Lost Profits: Direct Or Indirect Damages? (And Why It Matters)

Two species of compensation in breach of contract lawsuits are (1) direct damages and (2) indirect damages.  The former allows a plaintiff to recover money damages that flow directly from a breach while the latter – sometimes labeled “consequential” damages – are more remote and separated from the breach.

Deciphering the difference between the two damage regimes is easy in theory but often difficult in practice.

At the intersection of the two damages types lies the lost profits remedy.  Lost profits damages allow the non-breaching party to recover profits he would have earned had the breaching party performed under the terms of the contract.  They (lost profits) divide into direct or indirect damages depending on the facts.

Westlake Financial Group, Inc. v. CDH-Delnor Health System, 2015 IL App(2d) 140589 spotlights the lost profits question in a dispute between two businesses over an insurance brokerage contract (the “Insurance Contract”) and a separate on-line claims tracking agreement (“the Tracking Contract”).

Both contracts spanned four years with 60-day termination clauses.  The plaintiff sued when the defendant prematurely cancelled both Contracts with more than two years left on them.  Plaintiff sought damages for lost Insurance Contract insurance commissions and for fees it would have earned under the Tracking Contract.

The trial court granted the defendant’s motion to dismiss and the plaintiff appealed.

Result: Reversed in part.

The trial court dismissed the bulk of plaintiff’s claims based on a limitation of damages clause in the Insurance Contract that immunized the defendant from consequential damages.

In Illinois, contract damages are measured by the amount of money needed to place the plaintiff in  the same position he would be if the contract was performed.  Damage limitation provisions in contracts are enforced so long as they don’t offend public policy.  These limitation clauses are strictly construed against the party benefitting from them.  (¶¶ 29-30).

Direct damages or “general damages” flow directly and without interruption from the type of wrong alleged in a complaint.  By contrast, indirect or consequential damages are losses that are removed from the breach and usually involve an intervening event that causes the damage.

Lost profits can constitute either direct damages or indirect damages depending on the facts.  Where a plaintiff’s lost profits damages result directly from a defendant’s breach, the lost profits are recoverable as direct damages.

A prototypical direct lost profits damages example cited by the court is where a phone directory publisher is liable for lost profits caused by its failure to include a business’s name in the directory.  In that scenario, any lost profits suffered by the business are directly attributable to the publisher’s failure to publish the business name in the directory – the very thing it was hired to do.  (¶¶ 32-35).

The Insurance Contract here contained a consequential damages exclusion and specifically mentioned lost profits as a type of consequential damages.  Still, the court found that the exclusion did not bar plaintiff’s direct lost profits claim.  The court noted that the Insurance Contract’s damage limitation provision only mentioned lost profits as an example of consequential damages.  It didn’t say that lost profits were categorically excluded.

The court also rejected defendant’s argument that plaintiff’s claimed damages were too speculative to merit recovery.

Under Illinois law, damages are speculative where their existence is uncertain; not when there amount is uncertain.

Since lost profits can’t be proven with mathematical certainty, the plaintiff only has to show a “reasonable basis” for their (lost profits) computation.  (¶ 51).

Since the plaintiff premised its Insurance Contract lost profits claim on a four-year track record of calculable insurance commissions, the court found the plaintiff sufficiently pled the existence of damages.  Any dispute in the amount of plaintiff’s damages was an issue later for trial.  At the motion to dismiss stage, plaintiff sufficiently pled a breach of contract claim.  (¶¶ 52-53).

Afterwords:

– Consequential damages exclusion that mentions lost profits – as a type or example of consequential damages – won’t preclude lost profits that are a direct result (as opposed to an indirect result) of the breach of contract;

– A business plaintiff’s past profits from prior years can serve as sufficient gauge of future lost profits in a breach of contract claim.

 

Creditor (Bank) -Debtor (Borrower) Relationship Not A Fiduciary One – IL First Dist. (I of II)

Kosowski v. Alberts, 2017 IL App (1st) 170622 – U, examines some signature commercial litigation remedies against the factual backdrop of a business loan default.

The plaintiffs, decades-long business partners in the printing and direct mail industry, borrowed money under a written loan agreement that gave the lender wide-ranging remedies upon the borrowers’ default. Plaintiffs quickly fell behind in payments and went out of business within two years. A casualty of the flagging print media business, the plaintiffs not only defaulted on the loan but lost their company collateral – the printing facility, inventory, equipment and accounts receivable -, too.

Plaintiffs sued the bank and one of its loan officers for multiple business torts bottomed on the claim that the bank prematurely declared a loan default and dealt with plaintiffs’ in a heavy-handed way.  Plaintiffs appealed the trial court’s entry of summary judgment for the defendants.

Affirming, the First District dove deep into the nature and reach of the breach of fiduciary duty, consumer fraud, and conversion torts under Illinois law.

The court first rejected the plaintiff’s position that it stood in a fiduciary position vis a vis the bank. A breach of fiduciary duty plaintiff must allege (1) the existence of a fiduciary duty on the part of the defendant, (2) defendant’s breach of that duty, and (3) damages proximately resulting from the breach.

A fiduciary relationship can arise as a matter of law (e.g. principal and agent; lawyer-client) or where there is a “special relationship” between the parties (one party exerts influence and superiority over another).  However, a basic debtor-creditor arrangement doesn’t rise to the fiduciary level.

Here, the loan agreement explicitly disclaimed a fiduciary arrangement between the loan parties.  It recited that the parties stood in an arms’ length posture and the bank owed no fiduciary duty to the borrowers.  While another loan section labelled the bank as the borrowers’ “attorney-in-fact,” (a quintessential fiduciary relationship) the Court construed this term narrowly and found it only applied upon the borrower’s default and spoke only to the bank’s duties concerning the disposition of the borrowers’ collateral.  On this point, the Court declined to follow a factually similar Arkansas case (Knox v. Regions Bank, 103 Ark.App. 99 (2008)) which found that a loan’s attorney-in-fact clause did signal a fiduciary relationship.  Knox had no precedential value since Illinois case authorities have consistently held that a debtor-creditor relationship isn’t a fiduciary one as a matter of law. (¶¶ 36-38)

Next, the Court found that there was no fiduciary relationship as a matter of fact.  A plaintiff who tries to establish a fiduciary relationship on this basis must produce evidence that he placed trust and confidence in another to the point that the other gained influence and superiority over the plaintiff.  Key factors pointing to a special relationship fiduciary duty include a disparity in age, business acumen and education, among other factors.

Here, the borrowers argued that the bank stood in a superior bargaining position to them.  The Court rejected this argument.  It noted the plaintiffs were experienced businessmen who had scaled a company from 3 employees to over 350 during a three-decade time span.  This lengthy business success undermined the plaintiffs’ disparity of bargaining power argument

Take-aways:

Kosowski is useful reading for anyone who litigates in the commercial finance arena. The case solidifies the proposition that a basic debtor-creditor (borrower-lender) relationship won’t rise to the level of a fiduciary one as a matter of law. The case also gives clues as to what constitutes a special relationship and what degree of disparity in bargaining power is required to establish a factual fiduciary duty.

Lastly, the case is also instructive on the evidentiary showing a conversion and consumer fraud plaintiff must make to survive summary judgment in the loan default context.