Lewis Jorge Construction Management, Inc. v. Pomona Unified School District

Opinion

A school district terminates a construction contract when the contractor, four and a half months after the promised due date, still has not finished the project. The contractor’s bonding company then hires another firm to complete the project, but it suspends then later reduces the amount of bonding for the contractor. The latter successfully sues the school district for breach of contract, recovering in damages some $3 million for potentially lost profits, which the contractor claimed it would have earned on prospective construction contracts it never won because of its impaired bonding capacity. The Court of Appeal concluded that those potential profits were a proper item of general damages in this action for breach of contract. We disagree.

I.

In 1994, the Pomona Unified School District (District) solicited bids for building improvements at Vejar Elementary School. The District awarded the contract to Lewis Jorge Construction Management, Inc. (Lewis Jorge), the low bidder at $6,029,000. Although the contract originally provided for completion in December of 1995, heavy rains delayed work, and the parties agreed to a revised completion date of January 22, 1996. That date came and went, but the project remained unfinished.

Lewis Jorge sued the District, alleging it breached the contract by declaring Lewis Jorge in default and terminating it from the construction project. The complaint sought damages and alleged six causes of action. The first, alleging breach of contract, and the second, alleging breach of an implied warranty of sufficiency of the plans and specifications for the project, are both contractual claims naming the District as a defendant. Causes of action three through five—alleging nondisclosure of material facts, inducing breach of contract, and negligence—named a district employee as a defendant. The sixth cause of action sought equitable indemnity against both the District and the employee for claims against Lewis Jorge by its surety and its unpaid subcontractors. Lewis Jorge did not plead as special damages the profits it claimed to have lost on future contracts.

Lewis Jorge, in turn, was sued by a number of its subcontractors for nonpayment of their past due bills.

At trial, Lewis Jorge presented evidence from its bonding agent that in June 1996 it had a bonding limit of $10 million per project, with an aggregate limit of $30 million for all work in progress. By mid-1997, the only sureties willing to provide Lewis Jorge with bonding imposed a limit of $5 million per project, with an aggregate limit of $15 million, a reduction of its bonding capacity to the level its surety had imposed in the early 1990’s. Sometime in 1998, Lewis Jorge ceased bidding altogether and eventually closed down.

Lewis Jorge sought to prove the extent of its lost future profits on unidentified construction projects, using as the relevant period the date of the District’s breach to the date of trial, and relying on its profitability during the four years preceding the breach. Robert Knudsen, a financial analyst who specialized in calculating lost profits claims, projected that Lewis Jorge had lost $95 million in gross revenue for future contracts that, based on its past history, it would likely have been awarded. Historically, Lewis Jorge had realized a profit of about 6 percent of revenue. Knudsen calculated lost profits on unidentified projects at $4,500,000, which discounted to present value came to $3,148,107.

The injured party’s damages cannot, however, exceed what it would have received if the contract had been fully performed on both sides. (Civ. Code, § 3358.) This limitation of damages for breach of a contract “serves to encourage contractual relations and commercial activity by enabling parties to estimate in advance the financial risks of their enterprise.” (Applied, supra, 7 Cal.4th at p. 515.)

Contractual damages are of two types—general damages (sometimes called direct damages) and special damages (sometimes called consequential damages). (24 Williston on Contracts, supra, § 64.1, pp. 11-12; 3 Dobbs, Law of Remedies (2d ed. 1993) § 12.2(3), pp. 39-42; see, e.g., Erlich v. Menezes (1999) 21 Cal.4th 543 , 558 [ 87 Cal.Rptr.2d 886 , 981 P.2d 978 ].)

A. General Damages

General damages are often characterized as those that flow directly and necessarily from a breach of contract, or that are a natural result of a breach. (Civ. Code, § 3300 [damages “which, in the ordinary course of things, would be likely to result” from breach]; Mitchell v. Clarke (1886) 71 Cal. 163 , 167-168 [ 11 P. 882 ] [general damages are those that naturally and necessarily result from breach].) Because general damages are a natural and necessary consequence of a contract breach, they are often said to be within the contemplation of the parties, meaning that because their occurrence is sufficiently predictable the parties at the time of contracting are “deemed” to have contemplated them. (Calamari & Perillo, The Law of Contracts (2d ed. 1977) § 14-5, p. 525; Hunt Bros. Co. v. San Lorenzo Water Co. (1906) 150 Cal. 51 , 56 [ 87 P. 1093 ] [parties need not “actually have contemplated the very consequence that occurred,” but they would have supposed such a consequence was likely to follow a breach].)

