Lost Volume Theory: A Simple Recap

If there is one principle that’s key to understanding contract damages is that the legal system is terrified of someone getting more compensation than what they deserve. One mustn’t profit from a breach of K. Put the non-breaching party in the position they would’ve occupied but for the breach, but not a better one.

What follows from this principle is less intuitive. Contrary to what you might think, the legal system is fine with letting people who breach contracts get away with paying less–so long as the people whose contracts were breached won’t get more. (Need some convincing? think about the combined effect of certainty, mitigation, and foreseeability, and then think about the anti-punitive-damages stance permeating liquidated damages analysis).

So if a general contractor breaches a rehab K they had with a flipper, the losses may be estimated at $40,000. But the legal system would be 10 times more worried about giving the flipper $40,100 than it would about the possibility of letting the GC pay only $30,000. (why? probably because of the old myth that expectation damages are not ‘real’ in the way reliance damages are–the sentiment channeled by Fuller & Purdue).

OK, so giving the non-breaching party more than they lost is a K faux-pax; what does that have to do with lost volume sellers? What are lost-volume sellers?

If you feel confused about the lost-volume doctrine, the problem is not with you. It’s the doctrine itself that’s confused.

Consider Adam. He recently discovered he can supplement his income by flipping cars–he finds people trying to get rid of their cars, he buys their cars, does some fixing, and then sells the cars at a small profit. Adam was just able to put his hands on a 2020 Toyota 4Runner, for which he paid only $40,000. It’s in excellent condition and with only 20,000 miles on it, so Adam figures he can sell it for somewhere between $44,617-$47,701 (according to the KBB), with $46,169 as the middle point. Not bad!

Rachel contacts Adam, telling him she urgently needs a car, and she is willing to pay his requested $50,000 (roughly $4,000 more than the midpoint). They sign a K, but the next day she calls him and says she found a cheaper car, and she is no longer interested in the car.

If Adam were to bring a lawsuit, what would be the measure of damages?

The UCC has this easy formula: K-Mkt. That is, the K price (here we said it was $50,000) minus the market price (here KBB tells us it’s $46,169). So under the UCC, Adam should get $50,000-46,169=$3,831.

The common law has a seemingly different approach, but it will lead to the same end result (I promise that you still want to go through the steps). The common law focuses on lost profits. If we were to apply the formula of (Expected profits under the K) – (Actual profits after the breach), we would seem to get a very different number. The breach left Adam with no profits–the sale didn’t go through. He expected, however, to turn a nice profit of $50,000-$40,000=$10,000. Buying a car for $40k and selling it for $50k is a pretty good deal.

But remember the law’s fear of over-compensation? We notice that if we were to give Adam $10,000 in compensation, he would be in a better position than he was prior to the breach because not only he has the profits of the flip, he also has the car. If he now finds a new buyer, he will be able to sell the car for, say, $46,169. That means that net of his cost of buying the car ($40,000) he would have an additional $6,169 in profits, for a total of $10,000 (from Rachel) + $6,169 (from new buyer) = $16,169. That’s a lot! It raises a red flag for us, because we know the common law won’t let anyone profit from a breach. And indeed, it seems like we made a very common mistake: we double counted. After assessing lost profits, we need to deduct the value of the car that Adam gets to keep. When Rachel breached the K, she left Adam with a car that he can sell for its market price of $46,169. So we need to deduct this profit from what Rachel has to pay: $10,000-$6,169 = $3,831. I told you we’ll get to the same amount as the UCC!

To recap: If we use the UCC formula, Adam gets $3,831. If we use the lost profits formula, Adam is supposed to get $10,000, but after accounting for the value of the car he gets to keep, we are again finding ourselves with $3,831.

This is where the Lost Volume Doctrine kicks in. It tells us that if Adam has a large stock, we can (a) use lost profits rather than K-Mkt and (b) ignore the fact that he gets to keep the car. This will get Adam the $10,000 + $3,831.

Wait, what?

Well, here’s the Official Story. Suppose a widget broker has access to an ‘infinite’ supply of widgets from a factory (this can’t be literally true, but bear with me). To save the trees, we’ll recycle our numbers and suppose that clients order widgets from the broker at a quoted price of $46,169. For each one bought, the broker puts in an order and pays $40,000 to the factory. Now suppose that a client breaches the K after the broker puts in the order. Both UCC and Lost Profits would mean that broker can’t get any damages (see Box below), and the idea is that the broker gets to keep the widget and can simply sell them to someone else. No harm done.

To some people 0 compensation for breach feels unfair. So they came up with this great story: When the first contract was made, that created in our poor broker’s heart the expectation of a certain ‘volume’ of sales. She was already eyeing her fat commission (widget retail is where the big $$$ are at). When the client breaches the K, he impermissibly frustrates this expectation. Sure, our broker gets to keep the widget, but she lost something (the story goes) and we want to compensate her.

