Contract Damages: Domestic and International Perspectives 9781472560285, 9781841137414

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Foreword FOREWORD

This collection of essays is one result of a conference in June 2007 in Birmingham University’s attractive Business School, part of which I had the pleasure of chairing. Their focus is on a traditionally somewhat neglected field, but one of domestic and international significance to which increasing attention has rightly been addressed in recent years. The essays take damages in the widest (perhaps even controversial) sense of the word, with a number of papers tackling the border territory where ‘restitutionary damages’ may represent an alternative to reliance and expectation measures. This is territory where, since the House of Lords’ decision in Attorney General v Blake in 2000, no practitioner can afford to be lost. But the maps are still being written, with academic assistance playing an invaluable role. The courts will for some time be engaged in implementing Lord Steyn’s injunction in Blake to hammer out ‘on the anvil of concrete cases’ exceptions to the general principle that there is no remedy for disgorgement of profits in cases of breach of contract. The whole collection includes essays by a range of distinguished experts which address not only the philosophical underpinning of the law of damages, but also more specifically topics such as the UN Convention on the International Sale of Goods and UNIDROIT principles. Together, these essays represent a valuable, informative and stimulating body of material, for both study and reference. The organisers, Djakhongir Saidov and Ralph Cunnington, are to be congratulated for arranging the conference and marshalling, as a result, a most interesting set of contributions to learning in this important field. Lord Mance of Frognal

List of Contributors LI S T OF CONTRI BUTORS

MICHAEL BRIDGE, LLB, LLM, Professor of Commercial Law, London School of Economics ANDREW BURROWS, BCL, MA, LLM, QC, Norton Rose Professor of Commercial Law and Fellow of St Hugh’s College, University of Oxford RALPH CUNNINGTON, LLB, LLM, Lecturer in Law, University of Birmingham FRANCO FERRARI, JD, LLM, Professor, University of Verona DANIEL FRIEDMANN, MJur, LLM, DRJ Sur, Minister of Justice, Israel MICHAEL FURMSTON, LLM, MA, BCL, Dean, School of Law, Singapore Management University, Professor Emeritus, University of Bristol JOHN GOTANDA, JD, Professor of Law, Associate Dean for Faculty Research, Villanova University PASCAL HACHEM, Referendar, Research and Teaching Assistant, University of Basel PETER JAFFEY, BA, LLM, Professor of Law, Brunel University ALEXANDER KOMAROV, Doctor of Legal Sciences, Professor and Head of Private Law Chair, Russian Academy of Foreign Trade, President, International Commercial Arbitration Court at the Russian Federation Chamber of Commerce and Industry ADAM KRAMER, BA, LLM, Barrister, 3 Verulam Buildings HARVEY MCGREGOR, QC, DCL, SJD, Barrister, Hailsham Chambers DAVID MCLAUCHLAN, LLM, Professor of Law, Victoria University Wellington ANTHONY OGUS, BCL, MA, CBE, FBA, Professor of Law, University of Manchester CHARLES PROCTOR, LLB, LLD, Partner, Bird & Bird, Honorary Professor of Law, University of Birmingham JAN RAMBERG, LLD, Professor Emeritus, University of Stockholm DJAKHONGIR SAIDOV, LLB, LLM, PHD, Lecturer in Commercial Law, University of Birmingham

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List of Contributors

INGEBORG SCHWENZER, Dr iur, LLM, Professor of Private Law, University of Basel STEPHEN A SMITH, BA, DPhil, William Dawson Scholar and Professor of Law, McGill University STEPHEN WADDAMS, BA, MA, PhD, LLB, LLM, SJD, FRSC, University Professor and Goodman / Schipper Professor of Law, University of Toronto

Current Themes in the Law of Contract Damages: Introductory Remarks I NTRODUCTORY REMARKS

DJAKHONGIR SAIDOV AND R ALPH CUNNINGTON DJ AKHONGI R S AI DOV AND RALPH CUNNI NGTON

I

I NTRO DUCTION

The law of contract damages continues to fascinate and interest lawyers throughout the common and civil law world. The reasons for this are plenty, but perhaps three in particular stand out. First, much of the interest stems from the close connection between the law of damages and the wider policies and purposes pursued by the law of contract. In this respect, we would agree with Professor Farnsworth who argued that: [n]o aspect of a system of contract law is more revealing of its underlying assumptions than is the law that prescribes the relief available for breach.1

The better we understand the law of contract damages, the better we understand the policies and values that underlie the law of contract itself. Secondly, it is clear that the existence of remedies and, in particular, damages is vital for the effective operation of contract law. Without effective remedies,2 the law of contract would lose much of its force and value,3 and the market economy, which it aims to support and facilitate,4 1 EA Farnsworth, ‘Damages and Specific Relief’ (1979) 27 American Journal of Comparative Law 247. 2 Professor Coote makes the important point that contractual obligations are legal obligations only to the extent that they are enforced by the law: B Coote, ‘Contractual Damages, Ruxley, and the Performance Interest’ [1997] CLJ 537, 541. See also F Dawson, ‘Reflections on Certain Aspects of the Law of Damages for Breach of Contract’ (1995) 9 Journal of Contract Law 125, 125–6. 3 See, eg AL Corbin, Corbin on Contracts: A Comprehensive Treatise on the Working Rules of Contract Law (2002) 2. 4 H Collins, The Law of Contract (London, Butterworths, 4th edn, 2003) 9; J Jackson, ‘Global Economics and International Economic Law’ (1998) 1 Journal of International Economic Law 1, 5; A Rosett, ‘Unification, Harmonization, Restatement, Codification, and Reform in International Commercial Law’ (1992) 40 American Journal of Comparative Law 683.

