• California Supreme Court Limits Damages For Lost Profits
  • March 8, 2005
  • Law Firm: Atkinson, Andelson, Loya, Ruud & Romo, A Professional Corporation - Cerritos Office
  • On December 23, 2004, the California Supreme Court handed down a decision of great importance for the school facilities community. In the Lewis Jorge Construction Management, Inc. v. Pomona Unified School District (2004) 34 Cal. 4th 960, the Court held that a contractor who has been terminated from a project may not recover damages for potential lost profits that might have been earned on future construction contracts. In making its decision, the Court reaffirmed a centuries-old principle of contract law that unless a breaching party is apprised of special circumstances in advance, the party is only liable for those injuries which were foreseeable and contemplated at the time of contracting.

    The case, which presented an issue of first impression for the Court, arose from the following facts: In 1994, the Pomona Unified School District ("District") contracted with Lewis Jorge Construction Management, Inc. to perform building improvements at an elementary school. As part of the public contracting process, Lewis Jorge furnished a performance bond to guarantee its timely performance of the project. Ultimately, Lewis Jorge was late in completing the work, so the District terminated the contract and made a claim to the surety to finish the project. As a result of the termination, Lewis Jorge's surety reduced its bonding capacity by half, thereby rendering Lewis Jorge unable to bid on other public works jobs.

    Lewis Jorge subsequently filed a lawsuit against the District. The contractor claimed that had it not been for the District's wrongful breach of contract and the resulting loss of bonding capacity, Lewis Jorge could have successfully bid on other construction contracts worth millions of dollars. After hearing the evidence, a jury found that the District breached the contract by terminating Lewis Jorge, and awarded $3.1 million in prospective lost profits. An appeals court upheld the award, finding that since the District knew that contractors must provide bonds to secure their performance on all public works, the District must also have known that any breach of contract could impair Lewis Jorge's ability to obtain bonds, without which it could not bid on other public contracts.

    After granting review, the Supreme Court unanimously reversed the award of lost profits, holding that the sums claimed were entirely speculative and uncertain. The purpose of damages for breach of contract is to put the injured party in the place it would have enjoyed had the breach not occurred. According to the Court, damages for breach of contract fall into two categories: general damages and special damages. General damages are those that arise as a natural and necessary consequence of the breach. General damages are so direct or inevitable that the parties knew, or should have known, about them at the time they entered into the agreement. On the other hand, special damages are losses that do not ordinarily arise directly or inevitably from a contract breach, but rather are secondary or derivative losses that are unique to the particular contract or to the parties. Special damages are only recoverable if the unique and particular circumstances were communicated or made known to the breaching party at the time of contracting.

    After laying out these damage rules, the Court held that the loss of potential profits on future contracts are special damages, not general damages. The District's termination of the school contract did not directly or necessarily cause Lewis Jorge to lose potential profits. While the District's action may have been the first in a series of unfortunate events culminating in Lewis Jorge going out of business, it cannot be said from a legal standpoint that such devastating results stemmed directly or necessarily from the District's breach. Put differently, when the District signed the contract, it could not expect that a breach might result in Lewis Jorge losing its ability to be bonded and having to close its doors. Because the District was not put on notice of any special circumstances, i.e., Lewis Jorge being vulnerable to impaired bonding capacity, this potentiality was not part of the bargain. Thus, the District did not take on this risk when it contracted with Lewis Jorge, and therefore the District was not liable.

    Summary

    The Lewis Jorge decision represents a victory for school districts and taxpayers alike. A decision in the contractor's favor would have exposed public entities to sweeping liability on bonded projects. Public entities might have been deterred from terminating poorly-performing contractors, even when in the best interest of the project, rather than face potentially limitless liability for lost profits. Public entities might also have had to engage in expensive pre-bid evaluations and qualifications of contractors in order to screen out contractors with marginal bond ratings. The extra effort and time to perform these types of reviews would come at an enormous cost to the overall project budgets, and might have led to decisions to forego projects altogether. The Supreme Court's decision to limit liability avoids all these negative impacts, helps foster certainty in contractual dealings, and preserves the fundamental principle of contract law allowing parties to predict in advance the measure of their liability.

    Atkinson, Andelson, Loya, Ruud & Romo submitted an amicus curiae brief to the Supreme Court on behalf of the Education Legal Alliance of the California School Boards Associations, which played a significant role in the outcome of the Court's decision.