By: Edward Seglias and Zachary D. Sanders
Today’s construction projects are larger and more complex than ever before. If you look across the Philadelphia skyline, as in most major cities across the country and around the globe, you will see throngs of tower cranes leading the way for multimillion and even billion-dollar construction projects. In recent years, Philadelphia has seen the development of the FMC Tower, the Comcast Technology Center, the Pavilion of the Hospital of the University of Pennsylvania, and the W Hotel. But as construction projects continue to get larger, so do the risks.
Wrongful Terminations Pose a Serious Risk to Owners and Contractors
One such risk arises out of the termination of a construction contract. Because it is considered a draconian remedy, contract termination will be upheld by a court only upon good cause and rock-solid evidence. A wrongful termination exposes the terminating party to breach of contract damages, which may include lost profits. In today’s world of construction, those lost profits can easily total into the millions.
This very scenario recently played out in favor of Silvi Concrete, a concrete manufacturer and supplier who was wrongfully terminated from the W Hotel Project in Philadelphia. The project—a 52-story hotel skyscraper—required a 9-foot thick, concrete mat slab foundation. Due to a change in the concrete mix design, the original concrete supplier could not supply the concrete necessary to complete the mat slab in a timely manner. As a result, less than a day before the pour was set to begin, the project’s concrete subcontractor, Thomas P. Carney, Inc., contracted with Silvi to supply not only the mat slab but all of the concrete necessary for the project. Silvi immediately mobilized, supplying over 600 truckloads of concrete poured in a continuous fashion for approximately 26 consecutive hours. Twelve days after the pour, Carney wrongfully terminated its contract with Silvi without explanation or cause. Silvi subsequently filed suit against Carney in the Philadelphia Court of Common Pleas to recover its outstanding contract balance and lost profits on the unperformed work.
One of the major areas of contention during the litigation was whether Silvi was entitled to recover its lost profits on the unperformed work under the Uniform Commercial Code (UCC), and whether Silvi had fully mitigated its damages. After a six-day trial, the jury returned a $1.2 million verdict for Silvi, which completely compensated Silvi for its outstanding contract balance and lost profits on the unperformed work. The trial court upheld the jury’s verdict, rejecting Carney’s position on lost profits.
Lost Volume Sellers and the Mitigation of Damages
Breach of contract damages are based on the concepts of reliance and expectation. It is well-established that a damage award should place the non-breaching party in the same—or in nearly the same—position that it would have occupied had there been no breach. Under common law, courts allow for the recovery of lost profits for breach of contract if such loss is not too remote or speculative.
On the other hand, Article 2 of the UCC does not allow for the recovery of lost profits as the primary means of remuneration. Instead, the UCC’s general rule, Section 2-708(a), states that, “the measure of damages for nonacceptance or repudiation … is the difference between the market price … and the unpaid contract price[.]” For example, say you have a contract to sell your prized 1969 Ford Mustang Mach 1 for $50,000, but the buyer breaches. You only have one car to sell, so you spend $500 to relist your Mustang, and eventually sell it for $40,000 to another buyer. Your damages are $10,500 or, in other words, the difference between the original sales price and the ultimate sales price plus the incidental advertising costs. In this example, the seller is made whole.
In some cases, however, the measure of damages provided by Section 2-708(a) cannot adequately compensate the seller for its true loss. Thus, if a seller’s damages are undervalued by the difference between the contract price and the market price, Section 2-708(b) allows the seller to recover its lost profits, including reasonable overhead, together with any incidental damages less any proceeds arising from resale. The express purpose behind Section 2-708(b) is to put the seller in as good a position as if the buyer had performed under the contract.
Section 2-708(b) applies to at least two types of sellers who lose profits and volume on a breached contract, manufacturers and lost volume suppliers. A manufacturer is a person or company who acquires raw materials from which it assembles goods for a buyer. When notified of a breach, a manufacturer ordinarily ceases fabrication and is left either with unfinished goods or raw materials because fabrication has not yet commenced. A manufacturer with excess capacity loses volume and profits because it lacks completed goods that can be resold. Without goods to resell, a manufacturer can undertake only minimal efforts to mitigate.