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would be substantially undermined. Thirdly, in the context of commercial contracts, there can be little doubt that damages are the most commonly claimed remedy. This is due, in part, to the common law’s position that damages are the primary remedy for breach of contract. But there is another, more general, reason for the primacy of damages that applies to civil law jurisdictions as well. Because commercial people are predominantly concerned with pecuniary matters they want to achieve the end results in monetary terms. For that reason, the monetary remedy of damages will usually be their remedy of choice. In recent years, the challenge to understanding contract damages has increased significantly with the emergence and development of the law of international instruments such as the Convention on Contracts for the International Sale of Goods (CISG),5 the UNIDROIT Principles of International Commercial Contracts (UPICC)6 and the Principles of European Contract Law (PECL).7 These instruments pursue the goal of harmonising (and, to some extent, unifying) sales and contract law at the international and, in the case of the PECL, regional levels. This goal adds complexity to the analysis of contract damages in the context of these instruments, as lawyers now have to consider the importance and relevance of additional factors and values which might not have been relevant to a discussion of contract damages in the context of domestic legal systems. This book aims to contribute to the continuing discourse in this area of the law. The chapters are based on papers presented and discussed at the Contract Damages: Domestic and International Perspectives conference held at the University of Birmingham in June 2007. The essays reflect the central themes of the conference: the purpose and scope of damages, the measure of damages, issues of recoverability, the methods of limiting damages and the assessment of damages. Many of the chapters integrate an analysis of the common law position with a discussion from the perspective of the international contract law instruments. This reflects the contributors’ conviction that, in an increasingly globalised world, lawyers should be ready and willing to learn from the experiences of other legal systems. In the remainder of this introductory chapter we do not intend to follow the structure of the book (as many such essays tend to do) but instead focus on three themes that dominated discussion at the conference. In so doing, it is hoped that we will provide the reader with an insight into the discussion and debate that took place at the conference and enable the reader to see how the essays contained herein engage with that debate. Available at http://www.cisg.law.pace.edu/cisg/text/cisg-toc.html (accessed 27 June 2007). Available at http://www.unidroit.org/english/principles/contracts/principles2004/black letter2004.pdf (accessed 27 June 2007). 7 O Lando and H Beale, The Principles of European Contract Law (The Hague, Kluwer, 2000). 5 6

Introductory Remarks II

A

3

THE M ERITS O F A COMPARAT IVE APPROACH

General

Although a substantial emphasis in this volume is placed on contract damages in the common law and under the international instruments, it is fair to say that the volume reflects an ongoing dialogue on contract damages by representatives of different legal systems and there is little doubt that its scope is truly comparative. We believe that, in an age characterised by the globalisation of commerce and markets and arguably by a gradual ‘transnationalisation’ of commercial law,8 a comparative approach is not only beneficial but also necessary. The benefits associated with a comparative method are well known9 and this is not a place to set them out fully. What we aim to do in this section is to highlight the importance and some possible merits of a comparative approach to the extent that they have special relevance to contract damages and the volume’s scope.

B The Benefits of a Comparative Approach for the International Instruments While it is true that the starting point for any comparative exercise is to generate and disseminate knowledge,10 such an exercise will almost inevitably result in great practical benefits and will possibly lead to further legal development. Examining the experiences of different legal systems in the area of contract damages helps, in our view, to identify problems, questions and difficult factual situations that may arise and hence require treatment in any legal system. A comparative exercise will also provide a range of possible solutions to a particular problem, thereby broadening horizons for a lawmaker, a judge, a practitioner or a scholar. These potential benefits are particularly important so far as the international instruments are concerned. One reason is that neither the CISG nor the UPICC and PECL have yet had a degree of exposure and strength of experience comparable to those of well-developed legal systems. The CISG, for example, is often regarded as a ‘skeleton’ or a minimalist instrument11 and, for such a legal 8 See, eg KP Berger, ‘Transnational Commercial Law in the Age of Globalization’, available at http://w3.uniroma1.it/idc/centro/publications/42berger.pdf (accessed 27 June 2007). 9 For a helpful introduction containing extracts and references to relevant sources, see R Goode, H Kronke and E McKendrick, Transnational Commercial Law: Text, Cases, and Materials (Oxford University Press, 2007) 133–89. 10 K Zweigert and H Kötz, An Introduction to Comparative Law (Oxford, Clarendon Press, 3rd edn, 1998) 15. 11 See, eg JS Ziegel, ‘The Remedial Provisions in the Vienna Sales Convention: Some Common Law Perspectives’ in N Galston and H Smit (eds), International Sales: The United Nations Convention on Contracts for the International Sale of Goods (New York, Matthew Bender,

