Introduction: This article was authored at Duquesne University Thomas R. Kline Law School as an “independent study” during my third year of law school. It was graded an “A+ and notated, ‘That was an excellent essay.’” by Professor John L. Gedid, my contracts law professor at the time, who is currently Emeritus Professor of Law at Widner Law School.
As a result of the creation of this website repository, and after many years (about 40 years later at this point, sitting in a drawer), I thought the analysis was still as relevant now as then, particularly for academic review and contemplation.
What is published below is the first part of the referenced independent study. The second part regarded the applicability of the Uniform Commercial Code to computer software transactions, which was still (believe it or not) an unsettled area of law (like the applicability of Copyright law) at that point of time. The second portion of that study has been made immaterial—or perhaps less interesting—by the evolution superseding law, but the first part, regarding Hadley v. Baxendale, remains a relevant study of legal history, philosophy, and contract law evolution.
Every student of law should conduct a deepened study of Hadley v. Baxendale, because that seminal case isolates principles of contract damages at an initiating focal point in civil law. It is fascinating to observe and to analyze the evolution (perhaps devolution) of the jurisprudential state of contract damages, from its purity at philosophical birth, to today’s less pure and socialized standard.
Read below for paragons Baron Alderson, Oliver Wendell Holmes, Jr., and Andrew Cardozzo each making their cases, literally.
I. INTRODUCTION
There are few, very few, cases in our legal history in which an espoused legal principle so perfectly adapts to the social and economic needs of an ever-changing society that a legal foundation is laid for generations to follow.
This article is an analysis of the 1854 case of Hadley v. Baxendale.1 It is the case that established the fundamental rules for determining the extent of liability for special contract damages. So fundamental are its principles, that the direct or indirect study of the case is a sine qua non for every lawyer.
The purpose of this article is basic: to educate and to enlighten students of the law, which is where all good lawyers began and should remain.
II. OVERVIEW
A “contract” is defined as a bargained-for exchange; a transfer of legally binding obligations which are voluntarily assumed for consideration.2 A “tort” is an injury for which the law imposes a remedial obligation.3
A contract is not a tort.
III. THE COMMON LAW
At early common law, the then-current evolution of the socio-economic structure was such that there were basically no rules for determining the extent of liability of a party in breach of a contract; thus, juries usually had a great deal of discretion when assessing damages.4
This lack of rules for assessing commercial damages, prevented the stability and predictability which was required by the maturing commercial economy of England.
In 1854, the case of Hadley v. Baxendale5 was decided. In Hadley, for the first time, liability was limited to that extent of liability that was in the contemplation of both parties at the time of making the contract. The purpose for limiting liability has been succinctly stated as follows:
By introducing this requirement of “contemplation” for the recovery of consequential damages, the court imposed an important new limitation on the scope of recovery that juries could allow for breach of contract. The result was to impose a more severe limitation on the recovery of damages for breach of contract than that applicable to action in tort or for breach of warranty, in which substantial or proximate cause is the test.6
In both England and the United States, Hadley was accepted as the leading case for defining contract liability.
Since then, the courts have used primarily three approaches under the guise of Hadley; they are commonly referred to as: 1) the “Contemplation Test” of Hadley v. Baxendale; 2) the “Tacit Agreement Test” of Globe Refining v. Landa Cotton Oil Co.7; and 3) the “Foreseeability Test” of the Restatement of Contracts.8
Although each of these tests may seem to be the same, in fact, each is fundamentally different. Following, each of the tests will be analyzed beginning with Hadley v. Baxendale, the seminal case on special damages.
A. Hadley v. Baxendale: The “Contemplation” Test
1. Facts:
Hadley owned and operated a corn mill, which, on May 11, 1852, stopped operating because of a broken engine shaft. Hadley sent an employee to the common carriers, Pickford & Co., to inquire about having the broken shaft delivered to engineers where it would serve as a model in crafting a replacement. Hadley’s employee told the Pickford clerk that:
[T]he mill was then stopped, that the shaft must be delivered immediately, and that if a special entry was necessary to hasten its delivery, such an entry should be made.”9
The clerk responded that if the shaft were deposited there before twelve o’clock any day, it would be delivered to the engineers the following day.10
The shaft was delivered to the Pickford & Co. on May 14th, but it did not reach the engineers until May 21st because it was shipped by canal rather than rail.11 As a consequence, the mill was inoperative five days longer than necessary and Hadley brought a contract action against the manager of Pickford & Co., Joseph Baxendale. The claim was for approximately £300 in lost profits.
Hadley argued that the Pickford & Co. had voluntarily assumed certain obligations as common carriers. Pickford & Co. countered that the damages incurred were too remote.
The trial court found Baxendale liable for £50 and Baxendale appealed.12
On appeal in the Exchequer, Baron Alderson expressed the rule that laid the groundwork for the future of assessing damages:
Now we think the proper rule in such a case as the present is this:-Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered as either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.13
This rationale has come to be known as the Two Rules of Hadley14, which, briefly stated, impose liability for contract damages if:
1) The damages are the natural result of the breach; or
2) the damages may be supposed to have been contemplated by both parties, at the time of making the contract, as a probable result of a breach.
