Today, we're going to talk about a staple of the contract law, Canon. The famous chestnut of Hadley versus Baxendale. In some respects, this may be the case furthest remove from us today. It was decided more than a century and a half ago in 1854, in England. But the Hadley rule concerning recovery for foreseeable consequential damages is with us today and largely unchanged for. The brothers, Joseph and Jonah Hadley, owned the city flour mills in Glau Chester England. The crankshaft in the steam engine used to power the mill broke, halting the mills operation. The Hadleys' needed to get the broken crankshaft to the steam engines' manufacture in Greenwich, so that the manufacture could provide a replacement. The Hadleys' sent an employee to the defendants offices of Pickford and Sons to have them transport the crankshaft to the manufacturer. The Hadley employee and Pickford and Sons agreed that the delivery would be made the following day for a cost of two pounds and four shillings. The employee did not explain that the mill was inoperable due to this broken shaft. But then because of "some neglect," the delivery was delayed and so the mill couldn't run for several more days. The plaintiffs sued arguing contractual breach and seeking damages, not only for the amount they paid for the shipping service, but also for their lost profits of having the mill closed. The Judge "left the case generally to the jury," which awarded a verdict of 25 pounds damages, taking into account the plaintiff's lost profits from the days the mill couldn't run. Does the "some neglect" on the part of the company that the opinion discusses matters in this action? Not really. There is a strict liability for breach of contractual promises, whether it was intentional, whether it was negligent, even if was not negligent. If you don't perform your promises, you have to compensate the other side. The Hadley court awarded a new trial on the ground that the judge hadn't properly instructed the jury. Baron Alderson, an influential judge, agreed. He announced the rule that parties to a contract are only liable for damages that were foreseeable at the time of contract formation. The court found that damages for breach of contract should be such as may fairly and reasonably be considered either arising naturally from breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at that time they made the contract as the probable result of the breach of it. Did this necessarily mean that the jury's verdict of 25-pound damages was incorrect? Not quite. The court explained that parties could inform each other of unique circumstances that could make the damages of a breach more significant, more foreseeable than they'd be in an ordinary case. If they did so, these more significant damages would still have to be foreseeable. If the special circumstances were communicated by the plaintiff to the defendant, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily flow from a breach of contract under these special circumstances so known and communicated. It's important to understand that the error the court found was not that the jury award was necessarily too big. It was that the judge had failed to explain to the jury that its word had to be limited to foreseeable damages. The court did not rule that a properly instructed jury could not have returned the same damage award. On that note, let's make clear that we understand the difference between direct and consequential damages. One way to differentiate between these damages is to distinguish the damages that are needed to acquire substitute goods or services or other equivalent, which as we just saw last time, might be captured by cost or performance or diminution in value damages. So we want to distinguish those damages, from the damages flowing from the loss incurred as a consequence or result of the plaintiff not having the promised goods or services, which in this case is the plaintiff's lost profit from not having the mill operable. A rule that says non foreseeable loss profits like Hadley are non recoverable may seem unfair. Can you think of any reasons why courts might impose this limitation? Well, Baron Alderson opinion explained, "Had the special circumstances been known, the parties might have specially provided for breach of contract by special terms as to the damages in this case. And of this advantage, it would be very unjust to deprive them." You see, if parties are aware of special circumstances that will expose them to greater liability, they likely will take more care to make sure they perform and charge more for their services. Similarly, if parties know that courts will hold them responsible for damages they cannot foresee, they will raise their prices generally to take into account this greater chance that they're going to be tagged for high damages. They'll not be able to tailor their care to customers who need it the most. As a result, customers who only have typical foreseeable damages will have to pay more to help ensure customers with atypical damages. Federal Express, FedEx, provides that when shipping packages, "Unless a higher value is declared and paid for, our liability for each package is limited to $100. For each package exceeding $100 in declared value, an additional amount will be charged." That's from the FedEx contract on every FedEx package. Why might this be a better policy for customers than if FedEx did not limit liability for valuable items over $100? Well, it's for exactly the same reason we have just discussed. It makes more sense to require those who might incur substantial consequential losses if their packages are lost or damages to pay more to insure them than to have all those who use FedEx services to foot the