hadley v. Baxendale rule).
  • The damages can be proven with reasonable certainty (not speculative).

Calculation of Expectation Damages

The basic formula for expectation damages is:

Expectation Damages = (Value of promised performance) – (Value received) + (Incidental damages) + (Consequential damages) – (Losses avoidable by mitigation)

Duty to Mitigate

The non-breaching party must take reasonable steps to reduce their losses. Damages will not be awarded for losses that could have been avoided with reasonable effort.

Key Term: Mitigation
The obligation of the non-breaching party to take reasonable actions to minimize damages resulting from a breach.

Limits on Recovery

  • Damages must be proven with reasonable certainty.
  • Damages must not be speculative.
  • Consequential damages must be foreseeable.
  • Punitive damages are not available for breach of contract.

Worked Example 1.1

A supplier contracts to sell 500 widgets to a retailer for $10 each. The supplier breaches and fails to deliver. The retailer buys substitute widgets from another supplier for $12 each and pays $400 in extra shipping costs. What damages can the retailer recover?

Answer: The retailer can recover direct damages of $1,000 (the $2 per widget price difference × 500 widgets) and incidental damages of $400 (extra shipping costs). If the retailer can prove lost profits from lost sales due to the breach, and those profits were foreseeable, those may be recoverable as consequential damages.

Worked Example 1.2

A seller breaches a contract to deliver a custom machine, knowing the buyer needs it to fulfill a contract with a third party. The buyer loses $8,000 in profits from the third-party contract as a result. Can the buyer recover the lost profits?

Answer: Yes, if the seller knew or had reason to know at contract formation that the buyer would lose the third-party contract if the machine was not delivered, the lost profits are foreseeable consequential damages and are recoverable.

Exam Warning

Consequential damages are only recoverable if the breaching party had reason to foresee them at contract formation. If the damages result from special circumstances unknown to the breaching party, they are not recoverable.

Revision Tip

Always check whether the non-breaching party took reasonable steps to mitigate losses. Failure to mitigate will reduce or bar recovery for avoidable damages.

Summary

Expectation damages aim to put the non-breaching party in the position they would have been in had the contract been performed. Direct damages compensate for the value of the promised performance. Incidental damages cover reasonable costs incurred due to the breach. Consequential damages compensate for additional losses resulting from special circumstances, but only if foreseeable. Damages must be proven with reasonable certainty, and the non-breaching party must mitigate losses.

Key Point Checklist

This article has covered the following key knowledge points:

  • Expectation interest is the primary measure of contract damages.
  • Direct damages flow naturally from the breach and are always recoverable.
  • Incidental damages are reasonable expenses incurred due to the breach.
  • Consequential damages are only recoverable if foreseeable at contract formation.
  • Damages must be proven with reasonable certainty; speculative damages are not awarded.
  • The non-breaching party must mitigate damages.
  • Punitive damages are not available for breach of contract.

Key Terms and Concepts

  • Expectation Interest
  • Direct Damages
  • Incidental Damages
  • Consequential Damages
  • Mitigation
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