One of the mysteries in life is how different jurisdictions can be faced with the same legal problem and manage to come up with the same wrong answer. Case in point. Both English and American contract law hold that if a buyer cancels an order (breaches) and the seller resells the item at the same price, the seller’s remedy need not be the contract/market differential (zero). Rather, they both say, if the seller could have sold this item and another as well, the seller could have made the profits on both items. The seller would be a “lost volume seller” and, since the breach cost it the profits on the second sale, it should be compensated for the loss of that profit.

So, for example, suppose you agree to buy a car for $20,000 to be delivered in a week. A day later you change your mind. The dealer says you owe me my lost profits, $2,000—the difference between your retail price and my wholesale price. Treatise writers in both countries agree with the dealer. Indeed, in their UCC treatise James White and Robert Summers assert that the remedy is “the recovery which all right-minded people would agree the lost volume seller should have.” Nonetheless, I claim, all those right-minded people are wrong.

Why?  After entering into a contract, the buyer has a choice. It can go forward with the purchase or it can terminate (breach). That is, it has an option, and the contract determines the price of that option. If the contract did not include an explicit option price, the default contract remedy would be the implicit price of the option. If there were not an explicit price (say, a nonrefundable deposit, liquidated damages, or progress payments), what should the implicit price be? Does the lost profit remedy pass a simple test: Is the resultant contract absurd? No. It will typically set damages too high and, worse, it will be perverse, setting the option price high when it should be low and vice versa.

In the aborted car transaction, the lost-volume advocates argue that if the dealer had access to more cars to sell it could have sold that car and another; but if the dealer could not get the additional car, perhaps because it was a hot car and the manufacturer would only deliver a certain number to this dealership, then there would be no additional sale and the remedy would be zero dollars. If, the advocates argue in effect, the car is not very popular, the buyer would pay the high option price ($2,000); if the car were really hard to get, the option price would fall to zero. But it is precisely when the market is tight that dealers would insist upon a non-refundable deposit.That is the sense in which the rule is perverse. Car dealerships do have a legitimate concern that some customers will renege on their deals. It is a cost of doing business, one that is in their partial control. They could speed up delivery. And they can use price to encourage performance, setting an option price, typically with a nonrefundable deposit.

The lost volume measure has been applied in B2B cases as well. When the seller has high capital costs and R&D expenditures, the results can be truly absurd. In one case the contract price was around $98,000 while variable costs were about $22,000, so that the remedy for the breach was $76,000.[1] In effect the court held that the buyer paid $76,000 for the option to buy the goods for an additional $22,000 even though it knew that the goods would be available. Why assume that buyers would be that stupid? The absurdity of the remedy is illustrated by the peculiar way one court dealt with a defendant’s attack on a series of progress payments as an invalid penalty. [2] The buyer of an airplane to be built in a year paid an initial nonrefundable payment of $250,000. The buyer breached and demanded its money back, claiming that this was unreasonable and therefore an unenforceable penalty. To prove the reasonableness of the charge, the defendant showed that its lost profits were $1.8 million. The court concluded that since the damages were so much greater, $250,000 was not an unreasonable penalty. The court did not bother to note that the progress payments nicely established the prices of a series of nested options.

ENDNOTES

[1] Teradyne, Inc. v. Teledyne Industries, Inc. 676 F.2d 865 (1982).

[2] Rodriguez v. Learjet 24 Kan. App. 2d 461, 946 P.2d 1010 (1997).

This post comes to us from Victor P. Goldberg, the Jerome L. Greene Professor of Transactional Law Emeritus at Columbia Law School. It is based on his articles, “The Lost Volume Seller, R.I.P.,” available here, and “The Lost Volume Seller in English Law,” available here.