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McGill Faculty of Law
Smith, Stephen A.

Part 1: Damages for Breach of Contract
1. Basic Principles
The Compensation Principle
Class Notes, September 12, 2000
The meaning of words is very important in law. There are a lot of “weasel words”, words that look meaningful, but are actually meaningless. There are also a lot of “code words” that stand for a lot of issues (eg. remoteness). When a judge or academic uses a word, ask: “What does it denote? What does it connote? What is it code for? Does the judge really understand?”
The most common response to a finding by a court that a contract has been breached is an award of damages in favour of the person injured by the breach. The rule that has been adopted was set out by Lord Atkinson in Sally Wertheim v. Chicoutimi Pulp Co. (1911):
And it is the general intention of the law that, in giving damages for breach of contract, the party complaining should, so far as it can be done by money, be placed in the same position as he would have been in if the contract had been performed…that is a ruling principle. It is a just principle.
This appears straight-forward; however, there is a weasel-word: “same position”. This does not actually mean same position, but rather same position in so far as the law recognizes it. There is a standardized response and the law ignores a number of factors that are immediately obvious.
The following statement makes clear the extent to which the so-called compensation principle falls short of actual compensation.
Mayne Treatise on the Law of Damages (1856):
The theoretical idea of damages is, that they are to be a compensation and satisfaction for the injury sustained. Practically, however, there can hardly ever be a case in which they are completely so. Take the simplest instance, viz., the non-payment of a debt. Put out of question every element of mental suffering caused by the delay. There may be a clear amount of pecuniary loss flowing in the most direct manner from it. The creditor may become insolvent, and be permanently ruined. He may have to borrow money at an extravagant rate of interest. Even if nothing of the sort happens, still his taxed costs of the suit never repay him for the amount he has expended in the action; for none of this, however can he be compensated. The amount of debt, with interest, and taxed costs is all he can recover.
Obviously, an award of specific performance dramatically transforms the extent to which you get perfect compensation.
The compensation principle often gets confused with two other ideas: (1) the idea that the wrongdoer should not profit from his wrong; and (2) the idea that damages are intended to punish. When considering that the wrongdoer should not profit from his wrong, concepts of remoteness and mitigation do not arise. The courts falsely manipulate compensation to deal with the wrongdoer’s gain. Punitive damages raise a host of problems. The compensation principle get confused because of these other rationales for damages. You should be aware of all these reasons so that you can give your client the best advice on how to spin the issues.
Fuller and Perdue, “The Reliance Interest in Contract Damages”
[In 1936, the U.S. was undergoing a change in how people thought about the law. At the end of the 19th century, a lot of people spoke of a need for scientific analysis of law. They wanted a legal science that reduced law to basic principles that applied generally. Therefore, formalistic rules were applied rigidly – a series of propositions that could be applied like scientific laws. In the early 20th century, legal realism debunked the scientific method. Legal realism focussed on 2 things: (1) the tendency of the judge to find facts and cases to justify the conclusion he preferred; and (2) how people reacted to such judgments. Fuller and Purdue wrote when legal science was no longer valid; however, they didn’t care for legal realism, which said that the outcome of the case depended on what the judge had for breakfast. Fuller and Purdue consider the goals of law and how to reason about legal problems in a helpful way. Note that Canada never had a true legal realism movement – only recently have Canadian courts become more American than English.] There are three principal interests that are considered when awarding contract damages. They are, in order of need for judicial intervention: the restitution interest, the reliance interest and the expectation interest.
The restitution interest is similar to unjust enrichment. If the plaintiff has conferred some value on the defendant in reliance on his promise (partially performed his end of the bargain), then the court may order the defendant to disgorge the value he received.
The reliance interest is based on the plaintiff changing his position in reliance on the promise of the defendant. For example, the buyer of land may incur expenses in examining the seller’s title or may neglect to pursue other opportunities.
The expectation interest involves giving the plaintiff what he expected to make as a result of the contract, such as profit on the re-sale of the items.
[Take the example of a bank loan defaulted by the borrower. The bank can recover the principal of the loan as its restitution interest. It can also recover interest under the reliance interest (lost opportunity to lend to someone else). There is no true expectation interest; however, you can imagine it as the difference between the interest on this loan and the interest on the next-most-profitable loan the bank could have made.] Expectation interests are awarded because they are easiest to prove and the best way to calculate what the plaintiff really lost from the breach of contract (best way to measure reliance).
Posner, Economic Analysis of Law, 5th ed. (1999)
Posner argues that efficient breach is positive because the goods will go to their most valued use and the breacher can simply compensate the breachee. There are two problems with this: (1) the buyer never gets perfect compensation; and (2) if you claim that the seller is entitled to an appropriate gain, the whole thing collapses (?). It is also hard to imagine a transaction with higher costs than one achieved through litigation.
Canlin Ltd. v. Thiokol Fibres Canada (1983), Ont. CA – mesh pool covers
Facts: Canadian Tarpoly (Canlin) wanted to enter the U.S. market for mesh pool covers. It contracted with Thiokol to supply fabric that would ha

Arithmetic and Accounting Lesson
Suppose that purchaser (P) buys a machine from vendor (V). V warrants that the machine will bring in $10,000/a. (gross revenue) over the 10 year life of the machine. To earn sales, P must incur costs of raw material and labour of $4000 (cost of sales). This gives P a gross profit of $6000. Then P pays expenses, including rent, interest and property tax, etc. ($1500); office costs and administration ($1000) and depreciation of the machine ($2000) for a total of $4500 in expenses. This leaves a net profit of $1500/a.
Gross revenue                                                             $10,000
Cost of Sales (variable costs)                                         $4,000
Gross profit                                                                   $6,000
rent, interest, etc.                        $1500
office, admin.                              $1000
depreciation                                $2000
$4500             $4,500
Net profit                                                                       $1500

Profit has two meanings: net and gross. Of course, you can’t claim for gross profit and for expenses, because expenses would have been paid out of the gross profits. However, you can claim for expenses and net profit.
When awarding damages, the expenses come out of the profits (to give net profits). If, as in Anglia, the plaintiff cannot prove that it would have made a profit, you assume that it would have made at least enough money to cover its costs. These are expectation interests (incurred costs to woo that actor and on the understanding that the actor would play the role), not reliance interests (future sales, etc.). The default position is that you will break even. The plaintiff must show that it would have made a profit. The defendant must show that there would have been a loss (although this can be difficult when the plaintiff has all the books, research, etc.).
Watch how the judges get mixed up in Cullinane, Anglia, etc.