In our previous article in the Supply Chain Survival Series, we discussed what constitutes a breach of contract and whether a breach allows you to suspend performance until the breach is cured. Assuming that a contract has been breached, this article focuses on the obligations that a non-breaching party would have to mitigate their own damages caused by the other party’s breach. Specifically, this article will discuss how a party’s calculation of damages changes when a seller or buyer decides to minimize its damages and what steps such party must take to actually mitigate its damages.
Mitigation from the Seller’s Perspective
When does the obligation to mitigate damages arise? First, let’s start with an example from the seller’s perspective. You previously signed a contract on behalf of ABC Corp. to sell widgets to XYZ Corp., which XYZ Corp. needs to manufacture its product. Unfortunately, XYZ Corp. just sent you an email stating that it is discontinuing its product and no longer needs the widgets that ABC Corp. manufactures. XYZ Corp.’s email also states it is terminating the contract, even though there is a year left on its term. You wonder, is XYZ Corp. required to pay for these widgets, even though it breached the contract? If not, how does ABC Corp. get its money back for these widgets? Should ABC Corp. continue to manufacture the widgets that XYZ Corp. was required to purchase? Does ABC Corp. have to find a new buyer for the widgets that its already manufactured? And who has to pay for the storage costs of these widgets while ABC Corp. tries to find another buyer? You call your lawyer, who explains that while you are entitled to seek damages from XYZ Corp. related to its breach, you must mitigate your damages in order to be able to recover all your losses.
Seller’s Obligation to Mitigate
While the UCC does not explicitly require that a seller mitigate its damages, it does implicitly impose this duty on a seller, even if the seller has done nothing wrong and the buyer is at fault for the breach. This might mean the seller has to seek an alternative buyer, even if at a lower price than agreed to in the contract. For example, if a buyer has failed to pay for goods that it committed to buy in a contract, the seller can only recover the cost of those goods “if the seller is unable after reasonable effort to resell them at a reasonable price or the circumstances reasonably indicate that such effort will be unavailing.”1 In addition, common law imposes a duty to mitigate on a seller in the event of a buyer’s breach.2
Calculating Damages
A seller’s damages typically are calculated by (i) taking the difference in the original contract price and the resale price (or, if the seller is unable to successfully mitigate by reselling the goods, the different in the original contract price and market value), plus (ii) any incidental damages the seller may have, less (iii) any cost savings a seller might have from expenses related to the breach (if any).3
Difference in Resale Cost
If a buyer breaches its contract by refusing to take delivery of conforming goods, a seller may mitigate its damages by reselling the goods.4 In order to use the resale price in the calculation of damages though, the resale must be made in good faith and in a commercially reasonable manner.5 The seller can choose whether it wants to sell the goods in one sale or break them up and sell them to multiple buyers.6 The sale can either be a public sale or a private one, but the seller must give the buyer reasonable notice that the seller intends to resell the goods.7
Of course, a seller can only resell the goods if it has possession of the goods. If the buyer has accepted the goods and has possession or control of the goods, the seller is not able to resell the goods and mitigate its damages. In this situation, the UCC permits the seller to seek a claim against the buyer for the entire purchase price.8 Similarly, if the goods were uniquely created for a buyer, and resale of the goods would likely be ineffective, the seller could also seek a claim against the buyer for the entire purchase price.9
If the seller has not manufactured all the goods identified under the contract, the seller must execute “reasonable commercial judgment” as to what the best loss mitigation strategy is.10 The UCC provides the seller with two main options: (1) it can finish manufacturing the goods for the contract for the purposes of reselling them or (2) it can stop manufacturing the goods and resell any parts for scrap or salvage value.11 The burden would be on the buyer to show that the seller’s decision on whether to continue to manufacture the goods was commercially unreasonable.12
Incidental Damages
A seller may also recover incidental damages for any commercially reasonable charges, expenses or commissions incurred because of a buyer’s breach of contract. These damages could include additional transportation costs, costs related to returning rejected goods, and expenses related to managing, maintaining and reselling the rejected goods.[13] The UCC does not expressly allow a seller to recover for consequential damages (unlike in the situation where the buyer is the aggrieved party, as detailed below), and so courts often hold that sellers cannot recover them.
Cost Savings
If a seller receives cost savings from the buyer’s breach, those savings must be netted against the seller’s other damages. Although cost savings do not always occur, there are instances where a seller could be saving money by not selling the goods to the breaching buyer. For instance, perhaps a different buyer can receive the goods more quickly than the original buyer, so the seller would save on storage costs. That cost savings would need to be taken into account when calculating the seller’s total damages.
