This article was contributed by Rebecca Mordas, Esq., one of the attorneys in my Corporate Counsel Office.

It is important that both parties negotiating a contract not only contemplate the possibility of a breach, but also define the appropriate remedies available to each prospective non-breaching party in the event of a breach.  This technique will create certainty in your contracts as well as insulate the non-breaching party from spending time and money proving damages in court. In addition, if the contract clearly spells out the consequences of a breach, then each party will be forced to examine the costs of their potential breach before actually breaching.

In negotiating remedies, make sure you put yourself in the shoes of both the breaching and non-breaching party.  Determine in advance what you think would bean appropriate remedy if either you or the other contracting party fails to perform the obligations outlined in the contract.  When limiting damages, be sure you are not giving up too much.  For instance, if a supplier has expressly guaranteed the quality and lifetime expectancy of a particular good, and that particular guarantee is the reason or at least part of the reason that you feel comfortable entering into a contract with that party, do not agree to a contract that excludes express warranties.  (Even better, if you are the purchaser, try to incorporate those particular representations into the contract).

Limiting damages is a common risk management tools that parties agree to all the time.  In order to calculate the risk and protect your company, it is especially important that you not only understand what types of foreseeable risks are likely, but also you understand the contractual language used to limit potential damages.  Below are some terms used in contract law that parties tend to limit or exclude remedies in their contracts:

Consequential.  These damages are those attributable to a breach and are an immediate consequence of a breach.   A consequential damage could include loss profits, diminution of value, or loss of product.  Important concept to note on consequential damages is that whatever the non-breaching party is suffering must have been within the contemplation of the parties at the time the contract was entered into.  For example, if Tom Oto contracts with Farmer John to receive 100 lbs of high grade tomatoes for his special spaghetti sauce business from his farm by first harvest date and Farmer John fails to deliver by this date, Tom Oto can only recover for loss profits on the sale of tomato sauce only if Farmer John knew that Tom Oto was planning to use the tomatoes for his special sauce. Consequential damages can get tricky with showing that the other party knew or had reason to know of a particular use.   

Incidental.  These damages would include any reasonable costs incurred leading up to the breach, like any of the costs incurred for inspection and shipment of the breached goods, as well as the costs incurred by the non-breaching to find replacement goods or any reasonable expenses incurred as a result of a delay in shipment. Incidental damages also include attorney fees.

Liquidated Damages.  These damages are contained in the contract and make life quite simple. They state, in the event of a breach by a party, the breaching party will pay the non-breaching a predetermined amount of money.  These tend to be upheld in court as long as they are not grossly oppressive.  In the example above, it probably would be unfair if Farmer John had to pay Tom Oto a million dollars in liquidated damages if the event of breach.

Specific Performance.  Specific performance would require a breaching party to fulfill its obligations under the contract.  This rarely occurs as courts are hesitant to make parties act.  After all, there is such a thing as an efficient breach—-A breach of contract is sometimes more efficient to breach if the performance of the contract costs exceed the benefits to all the parties. (Disclaimer- I am not recommending or endorsing breaches of contract,just recognizing that the decision to breach is often a business decision made with careful consideration of whether benefits outweigh the cost or vice versa).

Despite your ability to limit remedies, be cognizant that not all remedies may be contractually discharged.  Certain damages, like punitive damages, are equitable remedies awarded by the court cannot be limited by contract.  Other statutorily mandated damages carry strict liability and also cannot be limited through contract.