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regime, knowledge of a range of problems and factual situations, which have not yet arisen but may potentially arise, will prove invaluable. Ingeborg Schwenzer and Pascal Hachem12 also make an important point in their chapter by stating that the modern age has brought about a number of new challenges, both in law and outside of it, which cannot go unnoticed when the CISG is applied. In fact, the authors’ point sends quite an alarming message: If [the CISG] does not respond to current demands and continues to focus on the state of discussion prevalent in the 1970s (or more accurately the nineteenth century), it risks falling back into obscurity. The necessary adjustments will then be made by the concurrent application of domestic remedies to precisely those cases for which the CISG was originally designed. The battle for uniformity fought by the CISG would be lost.

C The Knowledge of Factual Situations and the Complexity of Modern Transactions To return to our point about the importance of being aware of a range of possible factual situations, we believe that such awareness plays an essential role in our understanding of the law of damages. As Michael Bridge states,13 it is impossible to find ‘the law on damages in the text of statutory rules’, and for this reason we believe that a true knowledge of this area of law can only derive from a clear understanding of the complexity and variety of problems surrounding modern commercial transactions. This may also partly explain the prominent role played by the English commercial law today which, thanks to its long tradition and a well-developed culture of the reliance on judicial precedent, has accumulated a substantial body of case law from which commercial spirit and the intricacies of commercial life emanate. It is important, however, not to be blinded by the experience and relative successes of a particular system as legal development has often been driven by the movement of ideas from one system to another and, in our view, legal systems should exist in the atmosphere of mutual enrichment. Some of the contributions to this volume do provide relevant examples in this respect. Thus, Franco Ferrari traces the origin of the well-known ‘foreseeability rule’ and demonstrates that its establishment in the common law through the English case of 1984) 9–4; J Felemegas, ‘Introduction’ in An International Approach to the United Nations Convention on Contracts for the International Sale of Goods (1980) as Uniform Sales Law (Cambridge University Press, 2007) (with further reference to Albert Kritzer), available at http://www. cisg.law.pace.edu/cisg/biblio/felemegas14.html (accessed 18 October 2007). 12 See I Schwenzer and P Hachem, ‘The Scope of the CISG Provisions on Damages’, this volume. 13 See M Bridge, ‘The Market Rule of Damages Assessment’, this volume.

Introductory Remarks

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Hadley v Baxendale14 has roots in the civil law.15 Alexander Komarov,16 in turn, while also pointing out the civil law origin of the rule, states that the common law has been more successful than the civil law in developing this rule, largely due, once again, to a developed tradition of relying on case law. The complexity and diversity of modern commercial practices and transactions, referred to in the previous paragraph, also make it necessary for lawyers to go beyond a legal discipline and to get acquainted with, and learn from, developments in other disciplines and sciences. This point is made by Komarov, who, from the standpoint of his experience in commercial practice, argues that the reliance on general rules of damages, many of which were formed in domestic legal systems a long time ago, may no longer be adequate against the background of modern commercial practices, sophisticated transactions and the ‘complex mathematical formulae used by economists in providing their calculation of damages’. Djakhongir Saidov’s contribution17 has attempted to do just that, by taking account of modern developments, both within and outside of the law, insofar as they can be relevant for measuring damages for injury to business reputation and goodwill.

D

The Role of the International Instruments

Returning to the role played by the international instruments, despite the remarks made earlier about their possible lack of experience as compared with some more developed domestic counterparts, there is no doubt that the instruments deserve the most serious attention and examination. There are many reasons for this. First, the CISG has now been ratified by 70 states18 and its rules arguably represent an international consensus as to what rules should govern international sales transactions. Similarly, the UPICC not only contain rules which are common to many legal systems, (1854) 9 Ex 341. Professor Ferrari’s contribution is not only concerned with the origin of the rule. His central argument is that, while in cases where the Convention’s drafters intended a particular concept to be interpreted from the standpoint of its counterpart in a domestic legal system, resorting to the ‘domestic’ understanding of the concept should be allowed in interpreting the CISG; however, the foreseeability rule in Art 74 is no such rule. He suggests that ‘the mere fact that the wording of a particular CISG provision corresponds to that of a specific domestic rule (whether created by statute or case law) is per se insufficient to allow resorting to the interpretation of that domestic rule’ (F Ferrari, ‘Hadley v Baxendale v Foreseeability under Article 74 CISG’, this volume ). 16 See A Komarov, ‘The Limitation of Contract Damages in Domestic Legal Systems and International Instruments’, this volume. 17 See D Saidov, ‘Damage to Business Reputation and Goodwill under the Vienna Sales Convention’, this volume. 18 See http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980CISG_status.html (accessed 18 October 2007). 14 15