Conversely, a lost volume seller is a person or company who, after a buyer has breached a sales contract, resells the same goods to a different buyer who would have bought identical goods from the seller’s inventory even if the original buyer had not breached. A lost volume seller differs from a manufacturer in that he has completed goods, which can be sold to mitigate his damages. In the case of a lost volume seller, the seller expects two sales, but when the original buyer breaches, the seller is left with only one sale.
Because of the inequitable result that may occur because a lost volume seller theoretically can mitigate all of its damages simply by continuing to sell its goods, a number of courts have adopted the lost volume theory. Under this theory, courts have reasoned that, even though a lost volume seller resells the goods that he was to supply under the breached contract, it does not necessarily mean that by doing so the seller will avoid the loss. In such cases, the seller’s damages are based on the net profit that was lost as a result of the breach because courts have held that a lost volume seller has no duty to resell or otherwise attempt to mitigate the loss.
Manufacturers, Like Silvi, and Lost Volume Sellers Are Entitled to Lost Profits Under UCC Section 2-708(b)
In the Silvi case, Carney argued that Silvi was not entitled to recover its lost profits because Pennsylvania has not adopted the lost volume seller theory and Silvi fully mitigated its damages. The jury and, ultimately, the court rejected Carney’s position for two reasons. First, Pennsylvania’s rejection of the lost volume seller theory is not a blanket prohibition on a lost volume seller’s ability to recover lost profits. Rather, in rejecting the lost volume seller theory, Pennsylvania courts have held that even a lost volume seller must take reasonable steps to mitigate its damages. See Northeastern Vending v. P.D.O., 606 A.2d 936, 939 (Pa. Super. Ct. 1992); Unit Vending v. Tobin Enterprises, 168 A.2d 750, 754 (Pa. Super Ct. 1961). Indeed, after reviewing the history of the lost volume seller theory in Pennsylvania, the Northeastern Vending court then analyzed whether the plaintiff had proven its lost profits claim, ultimately finding that the plaintiff failed to carry its burden of proof. Thus, the court reaffirmed that lost volume sellers are not barred from recovering lost profits, but instead must undertake reasonable steps to mitigate their damages and must prove their lost profits with reasonable certainty.
Second, Silvi was not by definition a lost volume seller, but was a manufacturer—specifically, a manufacturer of concrete. As a manufacturer, who ceased production upon breach, Silvi had no completed product that it could resell to the next customer. Instead, Silvi demonstrated that it had significant capacity to supply not only the concrete needed for the Project, but also for all other construction projects on which Silvi was retained in the relevant years. Therefore, while Silvi undertook reasonable steps to mitigate its losses by, among other things, reselling or otherwise utilizing its raw materials, Silvi lost both the volume and the profits on the uncompleted portion of its work, thereby entitling Silvi to lost profits under Section 2-708(b).
An owner or contractor’s failure to fully evaluate its basis (or lack thereof) for termination can prove costly, exposing the party exercising its right to termination to significant litigation and substantial damage claims, including direct claims for lost profits and consequential damages due to debarment, reduced business capacity, or even loss of business. In deciding whether to terminate a construction contract, owners and contractors would be well served to begin with a properly drafted termination clause, consider supplementing the defaulting contractor’s forces, follow the contract carefully, mitigate damages, and document, document, document.
Editor’s note: Silvi Concrete was represented by the firm in the case referenced in this article.
Edward Seglias is vice president of Cohen Seglias Pallas Greenhall & Furman and a partner in the firm’s construction group. He has successfully tried numerous multimillion-dollar construction and commercial litigation cases nationwide, including many jury trials. Contact him at email@example.com and 267-238-4702.
Zachary D. Sanders is an associate in the firm’s construction group. Contact him at firstname.lastname@example.org and 267-238.-4732.