If you breach a contract by failing to timely pay your counterparty a sum due following your counterparty’s performance of its obligations, what damages are you potentially subject to? Does the possibility exist that you could be liable for more that the specified payment due, plus interest to compensate for the delay in payment? A recent Texas Supreme Court decision, Signature Industrial Services, LLC v. International Paper Co., 2022 WL 128546 (Tex. Jan. 14, 2022), answered this question by relying upon the venerable English case of Hadley v. Baxendale and its Texas progeny, suggesting that a breach of a contractual obligation to pay money is no different than any other contractual breach—i.e., “[d]amages for breach of contract may include both direct and consequential damages.” But, because all contract-based damages, including those arising from the unique special circumstances of the non-breaching party (i.e., consequential damages), must be foreseeable by the breaching party as a probable consequence of a breach at the time of contracting, it is going to be a rare case where damages beyond the amount of the defaulted payment plus interest will be recoverable. Still, there is some reason for caution by parties entering into contracts with troubled companies overly dependent upon the payments to be made under that contract (at least in some states).
Signature Industrial Services involved a dispute between International Paper Company (IP) and Signature Industrial Services, LLC (SIS) respecting a contract “for SIS to upgrade a slaker—a large vessel that recycles chemicals used to make paper—at IP’s mill in Orange, Texas.” After some delays, SIS completed its work and submitted a bill for payment in the amount of $2.4 million. IP felt that its prior payment of $1.1 million satisfied its obligations. When the parties could not reach agreement on the payment of any part of the additional $2.4 million invoice, SIS sued IP for damages. And the jury found that IP had in fact breached its obligation to pay the submitted invoice of $2.4 million and awarded direct damages in the amount. But the jury also awarded an additional $56.3 million in consequential damages. Woah! What? It turns out that there was a pending transaction to purchase SIS that allegedly fell though as a direct result of the failure of IP to pay its invoice for the completed work on the slaker (and SIS suffered some other untoward consequences as well). And there was apparently no consequential damages waiver in favor of IP in the contract.
On appeal, the Texas Court of Appeals reduced the consequential damages award, but the Texas Supreme Court then eliminated it altogether. According to the Texas Supreme Court, “[a] catastrophic decline in the plaintiff company’s overall market value was not, at the time of contracting, a consequence of breach foreseeable to the defendant.” Indeed, IP knew nothing about the pending sale. And, according to the court:
The law does not charge contracting parties with a duty to understand how their actions will affect the counterparty’s market valuation…. We do not expect contracting parties, regardless of their sophistication, to study the market for acquiring their counterparties before entering into a contract or breaching one. As a general rule, neither the counterparty’s market value nor the impact of breach on that value will be reasonably foreseeable at the time of contracting.
But, the court did note that it would be theoretically possible to create a circumstance in which a contracting party was aware of the probability of losses beyond the unpaid amount and thereby render itself liable for such losses:
Of course, parties can give notice of their dire financial straits at the time of contracting. When one party has given notice of the consequences of breach at the time of contracting, no further inquiry into the foreseeability of those consequences is required. Relying on this rule, a party in SIS’s position could give notice of its pending sale and of its expectation that a breach would scuttle the sale and drive its company’s value into the ground, thereby resulting in losses far exceeding the size of the contract. Whether anyone would contract with such a company is another matter. And whether bars other than foreseeability would foreclose such damages is a question we do not address. (Citations omitted)
Moreover, the court also indicated that had SIS been able to prove the loss of some specific business as a result of this non-payment, which was itself foreseeable, and sought those lost profits rather than the more amorphous loss of market value damages, SIS might have had a more receptive court.
Interestingly, had this case been brought under New York law, consequential damages would have apparently been excluded even without an express waiver in the contract. Why? Because according to a number of federal cases, “New York common law does not allow recovery of consequential or incidental damages for breach of a contractual obligation to make a payment.”1 Instead, “where the alleged breach of contract consists only of a failure to pay money, remedy for the breach is limited to the principal owed plus damages in the form of interest at the prevailing rate.”2
Why would a failure to pay a specified sum of money due under a contract have a different outcome than any other breach of contract? It is not exactly clear, but the Muses suggest that perhaps it has something to do with the distinction between primary contractual obligations, the breach of which creates a secondary obligation to pay monetary damages,3 and those secondary obligations to pay damages, which apparently do not themselves have any further tertiary obligations. So perhaps an obligation to pay a specified sum, unlike a non-monetary obligation to perform under a contract generally, has no secondary obligation that is triggered by its nonperformance because the primary obligation is already a monetary obligation itself. But I am speculating. The more relevant question is which states follow this New York rule and which states follow the general Hadley v. Baxendale approach to all contract breaches, both monetary and non-monetary? I will leave that for others to determine,4 but it does appear that there are states that have specifically adopted the apparent New York common law rule by statute.5
Bottom line: There continues to be a too-easy willingness to include consequential damages waivers where they don’t belong and can do real harm to the benefit of parties’ bargain in the indemnification regimes of M&A agreements—where damages are already capped and it is far from clear what damages would actually fall into what category.6 But there also may be a too-easy willingness to forego the inclusion of a consequential damages waiver in favor of a sponsor agreeing to make a payment, loan money or contribute equity to a distressed portfolio company—where there may be a dispute (involving not just that portfolio company but also its other creditors) as to the satisfaction of the conditions giving rise to such payment or funding obligations. And, in that later case, there is unlikely to be a damages cap for failure to fund, and the differentiation and consequences of direct versus consequential damages is more clear cut and, perhaps, more dramatic.