Example
Returning to our example above, let’s determine what damages ABC Corp. could seek from XYZ Corp. related to XYZ Corp.’s breach of contract. Let’s say that XYZ Corp. was going to purchase 100,000 widgets at a cost of $1.00/widget, and ABC Corp. was required to ship the widgets to XYZ Corp. in three months. ABC Corp. has already made 50,000 widgets. Because of XYZ Corp.’s breach, ABC Corp. took its lawyer’s advice and sold the 50,000 widgets ABC Corp. already made to another buyer, EFG Corp., at the rate of $0.75/widget. ABC Corp. was not able to find a potential buyer for the original price of the widgets because the demand for the widgets had decreased since ABC Corp. entered into the contract with XYZ Corp. Given the low demand for the widgets, ABC Corp. decided not to continue to manufacture the remaining 50,000 widgets because the cost of manufacturing the widgets would be more than the current resale value. EFG Corp. needed the widgets within the week, so ABC Corp. had to pay for expedited shipping to deliver the goods on time. However, because EFG Corp. needed the widgets within the week, ABC Corp. did not have to pay to store the widgets at a warehouse. What damages could ABC Corp. seek from XYZ Corp.? First, ABC Corp. could seek damages for the difference between the original contract price and the resale cost, which in this situation, is $0.25/widget, for the 50,000 widgets it had already made at the time of XYZ Corp.’s breach. For the other 50,000 widgets that were never manufactured, ABC Corp. could recover its expected profit on the sale of those widgets to XYZ. Corp. (i.e. the difference between the contract price and the cost to manufacture the goods). Additionally, ABC Corp. could seek damages for any incidental damages related to XYZ Corp.’s breach of contract, which would include the costs for expedited shipping. However, because ABC Corp. had a cost savings related to its storage costs, the amount saved would be deducted from the total amount of damages ABC Corp. could recover.
Mitigation from the Buyer’s Perspective
Now that we have discussed a seller’s duty to mitigate its damages when a buyer breaches a contract, it is important to also understand a buyer’s duty to mitigate its damages when a seller breaches. For instance, let’s circle back to ABC Corp. You have a supply contract to purchase widgets from 123 Corp., which ABC Corp. needs to manufacture its product. Unfortunately, 123 Corp. just sent you an email stating that it is unable to obtain a critical component of the widget, so it is not able to make the widgets for another 6 months, even though it is required to ship 1,000,000 widgets to ABC Corp. next month. You wonder, is it possible to get your money back related to the contract? What if you have to purchase the widgets from another company and because of the short time frame, the cost of the widgets is more than what you would have paid under the contact with 123 Corp.? You once again call your lawyer, who explains a buyer’s obligation to mitigate its damages when a contract is breached.
Buyer’s Obligation to Mitigate
Like in the case of a buyer’s breach of contract, the UCC does not explicitly require the buyer to mitigate its damages if a seller breaches a contract; however, it does encourage the buyer to do so, and a failure by a buyer to do so may impact the damages that the buyer can recover. If a seller breaches a contract, the buyer is entitled to recover incidental and consequential damages related to such a breach.14 In order for a buyer to obtain consequential damages, it must take reasonable efforts to avoid suffering further losses from the breach, which is typically referred to as the buyer’s obligation to cover. A buyer can choose not to cover, but if it does, it is only allowed to recover from the seller the damages that could not have been reasonably prevented by covering. In addition, common law imposes a duty to mitigate on a buyer in the event of a seller’s breach.15
Calculating Damages
A buyer’s damages typically are calculated by (i) taking the difference in the cost of the substitute goods and the original contract price (or, if the buyer does not cover with substitute goods, the different in the original contract price and market value), plus (ii) any incidental and consequential damages the buyer may have (other than damages that could have been reasonably prevented by covering), less (iii) any cost savings a buyer might have from expenses related to the breach (if any).