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but also introduce solutions which were thought to be most suitable for the needs of international commerce.19 Secondly, these instruments are of a different legal nature than domestic regimes and they have undeniably marked a new stage in the development of truly international commercial law. Thirdly, notwithstanding a degree of skepticism still existing in legal circles regarding the movement to unify, harmonise and codify commercial law,20 the international instruments have become firmly entrenched in the commercial and contract law world: they are regularly applied by judges and arbitrators, and used as models for legal reform in a number of states as well as for drafting international contracts.21 Fourthly, it can certainly be argued that, in a number of areas, the instruments are superior to even some of the leading domestic systems22 and for this reason domestic counterparts may have much to learn from them. Although the quality of many of the decisions under the CISG leaves a lot to be desired (for one thing, because it is applied in so many fora), there is now a substantial body of cases23 (particularly in relation to damages) which, if comprehensively analysed,24 may reveal and raise new problems and questions peculiar to international transactions with correspondingly novel solutions and analyses. Thus, while the instruments benefit from domestic regimes, the reverse is equally true. Unfortunately (but not surprisingly), this mutual interaction has not been, in our opinion, entirely satisfactory. Courts applying the CISG not infrequently manifest what is known as the ‘homeward trend’, that is, the interpretation of the Convention from the standpoint of their own domestic system. One reason is, of course, the lack of knowledge of the Convention’s regime, purpose and spirit, together with the lack of desire to gain that knowledge. The latter, we believe, is a major obstacle to a potentially fruitful interaction between domestic regimes and the Convention. Nowhere is this criticism more relevant than in the context of English 19 UNIDROIT Principles of International Commercial Contracts 2004 (Rome, International Institute for the Unification of Private Law, 2004) xv. 20 For a well-known exposition of this criticism, see JS Hobhouse, ‘International Conventions and Commercial Law: The Pursuit of Uniformity’ (1990) 106 LQR 530. 21 With respect to the UPICC, see, eg MJ Bonell, ‘UNIDROIT Principles 2004—The New Edition of the Principles of International Commercial Contracts Adopted by the International Institute for the Unification of Private Law’ (2004) 45 Uniform Law Review 5, 6–17. 22 See the quotation by Roy Goode reproduced in the main text below. 23 For a constantly growing collection of cases under the CISG, see, eg www.cisg.law.pace.edu (accessed 18 October 2007). 24 Some recent attempts to do so in the context of damages include H Stoll and G Gruber, ‘Arts 74–77 CISG’ in P Schlechtriem and I Schwenzer (eds), Commentary on the UN Convention on the International Sale of Goods (CISG) (Oxford University Press, 2nd edn, 2005) and CISG Advisory Council (CISG-AC) Opinion No 6 ‘Calculation of Damages under CISG Article 74’, available at http://www.cisg.law.pace.edu/cisg/CISG-AC-op6.html (accessed 18 October 2007). For a forthcoming work dedicated wholly to this subject, see D Saidov, The Law of Damages in International Sales—The CISG and Other International Instruments (Oxford, Hart Publishing, 2008).

Introductory Remarks

7

commercial law, and Roy Goode’s powerful argument is worth recalling here: Nowhere is [a] chauvinistic approach better exemplified than in our attitude towards the Vienna Sales Convention . . . it is for the most part a good deal better than our own Sale of Goods Act . . . it may serve the English party much better than a foreign domestic law to which that party might otherwise be subject . . . Why cannot we give leadership and in so doing increase our influence on transnational commercial law?25

E Final Remarks A few final remarks remain to be made. First, so far as the comparison between the instruments themselves is concerned, it needs to be noted that such an exercise may involve more than just achieving the purposes set out above. Thus, the preamble to the UPICC provides that the Principles ‘may be used to interpret or supplement international uniform law instruments’, and the question as to the extent to which the UPICC can supplement the provisions of the CISG on damages is still unresolved. In his contribution to this volume, John Gotanda sets out his views as to the relationship between the two instruments.26 His argument is that: while the UPICC should not exert influence of their own force in interpreting the CISG, they can facilitate an understanding of the general principles and help support a gap filling rule derived from general principles of the CISG.

Secondly, some time ago, it was said that the law of damages is a field of contract law which is ‘particularly fraught with national variation’.27 This leads us to wonder whether, so far as most legal systems (both domestic and transnational) are concerned, there is now a common way of thinking about contract damages. It is difficult to give a definite answer. On the one hand, as Komarov has shown, the methods of limiting damages used in different systems do not present a great deal of diversity and the international instruments, by and large, contain rules and concepts which are known to many domestic systems, and this may point towards an affirmative answer.28 It can also be argued that the fact that representatives of different legal systems manage to agree on a set of rules on damages is in itself evidence of the existence of a common way of thinking about damages. On the other hand, commercial law can be partly viewed as a R Goode, Commercial Law in the Next Millennium (London, Sweet & Maxwell, 1998) 95. J Gotanda, ‘Using the UNIDROIT Principles to Fill Gaps in the CISG’, this volume. See BM Cremandes, ‘The Impact of International Arbitration on the Development of Business Law’ (1983) 31 American Journal of Comparative Law 530. 28 This is, of course, subject to the instruments’ requirement that they be interpreted independently of domestic law and in accordance with the instruments’ international character. 25 26 27

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reflection of the level of economic and business development and culture to be found in a given country. In this regard, Komarov suggests that there is a link between the level of detail with which the law of damages is developed in a particular system, on the one hand, and the degree of economic development and the level and diversity of commercial turnover in a particular country, on the other. In particular, he states that: [a]s a rule, less developed legal techniques are to be found in countries with a lower degree of industrialisation and an insufficient diversity of commercial turnover as well as where private legal relationships are underdeveloped.

