By Anjali P. Gillette

In an attempt to mitigate risk, most commercial contracts contain a provision limiting monetary recovery. The most common provision is a waiver of consequential damages. Despite the parties’ best intentions, whether a category of damages are considered direct damages or consequential damages is often determined on a case-by-case basis.  Texas courts have provided the following general framework.

Direct damages are “the necessary and usual result of the defendant’s wrongful act; they flow naturally and necessarily from the wrong.”[1] Direct damages are intended to compensate the plaintiff for the loss incurred that was foreseeable by the defendant from his wrongful act.  Consequential damages, on the other hand, may “result naturally, but not necessarily, from the defendant’s wrongful acts.”[2]  Consequential damages must be foreseeable and must trace directly back to the wrongful act in order to be recoverable.

While a seemingly simple test, Texas courts have had varying outcomes depending the specific facts and circumstances. In Powell Electric Systems, Inc. v. Hewlett Packard Co.,[3] Powell and Hewlett Packard contracted for the installation, testing, and repair of a new transformer. During installation, Powell negligently connected a new transformer resulting in damages to Hewlett’s facilities. The court analyzed each of the damage items submitted by Hewlett and held that those specific items contemplated at the time of contract, such as repair costs, increased labor, facilities, and costs of materials, were all considered direct damages. However, the court ruled that a temporary transformer used in place of the defective transformer was not contemplated in the contract and, therefore, considered a consequential damage – waived under the contract’s damage limitation provisions.

In Cherokee Cty. Cogeneration Partners, L.P. v. Dynegy Mktg. & Trade,[4] the court held that the lost profits on the contract itself were direct damages, but the lost profits on other contracts for the sale of electricity produced by the facility were consequential damages.  The court opined that the parties’ contract contemplated the purchaser’s ability to profit from resales of the purchased gas as a higher price, so that those lost profits were considered direct damages.

In Continental Holdings, Ltd. v. Leahy,[5] the parties’ dispute centered on the wrongful termination of a contract for a vessel. The parties disagreed on whether Continental was entitled to the unrealized charter hire Western initially contracted. The court held that “lost profits damages may take the form of ‘direct’ damages or the form of ‘consequential’ damages.”[6] Those profits lost on the breached contract itself, such as the amount the non-breaching party would have received, less expenses saved, are considered direct damages. However, lost profits on other contracts or relationships resulting from the breach are indirect damages.

Thus, as we have seen through this sample of cases, while the Texas courts generally respect the parties’ contractual language classifying certain damages as direct or consequential, the courts will closely examine the circumstances giving rise to the claim. Depending on whether you are the breaching party or non-breaching party, we can assist you in determining what damages are recoverable.

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[1] Arthur Andersen & Co. v. Perry Equip. Corp., 945 S.W.2d 812, 816 (Tex. 1997).

[2] Id.

[3] 356 S.W.3d 113, 117 (Tex. App.—Houston [1st Dist.] 2011, no pet. h.).

[4] 305 S.W.3d 309, 315 (Tex.App. —Houston [14th Dist.] 2009, no pet. h.)

[5] 132 S.W. 3d 471, 473 (Tex. App.—Eastland 2003, no pet. h.).

[6] Id. at 475.