Limitations on the Recovery of Lost Profits
As we stand on the precipice of another economic downturn, a new Commercial Division case arising from the great financial crisis of 2007-2008 is a timely reminder of the limitations on the recovery of lost profit damages. The Commercial Division, Kings County, recently precluded plaintiffs from seeking to recover lost profit damages, finding that such damages were not in the contemplation of the parties at the time they entered into the underlying contract. In applying New York’s law on lost profit damages, the decision highlights the fact that the ability to recover lost profits is solely a function of the parties’ expectations as expressed in the contract without regard to the parties’ changing expectations or opportunities brought about because of changing economic times.
General or Direct Damages Versus Special or Consequential Damages
“Under New York law, lost profits can be either general or consequential damages, depending on the nature of the lost profits in question.” However, as the courts have observed, “[t]he distinction between general and special contract damages is well defined but its application to specific contracts and controversies is usually more elusive.” Nailing down the application of this elusive distinction is important because general damages are subject to a more forgiving standard, and, given the prevalence and general enforceability of contractual clauses that seek to limit or waive consequential damages, harder to eliminate in the drafting phase of the contract.
“It is well settled that in breach of contract actions the nonbreaching party may recover general damages which are the natural and probable consequence of the breach.” General damages obviously include, as the natural and probable consequence of the breach of the contract, “money that the breaching party agreed to pay under the contract.” Thus, lost profits “will qualify as general or direct damages when they ‘are the natural and probable consequence of the breach.’” Put another way, lost profits are recoverable as general contract damages where “the non-breaching party bargained for such profits and they are the direct and immediate fruits of the contract.”
Examples of situations where lost profits have been found to be general damages are distribution agreements where the contract expressly incorporates future payments based on profit, bringing the plaintiff’s profits within the contemplation of the parties or where the lost profits represented the measure of value of the contract to the plaintiff. Other examples include a power purchase supply agreement that included a termination payment provision, which the court characterized as providing that “the non-defaulting party is entitled to any net loss the party incurs as a result of the other party’s early termination of the agreement;” and an agreement between a plaintiff mailing list company and a defendant magazine pursuant to which the defendant agreed to rent a mailing list to be compiled by the plaintiff and funded by the defendant and a schedule of the payments due to plaintiff over the 10-year period of the agreement. In the latter case, the defendant argued that the scheduled payments were based on the plaintiff’s lost anticipated profits and therefore consequential damages. The court rejected that argument finding that having expressly set forth the fees in the contract, the fees “are general damages flowing as a natural and probable consequence of the breach.”
Lost profits are consequential damages when, as a result of the breach, the non-breaching party suffers loss of profits on collateral business arrangements. In the typical case, the ability of the non-breaching party to operate his business, and thereby generate profits on collateral transactions, is contingent on the performance of the primary contract. When the breaching party does not perform, the non-breaching party’s business is in some way hindered, and the profits from potential collateral exchanges are “lost.” Every lawyer will recall from his or her first-year contracts class the paradigmatic example of Hadley v. Baxendale, where Baxendale’s failure to deliver a crank shaft on time caused Hadley to lose profits from the operation of his mill. 9 Ex. 341, 156 Eng. Rep. 145 (1854).
While the courts have recognized that it is possible to recover lost profits as consequential damages, the rules governing the award of consequential damages in the form of lost profits significantly narrow the ability to recover lost profits characterized as consequential damages rather than lost profits that fall under the rubric of general damages.
Elements of Proof Necessary To Recover Lost Profits
In order to recover damages, whether they are lost profits or some other measure, a plaintiff must prove the amount of the damages. However, a lesser standard is required to establish lost profits when such lost profits are considered general damages. As the Tractebel court explained in rejecting the district court’s denial of lost profits over the 20-year life of the contract term as speculative:
certainty as it pertains to general damages, refers to the fact of damage, not the amount. For when it is certain that damages have been caused by a breach of contract, and the only uncertainty is as to their amount, there can rarely be good reason for refusing, on account of such uncertainty, any damages whatever for the breach. A person violating his contract should not be permitted entirely to escape liability because the amount of the damage which he has caused is uncertain. [T]he burden of uncertainty as to the amount of damage is upon the wrongdoer. The plaintiff need only show a stable foundation for a reasonable estimate of the damage incurred as a result of the breach. Such an estimate necessarily requires some improvisation, and the party who has caused the loss may not insist on theoretical perfection.