B. Special Damages

Unlike general damages, special damages are those losses that do not arise directly and inevitably from any similar breach of any similar agreement. Instead, they are secondary or derivative losses arising from circumstances that are particular to the contract or to the parties. Special damages are recoverable if the special or particular circumstances from which they

California follows the common law rule that an English court articulated some 150 years ago in Hadley v. Baxendale (1854) 156 Eng.Rep. 145. After Hadley’s mill shut down because of a broken crankshaft, he entered into a contract to have a new one built. When the builder asked Hadley to send him the broken shaft to use as a model, Hadley took it to Baxendale, a common carrier, for delivery to the builder. Baxendale did not deliver until seven days later. Hadley then sued Baxendale for lost profits for that period. Hadley’s lost profits, the court held, were not recoverable, because he had failed to inform the carrier that the mill would be shut down until delivery of the new shaft. (Id. at p. 151.) Because the special circumstance—the mill’s inoperability without a mill shaft—was not communicated to Baxendale, he did not assume the risk of compensating Hadley for mill profits lost as a resulting of Baxendale’s late delivery of the mill shaft.

Hadley did not expressly distinguish between general and special damages. But such a distinction flows naturally from that case; hence the rule that a party assumes the risk of special damages liability for unusual losses arising from special circumstances only if it was “advised of the facts concerning special harm which might result” from breach—it is not deemed to have assumed such additional risk, however, simply by entering into the contract. (1 Witkin, Summary of Cal. Law, supra, § 815, p. 733; See Mitchell v. Clarke, supra, 71 Cal. at pp. 165-169.)

The Hadley rule has long been applied by California courts, which view it as having been incorporated into California Civil Code section 3300’s definition of the damages available for breach of a contract. (Hunt Bros. Co. v. San Lorenzo Water Co., supra, 150 Cal. at p. 56; Christensen v. Slawter (1959) 173 Cal.App.2d 325 , 334 [ 343 P.2d 341 ]; Sabraw v. Kaplan (1962) 211 Cal.App.2d 224 , 227 [ 27 Cal.Rptr. 81 ].) Contract damages, unlike damages in tort (Civ. Code, § 3333), do not permit recovery for unanticipated injury. (Hunt Bros. Co. v. San Lorenzo Water Co., supra, 150 Cal. at p. 56.)

Here, the Court of Appeal affirmed the jury’s award to Lewis Jorge of $3,148,197 in general damages, based on profits Lewis Jorge did not earn on future unidentified contracts because its surety had reduced its bonding capacity after the District’s termination of the construction contract. The Court of Appeal concluded that such potential profits were recoverable as general damages because they followed “from the breach in the ordinary course of events” and were a “natural and probable consequence.” The Court of Appeal found it significant, as did the trial court, that the contract at issue, like much of Lewis Jorge’s business, was a public contract that required bonding.

The Court of Appeal reasoned: When the contract was formed, the District knew of its own bond requirements, and it knew that public works contractors must provide bonds to secure their performance. Because impaired bonding capacity “has long been recognized as a direct consequence of an owner’s breach of a construction contract,” the Court of Appeal concluded that the District should have known that breaching the contract and resorting to the surety to complete the project could impair Lewis Jorge’s ability to obtain bonds without which it could not bid on other public contracts. Accordingly,

We are not aware of any California authority involving a construction contract that has upheld an award of general damages against a breaching owner for profits unearned on unidentified contracts the contractor did not get when its bonding was impaired as a result of the contract breach. Lewis Jorge, nevertheless, urges us to permit such recovery, citing a Montana decision, Laas v. Mont. Hwy. Comm’n et al (1971) 157 Mont. 121 [ 483 P.2d 699 ]. In that case the plaintiff highway contractor, who had been in business for 22 years and had made a profit on every construction project, claimed three years of profits lost or $250,000 for projects he was unable to win when his bonding capacity was reduced after the state breached the construction contract. The Montana Supreme Court affirmed a jury award of $78,000 in lost profits. (Id. at p. 130.) It did so without reference to the construction context, by simply applying rules for profits lost to an established business. But five years later, in Zook Brothers Constr. Co. v. State (1976) 171 Mont. 64 [ 556 P.2d 911 ], another case involving breach of a highway construction contract, the same court disallowed recovery of profits lost on other projects after the state’s breach. The Montana court found “vague and speculative” future profits the contractor did not earn when the state’s breach caused him financial woes, forcing him to sell equipment without which he was unable to take on additional work. (Id. at p. 76.) The Montana court’s earlier decision in Laas appears to represent a singular instance of upholding lost profits on future construction projects as an item of general damages for breach of a construction contract, a holding that has not been followed in a published opinion outside Montana in the 33 years it has been on the books.

