When a supply chain manager contracts with a supplier of goods or services, both the buyer and the supplier are usually happy. The buyer is confident that he or she will receive the goods or services at a decent or even better than decent price and the seller is happy to have made the sale. Both parties believe that this transaction will be performed exactly as they have planned. They have reason to be optimistic. Millions of similar contracts are made every day and they are performed with little or no difficulty.

Unfortunately, not every deal ends happily. The buyer complains that the shipment was late or that the goods do not conform to the contract. The wrong model was sent, the shipment is short by a hundred units, the equipment is the right model but does not perform according to specifications, or the seller failed to ship at all. In a construction contract, the completed structure has a number of deficiencies. The HVAC system does not function as advertised, the elevators keep breaking down, the software continues to demonstrate various bugs. Any number of other problems may occur. The smiles at the time the contract was formed have turned into frowns and not just a little anger and frustration. What does the law—the legal system—do for the innocent ("aggrieved") party to this deal?

The rights and duties of the parties are based upon their contract. The purpose of contract law is to assure that the promises made by the parties are carried out. If one of the parties fails to perform its promise, contract law will intervene to assure that performance by providing a remedy that places the aggrieved party in the position it would have been in had the contract been performed. In a simple contract for the purchase and sale of equipment, if the seller fails to perform (breaches the contract) by not delivering the equipment, what is the buyer to do? The buyer will purchase the equipment from another supplier. If the buyer manages to buy the equipment from the second supplier at the same or lower price that it would have paid the breaching seller, the buyer is no worse off. While the first seller is guilty of a technical breach of contract and can be sued, the buyer can prove no damages. If the buyer sues the seller, the buyer will receive "nominal" damages, e. g., one dollar, simply to record the breach. There is rarely any reason to sue such a seller. Suppose, however, that the buyer can only find substitute equipment from another supplier at a higher price because the market price for the equipment has soared. To place the buyer in the same position it would have been in had the contract been performed, we must allow the buyer to purchase the equipment at the higher price and charge the breaching seller with the difference between the original contract price and the higher price. If the original contract price was $50,000 and the buyer had to "cover" by paying the substitute supplier $75,000, the buyer is entitled to recover damages of $25,000. By providing this remedy, the law places the innocent buyer in the position it would have been in had the original contract been performed, i.e., it provides the buyer with its "reasonable expectations." The buyer reasonably expected to receive this equipment for $50,000. By forcing the breaching seller to pay the buyer $25,000, the law protects those expectations because the buyer now has the equipment for the net price of $50,000.

Whether the contract is one for the purchase of equipment, supplies, raw materials or any other type of "good," or whether it is a contract for services, the same analysis applies. If the HVAC repair fails and the buyer resorts to another supplier to supply that service, the buyer should end up paying no more for the successful repair than it expected to pay under the original contract that was breached. If the equipment was delivered but was defective, the buyer may return that equipment. If the supplier cannot repair it or provide new equipment that is defective, the same analysis applies.

The buyer may also be entitled to other damages. When the equipment is not delivered or it is defective and the defects cannot be "cured" by the original supplier, beyond the difference between the original price ($50,000) and the substitute ("cover") price or $75,000, the buyer may be able to prove other losses. The buyer may have to stop production and lose the profits it would have made or suffer other extra expenses to perform its own contracts with its customers. If raw materials proved to be defective in the production process, the buyer may have to shut down the production process and clean it out before restarting it with conforming raw materials. The additional losses or damages are recoverable if the seller should have foreseen such damages at the time the original contract was formed. They are called "consequential" or "incidental" damages. In the simple equipment example, beyond the $25,000 in damages required by the cover purchase from a second supplier, a buyer may be able to prove $50,000 or more in consequential and incidental damages. Since it was the original supplier's breach that caused these damages, the buyer might recover such damages, again, to place the buyer in the position the buyer would have been in had the seller performed the original contract.

Buyers as well as sellers breach contracts. The seller is also entitled to have its reasonable expectations met. The seller is entitled to the price of the goods or services it supplies. If the buyer decided to breach the contract by refusing to accept the goods or services, the seller is typically entitled to the profit it would have made on the deal. If, for example, the seller simply refused to take the equipment priced at $50,000, the seller retains the equipment but can sue the buyer for the profit and reasonable overhead that the seller expected to earn on the contract. In a service contract, if the supplier has not taken another job because it booked the service for the buyer, the supplier must still pay its people and should not have lost the income it reasonably expected to make. The buyer can be held for such damages.

Other rules of contract law may allow the recovery of out-of-pocket expenditures (the reliance interest) or the recovery of the reasonable value of benefits conferred (the restitution interest) in other situations. Where, for example, a corporation incurred expenses in establishing a presentation for the sale of its product but was prevented from making the presentation because of a breach by another party, it cannot prove that it would have made any sales and profits if the presentation had taken place. It can, however, prove the expenses it incurred in reliance on the breaching party's promise which it should be permitted to recover. Sometimes a contract will not be enforceable because it is not evidenced by a writing. Contracts for the sale of goods must be evidenced by a writing. If a buyer makes some payment under an oral contract that is unenforceable, the seller may not keep that payment. The buyer should get its money back to prevent the unjust enrichment of the seller by protecting the buyer's restitution interest.

While the law of contract remedies works reasonably well, it has its deficiencies. If a party to a contract has to sue the contract breaker for damages, the cost of litigation can be significant. In the absence of a clause in the contract specifying that attorney's fees will be paid by the party who breaches the contract, even the "winner" of a lawsuit will be something of a loser when the bill for such fees arrives. Many more contracts disputes, therefore, are settled rather than litigated. It is generally wise to avoid the courtroom, if possible, because two things can happen and one of them is bad. You can lose, and even if you win, you may find that the cost of winning is expensive.