On January 14, 2022, the Texas Supreme Court issued its opinion in Signature Industrial Services, LLC v. Ogden, _ S.W.3d _ (Tex. Jan. 14, 2022) [20-0396). The court address the age-old question of How to measure consequential damages in a breach of contract case? In its 30-page opinion, the supreme court answered that basic question and a few others. This article focuses on the former.
Facts: Signature Industrial Services, LLP (SIS) contracted with International Paper Company (IP) for SIS to provide services, with a total payment obligation of about $775,000. The scope of the project grew, and SIS invoiced $2.4 million in addition to what IP paid. See id. at 3. Before litigation between them ensued, SIS received an acquisition purchase offer of $42 million from a third party. IP was unaware of the potential purchase transaction. But, due allegedly to IP’s failure to make payment, SIS faced significant cash-flow issues which led to payroll taxes and other debts that SIS could not manage such that SIS “all but collapsed.” SIS and its president sued IP, alleging breach of contract and fraud claims. SIS then received three more offers from the prospective purchaser. The first was at the $42 million level, although with less cash up front. The latter two offers were around $10 million each. SIS rejected all of them and proceeded against IP. Id. at 4.
Procedural History: At trial, SIS’s expert testified about SIS’s lost book value of $12.4 million, the lost sale of SIS in the amount of $42 million, and $1.9 million in payroll tax penalties, all of which, the expert opined, were a consequence of IP’s failure to pay. Others testified that, as a consequence of IP’s breach, SIS’s book value fell to “less than zero.” The jury awarded about $60 million in consequential damages to SIS as a result of IP’s breach of contract. The jury also awarded $2.4 million in direct damages, as well as amounts for claims asserted by SIS’s president. In all, the jury awarded about $125 million due to IP’s failure to pay $2.4 million to SIS. Id. at 5.
The court of appeals upheld direct damages to SIS of $2.4 million but reduced the consequential damages award to $12.4 million by eliminating the lost $42 million sale amount and the amount of $1.9 million for tax penalties. Id. at 5-6. The court of appeals rendered judgment against SIS’s president on his breach of contract claim.
All parties petitioned to the supreme court. SIS sought to reinstate all consequential damages awarded by the trial court, the president sought to reinstate his breach-of-contract recovery, and IP contended, among other things, that none of the consequential damages were recoverable.
Issue in Review: Did SIS present sufficient evidence to recover an award of consequential damages caused by IP’s breach of contract?
Short Answer: No.
Held: Consequential damages must be foreseeable and proved with reasonable certainty in order to be recoverable. IP had no knowledge of any potential sale of SIS. IP had no reason to foresee that a consequence of its breach would be the complete collapse of SIS’s market value, and IP had no duty to understand how its actions would affect SIS’s market valuation. Also, SIS’s evidence of lost book value did not establish with reasonable certainty a recoverable amount of consequential damages arising from IP’s breach.
Discussion on Consequential Damages: “Damages for breach of contract may include both direct and consequential damages. Direct damages often include restoration of ‘the benefit of the plaintiff’s bargain.’” Id. at 6 (internal citations omitted). Consequential damages compensate an aggrieved party for foreseeable losses that were caused by a breach of contract but were not a necessary consequence of it. The court summarized this long-standing contract law concept as follows:
From at least the time of Hadley v. Baxendale, 9 Exch. 341, 156 (Eng. Rep. 145 (1854), the widely recognized rule has been that consequential damages “are not recoverable unless the parties contemplated at the time they made the contract that such damages would be a probable result of the breach.” We call this requirement “foreseeability.” A foreseeable loss may either follow predictably from the breach “in the ordinary course of events” or arise from “special circumstances” that the party in breach “had reason to know.” A loss that is not the “probable” consequence of the breach, from the breaching party’s perspective at the time of contracting, is not foreseeable. Apart from foreseeability, consequential damages must also be proved with “reasonable certainty.” “Proof need not be exact, but neither can it be speculative.”
Id. at 7-8 (internal citations omitted).
Lost Market Value: As for SIS’s alleged lost market value, IP knew nothing about the pending sale of SIS to its prospective purchaser. Thus, the loss of that sale could not have been a foreseeable consequence of IP’s breach of contract, and such alleged damages were not in IP’s “reasonable contemplation at the time of contracting.” Id. at 9.
SIS contended, however, that the consequential damages measure was supported by the lost company value, rather than the lost sale of the business. SIS asserted that the lost company value was the difference between the price offered for the purchase ($42 million) and SIS’s book value at the time of trial (“less than zero”). SIS believed the decline in the company’s market value as a result of IP’s breach was a foreseeable consequence. The supreme court disagreed, noting that “[m]arket value and book value are not interchangeable measures.” Id. at 10.
The supreme court found that IP had no reason to foresee that a consequence of its breach would be the collapse of SIS’s market value. Also, the court noted that SIS pursued a “novel damages model” of a decline in SIS’s market value, rather than “travelling the well-worn path” of calculating profits that, due to IP’s breach, SIS may have lost from specific business opportunities. Id. at 12. “SIS proffered no evidence that IP ever had any reason to concern itself with SIS’s market value. . . . That alone renders SIS’s lost market value unforeseeable to IP and therefore unrecoverable.” Id. at 14.
The court noted that “[t]he law does not charge contracting parties with a duty to understand how their actions will affect the counterparty’s market valuation. . . . 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.” Id. at 14. Mere familiarity with another company does not alone make the collapse of that company a foreseeable consequence of breach. Id. at 15. “Parties need not scour the balance sheets of their counterparties and weigh the likely consequences of breach on the counterparty’s attractiveness to investors.” Id. at 16.
Lost Book Value: SIS also asserted that the lost book value of $12.4 million should be upheld as recoverable consequential damages. The supreme court disagreed. “While book value serves a purpose in accounting, we conclude that a drop in book value, without more, cannot support an award of consequential damages for breach of contract.” Id. at 18. “‘Book value is entitled to little, if any, weight in determining the value of corporate stock, and many other factors must be taken into consideration.’” Id. at 20 (citations omitted). SIS’s evidence of lost book value did not establish with reasonable certainty a recoverable amount of consequential damages.
Closing: In line with the classic consequential damages case of Hadley v. Baxendale, 9 Exch. 341, 156 (Eng. Rep. 145 (1854), the Texas Supreme Court, in Signature Industrial Services, LLP v. Ogden, affirmed that, in order to be recoverable, consequential damages must be foreseeable and contemplated at the time of contracting and proven to a reasonable degree of certainty. SIS invoiced IP for, and sought direct contract damages of $2.4 million. In its effort to recover that “benefit of the bargain,” SIS, together with its president, sought over $120 million in consequential damages, based in large part on (1) the loss of a sale of the business, which transaction—all parties agreed—IP knew nothing about; and (2) the collapse of SIS’s market valuation following IP’s breach, being a consequence IP did not, and for which it had no duty to foresee.
Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns.