The first rule, which has occasioned little, if any, controversy, imposes liability for damages which so naturally and obviously flow from the breach that everyone is deemed to contemplate them. Such damages are known as “general damages.”15
The second rule, which is the focus of this article, imposes liability for less obvious kinds of damages—those damages as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it. Such damages are generally known as “special” or “consequential” damages.16
2. Analysis:
The purpose of the second rule in Hadley was to limit liability so as to stabilize economic transactions. This stability was achieved by making parties liable for that which they expected to be liable—by an objective standard.
Thus, parties could, with foresight, establish a cost for a transaction based upon the risk related to performance.
For analytical purposes, the Contemplation Test of Hadley may be separated into five elements:
a. Damages that may be supposed to have been;
b. in the contemplation;
c. of both parties;
d. at the time they made the contract;
e. as a probable result of breach.
Each of these elements will be addressed in order.
a. “Damages that may be supposed to have been . . .“
As an initial consideration, the Contemplation Test is an objective—rather than subjective—test, since it allows damages to be imposed which “may reasonably be supposed to have been in the contemplation of both parties.”17 It needs no exhaustive analysis to demonstrate that the phrase “reasonably be supposed” indicates that the test is based upon a reasonable person standard—i.e. an “objective theory of contracts.”18 To read it without giving effect to the word “suppose” would substantially—and incorrectly—change the meaning of the sentence.19 The word “suppose,” is to assume the fact to be true, even if not true.20
b. “in the contemplation . . .”
The term “contemplation” traditionally is defined simply as “[T]he action of beholding, or looking at with attention and thought.”21 Consistent with this definition is the currently accepted legal definition, which defines “contemplation” as:
The act of the mind in considering with attention. Continued action of the mind to a particular subject. Consideration of an act or series of acts with the intention of doing or adopting them. The consideration of an event or state of facts with the expectation that it will transpire.22
As shown repeatedly throughout the definitions, the term “contemplation” means something more than mere notice or awareness—it is an active state of the mind in “considering with attention” a particular subject.23
The court’s use of this term, rather than another, becomes crucial in a proper analysis of Hadley.
c. “of both parties . . .”
What may be the most frequently overlooked element of the Contemplation Test is that it imposes liability for special damages only if such damages were contemplated by both parties.24
It is at least worth noting, at this point, that this requirement is clearly distinguishable from a rule which requires only the party in breach to have contemplated the damages.25
d. “at the time they made the contract . . .“
Quite simply, the Contemplation Test is meant to occur at the time of contract formation—rather than at the time of breach.26 This is, of course, necessarily correct and appropriate. Since a contract is based upon the consent of the parties in order to set a price for the transaction, it must occur prior to or with the bargain. This is also called the “foresight” approach to contractual damages.27
e. “as a probable result of the breach of [the contract].”
This phrase specifies that a party will be liable only for probable, rather than all possible, damages. However, damages which are considered “probable” are a function of the circumstances associated with performing the contract, and the risks incidental thereto..*16
For example, if only one party knows that special circumstances are associated with performing the contract, then only that party will also know of the special damages which will become probable in light of those special circumstances.
Therefore, Hadley provides two corollaries to the second rule of the Contemplation Test:
[1) If] the special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily follow from a breach of contract under these special circumstances so known and communicated.
[2)] But, on the other hand, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such a breach of contract.28
By its own terms, the second rule of Hadley addresses generally whenever special circumstances are supposed to be contemplated by both parties, regardless of whether there is a communication. Within the generality of the second rule, the first corollary specifically provides that, if special circumstances are actually communicated between the parties, then both parties will be supposed to contemplate the special damages. Thus, the scope of potential liability will be increased to those damages which are probable in light of the special circumstances so communicated.29
The second corollary to the second rule merely confirms the implied negative proposition.30 However, it is important to note: 1) that the second corollary addresses only the knowledge of the party in breach; and 2) Hadley never uses the terms “consequential” or “special” damages. Hadley only addresses the issue of “special circumstances.”31
In a practical world, contracting parties rarely have the opportunity to communicate all of the “special” circumstances that may be involved in performing a promise.32 Therefore, when all of the elements of the Contemplation Test are taken as a whole and applied, the fundamental question remains:
If special circumstances are contemplated by both parties at the time they enter the contract, and if the existence of those special circumstances causes damages as the result of a breach, who is legally responsible to bear the cost of those damages?
It is not enough, at least for analytical purposes, to answer the question simply by stating that the rule in Hadley would require the party in breach to pay for the damages. A rule becomes persuasive only through its rationale.
If the Hadley court had wished merely to allocate loss to the party at fault, it could have easily done so—but that is neither what the court did, nor what it intended to do. Briefly stated, the second rule in Hadley allocates the loss to the party that agreed to bear the risk of loss.33
Knowing that the terms of the contract might not address the issue of damages, and that both parties would have properly contemplated the special circumstances that would give rise to the special damages, that answer itself implies two conclusions: 1) Hadley requires an agreement that includes as a general term the allocation of risk, rather than damages imposed by law as a secondary obligation such as a tort; and 2) since the contract is silent with regard to such allocation of risk, Hadley allocates the risk of loss to the party in breach.
