R.E. Davis Chemical Corp. v. Diasonics, Inc.

CUDAHY, Circuit Judge. Diasonics, Inc. appeals from the orders of the district court denying its motion for summary judgment and granting R.E. Davis Chemical Corp.'s summary judgment motion. . . . We . . . reverse the grant of summary judgment in favor of Davis and remand for further proceedings.

I.

Diasonics is a California corporation engaged in the business of manufacturing and selling medical diagnostic equipment. Davis is an Illinois corporation that contracted to purchase a piece of medical diagnostic equipment from Diasonics. On or about February 23, 1984, Davis and Diasonics entered into a written contract under which Davis agreed to purchase the equipment. Pursuant to this agreement, Davis paid Diasonics a $ 300,000 deposit on February 29, 1984. Prior to entering into its agreement with Diasonics, Davis had contracted with Dobbin and Valvassori to establish a medical facility where the equipment was to be used. Dobbin and Valvassori subsequently breached their contract with Davis. Davis then breached its contract with Diasonics; it refused to take delivery of the equipment or to pay the balance due under the agreement. Diasonics later resold the equipment to a third party for the same price at which it was to be sold to Davis.

Davis sued Diasonics, asking for restitution of its $ 300,000 down payment under section 2-718(2) of the Uniform Commercial Code (the "UCC" or the "Code") . . . Diasonics counterclaimed. Diasonics did not deny that Davis was entitled to recover its $ 300,000 deposit less $ 500 as provided in section 2-718(2)(b). However, Diasonics claimed that it was entitled to an offset under section 2-718(3). Diasonics alleged that it was a "lost volume seller," and, as such, it lost the profit from one sale when Davis breached its contract. Diasonics' position was that, in order to be put in as good a position as it would have been in had Davis performed, it was entitled to recover its lost profit on its contract with Davis under section 2-708(2) of the UCC . . .

Diasonics subsequently filed a third-party complaint against Dobbin and Valvassori, alleging that they tortiously interfered with its contract with Davis. Diasonics claimed that the doctors knew of the contract between Davis and Diasonics and also knew that, if they breached their contract with Davis, Davis would have no use for the equipment it had agreed to buy from Diasonics.

The district court dismissed Diasonics' third-party complaint for failure to state a claim upon which relief could be granted, finding that the complaint did not allege that the doctors intended to induce Davis to breach its contract with Diasonics. The court also entered summary judgment for Davis. The court held that lost volume sellers were not entitled to recover damages under 2-708(2) but rather were limited to recovering the difference between the resale price and the contract price along with incidental damages under section 2-706(1). Section 2-706(1) . . . . Davis was awarded $ 322,656, which represented Davis' down payment plus prejudgment interest less Diasonics' incidental damages. Diasonics appeals the district court's decision respecting its measure of damages as well as the dismissal of its third-party complaint.

II.

We consider first Diasonics' claim that the district court erred in holding that Diasonics was limited to the measure of damages provided in 2-706 and could not recover lost profits as a lost volume seller under 2-708(2). Surprisingly, given its importance, this issue has never been addressed by an Illinois court, nor, apparently, by any other court construing Illinois law. Thus, we must attempt to predict how the Illinois Supreme Court would resolve this issue if it were presented to it. Courts applying the laws of other states have unanimously adopted the position that a lost volume seller can recover its lost profits under 2-708(2). Contrary to the result reached by the district court, we conclude that the Illinois Supreme Court would follow these other cases and would allow a lost volume seller to recover its lost profit under 2-708(2).

We begin our analysis with 2-718(2) and (3). Under 2-718(2)(b), Davis is entitled to the return of its down payment less $ 500. Davis' right to restitution, however, is qualified under 2-718(3)(a) to the extent that Diasonics can establish a right to recover damages under any other provision of Article 2 of the UCC. Article 2 contains four provisions that concern the recovery of a seller's general damages (as opposed to its incidental or consequential damages); 2-706 (contract price less resale price); 2-708(1) (contract price less market price); 2-708(2) (profit); and 2-709 (price). The problem we face here is determining whether Diasonics' damages should be measured under 2-706 or 2-708(2). To answer this question, we need to engage in a detailed look at the language and structure of these various damage provisions.

The Code does not provide a great deal of guidance as to when a particular damage remedy is appropriate. The damage remedies provided under the Code are catalogued in section 2-703, but this section does not indicate that there is any hierarchy among the remedies. One method of approaching the damage sections is to conclude that 2-708 is relegated to a role inferior to that of 2-706 and 2-709 and that one can turn to 2-708 only after one has concluded that neither 2-706 nor 2-709 is applicable. . . Under this interpretation of the relationship between 2-706 and 2-708, if the goods have been resold, the seller can sue to recover damages measured by the difference between the contract price and the resale price under 2-706. The seller can turn to 2-708 only if it resells in a commercially unreasonable manner or if it cannot resell but an action for the price is inappropriate under 2-709. The district court adopted this reading of the Code's damage remedies and, accordingly, limited Diasonics to the measure of damages provided in 2-706 because it resold the equipment in a commercially reasonable manner.