bill for others' valuable shipments. And it lets FedEx know when it needs to take special care to get a package through. As we noted at the outset, this was an English case, not an American case, but courts in the United States typically follow the Hadley rule. The Supreme Court at the turn of the century suggested a different path. Justice Holmes asserted in Globe Refining versus Landa Cotton Oil Company that, "mere notice to a seller of some interest or a probable action of the buyer is not enough necessarily and as a matter of law to charge the seller with special damages on that account if he fails to deliver the goods." The defendants had to have at least tacitly agreed to be liable for these extra losses at issue. But most courts reject this test. It is enough that the defendant foresaw or had reason to foresee the plaintiff's losses that are being claimed. This is reflected in the restatement of contracts section 351 which provides, damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made. Loss maybe foreseeable as a probable result of a breach because it follows from the breach in the ordinary course of events or, b, as a result of special circumstances, beyond the ordinary course of events, that the party in breach has reason to know. So, is the Hadley rule a default rule or a mandatory rule? Well, it's a default rule. Parties can contract around it by giving sufficient notice of special circumstances. Parties can also contract out of the rule in the other direction. They can explicitly exclude all liability for consequential damages. There's usually a term excluding liability for consequential damages in most consumer electronics contracts. Rob Gertner and I have categorized Hadley versus Baxendale doctrine as an example of a penalty default or an information forcing default. The court's refusal to award unforeseeable damages, Is a refusal not because those damages aren't real. But the Hadley doctrine gives promissees an incentive to reveal information to the promissors about what otherwise would be unusual consequential damages. One way to think about cases like Hadley, where breach occurred because of some neglect, is through a Torts Lens, where the law, among other things, should be trying to induce optimal promise or precaution. The risk of nonperformance can be thought of as the probability of nonperformance, the probability of breach, multiplied by the loss to the promissee including consequential damages that will result from nonperformance. The risk can be thought of as the probability times the loss. A standard move in law and economics is to place the risk of loss on the better risk bearer. Good risk bearer will tend to have information and control, information about the size of the risk and the control or ability to take action to change that size. And here is the structural problem with regard to contractual risks. Promissors tend to have better knowledge and control about the probability of breach, but promissees tend to have better knowledge and control about the size of loss that will result if breach occurs. The shipping company, Pickford, knew more about the probability that the ship would not be delivered and it's better placed to take action to affect that probability, say, by strapping on more horses to the carriage to make sure that the shipment goes through even if one of the horses goes lame. The Hadley's, on the other hand, knew more about the size of loss if their factory had to close down and they were better able to control the size of a loss, say, by keeping spare crankshafts in stock. So at first glance, it seems difficult to decide whether the promissor or the promissee is the better risk bearer. The promissor has better knowledge and control of one variable, P. The promissee has better knowledge and control of the other variable, L. But the genius of the Hadley rule is that by using an information forcing default, contract law can tip the scales and make the promissor the better risk bearer. By inducing promissees to disclose the size of their loss to the promissor, the Hadley rule makes the promissor now better placed to bear this loss, armed with better information about both the probability of breach and now also the size of the breach. Moreover, as we could see from the Fedex example, since promissors are going to respond to Hadley information by charging a higher price when performing for a high damage promissee, the Hadley rule even indirectly gives promissees incentives to exercise their control over the size of the loss to mitigate damages. Some Fedex shippers will find it cheaper to keep extra crankshafts in stock rather than pay the extra insurance that will be required if high perspective damages are disclosed. We have discussed the influence of the Hadley rule in the United States and the policy concerns that underlay it. We should note another less obvious way Hadley proved influential. Recall where the court in Hadley placed the error that occurred. The jury was not at fault for awarding excessive damages, rather, the judge improperly instructed the jury. As the court explained, "We deem it to be expedient and necessary to state explicitly the rule which the judge that the next trial ought to in our opinion to direct the jury to be governed by when they estimate the damages." Hadley was decided in an era in which English courts increasingly reformulated questions of fact that had been left previously to the jury's discretion like damages as matters of law to be decided by judges. By making a rule that consequential damages can only be awarded if damages are foreseeable, the court's dramatically limited the jury's power. This form of jury control became common in the United States as well as in England.