How much? well, every additional volume of sale gets our broker $6,169 in profits and so this is what we should get her. If she is lucky to find a sucker like Rachel who would pay $50,000, she can likewise get $10,000 in damages. We are compensating, in other words, for the loss of sales volume.

UCC (K-Mkt)
K= contract price = $46,169
Mkt = Market Price = $46,169
K-Mkt = $46,169-$46,169 = $0

Lost Profits
K price = $46,169
Resale value of the widget = $46,169
Damages = $46,169 – $46,169 = $0.

Illustration: In Locks v. Wade we have a broker that instead of widgets rents out nifty jukeboxes (what’s the proper, non-anachronistic adjective here to describe how cool they are? razz my berries? Made in the shade? Daddy-O?). Our broker collects orders from restaurant owners and then orders jukeboxes from its supplier. Each rental nets the broker $840. A breach, in one sense, doesn’t leave the broker worse-off–he can still rent out the same jukebox to another hip diner. But the court adopts the lost volume doctrine and allows the broker to recover the $840.

Now let’s move on to the fun part– critique. Does any of that make sense? I don’t think so. What is volume and how one loses it? And if such a thing exists, why isn’t a volume of one sale enough to get one the royal treatment? Would three lost sales be enough? I’m not nitpicking here: I recognize that there are many good legal rules where a bright line is hard to draw. My point is rather that there is no principled reason to draw the line anywhere.

Courts try to limit the doctrine only to cases where sellers have an ‘unlimited’ supply of goods. The meme I made below summarizes what I think about the merits of the argument, but I also find this to be completely arbitrary. Why isn’t a large stock enough? What makes the volume important?

Now there is this odd issue of horizontal and vertical equity if you will. This rule is anti-consumer in effect. Under standard K rules, if a consumer buys a car from a private person, they have a way out in case they later regret it. The standard rule offers consumers an almost no-penalty way out, because as long as they paid market price, the seller is unlikely to have suffered any harm from breach. Basically, the law makes it fairly easy to regret. This might be a good rule although you might disagree with it. But, in a world where such a rule exist, the effect of the lost-volume seller doctrine is to privilege* large sellers and retailers. If you breach a K with them, they can start complaining about lost volume and then recover damages. Breach is no longer costless and their interests are better protected. But this is perverse: it appears absurd to offer compensation only to large sellers who are in a better position to shoulder the risk.

(*Geeky footnote: I’m vastly simplifying: we can imagine that there might be price effects at play, and that this rule would lead to higher demand for purchases from small sellers because they involve the option to regret. This can get complicated, but the point stands: after full consideration, it doesn’t make much sense to think that large sellers need more protection than small sellers as a matter of default).

The most persuasive reason, I think, was put forward by Vic Goldberg. What do we think most parties would want? Would they want a no penalty termination clause? Would they prefer the lost volume’s approach of compensating sellers for their lost volume? If you look outside stare at your monitor, the answer is fairly self-evident. Most online consumer transactions today offer free returns, sometimes even with no-cost shipping. I decide to cancel my order of the Kindle Paperwhite because a voice in my dream told me that I’d be happier with an iPad (I have very strange dreams, don’t ask). In standard analysis, this would be a breach and not just a breach, but a ‘deliberate’ breach. Amazon clearly loses sale volume. But Amazon doesn’t care–they give me a 0 cost option to terminate at will for whatever arbitrary reason. Amazon can anticipate that every quarter it loses a certain volume of sales due to hallucinating consumers, and it just prices the ‘loss’ in its product, and consumers seem keen to pay a premium for having the ability to back out when they want.

So, the conclusion is yes. The lost volume seller doctrine doesn’t make sense, courts took a wrong turn at some point, and it’s not too late to undo the mistake.

One thought on “Lost Volume Theory: A Simple Recap

  1. This was awesome!! Thank you for taking time to break this down in such a way where it left me still confused hahahah, but no more confused than you expected I would be, and less confused than I expected I would be. LOL. I think all in all it was a win. In all seriousness, I love your voice in this article, I was able to read it and laugh while somewhat grasping the key points of this doctrine. I think by the end I felt pretty comfortable being able to at the very least, measure the amount of damages in a both a UCC and Common Law K. Interesting enough, I had no clue until coming across your article that this was part of the battle of the forms, and here I am thinking I understood the battle of the forms after finished 1L! You learn something new every day! hahahah!! Takecare, I will be back to review other goods I am sure you have on here, and I am sure I am going to NEED! 🙂

    Tockqua Edna Center!

Leave a Reply

Your email address will not be published. Required fields are marked *