9
Liability Risks
LIABILITY HAZARDS
An obligee who expects to realize a specified amount of value from a
transaction will expect compensation at least in that amount from its
obligor when the latter’s breach causes an unsuccessful outcome and
loss of such value. If, at contract formation, the extent of those damages
cannot be determined because conditions and contingencies are
unknown at that time, then the compensation that the obligee may
expect remains to be determined until the conditions are known and
the contingencies have occurred; the damages are uncertain. When
such damages are known, whether at contract formation or later, the
applicable law may not allow the obligee to recover all its losses. Such
damages are irrecoverable. At contract formation, the hazard to the
obligee is the uncertainty of the damages it may recover for breach
and the losses it may be unable to recover under applicable legal rules.
Uncertainty is also a hazard to an obligor, because at contract formation
it may be unable to determine the amount of its potential liability. The
law also may allow the obligee to recover damages that the obligor did
not anticipate could be awarded for breach of contract. The hazards to
the obligor are damages that are uncertain or unexpectedly recoverable.
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Inadequate and Excessive Compensation
The relief to which a party is entitled under the applicable law may
fall short of or exceed that party’s expectations. The relief falls short
of expectation when the value of the relief available to a party injured
by a breach of contract is less than the value it expected to realize and
would have realized had the transaction been successfully completed. For
example, in the textbook case Hadley v. Baxendale,1 the owners of a flour
mill in Gloucester lost five days’ revenue because the carrier delayed
delivery of their broken crank shaft to engineers in Greenwich but were
not entitled to compensation for their lost profits, having not made the
carrier aware that their mill was shut down until a new crank shaft was
delivered. The owners were not entitled to compensation for value they
expected to but did not realize because the operations resumed five days
later than expected. The hazard to the mill owners was the limitation on
the damages they could recover from the carrier for breach; the risk was
the chance that they might suer those losses.
The relief exceeds a defaulting party’s expectation when the value
of the relief available to a party injured by a breach of contract exceeds
the losses the defaulting party expected the injured party to incur as a
result of its default. For example, if, in Hadley v. Baxendale, the carrier
had been held liable for the mill’s lost profits, the mill owners would
have received compensation for losses the carrier did not expect the
mill owners to incur had the transaction been unsuccessful. The hazards
are the discrepancies between the rules that determine the damages
to which the injured party is entitled and either its expectations as to
damages it should recover or the defaulting party’s expectations as
to the damages for which it should be liable. The hazards occur when the
parties crystallize their expectations about such damages.
Uncertainty
At contract formation, the parties may or may not have sucient
information to forecast the losses that will likely result from an obligor’s
breach of contract. If a party has sucient information, it should have
reasonable certainty about the defaulting obligor’s liability. Such obligor
should be able to understand the extent of its potential liability and
1 9 Exch. 341, 23 L. J. (Ex.) 179, 23 L.T. (O.S.) 69, 18 Jur. 358, 2 W.R. 302, 2 C.L.R. 517, 17
Digest (Repl.) 91 (1854).
Counterparty Risks
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