September 07, 2017

Alternative Damages Remedies Under the New Restatement

Nelson A. F. Mixon and Barry A. Willits

The recently published Restatement (Third) of Restitution provides clarity to the ever-confusing legal landscape concerning alternative damages.  Historically, damages for contract breaches serve to protect one or more interests of the promisee:

(A)  his “expectation interest,” which is his interest in having the benefit of his bargain by being put in as good a position as he would have been in had the contract been performed,

(B)   his “reliance interest,” which is his interest in being reimbursed for loss caused by reliance on the contract by being put in as good a position as he would have been in had the contract not been made, or

(C)   his “restitution interest,” which is his interest in having restored to him any benefit he has conferred on the other party.1

Damages premised on the first two interests attempt to put the non-breaching party in the same position he would be in had the contract been fully performed.  Restitution-based damages aim to return any benefits conferred by the non-breaching party back to him.

While expectation damages are the typical measure of damages most often sought in construction disputes, alternative remedies based on “restitution” and “reliance” interests could prove more advantageous in certain circumstances.  The use of these remedies, however, can be plagued by misused terminology, conflicting case law, and ambiguities originating from the Restatement itself. 

The recent Restatement (Third) of Restitution attempts to address this by identifying in one place the various damages theories that can be used as an alternative to expectation damages.  The Restatement specifically identifies these alternative remedies as (i) rescission, (ii) cost-based performance damages, (iii) value-based performance damages, and (iv) disgorgement.  The Restatement also clarifies the role of quantum meruit damages in the context of breach of contract law.

A. Expectation Damages – The Baseline Standard

Expectation damages, which are sometimes called “benefit of the bargain damages,” are usually the measure of damages sought in contract cases.  They typically yield the highest level of damages since they permit a recovery of lost anticipated profit. These damages protect a contracting party’s “interest in having the benefit of his bargain by being put in as good a position as he would have been in had the contract not been performed.”2

Expectation damages are measured by: (a) the loss in value to the non-breaching party of the breaching party’s breach, plus (b) incidental and consequential losses caused by the breach, less (c) any cost or loss avoided by not having to perform.3  In other words, the damages are: the unpaid contract price + incidental and consequential losses – losses avoided by not having to perform.

B. Alternative Remedies Under the Restatement (Third) of Restitution

While the Rest. (2d) of Contracts recognized “restitution” and “reliance” as alternative damages measures to expectation damages, the Rest. (3d) of Restitution has done away with restitution and reliance damages in favor of a more comprehensive scheme of alternative remedies for a breach of contract.  As noted by the American Law Institute: “The most important purpose of this Restatement’s treatment of restitution and contract is to clear up the prevailing confusion.”4

Under the new Restatement, the alternative remedies are rescission, cost-based restitution, value-based restitution, and disgorgement.  The view of the new Restatement is that these remedies are simply “parallel versions of a single alternative damage remedy.”5

1. Rescission

Rescission is the remedy that attempts to restore both parties to the position they were in before the contract was made; in other words, the goal is to unwind the contract rather than to enforce it.  The classic example is a transaction where the purchaser pays the purchase price but the seller does tender the goods or property sold.  The purchaser might elect rescission, which would result in the return of the purchase price. The justification for rescission as a contract remedy is that, where practical, rescission “will usually be easier to do so than to calculate damages for breach or to compel the defendant to complete the interrupted exchange.6  The rules are generally designed to limit rescission to cases where each party’s performance can be returned in specie—a “mutual restoration.”7  Thus rescission is usually denied where the parties cannot be returned to the status quo ante unless the breaching party’s fault or the contractual assignment of risks makes rescission nonetheless appropriate.8

2. Performance-Based Damages (Cost-Based and Value-Based)

Performance/based damages are awarded based on either the cost or value of the non-breaching party’s uncompensated performance.  The prior Restatement called these “reliance” and “restitution” damages, respectively.

a. Cost-Based Performance Damages (fka Reliance Damages)

