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Lost Profit Damages: It Makes A Difference in Proof Whether the Damages Alleged Are General or Special

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  • Posted on: Oct 16 2019

In today’s commercial world, businesses claiming breach of an agreement often seek lost profits resulting from the breach. The hurdle that the plaintiff must overcome when seeking such relief, however, can be high. As discussed below, the reason has to do with the type of damages sought and the applicable standard of proof.

There are two types of damages recoverable as lost profits: (1) lost profits that are general damages; and (2) lost profits that are consequential or special damages. As the New York Court of Appeals has noted: “The distinction between general and special contract damages is well defined but its application to specific contracts and controversies is usually more elusive.” Biotronik A.G. v. Conor Medsys. Ireland, Ltd., 22 N.Y.3d 799, 805-806 (2014) (internal quotation marks and citation omitted).

Lost profits as general damages “are the natural and probable consequence of the breach” of a contract. Biotronik, 22 N.Y.3d at 805, citing American List Corp. v. U.S. News & World Report, 75 N.Y.2d 38, 43 (1989); Kenford Co. v County of Erie, 73 N.Y.2d 312, 319 (1989). General damages include “money that the breaching party agreed to pay under the contract.” Tractebel Energy Mktg., Inc. v. AEP Power Mktg., Inc., 487 F.3d 89, 109 (2d. Cir 2007), citing American List Corp., 75 N.Y.2d at 44. In other words, “a claim for general damages” exists where the plaintiff “seeks only what it bargained for—the amount it would have profited on the payments [the breaching party] promised to make.” Tractebel, 487 F.3d at 110; see also Biotronik, 22 N.Y.3d at 806 (the “direct and immediate fruits” of a contract are general damages) (quoting Tractebel, 487 F.3d at 109 n.20).

Lost profits may be recovered as general damages if there is a “stable foundation for a reasonable estimate.” Tractebel, 487 F.3d at 110 (internal quotation and citations omitted). To plead a stable foundation, a plaintiff must show that “[t]here are some facts upon which a jury could base a judgment, not certain nor strictly accurate, but sufficiently so for the administration of justice.” Wakeman v. Wheeler & Wilson Mfg. Co., 101 N.Y. 205, 216 (1886); accord Plant Planners, Inc. v. Pollock, 60 N.Y.2d 779, 780–81 (1983) (lost profits are “recoverable where plaintiff has supplied some adequate basis for computing the amount.”). This standard flows from the principle that a party who breaches “his contract should not be permitted entirely to escape liability because the amount of the damage which he has caused is uncertain.” Tractebel, 487 F.3d at 110 (quoting Wakeman, 101 N.Y. at 209).  Under the stable foundation standard, therefore, general damages may be awarded for lost profits even where they are uncertain and difficult to estimate. See Randall-Smith, Inc. v. 43rd St. Estates Corp., 17 N.Y.2d 99, 105 (1966) (“The rule to be applied is a flexible one”); see also Tractebel, 487 F.3d at 112 (“New York courts have significant flexibility in estimating general damages once the fact of liability is established.”).

Lost profits as consequential, or special damages, do not “directly flow from the breach.” American List Corp., 75 N.Y.2d at 43. Where the damages were the result of a separate agreement with a nonparty, they are consequential damages. Typically, consequential damages involve a breach of contract that interferes with “the ability of the non-breaching party to operate his business, and thereby generate profits on collateral transactions” such that “profits from potential collateral exchanges are ‘lost.’” Tractebel, 487 F.3d at 109.

Lost profits as consequential or special damages “are only recoverable when ‘(1) it is demonstrated with certainty that the damages have been caused by the breach, (2) the extent of the loss is capable of proof with reasonable certainty, and (3) it is established that the damages were fairly within the contemplation of the parties.’” Biotronik, 22 N.Y.2d at 806, quoting Tractebel, 487 F.3d at 109, citing Kenford Co. v. County of Erie, 67 N.Y.2d 257, 261 (1986). As to the second requirement, the damages must be capable of measurement based upon known reliable factors. Ashland Mgt. Inc. v. Janien, 82 N.Y.2d 395, 403 (1993). They cannot be “speculative, possible or imaginary, but must be reasonably certain and directly traceable to the breach.” Id. Finally, the damages cannot be “remote or the result of other intervening causes.” Id.

Notably, if a new business is seeking to recover for the loss of future profits, the courts impose “a stricter standard … for the obvious reason that there does not exist a reasonable basis of experience upon which to estimate lost profits with the requisite degree of reasonable certainty.” Id., citing Cramer v. Grand Rapids Show Case Co., 223 N.Y. 63 (1918); 25 CJS, Damages, § 42(b).