Thus, in cases where lost profits are found to be general damages, plaintiffs are held to a lesser standard of proof with respect to the amount of damages than if the lost profits are consequential damages. Nevertheless, a “stable foundation for a reasonable estimate requires putting forth a plausible theory that amounts to something more than a speculative measure of damages. Courts will not rely on a party’s internal financial projections as a stable foundation for a reasonable estimate of general lost profits if they are not based on reliable data.”
While certainty is not the standard for a plaintiff seeking lost profits as general damages, reasonable certainty is required with respect to lost profits as consequential damages. In the seminal Kenford cases, the Court of Appeals set the standard for establishing entitlement to lost profits as an element of consequential damages in a breach of contract action as follows: (i) certainty that such damages have been caused by the breach; (ii) the alleged loss must be capable of proof with reasonable certainty, “not be merely speculative, possible or imaginary, but must be reasonably certain and directly traceable to the breach, not remote or the result of other intervening causes”; and (iii) that the particular damages “were fairly within the contemplation of the parties to the contract at the time it was made.”
The Court of Appeals held that “[i]n determining the reasonable contemplation of the parties, the nature, purpose and particular circumstances of the contract known by the parties should be considered, as well as ‘what liability the defendant fairly may be supposed to have assumed consciously . . . when the contract was made.’” The purpose of limiting damages for breach of contract to damages that are reasonably foreseen or contemplated by the parties “is to limit the liability for unassumed risks of one entering into a contract and, thus, diminish the risk of business enterprise.” “New York courts have consistently applied the standards set by the Kenford cases and imposed liability for consequential damages only where the parties contemplated the imposition of such damages at the time of contracting, and the damages were capable of proof with reasonable certainty.”
“Where a contract is silent on the subject, courts, employing a commonsense approach, must determine what the parties intended by considering the nature, purpose and particular circumstances of the contract known by the parties . . . as well as what liability the defendant fairly may be supposed to have assumed consciously, or to have warranted the plaintiff reasonably to suppose that it assumed, when the contract was made.” Cases have held that when the contract makes no mention of lost profits, “courts evaluate ‘what the parties would have concluded had they considered the subject.”’ In Trademark Research, for example, the “court refused to permit recovery of lost profits when ‘the record contains no specific evidence that, at the time of contracting, [one party] accepted liability [for lost profits]’ or when ‘[n]o evidence was offered that the parties ever discussed lost profits liability.’” Similarly, courts will look to the proportionality of any such lost profit damages and will not award lost profit damages if they are “out of proportion to any liability contemplated by the contract.”
Even if lost profits are reasonably foreseeable and within the contemplation of the parties, they may not be recovered if they are speculative, as demonstrated by Kenford I. To recover lost profits, the “loss must be capable of proof with reasonable certainty.” “Where there are a ‘multitude of assumptions required to establish projections of profitability,’ which themselves require speculation, then the lost profits damages sought are not reasonably certain and cannot be recovered.” Where the party seeking lost profits is a new business, the burden is even stricter. “Moreover, if a new business is seeking loss of future profits, a stricter standard is imposed because ‘there does not exist a reasonable basis of experience upon which to estimate lost profits with the requisite degree of reasonable certainty.’” Generally, a party cannot demonstrate lost profits with reasonable certainty when that party’s business is a new business.
Contractual Provisions Waiving Consequential Damages
As if the bar were not high enough for the recovery of lost profits, parties to a contract may expressly waive the recovery of lost profits. “Under New York law, ‘if contracting parties agree to a limitation-of-liability provision, it will be enforced unless unconscionable, even if it leaves a non-breaching party without a remedy. New York courts have routinely enforced liability-limitation provisions when contracted by sophisticated parties, recognizing such clauses as a means of allocating economic risk in the event that a contract is not fully performed.’” For example, the First Department recently held that where the parties waived the right to recover consequential damages in a construction contract, lost profits could not be recovered.