Thus, while lawyers may naturally admire sophisticated and welldeveloped sets of rules and principles governing contract damages in a particular legal system, such a high level of sophistication and development may not necessarily be needed or, indeed, appropriate for some countries. However, a decision not to develop a detailed structure of the law of damages may flow not only from considerations linked to the country’s economic and commercial development but also from some other considerations, and examples of such an approach can be found in systems with both a high level of economic development and a long-standing legal culture and tradition. Komarov refers to the new Dutch Civil Code, which contains no fixed or formal criteria for determining damages except some principles intended to provide general guidance.29 It follows, from this discussion, that there is still a variety of ways in which the rules on contract damages are structured and the extent to which they are developed. And, perhaps, diversity is what is needed. If, in a global market place, various legal regimes (domestic and international) are viewed, in a way, as products on a market, then the potential consumers (that is, commercial people and their lawyers) would arguably want to have a choice.

III

A

T H E D E F I N I T I O N AN D P U R P O S E O F DA M AG E S

General

In this section, we examine four fundamental issues relating to the definition and purpose of damages: the first, that of the availability of non-compensatory measures of damages, is a relatively recent topic for debate stimulated by the House of Lords’ decision in Attorney General v Blake; the second, concerning the nature and essence of the law of damages, is a relatively underexplored, and we would suggest much neglected, topic; the third and fourth issues are much more widely 29 ‘Thus, Article 97 simply gives the authority to a court to assess damages in a manner most appropriate to their nature’ (Komarov, above n 16, with further references).

Introductory Remarks

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discussed in the literature and concern the age-old debates about the analytical structure and the normative basis of the law of contract. We believe that the essays contained in this volume make important contributions to each of these issues.

B The Definition of Damages and the Availability of Non-compensatory Awards Given the large number of works on the law of damages,30 one would have expected the definition of damages to be fixed and beyond dispute, but it appears that this is not so. Harvey McGregor opened the most recent edition of his work on damages with the following words: A resounding definition of the term damages would make for a fitting opening of a work on the law of damages and in their first sentence earlier editions have done just this. But it has become more and more difficult, as time has moved on, to construct a definition of damages which is satisfactory and which is comprehensive. So many exceptions to, and qualifications upon, once solid, clear, unadulterated rules have appeared, perfectly sensibly, that a clear-cut definition is no longer feasible; the arrival of restitutionary damages and of human rights was the last straw. The impossible search for a clear-cut comprehensive definition is therefore abandoned.31

We would suggest that the problem is not so much with defining damages per se but more with defining damages in the specific terms that were characteristic of previous editions of McGregor. In the aftermath of Attorney-General v Blake, it is no longer possible to limit damages to compensation. Nor can it be said that damages are only available in actions based on common law wrongdoing.32 Perhaps the most specific definition we can give today is that ‘damages are a monetary award given for a wrong’.33 30 See, eg H McGregor, McGregor on Damages (London, Sweet & Maxwell, 17th edn, 2003); S Waddams, The Law of Damages (Toronto, Canada Law Book, 4th edn, 2004); AM Tettenborn, D Wilby and D Bennett, The Law of Damages (London, Butterworths Tolley, 2003); A Ogus, The Law of Damages (London, Butterworths, 1973). 31 McGregor, ibid, 3 [1-001]. 32 Damages are now available for statutory wrongdoing under s 8 of the Human Rights Act 1998 and it is now quite common for judges to refer to equitable compensation as damages: Bartlett v Barclays Bank Trust Co Ltd (No 2) [1980] Ch 515 (Ch) 545 (Brightman LJ); Bristol and West Building Society v Mothew [1998] Ch 1 (CA) 17 (Millett LJ); Cia de Seguros Imperio v Heath (REBX) Ltd [2001] 1 WLR 112 (CA) 125 (Clarke LJ). 33 See J Stapleton, ‘A New “Seascape” for Obligations: Reclassification on the Basis of Measure of Damages’ in P Birks (ed), The Classification of Obligations (Oxford, Clarendon Press, 1997) 193; R Cunnington, ‘The Measure and Availability of Gain-Based Damages for Breach of Contract’, this volume.