In Electron Trading LLC v. Perkins Coie LLP, 2019 N.Y. Slip Op. 33019(U) (Sup. Ct., N.Y. County Oct. 9, 2019) (here), Justice O. Peter Sherwood of the Supreme Court, New York County, Commercial Division, addressed the foregoing principles in dismissing the plaintiff’s claim for lost profits.

[Ed. Note: the facts below are taken from Electron Trading LLC v. Morgan Stanley & Co. LLC, 157 A.D.3d 579 (1st Dept. 2018), as well as the factual recitation by Justice Sherwood.]

Plaintiff, Electron Trading LLC (“Electron”), a developer of intellectual property relating to “spread” trading, a type of electronic securities trading, entered into two agreements with Morgan Stanley & Co. LLC (“Morgan Stanley”): an Exclusive License Agreement (“ELA”) whereby it granted Morgan Stanley an exclusive license for its alternative trading system (“ATS”) and a Consulting Services Agreement (“CSA”) whereby it agreed to perform related consulting services. The ELA required Morgan Stanley to use commercially reasonable efforts to develop and implement necessary software and systems, to operate and market the ATS, and to launch the ATS by a defined deadline. Morgan Stanley conceded, for the sake of argument, that it breached the ELA by not performing any of its obligations. The parties disputed whether Electron’s damages were limited by the ELA’s limitation of liability provision.

Morgan Stanley moved to dismiss.  The Court (Saliann Scarpulla, J.) granted Morgan Stanley’s motion with regard to, inter alia, Electron’s breach of contract claim but only to the extent that Electron sought damages above the amount allowed under the contractual limitation of liability clause in the ELA. The Appellate Division, First Department, unanimously affirmed.

Thereafter, Electron commenced a legal malpractice action against defendants Perkins Coie, LLP and Bracewell LLP. Both firms represented Electron in negotiating the ELA and CSA. Plaintiff claimed that defendants failed to properly advise it as to the limitation of liability provision set forth in the ELA.

Among other damages, Electron sought the lost profits it would have received if Morgan Stanley had developed the system and third parties using the system had generated revenue to cover costs. Defendants moved to dismiss the claim for lost profits, arguing that such damages were inherently speculative and not within the parties’ contemplation when plaintiff and Morgan Stanley signed the ELA. Defendants also claimed that any diminution in value of the intellectual property due to Morgan Stanley’s breach was not caused by defendants and in any event, such claim was precluded by the Appellate Division’s decision.

Justice Sherwood granted the motion.

First, Justice Sherwood held that Electron failed to demonstrate that its lost profit damages were consequential or special damages. In fact, noted the Court, “[t]he complaint [did] not allege that the parties ever discussed lost profits damages in the event of breach of the License Agreement.” Slip Op. at *3. Thus, concluded the Court, plaintiff failed to meet “the foreseeability branch of the applicable standard.…” Id.

Second, the Court held that Electron failed to demonstrate that its lost profit damages were general damages. Justice Sherwood rejected the notion that Electron’s alleged damages were “quintessential general damages”. Id. (internal quotation marks and citation to briefing omitted).

Electron claimed that under the License Agreement, it was owed royalties as a consequence of Morgan Stanley’s breach. However, said the Court, there was no mechanism in the ELA or the CSA “for calculating the amount of royalties to be paid.” Id. The Court explained:

No comparable formula can be found in the parties’ agreements here. There is no provision for any specific payments to be used in the Spread Trading System. Morgan Stanley was not required to pay Electron any fixed amount. There was no minimum volume of trades acquired or commission amounts provided. In fact, there were no metrics by which the parties could project future receivables and therefore on which lost profits might be calculated.

Id.

The Court further explained:

The License Agreement only required Morgan Stanley to provide Electron 25% of the Net Revenue generated by the Spread Trading System if the parties were successful in fully developing it…. Thus, for Electron to receive any payment, third parties would have had to elect to use the system to execute spread trades; Morgan Stanley and Electron would then have to set a competitive amount of commissions to charge third parties for use of the system; and those commissions would have to generate revenues that exceed various expenses before Morgan Stanley would owe Electron the type of profit payments Electron might seek to recover.

Id. at **3-4.

Based upon the foregoing, the Court found that whether or how the system would have been received by third parties was “entirely speculative” – a conclusion, noted the Court, both Justice Scarpulla and the First Department reached. Id. at *4.

Accordingly, the Court granted defendants’ motion and dismissed plaintiff’s claims for lost profits and diminution-in-value damages.

Takeaway

As discussed above, the distinction between general and special or consequential damages is meaningful, especially given the standard of proof that attaches to each one. While the standard of proof applicable to general damages is less demanding than that which is applicable to consequential damages, it nevertheless requires a stable foundation upon which the trier of fact can base an award. In Electron Trading, the Court held that the plaintiff could not satisfy the less demanding standard of proof because there was no formula or metric by which the parties could project future receivables and, therefore, calculate the amount of lost profits that flowed from Morgan Stanley’s breach.

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