The district court's interpretation of 2-706 and 2-708, however, creates its own problems of statutory construction. There is some suggestion in the Code that the "fact that plaintiff resold the goods [in a commercially reasonable manner] does not compel him to use the resale remedy of § 2-706 rather than the damage remedy of § 2-708." . . Official comment 1 to 2-703, which catalogues the remedies available to a seller, states that these "remedies are essentially cumulative in nature" and that "whether the pursuit of one remedy bars another depends entirely on the facts of the individual case." . . .

Those courts that found that a lost volume seller can recover its lost profits under 2-708(2) implicitly rejected the position adopted by the district court; those courts started with the assumption that 2-708 applied to a lost volume seller without considering whether the seller was limited to the remedy provided under 2-706. None of those courts even suggested that a seller who resold goods in a commercially reasonable manner was limited to the damage formula provided under 2-706. We conclude that the Illinois Supreme Court, if presented with this question, would adopt the position of these other jurisdictions and would conclude that a reselling seller, such as Diasonics, is free to reject the damage formula prescribed in 2-706 and choose to proceed under 2-708.

Concluding that Diasonics is entitled to seek damages under 2-708, however, does not automatically result in Diasonics being awarded its lost profit. Two different measures of damages are provided in 2-708. . . The profit measure of damages, for which Diasonics is asking, is contained in 2-708(2). However, one applies 2-708(2) only if "the measure of damages provided in subsection (1) is inadequate to put the seller in as good a position as performance would have done. . . ." . . . Diasonics claims that 2-708(1) does not provide an adequate measure of damages when the seller is a lost volume seller. To understand Diasonics' argument, we need to define the concept of the lost volume seller. Those cases that have addressed this issue have defined a lost volume seller as one that has a predictable and finite number of customers and that has the capacity either to sell to all new buyers or to make the one additional sale represented by the resale after the breach. According to a number of courts and commentators, if the seller would have made the sale represented by the resale whether or not the breach occurred, damages measured by the difference between the contract price and market price cannot put the lost volume seller in as good a position as it would have been in had the buyer performed. . . . The breach effectively cost the seller a "profit," and the seller can only be made whole by awarding it damages in the amount of its "lost profit" under 2-708(2).

We agree with Diasonics' position that, under some circumstances, the measure of damages provided under 2-708(1) will not put a reselling seller in as good a position as it would have been in had the buyer performed because the breach resulted in the seller losing sales volume. However, we disagree with the definition of "lost volume seller" adopted by other courts. Courts awarding lost profits to a lost volume seller have focused on whether the seller had the capacity to supply the breached units in addition to what it actually sold. In reality, however, the relevant questions include, not only whether the seller could have produced the breached units in addition to its actual volume, but also whether it would have been profitable for the seller to produce both units. . . . As one commentator has noted, under

the economic law of diminishing returns or increasing marginal costs[,] . . . as a seller's volume increases, then a point will inevitably be reached where the cost of selling each additional item diminishes the incremental return to the seller and eventually makes it entirely unprofitable to conclude the next sale.


. . . Thus, under some conditions, awarding a lost volume seller its presumed lost profit will result in overcompensating the seller, and 2-708(2) would not take effect because the damage formula provided in 2-708(1) does place the seller in as good a position as if the buyer had performed. Therefore, on remand, Diasonics must establish, not only that it had the capacity to produce the breached unit in addition to the unit resold, but also that it would have been profitable for it to have produced and sold both. Diasonics carries the burden of establishing these facts because the burden of proof is generally on the party claiming injury to establish the amount of its damages; especially in a case such as this, the plaintiff has easiest access to the relevant data. .

One final problem with awarding a lost volume seller its lost profits was raised by the district court. This problem stems from the formulation of the measure of damages provided under 2-708(2) which 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 (Section 2-710), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale." . .. The literal language of 2-708(2) requires that the proceeds from resale be credited against the amount of damages awarded which, in most cases, would result in the seller recovering nominal damages. In those cases in which the lost volume seller was awarded its lost profit as damages, the courts have circumvented this problem by concluding that this language only applies to proceeds realized from the resale of uncompleted goods for scrap. . . Although neither the text of 2-708(2) nor the official comments limit its application to resale of goods for scrap, there is evidence that the drafters of 2-708 seemed to have had this more limited application in mind when they proposed amending 2-708 to include the phrase "due credit for payments or proceeds of resale." . . . We conclude that the Illinois Supreme Court would adopt this more restrictive interpretation of this phrase rendering it inapplicable to this case.

We therefore reverse the grant of summary judgment in favor of Davis and remand with instructions that the district court calculate Diasonics' damages under 2-708(2) if Diasonics can establish, not only that it had the capacity to make the sale to Davis as well as the sale to the resale buyer, but also that it would have been profitable for it to make both sales. Of course, Diasonics, in addition, must show that it probably would have made the second sale absent the breach. . .