Reckoning Contract Damages: Valuation of the Contract as an Asset

Abstract

When a contract is breached the law in most jurisdictions provides some version of the aphorism that the non-breaching party should be made whole. Application of the aphorism has proven problematic, particularly for anticipatory repudiations. This paper argues for a general principle that should guide application — the contract is an asset and the problem is one of valuation of the change in value of that asset at the time of the breach. This provides a framework that will help clear up some conceptual problems in damage assessment. The focus is on direct damages, not consequential damages.

The paper begins with the simplest case in which the breach occurs at the time of performance. Even in that case there is some controversy as to whether post-breach facts (e.g., changes in market conditions) should be taken into account. In the United States, for instance, some commentators argue that there is a conflict between UCC §2-706 (cover) and 2-708(1) (contract/market differential). The conflict is resolved if, instead of viewing the two as alternatives, we view cover as evidence of the value at the time of the breach.

Long-term contracts present two different issues, the breach of a single installment and the anticipatory repudiation of a contract with many years yet to run. The latter problem is exacerbated if the contract includes such complicating factors as take-or-pay clauses, price adjustment mechanisms, and early termination options. The value of the contract at the time of the repudiation would reflect both the expected future stream of income (lost profits) and the efforts of the counterparty to adapt if performance ceased (mitigation). Cases of this sort often arise in international arbitrations. A State might, for example, grant a concession to exploit an oil field and, after the development has been successful, it could try to recapture some, or all, of the value, perhaps by imposing taxes or by an out-and-out expropriation. The basic damage principle — valuation at the time of the repudiation — remains the same.