The duty of a legally-wronged party to mitigate its damages is an important legal mechanism that minimizes economic waste. Under North Carolina law, that duty can be waived in commercial contracts and leases. Before agreeing to do so, contracting parties should consider the potential risks and rewards.
You are a farmer. At the beginning of the growing season, you approach a produce vendor and offer to sell 100 bushels of apples at $10 per bushel once your apples are in season. The vendor agrees and a written contract is signed by you and the vendor. You are now obligated to supply to the vendor 100 bushels of apples. The vendor is obligated to pay you $1,000. Your contract allows you to invest your effort into growing your apples safe in the knowledge that you have a buyer at a predetermined price. The vendor can plan to sell your apples when they are in season safe in the knowledge that there will be a fixed supply at a fixed price.
When your apples are in season, you load 100 bushels onto your truck and drive to town and request payment from the vendor of $1,000. However, it turned out to be a bumper year for apples, and the vendor announces that he no longer wants your apples because he was able to buy 100 bushels from your neighbor and refuses to pay you anything. Angry at the vendor for dashing your expectations, you drive your truck to the side of the road, deposit your apples on the curb, and drive away. The apples rot and go to waste, benefiting no one.
You sue the vendor for breach of contract and ask for damages of $1,000. The vendor admits breaching your contract, but introduces undisputed evidence that you could have easily driven down the street one block and sold the apples to a competing vendor for $5 per bushel, or $500. What amount of damages will you be able to collect from the vendor?
The judge rules that you will be able to collect only $500 in damages from the vendor. He explains to you that the reason you cannot collect the full $1,000 in damages (the amount that you would have received if the vendor had honored your contract) is that your failure to mitigate your damages caused $500 of those damages and this portion is not recoverable from the vendor.
What is the Duty to Mitigate?
A nonbreaching party to a contract is entitled to the benefit it expected if the other party to the contract breaches it. Put simply, the nonbreaching party is entitled to be put in the same position it would have been but for the other party's breach. In the example described above, you were entitled to be put in the position you would have been if the vendor had honored your contract, which is that you would not have the apples, but you would have $1,000.
However, every contract carries with it an implied duty for a nonbreaching party to use reasonable care to avoid damages resulting from a breach by the other party. Thus, in the example above, you were required to make reasonable efforts to minimize the damage you suffered from the vendor's refusal to honor the contract. Thus, the duty to mitigate required you to reduce your damages by selling your apples to another vendor, even if that vendor will not pay you as much as the first vendor promised to pay you.
If you had successfully undertaken mitigation efforts in the example above, then your damages would have been reduced by $500. If you had sold your apples to the competing vendor, your total recovery would have been just what you expected from your contract: $1,000 ($500 from the sale of the apples to the competing vendor and the $500 the judge ordered the breaching vendor to pay you). Since you did not sell your apples to the competing vendor, you only recover the $500 the judge awarded.
Why Does The Law Require The Wronged Party To Mitigate?
Why do you have to undertake efforts to mitigate the vendor's breach? After all, it was the vendor's wrongful refusal to honor your contract that created the problem in the first place. The answer lies not in the relationship between you and the vendor and how much the vendor should have to pay to make you whole. The answer lies in society's general interest to avoid economic waste and the overall benefits to society when economic waste is avoided.
Economic waste is the loss to society when an economic asset is wasted without any corresponding benefit. In the example above, society's resources have been invested in producing your apples and your apples have an economic value to society. If your apples are left on the side of the road to rot, society at large loses the economic value of your labor and your apples. If your apples are sold to another vendor or otherwise utilized, this economic waste is avoided.
The law discourages economic waste. Thus, there is a duty imposed on every party to a contract to make reasonable efforts to mitigate their damages. Examples of potentials for economic waste and the responses that the duty to mitigate would require are:
- A tenant defaults on its obligation to pay the landlord rent. The landlord has a duty to make reasonable efforts to lease the premises to another tenant, the rent received by the replacement tenant reducing the damages the landlord is entitled to recover from the defaulting tenant.
- A contractor fails to complete construction of a commercial building on time. The owner has a claim against the contractor for the damages caused by the delay. The owner has a duty to make reasonable efforts to minimize the negative effects of the loss of use of the building during the delay period.
- A gear manufacturer sells a defective gear to an engine manufacturer. The engine manufacturer is at risk of losing sales of its engines due to the defective gear. The engine manufacturer has a claim for damages against the gear manufacturer for any actual lost profits. The engine manufacturer also has a duty to find replacement gears from another gear manufacturer.
Waiver of the Duty to Mitigate
Many duties can be waived if such waiver is expressly set forth in a contract. Can the duty to mitigate be waived in a commercial contract? In 2006, the North Carolina Court of Appeals ruled that the duty to mitigate could be waived in a commercial lease. In the 2006 case, the landlord of a commercial shopping space rented a store to a tenant. The written lease between the parties had an express waiver of the duty to mitigate. The waiver clause stated that it was "understood that Landlord shall no obligations to mitigate Tenant's damages by reletting the . . . Premises."
The tenant's business relied heavily on patronage from the local college community. Initially, the tenant's business thrived. When the spring college session ended, the tenant's business fell off precipitously and the tenant was unable to continue making the lease payments and vacated the leased premises. The duty to mitigate would require that the landlord make reasonable efforts to lease the premises to a new tenant in an effort to raise some revenue from use of the premises and correspondingly, to reduce the tenant's damages.
The landlord argued that any duty to mitigate had been waived by the express terms of the lease. Conversely, the tenant argued that the duty to mitigate cannot be waived. The Court of Appeals agreed with the landlord, holding that the provision in the lease regarding the landlord having no obligation to mitigate by reletting the Premises was effective. In so ruling, the Court of Appeals heavily relied on the fact that this was a commercial lease. The Court of Appeals reasoned that the lease was an arms-length commercial transaction, which neither party was forced to enter into, and which involved two parties with equal bargaining power. The Court of Appeals also reasoned that it was not a violation of public policy to allow parties in a commercial lease to waive the duty to mitigate. The Court of Appeals concluded that it could not "relieve a party of the consequences of a commercial agreement that, in hindsight, proved not to be advantageous."
Note that waiver provision in the case was not reciprocal; i.e., there was no waiver of the tenant's duty to mitigate if the landlord breached the lease. Thus, implicit in the Court of Appeals' ruling is that a waiver of the duty to mitigate may be enforceable even if the waiver is not reciprocal.
Although the Court of Appeals made it clear that the same reasoning would not apply to residential leases, nothing in its opinion implied that the same reasoning would not apply to any commercial contract; i.e., presumably, a waiver of a duty to mitigate would be effective in any commercial contract, not just leases.
In our example, if you had included a waiver of your duty to mitigate your damages and the vendor agreed, then you could collect the full $1,000 from the vendor even though, in a moment of anger, you dumped your apples on the side of the road to rot. But don't expect to get such a provision without a fight or at least your agreement to waive the other party's duty to mitigate. But, now that you have read this article, you are less likely to allow such a clause to slip past you when you read proposed contracts.
The duty to mitigate is an important contractual duty that helps to insure that economic waste is minimized. Under North Carolina law, that duty can be waived in commercial situations. Before attempting or agreeing to waive the duty to mitigate, each contracting party should carefully consider and weigh the risks and rewards of doing so.
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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.