Posted on: 8/23/2012
Mark E. Porada, Pierce Atwood
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Most lawyers learned in their first year contracts course in law school that the remedies for breach of contract generally are designed to place the non-breaching party in the same position it would have been in if the breach had not occurred. See, e.g., Magnusson Agency v. Public Entity Nat. Company-Midwest, 560 N.W.2d 20, 27 (Iowa 1997); Donovan v. Bachstadt, 453 A.2d 160, 165 (N.J. 1982); Goodstein Constr. Corp. v. City of New York, 604 N.E.2d 1356, 1360 (N.Y. 1992). That measure of damages usually is known as expectation damages. According to the Restatement of Contracts, "Contract damages are ordinarily based on the injured party's expectation interest and are intended to give him the benefit of his bargain by awarding him a sum of money that will, to the extent possible, put him in as good a position as he would have been in had the contract been performed." Restatement (Second) of Contracts § 347 cmt. a.
That tradition dates back to the early years of American common law. As Holmes said, "The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it – and nothing else." O. Holmes, "The Path of the Law," 10 Harv. L. Rev. 457, 462 (1897). The idea that contract damages are limited to those that return the non-breaching party to where it would have been had performance occurred – and nothing more, unlike tort relief – has been supported by the economic theory that an intentional breach of contract, known as an "efficient breach," may result in a net benefit to society as a whole. An efficient breach occurs when the breaching party's gain is greater than the corresponding loss suffered by the non-breaching party, which is thought to result in the optimal use of the parties' respective resources. See, e.g., R. Posner, Economic Analysis of Law at 107-08 (1986). Commentators who follow the efficient breach theory have noted that contract law must be careful in defining the scope of available damages "not to exceed compensatory damages if it doesn't want to deter efficient breaches." Id. at 108.
Under typical contract law, a non-breaching party's "recovery is limited to the loss actually suffered by reason of the breach, and he is not entitled to be placed in a better position than he would have been if the contract had been performed." Leard v. Breland, 514 So.2d 778, 782 (Miss. 1987) (internal quotation omitted). In instances where the breaching party has profited from the breach, efforts by the non-breaching party to recoup the profits realized by the breaching side usually is not a viable contract law remedy and must be pursued, if at all, under unjust enrichment or other equitable theories. And in many jurisdictions, courts have held that a party may pursue an unjust enrichment claim only where there is no contract between the parties that addresses the same subject matter; where the relationship is defined by contract, no unjust enrichment claim will lie. See, e.g., Federal Ins. Co. v. Maine Yankee Atomic Power Co., 183 F. Supp. 2d 76, 84 (D. Me. 2001); Interbank Investments v. Eagle River Water and Sanitation District, 77 P.3d 814, 816 (Colo. App. 2003); see also C. Roberts, "Restitutionary Disgorgement for Opportunistic Breach of Contract and Mitigation of Damages," 42 Loyola L.A. Law Rev 131, 132 (2008) ("the theoretical underpinnings of unjust enrichment and disgorgement diverge from governing principles of American contract law"). In those jurisdictions, the party that commits an efficient breach of contract normally is not required to disgorge its own profits as part of a breach of contract remedy, and equitable claims like unjust enrichment that otherwise could provide the means for requiring disgorgement may be barred.
All of that may change if the legal world embraces the recently issued Restatement (Third) of the Law of Restitution and Unjust Enrichment, formally adopted in 2011 after much debate and circulation of several tentative drafts over the preceding years. Although denominated as a restatement of the law of restitution and unjust enrichment, certain sections purport to impact the remedies available for claims sounding in contract, as well. The new Restatement provides:
If a breach of contract is both material and opportunistic, the injured promisee has a claim in restitution to the profit realized by the defaulting promisor as a result of the breach. Liability in restitution with disgorgement of profit is an alternative to liability for contract damages measured by injury to the promisee.
Restatement (Third) of the Law of Restitution and Unjust Enrichment § 39. As the accompanying Restatement commentary explains, an "opportunistic breach of contract involves a deliberate choice by the defaulting promisor to improve the terms of the transaction in the promisor's favor, exploiting the vulnerability of a promisee whose contractual expectations would be inadequately protected by a remedy limited to damages." Id. at cmt. d. Thus, under section 39, disgorgement of the breaching party's profits may be a viable measure of damages if the breach of contract is both material and opportunistic.
