Consequential Damages In Construction Contracts and Architects Agreements Part 3 - Why Treat Consequential And Direct Damages Differently?
In the last consequential damages post we talked about how direct damages and consequential damages get treated differently. Today we're going to talk about why they get treated differently. It's actually pretty simple - when people take more risk, they should get the opportunity to get more reward.
The Theory Of Why
It's pretty safe to assume that providers base the prices of their goods and services in part on the possibility that they'll have to pay damages to a customer if a good or service turns out to be defective. And that part of pricing is usually based on the types, and the amounts, of damages they think are possible, or should think are possible - direct damages.
Now if a defect is going to cause the customer to suffer other types or amounts of damages - consequential damages - the provider's risk get s bigger, often exponentially. And usually a provider who knows that they're taking on this greater risk will want the opportunity to adjust the price of their goods or services - raise the price so they get a bigger reward for exposing themselves to a bigger risk.
But if the provider doesn't know of the bigger potential risk, they can't consider raising their price. It doesn't seem fair to stick a provider with bigger than expected risk without the opportunity for them to first consider asking for a bigger reward. And that's why judges treat direct and consequential damages differently - to ensure that the provider gets the opportunity to consider the extra risk and the opportunity to ask for the bigger reward. How do they do that?
By requiring that before the customer gets consequential damages,
they must first prove that the provider contemplated the possibility of
those consequential damages when the provider and customer entered into
their contract. If the customer can prove that the provider
contemplated, then judges are reassured in assuming that the provider
considered that bigger risk and "baked" a reward for taking it into the
their price.
Practical Application
We'll use the classic case of Hadley v. Baxendale as our example. In this case a 19th Century flour mill operates off of a steam engine.
The engine powers mill operations via a crankshaft connected to other machinery. One day the crankshaft breaks and the mill operator doesn't have a spare. So work at the mill stops until the operator can get the crankshaft replaced. Meanwhile, the mill sits idle - no wheat gets processed, no flour gets sold, and the mill operator collects no money.
Now this is the 1850's, long before standardized replacement parts. The operator can't just go to the manufacturer's website with the crankshaft's part number and order a replacement. The original manufacturer must custom make the replacement. And because the crankshaft must fit with the mill's other custom made parts, the manufacturer tells the mill operator to send the broken crankshaft back; the manufacturer needs it as a model for the replacement so once installed it will fit other machinery in the mill.
So the mill operator hires a shipping
company to ship the broken crankshaft back to the manufacturer. The
operator pays the shipping company about £2 to deliver the broken
crankshaft in 2 days. And while arranging for the shipping, one of the
mill operator's employees mentions to the shipping clerk that the mill
is stopped so the crankshaft must be shipped immediately.
The shipping company then ships the crankshaft. But the crankshaft arrives 5 days late. And so the manufacturer is 5 days late in building and delivering the replacement back to the mill operator.
Because of this delay, the mill sits idle for an extra 5 days. The mill operator claims that they're out £300 for (1) wages paid to idle workers and (2) lost sales. They sue the shipping company.
The case goes to trial and the mill operator wins a judgment for £25. The shipping company appeals asking for a new trial. Why? The shipping company contends that the trial judge should have given the jurors different instructions on how to measure the mill operator's damages. £25 must have still been real money back in the 1850's. Today it barely buys you a man's dress a shirt from the clearance rack.
I'm
going to spare you reading a 19th Century judicial opinion and instead
give you my own re-phrasing of the instruction the shipping company
wanted given to the jurors and what the appeals court suggested they
should get at the new trial:
When you're deciding how much damages to award to the mill operator, before you can award damages for wages paid and lost sales while the mill was idle, you must first find that at the time they entered into the contract to ship the crankshaft, the shipping company contemplated that the mill owner would suffer those idleness damages as a result of late delivery.
So before the mill operator can get
consequential damages -
wages paid and sales lost while the mill was idle - they must prove
that the shipping company
contemplated those damages as a risk of agreeing to ship the broken
crankshaft. Requiring that proof of contemplation helps ensure the
shipping company had the opportunity to consider the extra risk and
decide whether to raise their price above the customary £2.
Conclusion
Entering into any contract is taking a leap. Consequential damages make the fall a lot longer with a more dramatic stop at the end. Judges think people should look before they leap. And when looking, they should be able see how long their fall might be. If it's going to be longer than ordinarily expected, they should be able to reconsider and get the opportunity to don a parachute before they jump. That's why direct and consequential damages get treated differently.
Construction Law Today is a legal blog about construction contracts, disputes, finance, and the people whose job it is to deal with them.
