Don’t lose your rights to full profits on lost volume sales

If your business sells goods that scale, you may be what the law identifies as a “Lost Volume Seller.”  Your status as a Lost Volume Seller carries with it some very special rights.  Unfortunately, many merchants unwittingly give up these rights by failing to take a simple precaution at the time they enter into the contract to make the sale.

Why Do I Care?  Most contracts include stock clauses that effectively bar the Lost Volume Seller from recovering its proper measure of damages.  If you are a seller of goods or services and want to make sure you are in a position to take full advantage of your rights if a buyer walks away from a transaction, you can protect yourself.  You simply need to be thoughtful with regard to setting up certain specific provisions of your own from standard sales contract, and/or learn how to look for troublesome terms in purchase orders from customers.

These changes are easy to make.  Moreover, and unlike a lot of “the legal language” in form contracts, the business reason for including such a clause (or making a change to a problematic one) is easy to explain and should be readily accepted by your customer.

Damages and The Duty to Mitigate.  Generally speaking, the measure of damages for a breach of contract is the difference between the “contract” price and the “market” price.  For example, say you have a contract to sell your 2011 Ford Fiesta to someone for $15,000. The buyer breaches.

You only have the one car to sell.  You have an obligation to “mitigate your damages” by trying to resell the car to another buyer.  You do, spend $500 in additional advertising and sell it for $11,000 (a figure closer to its likely market value in St. Paul).  Your damages are $4,500; or the sum of the $4,000 in direct damages (the difference between the original sales price and ultimate sales price) plus the $500 in “incidental damages” (the cost of extra advertising).

Sometimes the “market price” and the duty to mitigate approach fails to place the seller in the same position as it would otherwise be.  Where this measure is inadequate, Minnesota’s Commercial Code states that the seller’s “the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer, together with any incidental damages provided in this article.”  

Lost Volume Sellers are Different.  A Lost Volume Seller, however, is a business that has the capacity to make “one more sale” if there is more than one buyer.  In theory, the Lost Volume Seller would have made the sale represented by the resale whether or not the breach occurred.

Using the above example, a Ford dealer, as opposed to the individual Ford Fiesta owner, may have as many 2011 Ford Fiestas as it can possibly sell available to it.  In fact, if that dealer had two identical Ford Fiestas on its lot, it would have made the second sale even if the original breach of contract never occurred.

Another form of “Lost Volume Seller” is a supplier of software or online services, such a data aggregators or providers of digital downloads.  These sellers typically have a fixed-cost for the research and development of a product, but once the software goes to market the seller has a relatively small production cost.  (Contrast that to, for example, the car on which the per unit profit margin is a lot lower than it is on software.)

Irate Butterflies and the Lost Volume Seller.  Consider a fictional software company as an example.  The company developing and releasing “Violently Irate Butterflies, version 3.0.”  It invests the bulk of its development dollars into writing the computer code that permits its game to display correctly on an Android device, an iPhone, and a Blackberry.

Once the code is ready for general release on, for example, the Android platform, the developer uploads a master file.  The developer may sell one unit, 50 units, or 5 million units of the game.  Its only per unit cost is the referral fee it pays to Google Play and the bandwidth charges it pays to its internet provider to supply the downloads.

What this means is that each sale is, on a per unit basis, almost “pure profit.”  (This does not mean the company itself is necessarily profitable.)  The company has no further cost to develop “Violently Irate Butterflies 3,” and its incremental costs per each additional sale are relatively negligible.

Lost Volume Seller Beware: Most Contracts Exclude Lost Profits.  A great many contracts, including the electronic “Terms & Conditions” so many of us click through without reading, impact Lost Volume Sellers.  These contracts typically include a section that excludes certain types of damages.

For example, the website from which the author obtained the likely market price of the Ford Fiesta has terms of service.  These terms disclaim all warranties regarding the service.  (These disclaimers, ironically, say that the very pricing information the site supplies as its principal service could be wrong!)  They also include a limitation of liability that purports to exclude at least nine different categories of damages:


How to Avoid this Trap.  Generally speaking, parties can contract to limit their exposure to certain types of damages.  The categories carved out in the terms of service, including lost profits, are among those limits that a court will often uphold.

Parties can also remove these caps, or create a “carve out of the carve out.”  The devil in such instances is always in the details, and requires a careful reading of the contract’s supposed limitations of liability and damage exclusions.

If you truly are a Lost Volume Seller, your buyer will most likely agree to an appropriate carve out at the outset.  You simply need to (a) know what to ask for in the contract, and (b) know how to ask for it.

If you are about to click through or sign a contract that contains such a provision, consider reaching out to Hellmuth & Johnson’s Business Department ahead of time.  It is much easier (and less expensive) to fix a problem like this at the outset of a contractual relationship than it is to do so months down the line.