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APPELLATE COURT REAFFIRMS APPLICATION OF SPECIAL RULE GOVERNING THE MEASURE OF DAMAGES IN CONTRACT CASES.

A case our firm recently won in the New York Appellate Division, First Department, established that despite apparently contrary language in the Uniform Commercial Code (“UCC”), a plaintiff who sues for breach of a contract for sale of goods cannot recover more than his actual damage from the breach. Fruition, Inc. v. Rhoda Lee, Inc., 2003 WL 22511687 (2003 N.Y. Slip Op. 18165), __ A.D.2d __, 766 N.Y.S.2d 437 (1st Dep't 2003). This decision follows a 128-year-old case from New York's highest court, the Court of Appeals.

Under that case, Booth v. Spuyten Duyvil Rolling Mill Co., 60 N.Y. 487 (1875), a plaintiff-buyer who contracted to buy goods for the purpose of reselling them to a third-party under a separate resale contract was permitted to recover only his lost profits from the resale when the seller breached his sale contract by failing to deliver the goods to the buyer. The buyer was not entitled to resort to the usual damages rule, under which a buyer can recover the difference between the contract price and the market price of the goods at the time and place of the breach. Although Booth has rarely been cited or discussed in the past century, Fruition v. Rhoda Lee has made clear that it still is good law.

Fruition v. Rhoda Lee arose from a contract in which Rhoda Lee agreed to sell fabrics to Fruition, which was a fabric broker that had bought the fabric from Rhoda Lee in order to resell it to a third-party at a profit. Rhoda Lee has asserted that it could not deliver the fabrics to Fruition because they had been stolen from Rhoda Lee's factory before they could be delivered. Fruition sued Rhoda Lee for breaching the contract.

Under UCC § 2-713, when a seller breaches a contract for sale of goods by failing to make delivery, the buyer can recover as damages the difference between (i) the market price of the goods at the time and place of the breach, and (ii) the price for which the buyer has contracted to buy the goods from the seller (together with any incidental and consequential damages, less expenses saved as a result of the seller's breach). This UCC provision was derived from a similar common law rule governing the measure of damages.

In the Fruition case, however, the plaintiff claimed that the market value of the fabrics was much higher than the price at which Fruition had contracted to resell the fabrics to its own third-party customer. Thus, Fruition invoked UCC § 2-713, and demanded damages of $366,000, based on its contention that the fabrics had a market value of more than $560,000 (taking into consideration the shipping expenses that Fruition would have incurred, of $85,000) -- even though Fruition had contracted to pay Rhoda Lee only $115,000 for the fabrics, and Fruition had contracted to resell them to a third-party for only $171,000, resulting in anticipated profits of no more than $56,000. Fruition in fact had admitted to Rhoda Lee on two occasions, in writing, that its total loss was only in the amount of $56,000, not $366,000. So it was obvious that Fruition was trying to exploit the normal damages rules to obtain a windfall at Rhoda Lee's expense.

In the trial court, we moved on Rhoda Lee's behalf for summary judgment on the issue of damages. We argued that Fruition could not recover more than its actual loss. Specifically, Fruition could recover no more than its lost profits, the difference between its purchase price from Rhoda Lee and the resale price to its third-party customer. Our argument was based on the Court of Appeals' 1875 decision in Booth. Booth acknowledged that, under the usual rule for contract damages, a plaintiff buyer can recover the difference between the contract price and the market value of the goods (the reason being that the plaintiff would have to go into the market to replace the goods that the defendant failed to deliver). But Booth also recognized that there is an exception to this general rule when “special circumstances” are present. A case where the buyer is also a re-seller, and both buyer and seller know at the time of their contract that the buyer is purchasing the goods for the purpose of performing a resale contract with a third-party, is an example of “special circumstances.” In such a case, the court is required to limit the buyer's damages from the seller's breach of contract to the difference between the original contract price between the buyer and seller, and the resale contract price between the buyer and the third-party. Essentially, the buyer's damages are equivalent to its anticipated profits from the resale contract.

This common-law exception serves two main functions: First, it restores the buyer to the same position it would have been in if the breach had not occurred, which is the precise goal of contract damages. The buyer's damages will compensate it for the loss it actually suffered.

The exception serves a second, but equally important purpose: it prevents the buyer from obtaining a windfall, which otherwise could occur under the general rule when the plaintiff-buyer claims that the market value of the goods at the time of the breach is greater than the resale price it had agreed to. When “special circumstances” are shown to exist, the buyer's actual injury is readily knowable – it is the amount of its lost profit (resale price minus purchase price) – so there is no need even to consider market value. Therefore, under this exception, there is no opportunity for the plaintiff-buyer to obtain a windfall recovery from the allegedly breaching seller because the buyer can recover only what it has actually lost -- its anticipated profits from the resale of the goods.

The trial court granted our motion for summary judgment, and on appeal the Appellate Division affirmed. Fruition had argued on appeal that there were no “special circumstances” because Rhoda Lee did not know at the time of its agreement with Fruition what the price was at which Fruition planned to resell the fabrics. But the Appellate Division disagreed, and specifically concluded that the “special circumstances” condition was “certainly satisfied here where the parties were indisputably aware at the time of the contract that plaintiff broker was purchasing the fabric for immediate resale.” As the Booth court had previously held, the Appellate Division emphasized that the exception applies so long as the seller knows the buyer is purchasing the goods in order to perform a resale contract, whether or not the seller knows the specific resale price, and regardless of whether the resale contract exists at the time of the original contract of sale.

As a result of this decision, Rhoda Lee's potential exposure in this case has been reduced from $366,000 to $56,000, and Fruition, if it succeeds in proving its case at trial, will have been prevented from obtaining a windfall far in excess of its admitted actual loss. This case will no doubt have salutary effects by preventing windfalls in other cases in which the claimed market price exceeds the buyer's anticipated resale price. It may even serve to promote more reasonable settlements, by clearly defining and limiting the potential damages.

If you have any questions about these cases, or would like copies of them, please feel free to call Pamela L. Kleinberg at 212-981-2329, or send an e-mail to pkleinberg@wilkauslander.com .