What Is Reliance Damages?
Reliance damages are a form of monetary damages awarded in contract law to compensate a party that has suffered a financial loss due to acting on a promise that was subsequently broken by another party. This type of compensation aims to restore the injured party to the position they would have been in had the contract never been made, rather than putting them in the position they would have been in had the contract been fully performed. Reliance damages are typically sought when it is difficult to accurately prove lost profits or other anticipated gains from a breached agreement. They cover expenditures made in preparation for or in performance of a contractual agreement.
History and Origin
The concept of reliance damages, while a distinct remedy, is deeply intertwined with the development of contract remedies and the principle of foreseeability in damages. A landmark English case, Hadley v. Baxendale (1854), significantly shaped the modern understanding of recoverable damages for a breach of contract. In this case, a mill owner sued a carrier for lost profits due to a delayed delivery of a broken crankshaft, which prevented the mill from operating. The court ruled that the carrier was not liable for these lost profits because they were not reasonably foreseeable at the time the contract was made, unless those special circumstances were communicated to the carrier.7, 8 This case underscored the importance of what a party knew or should have known when entering an agreement, influencing the scope of recoverable damages, including those based on reliance. Subsequent legal developments, particularly in American contract law, articulated reliance damages as a specific interest distinct from expectation or restitutionary interests, often formalized in legal treatises like the Restatement (Second) of Contracts.
Key Takeaways
- Reliance damages compensate an injured party for expenses incurred in anticipation of a contract's performance.
- The goal of reliance damages is to return the non-breaching party to their pre-contractual position.
- They are often sought when proving lost profits (expectation damages) is too speculative.
- Reliance damages may include expenditures made in preparation for performance or in actual performance of the contract.
- The breaching party may be able to reduce the award by proving any losses the injured party would have suffered even if the contract had been performed.
Formula and Calculation
Reliance damages are calculated by totaling the expenditures reasonably made by the injured party in reliance on the contract, minus any loss that the breaching party can prove the injured party would have suffered even if the contract had been performed.
The formula can be expressed as:
Where:
- Expenditures Incurred: All costs, expenses, and investments made by the non-breaching party directly related to their reliance on the performance of the contract. This can include costs for preparation, materials, labor, or services.
- Loss Avoided: Any expenses that the injured party saved or would have saved by not having to complete their performance under the contract, or any losses the breaching party can demonstrate the injured party would have incurred even if the contract was fulfilled (e.g., if the contract was a "losing contract").
For example, if a party spent $10,000 preparing for a project and the other party breached, resulting in the project's cancellation, the reliance damages would initially be $10,000. However, if the breaching party could prove the injured party would have lost $2,000 on the project even if it had gone through, the reliance damages would be reduced to $8,000. This calculation directly aims to restore the party's position as if the contractual agreement had never been entered into.
Interpreting Reliance Damages
Interpreting reliance damages involves understanding their purpose within the broader scope of contract remedies. Unlike expectation damages, which aim to put the injured party in the position they would have been in had the contract been performed, reliance damages focus on undoing the harm caused by relying on a broken promise. This is particularly relevant when the future profits from a contract are uncertain or speculative, making expectation damages difficult to prove.
Courts award reliance damages to reimburse the plaintiff for out-of-pocket expenses, ensuring that they are not left at a financial disadvantage due to the defendant's breach. The damages aim to return the party to the status quo ante, or the state they were in before the contract was formed. It's a retrospective approach to compensation, considering costs incurred rather than profits lost. This approach helps maintain fairness and accountability in business transactions where promises are made and acted upon, even if the ultimate outcome of the venture was uncertain. When assessing the amount, courts evaluate the reasonableness of the expenditures made in reliance on the promise.
Hypothetical Example
Imagine "Green Solutions Inc." (GSI) enters into a contract with "EcoBuild Corp." to design a new energy-efficient building. EcoBuild promises GSI a multi-million dollar contract for the construction phase once the designs are approved. In reliance on this promise, and before the formal construction contract is signed, GSI invests in specialized equipment and hires additional architectural staff, costing them $150,000, to prepare for the anticipated project scale.
Suddenly, EcoBuild Corp. breaches their preliminary agreement and decides to use a different construction firm, citing unforeseen internal restructuring. GSI can demonstrate that they spent $150,000 purely in preparation for EcoBuild's project, costs they would not have incurred otherwise. They cannot, however, accurately calculate the exact profit they would have made on the construction, as market conditions are volatile and the final scope was still being detailed.
In this scenario, GSI would seek reliance damages. A court would likely award them the $150,000 spent on equipment and staff, as these were reasonable expenditures made in reliance on EcoBuild's promise. The aim is to put GSI back in the financial position they were in before they started investing in anticipation of the EcoBuild project, effectively unwinding the negative financial impact of the broken promise. This differs from other forms of compensatory damages which would try to award GSI the lost profits from the construction.
