The New Business Rule and Compensation for Lost Profits

For many years most American jurisdictions applied the “new business” rule, denying recovery of lost profits for new businesses. The majority position today rejects the per se rule, treating the issue as a rule of evidence — lost profits must be proved with “reasonable certainty.” This paper argues that the new business rule ought not be viewed as merely a matter of whether the evidence is sufficient to surmount the “reasonable certainty” hurdle. The confusion arises because courts have lumped together a number of different problems. By breaking these out, a more nuanced picture emerges. For one category, in particular, the denial of recovery would be correct: Following a breach, the plaintiff, who has done nothing in reliance, claims that, but for the breach, I would have done X and I would have made a lot of money by doing so. The damage remedy has to take account of the opportunity cost of capital. Since there is no reason to believe that this particular investment would have been more profitable than any alternative use of the funds that the plaintiff saved because the deal cratered, there would be no loss. By failing to recognize this courts have in many instances overcompensated claimants.The loss would not be zero in other contexts in which the new business defense has been raised. If a licensee wrongfully failed to exploit intellectual property, the licensor’s claim for royalties foregone has a positive value. Claims for delay or breach of warranty likewise would have a positive expected value. By failing to distinguish these different categories, the courts produced a doctrinal mess.