A Basic Primer on Damages Terms in Contracts
When entering into arrangements with clients or engaging vendors, startup companies may be faced with a confusing array of contractual terms, including terms that reference various types of damages. Such terms are worthy of attention due to their potential financial implications. For example, an agreement might include a limitation of liability clause that reads something like this: IN NO EVENT WILL LICENSOR BE LIABLE UNDER OR IN CONNECTION WITH THIS AGREEMENT OR ITS SUBJECT MATTER UNDER ANY LEGAL OR EQUITABLE THEORY, INCLUDING BREACH OF CONTRACT, TORT (INCLUDING NEGLIGENCE), STRICT LIABILITY, AND OTHERWISE, FOR ANY…CONSEQUENTIAL, INCIDENTAL, INDIRECT, EXEMPLARY, SPECIAL, OR PUNITIVE DAMAGES … You may understand that this provision purports to eliminate the software vendor’s (licensor’s) liability for these types of damages if there is a problem with the product in question. But what, for example, are consequential damages? Obtaining an attorney’s advice when signing contracts is advisable—particularly when they contain terms such as these. However, having a very basic understanding of these types of damages concepts is also helpful. Following is a very general, limited overview of damages concepts. Keep in mind that the meaning of these terms and the applicable categories can vary from jurisdiction to jurisdiction and based on the type of contract in question (e.g., a services contract versus a contract involving commercial goods, such as software). Measures of Damages There are a variety of theories and approaches to measuring damages used by courts in different contexts. The most common approach in situations involving the breach of a contract is to attempt to define the aggrieved party’s “expectation interest” and put them in the same position they would have been in had the contract not been breached. For example, Startup Company signs a contract with Slipshod Software, under which it pays Slipshod $100,000 for a software license. However, the software does not function. As a result, Startup Company incurs $10,000 in personnel costs finding and vetting alternative software with comparable features for its business, which it licenses for the best available price of $115,000. Due to the delay in securing the software, which Startup Company needed for its business, Startup Company loses two clients, which would have yielded $50,000 in profit. Startup Company/Slipshod Example $100,000 licensing cost for nonfunctioning software $10,000 additional expense in personnel costs $15,000 above $100,000 for licensing new functioning software $50,000 profit loss from clients who leave = $175,000 expectation damages Startup Company can argue that its expectation damages total $175,000, including the $100,000 it had paid Slipshod Software, the $10,000 in personnel costs in finding comparable alternative software, the extra $15,000 for the alternative software, and the $50,000 in lost profits. Awarding these expectation damages approximates the position Startup Company would have been in if Slipshod Software’s product had functioned properly. Direct Damages In the previous example, Startup Company can argue that it suffered $115,000 in direct damages (the $100,000 original licensing fee and the extra $15,000 it had to spend to obtain comparable alternative software). Direct damages, also called “general damages” in some contexts, are damages that naturally result from a breach of contract (i.e., the damages any party would usually incur in this situation). Here, any company that requires this type of software for its business would need to recoup its licensing fee from Slipshod Software and would need to obtain comparable alternative software at the best available price. Indirect Damages On the other hand, Startup Company’s other damages—personnel costs and lost profits—depend on other intervening factors that may not be typical or usual for other companies in this situation. Different companies’ exact personnel costs and lost profits may...
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