Applying these rules to the school construction contract here, we cannot say that the parties’ bargain included Lewis Jorge’s potential profits on future construction projects it had not bid on and been awarded. Full performance by the District would have provided Lewis Jorge with full payment of the contract price. Certainly, Lewis Jorge anticipated earning a profit on the school contract with the District, but that projected profit was limited by the contract price and Lewis Jorge’s costs of performance. If Lewis Jorge’s bid accurately predicted its costs, the benefit of its contractual bargain for profits was capped by whatever net profit it had assumed in setting its bid price.

The District’s termination of the school contract did not directly or necessarily cause Lewis Jorge’s loss of potential profits on future contracts. Such loss resulted from the decision of CNA, Lewis Jorge’s surety at the time of the breach, to cease bonding Lewis Jorge.

Contrary to Lewis Jorge’s contention, our decision in Warner Constr. Corp. v. City of Los Angeles (1970) 2 Cal.3d 285 [ 85 Cal.Rptr. 444 , 466 P.2d 996 ] does not compel a different result. There, a contractor sued the city for breach of a contract to construct a retaining wall. The complaint alleged four causes of action. As relevant here, the third cause of action alleged that the city had breached the contract by refusing to issue a “change order” to compensate the contractor for additional costs when soil at the site proved to be more unstable than city test holes had revealed, requiring the contractor to use special, more expensive casting methods, which did not comply with the contract’s specifications. (Id. at p. 290.) The fourth cause of action alleged

Having here concluded that profits Lewis Jorge might have earned on future construction projects were improperly awarded as general damages, we now decide whether those lost potential profits were recoverable as special damages. Lost profits, if recoverable, are more commonly special rather than general damages (3 Dobbs, Law of Remedies, supra, § 12.4(3), pp. 76-77), and subject to various limitations. Not only must such damages be pled with particularity (Mitchell v. Clarke, supra, 71 Cal. at p. 164), but they must also be proven to be certain both as to their occurrence and their extent, albeit not with “mathematical precision.” (Berge v. International Harvester Co. (1983) 142 Cal.App.3d 152 , 161 [ 190 Cal.Rptr. 815 ]; accord, Grupe v. Glick, supra, 26 Cal.2d at pp. 692-693; Resort Video, Ltd. v. Laser Video, Inc. (1995) 35 Cal.App.4th 1679 , 1698-1700 [ 42 Cal.Rptr.2d 136 ].) “When the contractor’s claim is extended to profits allegedly lost on other jobs because of the defendant’s breach” that “claim is clearly a claim for special damages.” (3 Dobbs, Law of Remedies, supra, § 12.4(3), fn. 12, p. 71.) Although Lewis Jorge did not plead its lost ñiture profits as special damages, the issue of their availability as special damages was presented to the jury, and at oral argument the District expressly stated that it was not relying on that pleading omission.

Although a few cases state that a contractor suing for breach of contract may recover as special damages any profits it might have earned on other unawarded construction contracts, such damages are frequently denied as too speculative. (See, e.g., Hirsch Elec. Co., Inc. v. Community Services, Inc. (1988) 145 A.D.2d 603 , 605 [ 536 N.Y.S.2d 141 , 143] [contractor’s claim that breach rendered it unable to obtain bonding, without which it could not bid or win another contract on which it would have made a profit of $800,000, was rejected as consisting of “inferences piled upon inferences” that “as a matter of law, are too speculative to give rise to the recovery of damages for lost profits”]; Manshul Constr. Corp. v. Dormitory Auth. of N.Y. (1981) 111 Misc.2d 209 [ 444 N.Y.S.2d 792 , 803-804].) And there are federal decisions that likewise have rejected as too remote and speculative special damages for breach consisting of profits lost on other contracts. As one circuit court explained, “even in a common-law suit there would be no recovery for general loss of business, the claimed loss of [the contractor’s entire] net worth, and losses on the non-federal work—such damages are all deemed too