In the recent case of Siegel v. People’s United Bank, the Kings County Commercial Division, applying the above principles, found that the plaintiffs were not entitled to proceed to trial on their lost profits claim arising from an alleged breach of a construction loan commitment. The court rejected plaintiffs’ claim that the lost profits should be characterized as general damages, finding that lost profits were not “the natural and probable consequence of a funding agreement due to the economic climate” because, as the court explained, “[i]t is generally understood that ‘[b]ecause money is fungible, a party seeking enforcement of an agreement to lend money would be expected to borrow money elsewhere and recover damages based on the higher costs associated with the replacement loan.’” “The fact that market conditions suddenly made lending a riskier proposition and rendered plaintiffs unable to obtain alternate financing does not automatically transform the essence of the parties’ loan agreement.” Under New York law, the normal measure of damages for a breach of a loan commitment is the additional costs, if any, incurred by plaintiff in obtaining a substitute loan and not lost profits. The court also rejected the argument that lost profits were recoverable as consequential damages since lost profits were not contemplated by the parties at the time of the agreement.
As changing economic times upend expectations of profits, it is important to remember that under New York law entitlement to recover lost profits based on a breach of contract looks back to the parties’ expectations at the time of contracting as to whether lost profits are properly recoverable as either general or consequential damages. Both transactional attorneys and litigators should keep this principle in mind in representing their clients.
2 Kayo Corp. v. Fila U.S.A., Inc., 2022 U.S. Dist. LEXIS 14445, at *2 (S.D.N.Y. Jan. 26, 2022); see also Siegel, at 13 (‘“Lost profits may be either general or consequential damages, depending on whether the non-breaching party bargained for such profits and they are the direct and immediate fruits of the contract”’) (quoting Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 22 N.Y.3d 799, 806 (2014)).
8 Id. at 808 (contract price plaintiff was obligated to pay defendant was calculated based on the market price obtained by plaintiff for the resale of the product even though not specifically identified as lost profits); see also Orester v. Dayton Rubber Mfg. Co., 228 N.Y. 134 (1920) (recognizing lost profits as available remedy for breach of tire distribution contract, where contract contemplated plaintiff distributor would create a market for defendant’s tires).
21 Siegel, at 14 (internal quotations omitted) (quoting Awards.com v. Kinko’s, Inc., 42 A.D.3d 178, 183-84 (1st Dep’t 2007)); see also Maimis-Knox Group, Ltd. v. Grand Cent. Zocalo, LLC, 5 A.D.3d 129 (1st Dep’t 2004).
26 Anchor Glass Container Corp. v. Pabst Brewing Co., LLC, 69 Misc. 3d 1207(A), at *41 (Sup. Ct. N.Y. Cty. 2022) (quoting PIA Invs. v. UBS Sec., 211 A.D.2d 599, 599 (1st Dep’t 1995)); RIJ Pharm. Corp. v. Ivax Pharms., Inc., 322 F. Supp. 2d 406, 415 (S.D.NY 2004) (“[A] calculation and award of lost profits may not be based on speculation.”).
27 Bersin Props., LLC v. Nomura Credit & Capital, Inc., 159 N.Y.S.3d 828 at *41 (Sup. Ct. N.Y. Cty. 2022) (“New York has a ‘relatively demanding standard for an award of lost profits’ and applies a near per se rule rejecting plaintiffs’ attempts to collect purported lost profits from a business venture with no prior track record to support claims of future success . . .”) (quoting Kidder, Peabody & Co. v. IAG Int’l Acceptance Group N.V., 28 F. Supp. 2d 126, 131 (S.D.N.Y. 1998), aff’d 205 F.3d 1323 (2d Cir. 1999)); see also RMLS Metals v. Int’l Bus. Machs. Corp., 874 F. Supp. 74, 76 (S.D.N.Y. 1995) (“In deciding whether lost profits are capable of proof with reasonable certainty, ‘courts distinguish between established businesses and new or ‘fledgling’ enterprises . . .’”) (internal citations omitted); Nineteen N.Y. Props. Ltd. P’ship v. 535 5th Operating, 211 A.D.2d 411, 412 (1st Dep’t 1995) (holding that where business was a start-up venture, “lost profits were too speculative”).