Difference in Cost of Goods
If a buyer covers by purchasing substitute goods, it can recover the difference between the cost of those substitute goods and the price that the buyer would have originally paid under the contract that the seller breached. However, this is not a blank check for the buyer to purchase any substitute goods at any time. The substitute goods must be a reasonable purchase. Courts typically presume that the purchase of substitute goods is reasonable, but the seller does have the opportunity to rebut the presumption.16 Additionally, a buyer must purchase the substitute goods “without unreasonable delay” to minimize market fluctuations.17 If the buyer does not cover, the buyer can instead seek damages based on the difference between the original contract price and the market price of the goods (rather than the actual cost of the substitute goods).18 To calculate the market price, courts take different approaches. Some look at the market price at the place of delivery when the contract was breached,19 while others look at the market price at the time of repudiation.20
Incidental and Consequential Damages
A buyer can also recover incidental damages and, unlike a seller in the case of a buyer’s breach, consequential damages. Incidental damages can include reasonable charges and expenses relating to the defective goods (such as inspection costs, transportation costs, etc.) and any other reasonable expense arising from seller’s breach. If the buyer covers, then these damages can also include any commercially reasonable charges, expenses or commissions in connection with effecting cover.21 Consequential damages can include any loss resulting from the seller’s breach of warranty, or from the buyer’s requirements which the seller had reason to know about at the time of contract, which the buyer could not reasonably have prevented by cover.
Although the UCC permits the recovery of incidental and consequential damages, it is important to remember that parties often include a waiver of incidental and consequential damages in the contract, which would limit the buyer’s right to recover for those damages.
Cost Savings
If a buyer receives cost savings from the seller’s breach, those savings must be netted against the buyer’s other damages. For example, perhaps the replacement supplier is located closer to buyer, and so shipping costs from that supplier are less. Those cost savings would be taken into account when calculating the buyer’s total damages.
Example
Returning to our example above, let’s say that ABC Corp. needs the 1,000,000 widgets within the next three months in order to meet its customer’s timeline. ABC Corp. cannot wait for 123 Corp. to ship the widgets in six months, so it has to purchase the widgets from another supplier. Instead of the price of $10.00/widget that ABC Corp. would have had to pay under its contract with 123 Corp., ABC Corp. had to pay a different supplier $20.00/widget. Additionally, because the replacement supplier is located in a different country, ABC Corp. has to pay import duties and incur other expenses to import the widgets into the United States and has to pay increased shipping fees. Fortunately for ABC Corp. though, the replacement supplier is able to provide the widgets in ABC Corp.’s preferred color, so ABC Corp. does not need to paint the widgets upon receipt. Because of the delay in obtaining the replacement widgets, ABC Corp. is not able to deliver its final product to its customer on time. What damages could ABC Corp. seek from 123 Corp.? First, ABC Corp. could seek damages for the difference between the original contract price and the replacement cost, which in this situation, is $10.00/widget. Additionally, ABC Corp. could seek damages for any incidental damages related to 123 Corp.’s breach of contract, which would include the increased costs for shipping as well as the import duties and expenses. ABC Corp. could also seek consequential damages for any lost profits it suffers by not being able to fulfill its customer’s order. However, ABC Corp.’s costs savings it realized from not needing to paint the widgets would reduce the amount of damages that ABC Corp. can recover.
Having gained a better understanding of both a buyer’s and seller’s obligation to mitigate their damages when a contract is breached, we move next to a deeper dive into the parties’ remedies, which will be addressed in our next article.
END NOTES
1 UCC § 2-709(1).
2 See, e.g., Mack Cali Realty, L.P. v. Everfoam Insulation Sys., Inc., 972 N.Y.S.2d 310, 312 (2d Dep't 2013).
3 UCC § 2-708.
4 UCC § 2-703.
5 UCC § 2-706.
6 Id.
7 Id.
8 § 2-709.
9 Id.
10 UCC § 2-704.
11Id.
12 UCC § 2-704, official cmt. 2.
13 UCC § 2-710.
14 UCC §§ 2-712 and 2-713.
15 See, e.g., Mack Cali Realty, L.P. v. Everfoam Insulation Sys., Inc., 972 N.Y.S.2d 310, 312 (2d Dep't 2013).
16 See, i.e., Bayer Corp. v. DX Terminals, Ltd., 214 S.W.3d 586, 605 (Tex. App. 2006); Glenn Distribs. Corp. v. Carlisle Plastics, Inc., 297 F.3d 294, 302 (3d Cir. 2002).
17 UCC § 2-712.
18 UCC § 2-713(1).
19 See, e.g., Edwardo Galleries, Ltd. v. Fed. Exp. Corp., 773 N.Y.S.2d 550 (1st Dep't 2004); Goltzman v. Rougeot, 122 F. Supp. 700, 705 (W.D. La. 1954).
20 See, e.g., First Nat'l Bank of Chi. v. Jefferson Mortg. Co., 576 F.2d 479, 492 (3d Cir. 1978).
21 UCC § 2-715(1).
