A recent decision from the Delaware Chancery Court adds a twenty-first century interpretation to the common law doctrine of consequential damages which has roots reaching back to English contract law. This decision highlights another reason why practitioners should carefully consider contractual provisions drafted with the intent of preserving or waiving claims for consequential damages. It also fuels the debate as to what the term "consequential damages" actually means when used in M&A transactions.
The case, Brace Industrial Contracting, Inc., et al v. Peterson Enterprises, Inc., et al, C.A. No. 11189-VCG (Del. Ch. Oct. 31, 2016), involved the sale of a scaffolding business. In the stock purchase agreement (the "SPA") the sellers represented to the accuracy of a list of the target company's equipment being sold to buyer as part of the transaction, and also disclosed that the target company regularly rented supplemental equipment for purposes of operating its business. Following the closing, the buyer determined that it did not receive all the equipment promised by the sellers. To remedy the situation, the buyer rented additional equipment to operate the business and brought a claim against the sellers to recover the rental costs. The sellers, however, argued that the rental costs were not recoverable damages since they constituted “consequential damages”, which were expressly disclaimed under the SPA.
Consequential damages were not defined in the SPA. In the decision, Vice Chancellor Glasscock interpreted the phrase by reference to Black’s Law Dictionary: “[l]osses that do not flow directly and immediately from an injurious act but result indirectly from the act.” Vice Chancellor Glasscock concluded “that is precisely what the Plaintiff seeks here… Plaintiff’s choice to use extra rental components on a particular job – rather that purchasing items – led to consequential, not direct or expectation damages.” Accordingly, the court refused to award damages for the rental costs, concluding they were barred under the damages waiver section of the SPA.
This case is noteworthy because it demonstrates that parties cannot necessarily predict how a court will interpret or apply the phrase "consequential damages" when used in a transaction agreement.
The seminal case on consequential damages is Hadley v. Baxendale, 156 Eng. Rep. 145 (Ex. Ch. 1854). The rule established there is that a non-breaching party is entitled to recover the reasonably foreseeable damages it sustains as a result of a breach, either because (a) they are the type of damages that would naturally and ordinarily be expected to arise from a breach of any similar contract, or (b) they are the type of damages that arise from special circumstances applicable to the particular non-breaching party and those special circumstances were actually brought to the attention of the breaching party at the time of contracting, so that it can be fairly said that the probability of such damages arising from such special circumstances were within the contemplation of the parties at the time of contracting.
Damages that fall in bucket (a) above have historically been referred to as general or direct damages and those falling into bucket (b) above have historically been referred to as special or consequential damages. In Hadley, the plaintiffs lost their claim for damages for lost profits resulting from delivery delays because lost profits damages were not the type that typically flowed from a breach of a delivery contract, nor did the plaintiffs communicate their circumstances to the carrier. The losses suffered were determined not to be reasonably foreseeable damages arising from special circumstances of the plaintiff.
Importantly, where Hadley and its progeny leave us, as a matter of common law, foreseeability is a determining (or limiting, as the case may be) factor for the imposition of all damages, including consequential damages. In Brace, however, Vice Chancellor Glasscock deviated from the interpretation of "consequential damages" under the Hadley line of cases, by failing to award damages even though the claimed damages were arguably a reasonably foreseeable result of the breach-- indeed, the regular rental of certain additional equipment to supplement the target company's owned equipment was a circumstance disclosed under the SPA.
The Brace decision should serve as another reminder to practitioners that the best way to ensure the desired interpretation of the term “consequential damages” is to include a definition (or other clarification) of the term in the contract at hand. Although many clients and practitioners may seek to rely on a court to read in a common law standard of foreseeability, parties should consider attempting to avoid the debate altogether by drafting loss definitions and carve outs/ waivers to suit their needs and expectations.