29 Nineteen NY Props. LP v. 535 5th Operating, 211 A.D.2d 411, 412 (1st Dep’t 1995) (“[t]hese counterclaims should thus be reinstated except to the extent that the fourth counterclaim seeks to recoup lost profits . . . [the] business was a start-up venture; the lost profits were too speculative”); Awards.com, 42 A.D.3d at 185 (“Even if plaintiffs could show that the parties had, in fact . . . contemplated liability for lost profits damages, their claim for such damages would still have been properly dismissed because of its purely speculative nature . . . there is no profit record to serve as a basis for projecting millions of dollars in future profits.”); Digital Broadcast Corp. v. Ladenburg, Thalmann & Co., Inc., 63 A.D.3d 647 (1st Dep’t 2009) (“[S]ince plaintiff was a ‘development stage’ company and had never generated any revenue, it could not meet the stricter standard for the award of lost profits . . . ”); Wathne Imports, Ltd. v. PRL USA, Inc., 101 A.D.3d 83, 88 (1st Dep’t 2012) (“claims for lost profits have been dismissed by this Court upon a motion for summary judgment where the plaintiff’s lost profits were said to arise from a ‘new business endeavor’ with no track record or a business in the ‘development stage’ that ‘had never generated any revenue’”); RMLS Metals, 874 F. Supp. at 76.
30 In Integrity Int’l, Inc. v. HP, Inc., the contract contained the following limitation as to damages, “[i]n no event will [defendants] be liable to [plaintiff] for any special, indirect, or consequential damages (including but not limited to loss of profits) arising out of any performance of this agreement or in furtherance of the provisions or objectives of this agreement.” 211 A.D.3d 1194, 1200 (3rd Dep’t 2022) (emphasis omitted). The court held that “the limitations clauses are enforceable and, as a result, plaintiff is precluded from recovering consequential damages.” Id.
31 Evemeta, LLC v. Siemens Convergence Creators Corp., 2020 N.Y. Slip. Op. 33827(U), at *22 (Sup. Ct. N.Y. Cty. 2020), quoting Biotronik, 22 N.Y.3d at 822; Process Am., Inc. v. Cynergy Holdings, LLC, 839 F.3d 125, 138 (2d Cir. 2016).
32 Rising Sun Constr. L.L.C., 202 A.D.3d at 558 (“The parties’ initial subcontract unambiguously precludes the recovery of lost profits as it provides that the parties waived claims for consequential damages.”), citing Bankers Conseco Life Ins. Co. v. Wilmington Trust, N.A., 195 A.D.3d 109, 116 (1st Dep’t 2021) (noting that claim for lost profits is a “classic example of consequential damages”).
33 Siegel, at 15 (quoting Destiny USA Holdings. LLC v. Citigroup Global Mkts. Realty Corp., 69 A.D.3d 212, 217 (4th Dep’t 2009)); see also Randolph Equities, LLC v. Carbon Capital, Inc., 648 F. Supp. 2d 507, 510 (S.D.N.Y. 2009); Ainbinder v. Money Ctr. Fin. Group, Inc., 2014 U.S. Dist. LEXIS 39788, at *14 (E.D.N.Y. Mar. 2014); Networks USA, LLC v. HSBC Bank USA, N.A., 94 A.D.3d 638 (1st Dep’t 2012).
35 Towers Charter & Marine Corp. v. Cadillac Ins. Co., 894 F.2d 516, 523 (2d Cir. 1990) (“even if [defendant] breached the agreement, [plaintiff] would be entitled only to money damages reflecting the difference between the interest rate it had agreed to with [defendant] and such higher interest rate as it was reasonably forced to pay another lender as a result of [defendant’s] breach.”); Binghamton Masonic Temple v. City of Binghamton, 158 Misc. 2d 916, 917-18 (Sup. Ct. Broome Cty. 1993) (“[T]he normal measure of damages for the breach of a loan agreement: the increased interest cost that would have been incurred if plaintiff had borrowed a comparable amount of money from another lender.”).