Section 39 was adopted in part to rebut the long-standing theory of efficient breach, so that in cases in which the breaching party gains more by breaching the contract and subsequently paying expectation damages than by abiding by its contractual obligations, the breaching party is not rewarded for such behavior. As the comments note, section 39 "recognizes an alternative claim in unjust enrichment by an injured party who might instead assert a claim to enforce the contract." Id. at cmt a. As such, section 39 proposes a departure from established law in many jurisdictions. Its adoption was not without controversy, as the Restatement's Reporter for section 39 observed in an earlier draft that the rule is "essentially new" and that "[t]here are important questions to be addressed about the fundamental propriety of these rules, about the way they have been formulated in black letter, and about the scope and choice of the Illustrations." Restatement (Third) of Restitution and Unjust Enrichment, Reps. Mem. (T.D. No. 7, 2010).
Commentators have described section 39's adoption as the equivalent of a "quiet revolution" that "is breathtaking in its potential transformation of the traditional contractual landscape from a choice model of contract law to a perspective that values keeping promises and condemns certain breaches." C. Roberts, "Restitutionary Disgorgement as a Moral Compass for Breach of Contract," 77 U. Cin. L. Rev 991, 993 (2009); see J. Rogers, "Restitution for Wrongs and the Restatement (Third) of The Law of Restitution and Unjust Enrichment," 42 Wake Forrest L. Rev. 55 (2007) (describing section 39 as having "boldly carved out a place for restitution despite the common view that her other stepsister, the law of contract, should be the sole belle of [the] ball" for "benefits obtained by breach of contract," and stating that section 39 "is anomalous in the extreme" when viewed against the concept of efficient breach of contract).
The trend in recent Restatements seeking to shape (or outright change) the evolving law, rather than merely collecting and restating existing law, has been the subject of criticism by both courts and commentators. See, e.g., Lorah v. Luppold Roofing Co., Inc., 622 A.2d 1383, 1387 n.3 (Pa. Super. Ct. 1993) (criticizing "a disturbing trend" in the "attempt to predict the law rather than summarize it"); Delaney v. Deere and Co., 999 P.2d 930, 946 (Kan. 2000) (finding that "the new Restatement goes beyond the law"); M. Shapo, "In Search of the Law of Products Liability: The ALI Restatement Project," 48 Vand. L. Rev. 631, 635, 655 (1995) (criticizing the adoption of a provision in the Restatement where "there is simply not enough sharply etched judicial opinion on the subject"). In the case of the new section 39 in particular, commentators have pointed to potential problems that have arisen in other jurisdictions, such as England, that have allowed similar restitutionary types of relief to enter into the realm of contract remedies, going above and beyond typical expectation damages. See D. Campbell, "A Relational Critique of the Third Restatement of Restitution § 39," 68 Wash. & Lee L. Rev. 1063 (2011).
A full discussion of the back-and-forth debate among legal scholars on the wisdom and application of section 39 is beyond the scope of this article. Suffice it to say that section 39 purports to recognize an important and significant change in the way many courts and lawyers have thought about the limitations on damages for breach of contract. Exactly how willing courts may be to embrace section 39 remains to be seen, as there has been limited discussion of the new provision by the courts to date. See, e.g., Watson v. Cal-Three, LLC, 254 P.3d 1189, 1195 (Colo. App. 2011) (discussing section 39 and stating that it "appears to formulate a general rule in synthesizing breach of contract cases allowing recovery of a defendant's profits").
Presumably, even if courts in a particular jurisdiction choose to follow section 39, parties to contracts retain the right to limit the availability or scope of those restitutionary or disgorgement damages by the terms of the contracts themselves. See, Restatement (Second) of Contracts § 347 cmt. a (stating that the measure of damages for breach of contract "is subject to the agreement of the parties, as where they provide for liquidated damages … or exclude liability for consequential damages"). But lawyers would be well advised to consider the potential impact of section 39 in appropriate cases involving a breach of contract that could be deemed opportunistic as defined in the new Restatement. If section 39 does apply, it may open up an expansive category of damages not routinely allowed under traditional contract theories that focus exclusively on expectation interests.
Mark Porada is a partner at Pierce Atwood LLP, with a broad litigation practice in a wide range of disputes involving complex litigation, commercial disputes, financial institution litigation and insurance coverage disputes. He can be reached at (207) 791-1108 or mporada@pierceatwood.com.