1) The usual interpretation of Hadley is that it merely requires that the party in breach have notice of special circumstances. Most interpretations stop there.34
In fact, Hadley does require that, if a party is to be held liable, that party must have contemplated, and, therefore, been on notice, that the damages were probable in light of the special circumstances. And, while a communication is not required, Hadley states that a communication is what should reasonably force both parties to contemplate the risk of special damages. Specifically, Hadley states in the second rule’s first corollary:
[I]f these special circumstances were . . . communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily follow from a breach of contract under these special circumstances so known and communicated.35
In other words, the actual communication of special circumstances, at the time of contract formation, would create the reasonable implication (as a matter of evidence) that special damages were supposed to have been contemplated—i.e. “considered with attention”—by both parties.36
Following, therefore, the fact that both parties have “contemplated” the damages as probable at the time of entering into the contract would imply that the risk associated with performance in light of the special circumstances of the non-breaching party so communicated was allocated as part of the bargain. And, the transaction is, like all issues of contract formation, interpreted using an objective standard.37
As a theoretical matter, a communication is not required by the second rule of Hadley. However, as a practical matter, a communication is superior evidence that the special circumstances of the non-breaching party were contemplated by the party in breach and thusly both parties.
2) Again, Hadley was a limitation on damages; thus, meeting the five elements of the Contemplation Test is not easily accomplished. However, once the test is met, i.e. the risk associated with the special damages was part of the bargained-for exchange, the final question is: Which party agreed to assume the risk of the damages associated with the non-breaching party’s special circumstances?
Since, in Hadley-type situations, there is no allocation of risk by the express words of the bargain, the Hadley rule requires the court to make a presumption. And, the presumption is this:
When both parties are supposed to have contemplated special damages at the time of making the contract, then they are presumed to agree that the risk of loss shall be allocated to the party in breach.
In effect, when both parties contemplate the special circumstances of the other party that might probably give rise to damages ordinarily arising therefrom, then, unless they expressly bargain away the risk, each party assumes the risk of their own breach.
Thus, the Hadley rule complies with traditional contract principles that the terms of a contract are bargained-for, while allocating the risk to the party at fault.
3. Conclusion:
In conclusion, the Contemplation Test of Hadley v. Baxendale checks whether both parties to a contract should have “considered with attention” the special circumstances at the time of entering into the contract. If so, then the party in breach will bear the liability related to his or her own breach.
In effect, the Contemplation Test creates a rebuttable presumption that the parties have agreed that if one party breaches the contract, then that party will be liable for all damages which both parties contemplated as probable at the time of making the contract.
The second distinct test was the “Tacit Agreement Test” of Globe Refining v. Landa Cotton Oil Co.38
B. Globe Refining Co. v. Landa Cotton Oil Co.: The “Tacit Agreement” Test
1. Facts:
Through the services of a broker, Globe Refining Co. (“Globe“) contracted on July 30, 1897 to purchase oil from Landa Cotton Oil Co (“Landa“). The only express term of the contract provided that Globe was to send its oil tank cars to the Landa mill for filling.
On September 2, Landa canceled the contract but did not notify Globe of the cancellation until September 14, at which time Globe had already sent its filling cars to the Landa mill via railway. Subsequently, Globe brought a contract action against Landa for damages.
In an “ideal” pleading for special damages, Globe made five allegations:39
1) it was “agreed and understood” that Globe would send its tanks via railroad at an additional expense; 2) the late notification of Landa’s breach of the contract caused an unnecessary loss; 3) as a result of the breach, Globe lost use of the tanks for 30 days; 4) Landa knew that Globe had contracts which required the delivery of the oil and non-delivery caused loss of customers, credit and reputation; and 5) Globe had to pay additional freight costs.40
In 1903, the case succeeded to the United States Supreme Court,41 and Justice Oliver Wendell Holmes, Jr. delivered the court’s opinion.
Because none of the alleged items were expressly contemplated by the parties by words of bargain, Holmes was forced to determine the liability on a contract which was silent to the issue of damages. Holmes, in his typically methodical approach, began his rationale by stating:
When a man commits a tort, he incurs, by force of the law, a liability to damages, measured by certain rules. . . . But, unlike the case of torts, as the contract is by mutual consent, the parties themselves, expressly or by implication, fix the rule by which damages are measured.42
Building upon this premise, Holmes recognized that because contracting parties contemplate performance, rather than breach, when bargaining, rules must be established which will assist a court in determining the risk which was likely to have been, or should have been, bargained for when making the contract.43
Holmes thus proceeded to express what he thought were “common sense”44 rules of contract damages:
The extent of liability . . . [depends upon what] is likely to be within [the defendant’s] contemplation and, whether it is or not, should be worked out on terms which it fairly may be presumed he would have assented to if they had been presented to his mind. . . . [A]nd that depends on what liability the defendant fairly may be supposed to have assumed consciously, or to have warranted the plaintiff reasonably to suppose that it assumed, when the contract was made. . . .45
This point, according to Holmes, was “taken by implication” from the second rule of Hadley.46 However, in order to clarify what he (and possibly the rule in Hadley) meant by the term “contemplation,” Holmes posed the precise question:
What is sufficient to show that the consequences were in contemplation of the parties, in the sense of the [party in breach] taking the risk?47 . . . “[Will] the mere fact [that] such consequences [were] communicated to the other party . . . be sufficient, without going on to show that he was told that he would be answerable for them, and consented to undertake such a liability[?]”48
In answering the question, Holmes incorporated the language of Justice Willes, who stated in a prior case:
[O]ne of two contracting parties ought not to be allowed to obtain an advantage which he has not paid for. . . . If that [risk] had been presented . . . at the time of making the contract, as the basis upon which he was contracting, he would at once have rejected it. And though he knew . . ., the mere fact of knowledge, without more, [is not] a reason for imposing upon him a greater liability than would otherwise have been cast upon him. To my mind, that leads to the inevitable conclusion that the mere fact of knowledge cannot increase the liability. The knowledge must be brought home to the party sought to be charged, under such circumstances that he must know that the person he contracts with reasonably believes that he accepts the contract with the special condition attached to it.49
As a result of this rationale, the rule established in Globe has been properly called the “Tacit Agreement Test” for special damages because there must be a tacit (i.e. silent) agreement between the parties as to the allocation of risk for special damages.50
2. Analysis:
The most basic premise of the Holmes rationale is that the risk associated with a contract, i.e. the potential liability which may result from a breach, is part of the bargained-for exchange.
