Contracts And The Mitigation Of Damages Rule
If in business long enough just about all companies are faced with a customer or vendor who does not fulfill his end of the contract. When that occurs, it is important to understand the mitigation of damages rule.
A contract is a legally enforceable agreement between two or more persons to perform certain actions. The most common example of a contract is where one person promises to pay money in exchange for the other person promising to provide goods or services.
A breach of contract occurs when one of the parties to the contract does not perform as promised. Using the above example, if one person paid money in return for a promise to deliver goods or services, and the other party does not provide those goods or services, a breach of contract has occurred.
When a breach of contract occurs, contract law tries to compensate the non-breaching party by awarding compensation. In legal terms, it is called making the non-breaching party whole. For example, if a person agrees to pay a house painter $5,000.00 in return for a promise to paint a house, and the painter does not paint the house, contract law awards damages to the person equal to the difference in the promised price ($5,000.00) and the actual price the person had to pay in order to get the house painted.
Contract law is not about punishing the breaching party. Contract law is about giving the non-breaching party the benefit of the bargain. Just because a breach of contract occurs, it does not mean the non-breaching party gets compensation.
To receive compensation for a breach of contract, there must be resulting damages from the breach. Using the above example, if the person wanting to paint his house can find another painter at the same price or less, there are no damages. If the person can find another painter who will paint the house for $5,500.00, the damages under contract law are $500.00 ($5,500.00 – $5,000.00). If the house can be painted for less than the original contract price, then there are no damages.
When a breach of contract occurs, the non-breaching party has a duty to minimize the damage. Let’s add a few facts to the painter example. Let’s assume that the house is under a contract to be sold and the sale is conditional upon the house being painted within 30 days. Let’s assume that the contract to paint the house required the house to be painted within 30 days and clearly informs the painter that the sale of the house is dependent upon the painting job being complete within that 30 days. On day 5, the painter declares that he cannot get the house painted. Now, the potential damages to the non-breaching party are far more than any increase in the cost to paint the house. The loss of the house sale could mean thousands of dollars in damages.
In this situation, the non-breaching party cannot just sit back, do nothing and collect damages based upon the loss of the house sale. The non-breaching party must act to reduce or mitigate the damage by trying to find another painter to complete the job within the remaining 25 days.
When a breach of contract occurs, the non-breaching party must mitigate their damages. This obligation to mitigate damages is central to contract law. Contract law is about economics and efficiencies. Theoretically, there may be good economic reasons why the painter did not perform as promised, like, for example, a better paying painting job. If the house can be painted by another painter for the same price within the same time constraints, some argue that contract law encourages the breach in order to make the market more efficient.
Regardless of the theory, the reality is that a non-breaching party cannot just be idle when a breach occurs. There is a duty to go out into the market and try to minimize the damage caused by the breach. Failure to minimize the damage can reduce or even eliminate any compensation under contract law.