California, likewise, has not upheld as special damages a contractor’s unearned profits after breach of the construction contract. In S.C. Anderson v. Bank of America (1994) 24 Cal.App.4th 529 [ 30 Cal.Rptr.2d 286 ], a contractor hired to build tenant improvements did not receive timely payment from a financially strapped developer, and because of the contractor’s rising receivables, its surety reduced its bonding capacity. Before the surety’s action, the contractor had submitted the low bid on a public school construction project. Instead of awarding the contract to that contractor, the school district rebid the project. The contractor prepared a rebid, but could not submit its rebid because it lacked the requisite bonding capacity. Its rebid was lower than the winning bid for the school project. The contractor sued the developer’s lender for fraud, seeking damages of $140,588 for profits it did not earn on the school project, amounting to 5 per cent of its rebid. The Court of Appeal affirmed nonsuit for the lender on the lost profits damages, noting there was “no evidence which would have enabled the jury to conclude it was reasonably probable” the contractor “would in fact have earned a profit” in the claimed amount. (Id. at p. 536.) Although the contractor “was only obliged to demonstrate its loss with reasonable certainty” (id. at pp. 537-538), the court said that the contractor had failed to show that it would be “impossible or impracticable to produce evidence relating to the accuracy of its bid, its ability to competently and efficiently perform the [school] project, or its likely net profit.” (Id. at p. 538.)

At trial, Lewis Jorge presented evidence that its bonding capacity was reduced by its surety after the District’s termination of the contract. But Lewis Jorge did not establish that when the contract was formed the District could have reasonably contemplated that its breach of the contract would probably lead to a reduction of Lewis Jorge’s bonding capacity by its surety, which in turn would adversely affect Lewis Jorge’s ability to obtain future contracts. As the evidence at trial disclosed, Lewis Jorge’s bonding agent, who had obtained the construction bonds from CNA, anticipated that CNA’s suspension of Lewis Jorge’s bonding capacity would only be temporary. “Damages may be awarded for breach of contract for those losses which naturally arise from the breach, or which might reasonably have been foreseen by the parties at the time they contracted, as the probable result of the breach.” (Burnett & Doty Development Co. v. Phillips, supra, 84 Cal.App.3d at p. 389.) But the breaching party “is not required to compensate the injured party for injuries that it had no reason to foresee as the probable result of its breach when it made the contract.” (Ibid.; See Coughlin v. Blair (1953) 41 Cal.2d 587 , 603 [ 262 P.2d 305 ].)

Evidence at trial established that the owner’s terminating a contract might or might not cause the contractor’s surety to reduce its bonding capacity. As the District pointed out at oral argument, when it signed the contract it did not know what Lewis Jorge’s balance sheet showed or what criteria Lewis Jorge’s surety ordinarily used to evaluate a contractor’s bonding limits. Absent such knowledge, the profits Lewis Jorge claimed it would have made on future, unawarded contracts were not actually foreseen nor reasonably foreseeable. Hence they are unavailable as special damages for the breach of this contract.

To summarize: It is indisputable that the District’s termination of the school construction contract was the first event in a series of misfortunes that culminated in Lewis Jorge’s closing down its construction business. Such disastrous consequences, however, are not the natural and necessary result of the breach of every construction contract involving bonding. Therefore, as we concluded earlier, lost profits are not general damages here. Nor were they actually foreseen or foreseeable as reasonably probable to result from the District’s breach. Thus, they are not special damages in this case.

The judgment of the Court of Appeal must be modified to read: “The judgment against Christopher Butler is reversed; the award of prejudgment interest is reversed; the award of attorney fees is reversed; and the award of $3,148,197 for lost profits is reversed. In all other respects, the judgment is affirmed. The matter is remanded to the trial court for an award of prejudgment interest consistent with the opinion of the Court of Appeal.” As modified that judgment is affirmed.

George, C. J., Baxter, J., Werdegar, J., Chin, J., Brown, J., and Moreno, J., concurred.

Respondent’s petition for a rehearing was denied February 16, 2005.