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The nature and availability of non-compensatory measures of damages is addressed in a number of the essays in this volume. Stephen Smith,34 Anthony Ogus35 and Schwenzer and Hachem all address the availability of punitive damages. They all concede that such awards are not currently available in English law or under the CISG, but each proposes a role for punitive damages in certain exceptional cases.36 Schwenzer and Hachem suggest that punitive damages should be awarded in cases where the breach of contract was intentional and in bad faith in order to provide full compensation for the aggrieved party. Ogus, on the other hand, suggests a more limited role, restricting punitive damages to cases where the party in breach sought to ‘cover up the breach’ or evade its contractual liability.37 Several of the essays address the measure and availability of gain-based damages. Andrew Burrows38 and Stephen Waddams39 adopt contrasting analytical approaches to this topic. Waddams applies what he refers to as a historical approach, suggesting that ‘considerations of justice, undue enrichment, restitution, and compensation were all in operation’ in the cases where gain-based damages were awarded.40 Burrows, on the other hand, argues that all attempts to analyse Wrotham Park damages as a form of compensation are unrealistic. He prefers a restitutionary analysis, viewing Wrotham Park damages as a partial disgorgement of a fair proportion of the contract breaker’s profits. While Ralph Cunnington agrees with Burrows that Wrotham Park damages are gain-based rather than compensatory, 41 he insists that a distinction must be drawn between damages that reverse a transfer of value (Wrotham Park damages) and damages that disgorge the contract breaker’s profit (Blake damages).42 Regarding the issue of when gain-based damages ought to be available, Waddams suggests that a number of factors ought to be taken into account, including: S Smith, ‘The Law of Damages: Rules for Citizens or Rules for Courts?’, this volume. A Ogus, ‘The Economic Basis of Damages for Breach of Contract: Inducement and Expectation’, this volume. 36 Although Smith provides no view on the desirability of punitive damages for breach of contract in his chapter, see his earlier work: S Smith, ‘Performance, Punishment and Contractual Obligations’ (1997) 60 MLR 360. 37 See also S Smith, ‘Performance, Punishment and Contractual Obligations’ (1997) 60 MLR 360, 375. 38 A Burrows, ‘Are “Damages on the Wrotham Park Basis” Compensatory, Restitutionary or Neither?’, this volume. 39 S Waddams, ‘Gains Derived from Breach of Contract: Historical and Conceptual Perspectives’, this volume. 40 The question of whether gain-based damages can be treated as a proxy for compensation in circumstances where loss is difficult to measure is dealt with below in our consideration of the meaning and definition of loss. 41 R Cunnington, ‘The Measure and Availability of Gain-Based Damages for Breach of Contract’, this volume. 42 The importance of this distinction is discussed below in relation to the availability of these measures of damages. 34 35

Introductory Remarks

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—the availability of specific enforcement; —the proprietary or quasi-proprietary nature of the interest infringed; —whether the claimant has been deprived of a valuable opportunity to bargain; —whether the claimant has a legitimate non-economic interest that is not adequately compensated by the ordinary measure of damages; —whether the defendant is unjustly enriched by retaining the gain; —whether the claimant would be perceived as receiving a windfall if the gain were transferred; —whether the breach of contract is reprehensible; and —whether there was a public interest in deterring it. Cunnington prefers a single criterion and ties the availability of gain-based damages to the availability of specific relief. He does, however, draw a distinction between cases in which the court ‘cannot’ order specific relief (in which case, he suggests that account of profits is appropriate) and cases in which the court ‘will not’ order specific relief (in which only Wrotham Park damages should be available). A substantial part of Burrows’s chapter is dedicated to examining Robert Stevens’s ‘rights-based’ approach to damages. Stevens argues that Wrotham Park damages are neither compensatory nor restitutionary but are instead awarded in substitution for the right infringed by the contract breaker.43 Burrows rejects this approach, arguing that it is impossible for it to be reconciled with the current state of the law. In particular, he suggests that it contradicts the law on mitigation, is inconsistent with the rules on the date of assessment, is liable to lead to double recovery and renders nominal damages redundant. Burrows also questions whether we sensibly can, or would want to, put a value on the right infringed by the contract breaker without any consideration of the actual impact of the infringement.

C

The Nature of the Law of Damages

Although there exists voluminous literature on the analytical structure of the law of damages and on the normative basis for damages, very little has been written on the nature of the law itself. Few commentators have asked the question: what precisely is the law of damages? Smith’s chapter analyses 43 R Stevens, Torts and Rights (Oxford University Press, 2007) ch 4. Other commentators have adopted a similar analysis but within a compensatory framework: see M McInnes, ‘Gain, Loss and the User Principle’ (2006) 14 Restitution Law Review 76; J Edelman, ‘Gain-based Damages and Compensation’ in A Burrows and Lord Rodger (eds), Mapping the Law (Oxford University Press, 2006) 153–8. See also Cunnington’s chapter in this volume.