Thus, the Tacit Agreement Test for special damages is tested as any other implicit or explicit term of the contract.
According to Globe, the parties do not “contemplate” the loss unless they have expressly or impliedly agree who should bear the risk of loss. Holmes stated:
[T]he knowledge must be brought home to the party sought to be charged, under such circumstances that he must know that the person he contracts with reasonably believes that he accepts the contract with the special condition attached to it.51
The Globe test, like Hadley, is an objective, rather than subjective test. The statement that liability is determined by what the “defendant fairly may be supposed to have assumed consciously”52 clearly establishes that the test is based upon a reasonable person standard.53 Furthermore, Globe follows Hadley by requiring “contemplation” as the fundamental basis upon which the liability is based, which is tested at the time of making the contract.54
The first departure from Hadley occurs in that the rule in Globe speaks in terms of the party in breach, rather than both parties. However, this departure is immaterial. Since Globe requires at least one party to agree to assume liability as part of the bargained-for exchange. Obviously, if the parties bargained for a risk, then they must have both contemplated it.
The second departure from Hadley is that Globe does not explicitly state that the damages which must be contemplated must be probable as a result of the breach. Again, this departure is immaterial. Since Globe requires that the liability be bargained-for, it is immaterial whether the damages are probable.
The fundamental difference between Hadley and Globe is the presumption made by the court. Unlike Hadley, the presumption in Globe is that if a party knew of special circumstances associated with that party’s performance of the contract, then that party could have contracted them away. Thus, on this point, Globe is not really a more extreme rule than Hadley, but it is different in that is places liability on the party who knew of his or her own special circumstances and chose not to expressly or impliedly contract them away.
However, a communication of special circumstances by the non-breaching party would alone not suffice to transfer liability, as it would pursuant to the first corollary in Hadley.
3. Conclusion:
In conclusion, the Tacit Agreement Test of Globe Refining Co. v. Landa Oil Co. checks the terms of the contract, whether expressed or implied, to determine which party bargained for the risk of loss.
In effect, this test creates a rebuttable presumption that parties have agreed to bear the risk of loss which results from their own special circumstances, regardless of which party breaches the contract. The presumption is rebutted, however, when evidence is introduced which proves that the party in breach agreed to assume the risk of loss associated with the non-breaching party’s special circumstances.
Like Hadley, such an approach is theoretically correct according to fundamental contract principles; however, it allows parties in breach to easily escape the damages which they may have contemplated and for which they are responsible.
The third, and final, distinct test for special damages is the “Foreseeability” Test of the Restatement (Second) of Contracts.
C. Restatement (Second) of Contracts: The “Foreseeability” Test
1. Analysis:
Section 351 of the Restatement (Second) of Contracts provides, in pertinent part:
(1) Damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made.
(2) Loss may be foreseeable as a probable result of a breach because it follows from the breach
(a) in the ordinary course of events, or
(b) as a result of special circumstances, beyond the ordinary course of events, that the party in breach had reason to know.55
The Restatement, like both Hadley and Globe, is an objective test. The test is not based upon what the party in breach did, in fact, foresee as probable damages, but what that party “had reason to foresee as a probable result of the breach.”56 In addition, the Restatement, like Hadley, establishes a test which is to occur at the time of contract formation.57
Even a superficial reading of the Restatement indicates that the extent of liability is associated with foreseeability of damages (a tort term), rather than notice of the circumstances.
However, the fundamental divergence from Hadley is that the Restatement requires only that the party in breach to have foreseen the damages. Accordingly, since only one party is required to foresee the damage, rather than both parties, the Restatement imposes liability without regard to fundamental principals of contract formation—i.e. that the bargained-for exchange includes the risks associated with performance.
The Restatement provides:
A contracting party is generally expected to take account of those risks that are foreseeable at the time he makes the contract. . . . Furthermore, the party in breach need not have made a “tacit agreement” to be liable for the loss. Nor must he have had the loss in mind when making the contract, for the test is an objective one based on what he had reason to foresee. There is no requirement of foreseeability with respect to the injured party.58
Clearly, the Restatement of Contracts ironically imposes liability which is not based upon the bargain-for exchange, but which is imposed by law as a secondary liability on the contract in the same or similar manner of a tort.59
However, the Restatement fails to recognize that persons do not bargain for a contract in-and-of-itself, but they bargain for the legally binding promise of performance embodied in the contract. And, because performance is unsure, the degree of risk associated with performance is an inherent part of the bargained-for exchange.