Practical Applications
Reliance damages frequently appear in contract disputes where proving anticipated profits is challenging or impossible. They serve as a crucial form of legal remedy, particularly when parties incur significant costs in preparing to perform an agreement.
For instance, a start-up company might enter a preliminary agreement with a large distributor, investing heavily in product development and marketing efforts based on the distributor's promise to carry their product. If the distributor then backs out, proving the exact sales and profits lost can be speculative. In such a case, the start-up could pursue reliance damages to recover the money spent on development and marketing, aiming to be reimbursed for their sunk costs. This type of claim is also common in cases involving promissory estoppel, where a party makes a clear and unambiguous promise, another party reasonably relies on that promise, and the relying party suffers detriment as a result.6
The Restatement (Second) of Contracts, a widely influential legal treatise in the United States, supports the availability of reliance damages as an alternative to expectation damages, particularly when expectation damages are difficult to prove with reasonable certainty.5 This demonstrates the practical necessity of reliance damages in ensuring that an injured party can obtain some form of compensation for demonstrable losses, even when the full "benefit of the bargain" cannot be definitively quantified.
Limitations and Criticisms
While reliance damages offer a valuable avenue for compensation, they are not without limitations or criticisms. One primary limitation is that they aim to restore the injured party to their pre-contractual position, which may be less than what they would have gained had the contract been fully performed. If the contract was a potentially profitable one, reliance damages will not cover the lost profits, only the expenses incurred.3, 4
Another criticism relates to the concept of "losing contracts." If a defendant can prove that the injured party would have suffered a loss even if the contract had been performed, reliance damages may be reduced or even eliminated to reflect that loss. This means the injured party cannot use reliance damages to escape from a bad bargain they made. The burden of proving this potential loss typically falls on the breaching party.1, 2
Furthermore, the "reasonableness" of the expenditures can be a point of contention. Only expenses that were reasonably incurred in reliance on the defendant's promise are recoverable. If expenditures are deemed excessive or unforeseeable to the breaching party, they may not be fully reimbursed. This aligns with principles of mitigation of damages, where the injured party is expected to take reasonable steps to minimize their losses after a breach.
Reliance Damages vs. Expectation Damages
Reliance damages and expectation damages are two distinct measures of compensation in contract law, each serving a different purpose.
| Feature | Reliance Damages | Expectation Damages |
|---|---|---|
| Goal | To restore the injured party to the position they were in before the contract was made. | To place the injured party in the position they would have been in had the contract been fully performed. |
| Focus | Reimbursement of out-of-pocket expenses, investments, and costs incurred in reliance on the contract. | Recovery of the anticipated profits or benefits that would have been gained from the contract's completion. |
| Proof | Easier to prove, as it deals with actual, verifiable expenditures. | Often harder to prove, as it involves quantifying speculative future profits. |
| Application | Typically used when lost profits are uncertain or unprovable, or when the contract was a "losing contract" (where full performance would have resulted in a loss). | The standard measure of damages for breach of contract, aiming to provide the "benefit of the bargain." |
| Scope | Limited to expenses reasonably incurred. | Can include direct losses, consequential losses, and lost profits, subject to foreseeability and certainty. |
While expectation damages are the most common form of recovery for a breach, reliance damages provide a crucial alternative when the "benefit of the bargain" cannot be adequately measured.
FAQs
What is the main difference between reliance damages and restitution?
Reliance damages compensate for expenditures made by the injured party in reliance on a promise, aiming to restore their pre-contractual position. Restitution, on the other hand, focuses on preventing unjust enrichment of the breaching party by requiring them to return any benefit conferred upon them by the injured party.
When are reliance damages typically awarded?
Reliance damages are typically awarded when it is difficult to calculate the lost profits or other anticipated gains (expectation damages) that the injured party would have received had the contract been performed. They ensure that the non-breaching party does not suffer a net financial loss from having entered into and prepared for the agreement.
Do reliance damages cover lost profits?
No, reliance damages do not cover lost profits. Their purpose is to reimburse the injured party for their expenses and return them to their pre-contractual state, not to provide the benefit of the bargain. If lost profits can be proven with reasonable certainty, expectation damages would be the appropriate remedy.
Is "consideration" relevant to reliance damages?
Yes, consideration is relevant, as reliance damages often arise in situations where there was a valid contract supported by consideration. However, reliance damages can also be awarded in cases of promissory estoppel, where a promise is enforceable due to reliance, even without traditional contractual consideration.
Can reliance damages exceed what the contract was worth?
Generally, courts aim to limit reliance damages to the contract price or what the injured party would have received if the contract had been performed, especially if the breaching party can prove that the contract would have been a losing one for the injured party. The goal is not to punish the breaching party but to fairly compensate the injured party for their expenditures.