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the kinds of rights that are dealt with by the law of damages and asks whether those rights are private law rights or public law rights. He suggests that there are three main categories of rights that the courts take into account when making damages orders: (i) the rights that citizens enjoy against other citizens prior to any action by the court (‘ordinary rights’); (ii) the rights that citizens enjoy against courts (‘remedial rights’); and (iii) the rights that citizens enjoy against other citizens by virtue of orders made by courts (‘court-ordered rights’). The first and third categories constitute private law rights, while the second concerns public law rights. The relationship between the three categories is both complex and symbiotic. In some cases (eg an action for payment of a debt), the court-ordered right will be derived from the claimant’s remedial right and its content will be derived from the creditor’s ordinary right to payment. In other cases, however (eg orders of punitive damages), the court-ordered right will be non-derivative and created at the time of the order. The law of damages is correspondingly complex. Smith suggests that there are four kinds of court orders. First, there are orders that have a mixed private/public law explanation. Here the claimant’s court-ordered right is derived from a combination of the claimant’s remedial and ordinary rights. An order to pay a debt is a classic example. Secondly, there are orders that have a pure private law explanation. In this category, the content of the order is fixed by the claimant’s ordinary right but the claimant has no remedial right to the order. Smith suggests that an order of specific performance would be an example, but admits that this is by no means uncontroversial. Thirdly, there are orders with a pure public law explanation. This category comprises orders to which the claimant has a remedial right but whose content is not dictated by the claimant’s ordinary right. Smith suggests that monetary restitution in a quantum valebant claim would fall into this category. Fourthly, there are orders with no legal explanation. The existence and content of these orders is completely within the discretion of the court. A remedial constructive trust is a possible example. Smith suggests that this reconceptualisation of court orders is of importance at both a theoretical and a moral level. It determines when the moral obligation to pay damages arises (which inevitably has important practical implications as well) and is important to judges (and other lawmakers) who have the responsibility of determining what morality requires them to do in their particular office. The reconceptualisation is also important for legal scholars who strive to better understand and explain the law of damages. Smith concludes that the law as it stands lumps together qualitatively different kinds of monetary orders under the heading of ‘damages’. These groups, he suggests, need to be disentangled, although the question as to which group should retain the label ‘damages’ must remain a question for the future.

Introductory Remarks D

13

The Interests Protected by an Award of Damages

There has been a lot of debate in the academic literature about the nature of the interests protected by an award of damages. Perhaps the best known article is that of Fuller and Perdue, in which they argued that an award of damages pursued three purposes: (i) protection of the restitution interest; (ii) protection of the reliance interest; and (iii) protection of the expectation interest.44 The writers contended that it was the reliance interest rather than the expectation interest that deserved the protection of the courts, and that expectation damages are only justified because they provide a proxy for reliance loss and operate as a deterrent to losses incurred through detrimental reliance. Almost 60 years after Fuller and Perdue’s article was published, Daniel Friedmann wrote a devastating response.45 He reasserted the primacy of the ‘performance interest’ (his preferred term for the expectation interest) and suggested that it was only the terminology and not the substantive content of Fuller and Perdue’s thesis that has exercised influence over the development of the law. Friedmann’s chapter in this volume 46 examines the distinct roles played by damages and specific performance in the protection of the performance interest. His central thesis is that an order of specific performance protects the subjective value of the promised performance whereas an award of damages protects its objective value. This has a number of significant implications. First, the assessment of damages will generally not take into account subjective elements such as distress, vexation and aggravation, whereas specific performance will ordinarily remedy those harms. Secondly, specific performance will be more advantageous to the aggrieved party where the subjective value that she places upon the promised performance exceeds its objective value (eg the Ruxley case47). Thirdly, damages will be more advantageous in situations where the subjective loss to the aggrieved party is lower than the objective loss assessed for the purpose of damages. Fourthly, the contractual rules of remoteness are irrelevant to an order of specific performance and the burden of mitigation has only a limited role to play. Fifthly, specific performance may benefit third parties for whom damages may not be available. Friedmann maintains that both damages and specific

44 LL Fuller and WR Perdue, ‘The Reliance Interest in Contract Damages’ (1936) 46 Yale Law Journal 53. Although some commentators have equated the restitution interest with awards of gain-based damages, it is clear from what Fuller and Perdue actually wrote that what they had in mind was the action for autonomous unjust enrichment. 45 D Friedmann, ‘The Performance Interest in Contract Damages (1995) 111 LQR 628. 46 See D Friedmann, ‘Economic Aspects of Damages and Specific Performance Compared’, this volume. 47 Ruxley Electronics and Construction Ltd v Forsyth [1996] AC 344 (HL).