Unlike Hadley, which limited liability based upon the bargained-for exchange of the parties, liability under the Restatement test is limited only by the foreseeability of the party in breach. Because such a rule is theoretically incorrect according to fundamental contract principles, the Restatement further provides:
(3) A court may limit damages for foreseeable loss by excluding recovery for loss of profits, by allowing recovery only for loss incurred in reliance, or otherwise if it concludes that in the circumstances justice so requires in order to avoid disproportionate compensation.60
Ostensibly, this paragraph attempts to limit liability to the same degree as would naturally occur by following a philosophically correct Hadley or Globe approach.61 For example, an Official Comment to the Restatement provides:
There are unusual instances in which it appears from the circumstances either that the parties assumed that one of them would not bear the risk of a particular loss or that, although there was no such assumption, it would be unjust to put that risk on that party. . . . The limitations within [§ 351] are more likely to be imposed in connection with contracts that do not arise in a commercial setting.
This comment, according to the Restatement, is suggested by Kerr S.S. Co. v. Radio Corporation of America.
In that case, Radio Corporation of America (“RCA“), a carrier, agreed to deliver Kerr S.S. Co.’s (“Kerr“) message. The message was encrypted so that its contents were not known to RCA. RCA did not deliver the message as agreed, and Kerr brought an action to recover the contract fee and special damages.
On appeal in the New York Court of Appeals, Justice Andrew Cardozo wrote the court’s opinion and stated:
[RCA] upon receiving . . . a long telegram in cipher . . . would naturally infer that the message had relation to business of some sort. Beyond that it could infer nothing.
. . . .
[W]hatever the carrier could have ascertained by diligent inquiry as to the nature of the undisclosed transaction, this he should be deemed to have ascertained, and charged with damages accordingly.
. . . .
Something, however, there must be to give warning that the subject of the message is not merely business in general, but business of a known order.
Accordingly, the court reversed the holding of the lower court and held RCA liable for the contract price only—without special damages.
Kerr was an “unusual instance” which required that damages to be limited according to Restatement § 351(3), because RCA was on notice of the business nature of the telegram; and thus, it should have foreseen the probability of, and should have been liable for, special damages.
It is not clear whether this case supports the comment to the Restatement because RCA did not assume it would bear the loss, or because it would have been “unfair” to make RCA pay. In either case, limiting the liability of RCA may be a correct result, but the Restatement rationale is not founded upon fundamental principles of contract.
However, both the result and rationale of Kerr is consistent with Hadley.62 Following the Hadley test, the lack of notice of the risk which is associated with performance of the contract prevented both parties from contemplating the probable result of a breach.63 Thus, the bargain itself limits the damages to merely those damages ordinarily flowing from regular circumstances.64
2. Conclusion:
In conclusion, the Foreseeability Test of the Restatement of Contracts merely checks whether the party in breach had reason to foresee the special damages. Since foreseeability of special damages merely arises upon notice of special circumstances, this test is the easiest to achieve. However, this test not only fails to be supported by fundamental contract principles, but it also expands liability beyond that allowed by either Hadley or Globe. And, the reader should think long and hard about the fact that the Restatement of Contracts formula does not require contract-theory meeting-of-minds mutuality of foreseeability.65
D. The Common Law Applied
The fundamental question that all of the aforementioned rules seek to answer is
“When a party breaches a contract which is silent as to the allocation of risk of loss, who should bear the loss which actually occurred?”
Each of the three tests answers the question in a different way. The following four hypothetical situations will demonstrate the differences among the tests.66
Suppose that A and B contract at arm’s length for consideration of equal value. B breaches the contract and A brings an action against B which includes a claim for special damages. When making the contract:
1. Neither A nor B knew or had reason to know of A’s special circumstances that would make special damages probable as a result of a breach.
2. A knew of A’s special circumstances that would make special damages probable, but B did not know or have reason to know of the same.
3. A did not know or have reason to know of the circumstances that would make special damages probable, but B knew of the same.
4. Both A and B knew of the special circumstances that would make special damages probable.
In all of the above situations, it is important to note that when applying the Hadley and Globe approaches, there is not one set of special damages67 which each party may be supposed to have contemplated, but two.
For example, when bargaining, A would contemplate, and thus bargain for: 1) the risk associated with performing the contract in light of A’s special circumstances, and the possibility that B might breach; and 2) the risk associated with B’s special circumstances, and the possibility that A might breach.
Situation #1: Neither A nor B knew or had reason to know that special damages were a probable result of a breach.
Result: No liability for B under any test.
Rationale: All three tests require that the party in breach either to have contemplated, or have reason to know of, such damages. Since B did not have reason to contemplate special damages, B could not have contracted for them such under Hadley or Globe. Furthermore, because B had no reason to foresee the damages, B would not be liable under the Restatement approach. This result is fair because A did not expect to be compensated for the special damages. Likewise, B, not having any reason to contemplate the damages at the time of contracting, did not bargain for the risk associated with A’s special circumstances.
Situation #2: A knew that special damages were probable, but B did not know or have reason to know of the same.