Cost-based performance damages are measured by the non-breaching party’s “uncompensated expenditures made in reasonable reliance on the contract…”9 However, unlike the prior Restatement (2d) of Contracts, the new Restatement makes clear that cost-based performance damages should be reduced by the losses the non-breaching party would have incurred had there been no breach.10  In other words, the non-breaching party is still held to its bad contract.

b. Value-Based Performance Damages (fka Restitution Damages)

Value-based damages award the non-breaching party the value of the performance it tendered.11  However, the recovery is limited by the contract price “even if this is insufficient to allow the plaintiff to recoup the cost of performance.”12

3. Disgorgement

Disgorgement under §§ 39 and 51 is the remedy available for an “opportunistic breach,” and seeks “to eliminate profit from wrongdoing while avoiding, so far as possible, the imposition of a penalty.”13 Thus, unlike other areas of contract law, disgorgement injects consideration of fault and wrongdoing into contract cases.  The classic disgorgement case is one where a builder intentionally substitutes a different material than required by the contract to save itself money at the owner’s expense.14

C. The Problem of Quantum Meruit

Restitution damages are frequently confused with quantum meruit damages and concepts of unjust enrichment, particularly since courts frequently use the terms interchangeably.

The new Restatement makes clear that there can be no unjust enrichment claim in the context of an enforceable contract.15 Indeed, the Restatement places questions of unjust enrichment and quantum meruit damages into separate chapters from those dealing with restitution damages for breach of contract.

D. Damages For Breach of a Losing Contract

Under the Restatement (2d) of Contracts, restitution damages didn’t take into account the problem of the losing contract, which is a contract where the non-breaching party would have suffered a loss even if the breaching party had fully performed its obligations.  The intent of the new Restatement is “to foreclose ‘restitution’ as a means by which a party bound to perform at a loss can escape the consequences of a disadvantageous bargain.”16  The American Law Institute’s view is that “damages compensate loss attributable to the breach, not loss attributable to an unfavorable exchange.”17

Thus under the new Restatement, performance-based damages are structured in order to prevent a windfall for breach of a losing contract.  When cost-based performance damages are sought, for example, a non-breaching party’s damages are reduced by the loss it would have suffered had the contract not been breached.  When value-based performance damages are sought, they are limited by the contract price: “[T]he value of a plaintiff’s performance may not exceed the contract rate (if there is one) fixed by the parties’ agreement.”18  By either measure, a party’s bad deal acts as a ceiling on damages in the losing contract context.

Conclusion

The Restatement has codified alternative remedies to expectation damages, which historically were lumped together under the catch-all term “restitution.”  While it remains to be seen whether courts will adopt the new terminology, these alternative remedies should be considered when bringing construction claims.  Even if they provide a lesser recovery than expectancy damages, they may be simpler and less expensive to prove, or may yield a recovery where expectancy damages would not.19

Endnotes

1. Restatement (2d) of Contracts § 344.

2. Rest. (2d) of Contracts § 344; Rest. (3d) of Restitution § 38, cmt. a.

3. Rest. (2d) of Contracts § 347. 

4. Rest. (3d) of Restitution, Ch. 4, Intr. Note.

5.  Id.

6. Rest. (3d) of Restitution § 37, cmt. a.

7. Rest. (3d) of Restitution § 54(2).

8. Rest. (3d) of Restitution § 54(3).

9. Rest. (3d) of Restitution § 38(2)(a).

10. Rest. (3d) of Restitution § 38, cmt. b.

11. Rest. (3d) of Restitution § 38(2)(b).

12. Rest. (3d) of Restitution § 38, cmt. b.

13. Rest. (3d) of Restitution § 39(4).

14. Rest. (3d) of Restitution § 39, Illus. 13

15. Rest. (3d) of Restitution § 2 (“A valid contract defines the obligations of the parties as to matters within its scope, displacing to that extent any inquiry into unjust enrichment”).

16. Rest. (3d) of Restitution, Ch. 4, Intr. Note.

17. Rest. (3d) of Restitution § 38, cmt. c.

18. Rest. (3d) of Restitution § 38 cmt b.

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Nelson A. F. Mixon

Holden Willits PLC, Phoenix, AZ

Barry A. Willits

Holden Willits PLC, Phoenix, AZ