E. Applying the Expectancy Principle

Author:John D. McCamus
Profession:Professor of Law. Osgoode Hall Law School, York University

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A variety of difficulties may be encountered in applying the general expectancy principle to particular fact situations. Four will be considered here. First, there are a number of different methods that might be

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adopted for calculating expectancy damages and the possibility exists of intermingling or confusing them. Second, disarming complexities may arise when a proposed calculation of the expectancy involves both a capital and an income element. Third, the expectancy principle may be capable of more than one interpretation or application in a particular fact situation and the correct or preferable choice may be unclear. Fourth, it may be considered whether, in a case where the plaintiff can establish only a chance of future profit, some value should be placed on that chance.

1) Two Formulae for Calculating Expectancy Damages

In a simple case, such as a seller’s failure to deliver goods to the buyer, it is evident that expectancy damages may be calculated by determining the amount, if any, by which the market value of goods exceeds the contract price. Where the amount is $200, the purchaser will be enabled by its recovery to be put in as good a position as would have been the case by purchasing a substitute. Further, it is obvious that if the purchaser has already paid an amount, say $100, as a deposit or partial payment, this amount must be added to the $200 in order to compensate the purchaser in the full expectancy measure, which, on the revised facts, yields $300. What is less obvious, however, is that there are, broadly speaking, two different approaches or methods of calculation that lead to this result. The method alluded to above involves the calculation of a net profit or surplus value that the purchaser has achieved in this transaction and adds to it a component to reflect any expenditures made to date by the purchaser that are attributable to this transaction. This formula may be expressed as follows:

net profits ($200) + expenditures to date ($100) = expectancy ($300)

If we give precise values to the market value of the goods, say $1,000, and the contract price, say $800, a second method for producing the $300 calculation becomes apparent. One could begin with the gross value to which the purchaser is entitled under the agreement, that is, $1,000, and deduct therefrom an amount reflecting the expenditures that the purchaser would have been required to make under the agreement if performance were completed, that is, $700 (purchase price less moneys already paid to the seller). In a more complicated transactional form, such as the sale of a business or the purchase of equipment to be used in a profit-making venture, calculation of the gross value of the transaction may involve the determination of projected revenues or gross profits, which are the anticipated result of the performance of

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the transaction. The second approach or formula, may be expressed as follows:

gross value, revenue or "profits" ($1,000) ? avoided expense ($700) = expectancy ($300)

Although the choice of one method or formula over another is a matter of mathematical indifference, there may be some practical advantages in the real world, either in matters of calculation or proof, that might lead the plaintiff to prefer one method over the other. While the choice of method may be a matter of indifference, it is of course important that the method chosen is followed consistently. Possibilities for confusion arise, however, because both formulae involve an expense calculation (past expenses in one and future expenses in the other) and both may involve a profit calculation (net profits in the first and gross in the second). In the reported cases, it is not invariably clear which of the two profit calculations has been employed and whether the court has consistently followed the adopted method. In one case, for example, a court appears to have restricted the plaintiff’s recovery to past expenses by reason of the fact that net profits did not exceed them.75Such an approach would be erroneous. One may recover both profits and expenses, provided that the profits are calculated on a net basis and the expenses in question are those that have already been incurred.

2) Capital vs Income

It is occasionally suggested that an expectancy calculation cannot include both a capital and an income component. Although this generalization rests upon an unassailable proposition, it is nonetheless likely to mislead and has inspired some confusing discussion in the reported cases.76The unassailable proposition is that where the breach involves failure to supply a capital asset, the plaintiff cannot recover both the cost of acquiring a substitute capital asset and the value of the income stream that would be generated by the asset in question. Such a calculation would palpably involve a double recovery. However, it would be incorrect to suggest, as courts occasionally do, that a proper expectancy calculation could never include both a capital and an income element.77

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Such an approach may be appropriate, for example, where a purchaser of equipment used to generate a profit is in possession of defective equipment for a period of time before returning it to a supplier. Assuming that the purchaser has suffered an income loss during the period of possession as a result of the defects, one possible method for calculating expectancy damages would be to award the plaintiff recovery of the net profits lost during the period of possession, together with sufficient money to replace the defective equipment with used equipment whose value would reflect the depreciation that would normally occur during the period of possession. In short, in an appropriate case, a satisfactory expectancy calculation could include both net profits lost in the past as a result of the breach together with replacement of the capital asset at its depreciated value. Although such an approach was rejected in an English case,78it is sound in principle and has been adopted in other cases.79Again, then, it would be incorrect to suggest that an expectancy calculation can never include both a capital and an income element. When both elements are included, however, care must be taken to avoid the possibility of double recovery or overcompensation.

3) Conflicting Methods of Application

In some fact situations, the expectancy principle speaks ambiguously in the sense that it offers two different and conflicting methods for calculating the amount of expectancy damages. If a builder refuses to carry out an agreement to build a structure on a parcel of land, for example, one method of calculating the owner’s damages would be to calculate the difference, if any, between the contractor’s price for the work and the price that would be required to hire a substitute contractor to perform the work. A second method would be to calculate the difference in value between the land unadorned and the land with the completed structure. The former measure is often referred to as "cost of performance" and the latter as the "diminution in value" resulting from the refusal to perform. The two different measures might yield quite different valuations. In the mythical case of a contract to build an ugly fountain for a homeowner, for example, the cost of performance might

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constitute a substantial number but the diminution in value from not constructing an ugly fountain on one’s front lawn might be non-existent. Indeed, the presence of the fountain might reduce the value of the property. This type of contest between the cost of performance measure and the diminution-in-value measure can arise in a variety of factual settings. In broad general terms, the courts attempt to strike a balance in these cases that will avoid unjust enrichment of the plaintiff through overcompensation and, on the other hand, unjust enrichment of the defendant through undercompensation of the plaintiff.

In the case of a partially completed building contract, the cost of performance is the usual measure of recovery. Allowing the plaintiff owner of the property to recover the difference between the contract price and the price required to obtain a substitute performance meets the justice of the case. The owner is likely to complete the structure and, accordingly, such an award will be the preferred measure for placing an owner in the position he or she would have been in if the contract had been performed. This would normally be the result even if the completion of the structure does not result in an enhancement of the value of the property that is equivalent to the cost of performance. Indeed, were the general rule otherwise, the diminution-in-value measure would often apply to building contracts with an unattractive result. In the context of home renovations and repairs, for example, it would often be the case that the cost of doing the work in question would not be matched by an equivalent increase in the value of the property.80

When the construction work has been completed defectively or not in compliance with the contract’s specifications, however, the diminution-in-value measure may apply if, in the circumstances, it is evident that the owner will not or is very unlikely to cure the defects in question.81In such cases, there is a concern that awarding the cost of performance will amount to an overcompensation of...

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