Result: No liability for B under any test.
Rationale: As in Situation #1, B, the party in breach, did not have reason to know that special damages were a probable result of the breach. Thus, again, every test provides that B should not be liable for the damages.
Since A knew of the circumstances which would make special damages probable, then, if A wanted to transfer liability to B, A should have communicated the special circumstances to B. In fact, once A knows that there are special circumstances associated with performance, A must communicate the information to B—since A would not know if B likewise contemplates, or foresees, the special damages.68 If A does, in fact, communicate the special circumstances to B, then B may become liable. In that case, the analysis would proceed under Situation #4.
Situation #3: A did not know or have reason to know that special damages were probable, but B knew of the same.
Result: No liability for B under the Hadley Contemplation Test or the Globe Tacit Agreement Test. Liability for B under the Restatement Foreseeability Test.
Rationale: In this situation, only B, the party in breach knew that special damages were probable. If the court uses either the Hadley or Globe test for damages, then B will not be liable for special damages. According to the Hadley test, the court must find that the damages “may reasonably be supposed to be in the contemplation of both parties.”69 Likewise, according to Globe, B must implicitly agree to pay for the special damages at the time of contract formation. Thus, both tests fail and liability is limited. Shielding B from liability in this situation is fair, since otherwise, A would receive a benefit which was clearly not part of the bargain.70 Moreover, A did not rely on B bearing the risk of loss, nor did A expect to be compensated for such loss.
Under the Restatement test, however, A should recover. The Restatement requires only that the party in breach have reason to foresee the special damages. Thus, because B, the party in breach, knew that special damages were probable, B will be liable. This is true even though A did not even think about such damage at the time of contracting so as to consider being paid for it, and even though B did not bargain to assume that risk. This result follows the fact that the Restatement requires only that the party in breach foresee the special damages—no agreement to assume the risk of loss is necessary.71
Situation #4: Both A and B knew that special damages were probable.
Result: Liability for B under the Restatement Foreseeability Test and the Hadley Contemplation Test. As stated, no liability for B under the Globe Tacit Agreement Test.
Rationale: According to the Restatement, the party in breach must have reason to know of the loss. Because the facts are clear that B, the party in breach, had reason to know of the loss, B should be liable.
Likewise, according to the rule in Hadley, B will be liable since both A and B contemplated the special damages at the time of entering the contract. Following the previous analysis of Hadley, the parties are presumed to agree that any loss will fall on the breaching party if both parties contemplated the special damages at the time of contracting.
Thus, B will be liable under the Restatement or Hadley. However, according to Globe, B will not be liable. Although both A and B knew of the damages, there is no evidence that B assumed, by an objective determination, the risk of loss at the time of entering the contract with A. Clearly, the rule in Globe stands for the proposition that the “mere fact of knowledge cannot increase the liability [of a party for special damages].”72
E. Conclusion
In the opinion of this writer, Hadley v. Baxendale was not only the first distinct rule on special damages, but also the best rule.73
The Foreseeability Test of the Restatement of Contracts is easily dismissed as the proper test because it [ironically, perhaps hypocritically] gives no regard to the basic contractual principal that risks associated with performance of a contract are part of the meeting-of-the-minds mutual assent bargained-for exchange.74
The Tacit Agreement Test of Globe Refining Co. v. Landa Cotton Oil Co., although possibly the most philosophically accurate test according to fundamental contractual principles, creates a presumption that allows a party in breach to escape liability even when that party contemplated special damages at the time of contract formation.
The Contemplation Test of Hadley v. Baxendale is the best test because it not only adheres to fundamental contractual principles, but also places the loss on the party in breach. Thus, Hadley is both theoretically correct and practical.
* * * *
III. APPENDIX
Table 1. Knowledge
| Test/ Knowledge | 1. | 2. A | 3. B | 4. A&B |
| Hadley | No | No | No | Yes |
| Globe | No | No | No | No |
| Restatement | No | No | Yes | Yes |
Table 2. Standard
| Objective | Mindset | Who | K Time | Probable | |
| Hadley | Yes | Contempl | Both | Yes | Yes |
| Globe | Yes | Contempl | Both1 | Yes | No2 |
| R.2d | Yes | Foresee | Breacher | Yes | Yes |
1 Holmes speaks in terms of the party in breach; however, the party in breach must have “accepted” the terms by the offering party. Thus, effectively both parties must contemplate the probability of special damages.
2 This distinction becomes immaterial, since the other factors in Globe place the presumption of liability on the party who knew of “special circumstances” associated with their performance and did not contract them away.
* © 2025 by Gregg R. Zegarelli, Esq. [1988 as Unpublished work, certain edits made in 1999 and 2025.] All Rights Reserved. [The conversion of the article to this format may have introduced errors of footnote reference not yet reconciled.]
1 9 Ex. 341, 156 Eng. Rep. 145 (1854).
2 See generally, Black’s Law Dictionary, Fifth Edition (1979). [The term “contemplation” is no longer used as a defined term in all “evolved” versions of the work.]
4 See Hadley at 9 Ex. 341, 156 Eng. Rep. at 150 (providing the rationale for remanding the case with suggested jury instructions to limit the extent of permittable damages, the court stated: “[I]f the jury are left without any definite rule to guide them, it will, in such cases as these, manifestly lead to the greatest injustice.”); see also note 14, 15 and accompanying text at 4, 5.
5 Hadley supra note 1, 28, 31, at 1, 8.
6 E. Farnsworth, Contracts, § 12.14 (1982) [hereinafter “Farnsworth”]; see id. at n. 8.
8 Restatement (Second) of Contracts § 351 (1981) [hereinafter “Restatement“]; see also Uniform Commercial Code § 2-715(2) (1985) [hereinafter “U.C.C.“].
9 Hadley, 9 Ex. at 349, 156 Eng. Rep. at 148.
10 Hadley, 9 Ex. at 342, 156 Eng. Rep. at 146.
11 R. Danzig, Hadley v. Baxendale: A Study in the Industrialization of the Law, 4 J. Legal Stud. 249, 251 (1975) [hereinafter “Danzig”].
12 The jury was instructed: “[T]o consider what, under the circumstances was a reasonable time for delivering the shaft; and next, what was the damages caused to the Plaintiffs by the delay in the delivery. . . . They should give their damages for the natural consequences of the defendant’s breach of contract, and with that view they would have to consider whether the stoppages of the Plaintiff’s works was one of the probable and natural consequences of the breach of contract, and then, looking to all the circumstances of the case and the position of the parties, to say what was the amount of the damages occasioned by the stoppage of the works.” Danzig, at 252.
13 Hadley, 9 Ex. at 354, 156 Eng. Rep. at 150. Note that in Hadley, this test for imposing liability was not met. As a result, Baxendale was not liable, and the purpose of the rules to limit liability was demonstrated.
15 See Restatement § 351, comment b; see also J. Calamari & J. Perillo, The Law of Contracts § 14-5 (1977) [hereinafter “Calamari & Perillo”]. An analysis of the differences between general and special damages is provided by C. J. Cardozo in Kerr S.S. Co. v. Radio Corporation of America, 245 N.Y. 284 (1927).
16 See Restatement § 351, comment b. This article uses the term “special damages” rather than “consequential damages” because the former term parallels the “special circumstances” which give rise to special damages. See, also, note 23 and note 29, infra.
17 Hadley, 9 Ex. at 354, 156 Eng. Rep. at 150 (emphasis added); see generally Restatement § 351, comment a.
18 See generally J. White & R. Summers, The Handbook of the Law Under the Uniform Commercial Code § 10-4 (1980) (Hadley is an objective test) [hereinafter “White & Summers”]; Calamari & Perillo § 2-2 (discussing the “objective theory of contracts”); cf. Restatement § 19 (conduct as manifestation of assent).
19 See generally Calamari & Perillo § 14-5.
20 IIC Oxford English Dictionary 894-5 (1970).
22 Black’s Law Dictionary, at 288.
23 The subject of the contemplation by a party may very well be the probability of liability resulting from circumstances then-known to such party. [The concept of “general damage” by the first rule of Hadley subsumes the second rule to the extent that “special circumstances” are known, because the new special circumstances change the scope of what is general and probable in light of the special circumstances. Thusly, the term “special damages” is actually a misnomer, as such. See fn. 29]
24 See e.g. White & Summers, § 10-4; Calamari & Perillo §§ 14-5, 14-6 (neither of which address the issue of “both parties”); cf. Restatement, § 351, comment a.
25 Compare Hadley 9 Ex. 354, 156 Eng. Rep. at 151 with Restatement S 351 (Restatement requires foreseeability only by the party in breach).
26 Cf. Globe Refining Co. v. Landa Cotton Oil Co., supra note __, citing Hydraulic Engineering Co. v. McHaffie, L.R. 4 Q.B. Div 670, 674, 676 (rejecting theory of notice of special circumstances after the contract was made, but before the breach); see also Restatement ‘ 351(1).
27 That is, at the time the contract was made, looking forward, rather than back from the time of the breach.
28 Hadley, 9 Ex. at 354-5, 156 Eng. Rep. at 150. Note specifically that there are two rules, and the second rule has two corollaries.
29 Stated another way, the term “special damages” may be a misnomer. The first corollary seems to indicate that a person should never liable for special damages, because if special circumstances are communicated, then the otherwise special damages become general damages in light of the fact that those damages ordinarily result from such special circumstances. Note that the first corollary addresses the problem only if the special circumstances were “communicated.” The corollary itself does not address the issue if only one party knows of special circumstances, or if both parties know of special circumstances but there is no communication of that fact.
30 Note that the use of the words “wholly unknown” does allow for an undistributed middle. In other words, one may argue that the corollaries address either complete knowledge or ignorance, objectively determined. However, if the corollaries are read consistently with the second rule, then the generality of the second rule will adequately address the issue. Furthermore, it may be argued that special circumstances, to some extent, are either completely known or not, but the knowledge could not be partial. Furthermore, since the second corollary identifies a failure of the test, lack of knowledge of only one party is sufficient for the purpose.
32 See infra note 43, 51, at 13, 14.
33 [The author asks that the reader restrain any feelings of violence that may result because both the Restatement and U.C.C. have rejected the “Tacit Agreement Test.” After all, this is contract law, and an assertion that the parties agree to damages is surely consistent.] As will be shown, depending upon the evaluation criteria, this approach is both the same as, and different from, the “Tacit Agreement Test.” See infra note 54 and accompanying text, at 15.
34 See Calamari & Perillo ” 14-5, 14-7; White & Summers ‘ 10-4.
35 Hadley, 9 ex. at 354B5, 156 Eng. Rep. 150B1 (emphasis added); see supra note 23 and note 29.
36 The facts are not entirely clear as to whether the communication by Hadley’s clerk was accepted by the court as notice of the special circumstances that the make the claimed damages probable. See id. at 356, 156 Eng. Rep. at 151 (“it is obvious that, in the great multitude of cases…such consequences would not, in all probability, have occurred; and these special circumstances were here never communicated by the plaintiffs to the defendants”); see also Victoria Laundry (Windsor) Ltd. v. Newman Indus. Ltd., 2 K.B. 528, at 537 (1949) (“it is reasonably plain from Alderson judgment that the court rejected this evidence [as notice of special circumstances]”).
37 One may argue that, even if these elements otherwise meet the criteria of a contract, there is no requirement of “mutual assent” which would bring the contemplation to the level of a bargained-for exchange. In fact, such a rationale is the foundation of the Tacit Agreement Test. See generally, Restatement § 19 (mutual assent).
39 Holmes stated: “These allegations must be read with care, for it is obvious that the pleader has gone as far as he dared to go, and to the verge of anything that could be justified under the contract, if not beyond.” Globe, 190 U.S. at 541-2.
41 In Federal Court using “general federal common law” prior to Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938).
42 Hadley, 190 U.S. at 543; see also O.W. Holmes, The Common Law 234-40 (1963); compare id. with note 6 and accompanying text, at 2.
48 Id. at 544-5, quoting, Elbinger Actien-Gesellschafft v. Armstrong, L.R. 9 Q.B. 473, 478 (1874). Note that the court in the quoted material, unlike Hadley, asks if the “consequences,” not the “circumstances” were communicated.
49 Id. at 545, quoting, British Columbia & V.I. Spar, Lumber, & Saw Mill Co. v. Nettleship, L.R. 3 C.P. 499, 500 (1868) (emphasis added).
50 See generally Calamari & Perillo § 14-5; White & Summers § 10-4.
51 Globe, 190 U.S. at 545, quoting, British Columbia & V.I. Spar, Lumber, & Saw Mill Co. v. Nettleship, L.R. 3 C.P. 499, 500 (1868).
52 Globe, 190 U.S. at 544 (emphasis added); see also White & Summers ‘ 10-4.
54 See Globe, 190 U.S. at 544.
55 Restatement § 351. Note that the Restatement § 351 and U.C.C. § 715(2) probably mean “know or have reason to know.” If this were not the case, a party in breach who “knows,” but does not have reason to know, could use both sections defensively.
56 Restatement § 351, comment a (emphasis added).
58 Id. (emphasis added); see U.C.C. § 2-714, comment 2.
59 See A. Corbin, Contracts ” 1008-12 (1964) (damages are a secondary obligation imposed by law).
62 In fact, Kerr is also consistent with Globe, but let us not move our point of measure.
63 Compare Globe, 157 N.E. at 141-2, with Hadley, 9 Ex. at 354-5, 156 Eng. Rep. at 150-1.
64 See generally supra note 15 and accompanying text, at 4.
66 A summary table of the Situations is provided at Appendix A, Table 1.
67 For ease of discussion, at times no distinction will be made between “special circumstances” and “special damages.”
68 See supra note 36 and accompanying text, at 10.
69 Hadley, 9 Ex. at 354, 156 Eng. Rep. at 150 (emphasis added).
70 One may argue that it is unfair to limit liability when B knew or had reason to know of the special circumstances which would make special damages probable. However, again, the essence of any contract is a bargained-for exchange, which could not exist without A’s knowledge of such special circumstances. Imposing liability for damages based upon a general social-duty concept is the inter-mingling of contract and tort principles.
71 Note that Restatement § 351(3) permits the court to limit damages in accordance with “justice.” See Restatement S 351(3); see also note 60 and accompanying text, at 18.
73 A summary table of evaluation criteria is provided at Appendix A, Table 2.
74 The Restatement also references the Uniform Commercial Code. See Restatement § 351, comment f. As a result, a notation and reconciliation on that point is in order.
The common law presumptions of the Contemplation Test of Hadley provides that when parties to a contract both contemplate the risks that are associated with the performance of the contract, only then are they are able to establish a cost for the transaction.
The statutory U.C.C. provides a table of standard presumptions imposed by law, the purpose of which is to increase the stability and predictability of economic transactions required in a highly commercial society. How can the presumptions of the U.C.C. be reconciled with the common law requirement for a bargained-for exchange? In this way: The U.C.C. encourages commerce and allows for profit maximization by allowing parties to do “advance bargaining.” By statute, the parties to a U.C.C. transaction are deemed to “contemplate” the U.C.C. provisions, therefore they “agree” to the terms imposed by the U.C.C. Furthermore, to the degree that parties actually communicate their bargain, that bargain overrides the U.C.C. presumptions. Thus, the “Contemplation Test” of Hadley is satisfied even though the U.C.C. provides that only the party in breach is required to foresee special loss.
As a result, because the U.C.C. is statutory law, it can be easily reconciled with Hadley.
GRZ226.20250213 GRZUID226