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performance operate to protect the performance interest of the contract but that they do so in vastly differing ways. Peter Jaffey, in his contribution to the volume,48 prefers a reliance-based account of contracting, insisting that the basic measure of contract damages is the reliance measure. He recognises that the orthodox promissory analysis provides a simpler account if one looks at damages alone, but suggests that the promissory analysis fails to explain other aspects of the law of contract remedies, such as the absence of a general right to specific performance or disgorgement. Jaffey argues that the reliance theory explains all of these rules. The expectation measure rule is justified on the ground that expectation damages quantify the opportunity cost of the contract that the aggrieved party made with the contract breaker. The inadequacy requirement limiting the availability of specific relief and disgorgement is explained on the grounds that those remedies are only available in situations where actual performance, as opposed to pecuniary compensation, is necessary to ensure that the aggrieved party is protected against reliance loss. Jaffey also contends that the reliance analysis provides a better explanation of the actions that are traditionally assigned to the law of unjust enrichment. He criticises the attempts made by unjust enrichment theorists to assign these actions to the unjust factors of ‘failure of basis’ or ‘failure of condition’, arguing that these very labels demonstrate that the claim is in essence a contractual one. Jaffey suggests that his agreement-based reliance theory provides a much more plausible account of such claims, explaining why recovery is capped by the expectation measure and why losses are redistributed evenly following the frustration of a contract.

E The Economic Basis of Contract Damages Much ink has been spilt, especially on the other side of the Atlantic, on analysing contract law from a law-and-economics perspective.49 The best known theory is, of course, the efficiency theory of contract, which regards contract law as an instrument for promoting economically efficient behaviour. From this perspective, the justification for contract remedies is not that they recognise or vindicate rights, but that they provide incentives for economically efficient behaviour. According to this approach, contract remedies should never operate to deter economically efficient breaches. This, the legal economists argue, explains why specific performance P Jaffey, ‘Damages and the Protection of Contractual Reliance’, this volume. Leading examples of such economic analyses include: R Posner, Economic Analysis of Law (New York, Aspen Publishers, 6th edn, 2003); R Cooter and T Ulen, Law and Economics (Boston, MA, Pearson/Addison Wesley, 5th edn, 2007); AM Polinsky, An Introduction to Law and Economics, 3rd edn (New York, Aspen Publishers, 3rd edn, 2003). 48 49

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remains an exceptional remedy in Anglo-American law,50 and why gain-based damages are unnecessary except where they can be used to deter opportunistic breaches of contract.51 A number of essays in this volume address the law-and-economics approach to damages. Ogus accepts the orthodox formulation of the efficient breach theory and shows how the goal of allocative efficiency justifies awarding expectation damages as the default remedy for breach of contract. He does, however, suggest that the default rule requires a number of modifications if the law is to consistently induce economically appropriate behaviour. First, he identifies the problem of imperfect monitoring and enforcement (ie situations where the defendant is able to conceal the breach and evade liability), and suggests that in such cases gain-based or even punitive damages may be appropriate. Secondly, he argues that the courts should be willing to reduce damages on the grounds of contributory negligence if it can be shown that it would be cheaper for the promisee to take precautions to avert, or reduce the risk of, a breach. This, he argues, would provide an incentive for promisees to engage in economically efficient behaviour pre-breach and would mirror the function performed by the doctrine of mitigation in relation to post-breach behaviour. Thirdly, Ogus suggests that the rules on the availability of damages for non-pecuniary loss may have been too narrowly drawn. He suggests that the reason for this is the difficulty encountered by judges when attempting to formulate rules as to their availability. He further argues that economic reasoning can assist here, and that damages for non-pecuniary loss should be available whenever it can be shown that the promisee was willing to pay, and perhaps did pay, an additional premium in order to have the promisor insure him against the loss.52 Jaffey’s contribution to this volume also engages with the economic analysis of contract damages. He suggests that the expression ‘efficient breach’ is self-contradictory. It implies that at one and the same time a contracting party has a duty to perform and also a liberty not to perform. Jaffey suggests that this paradox can be avoided if the argument for efficient breach abandons the idea that agreements ordinarily generate duties of performance and instead adopts the view that agreements create merely liabilities, rather than duties (the agreement-based reliance theory that Jaffey proposes).

50 A Kronman, ‘Specific Performance’ [1978] University of Chicago Law Review 351; A Schwartz, ‘The Case for Specific Performance’ (1979) 89 Yale Law Journal 271; W Bishop, ‘The Choice of Remedy for Breach of Contract’ (1985) 14 Journal of Legal Studies 299. 51 Posner, above n 49, 119. 52 A similar argument is made by Schwenzer and Hachem in their contribution to this volume. Adam Kramer also notes that the price paid for the promise will reflect the content of the allocation of risks under the contract: A Kramer, ‘Remoteness: New Problems with the Old Test’, this volume.

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Friedmann, who is a well-known critic of the efficient breach theory,53 suggests, in his chapter, that there is a role for the concept of ‘tolerated breach’ within the law of contract.54 This concept would apply in situations where the parties have entered into a wasteful contract, that is, a contract in which the loss to one party that would result from its performance exceeds the benefit that would be acquired by the other party. Friedmann gives the example of a contract for the construction of a four-storey building on a plot of land where, shortly after the contract is agreed, a change in the zoning laws makes it possible to build up to 30 stories on the site. Completion of the contract would lead to significant waste since the four-storey building would need to be torn down in order to enable the construction of a 30-storey structure. In such cases Friedmann suggests there is no room for specific performance or gain-based damages. Tolerated breach differs from efficient breach in three fundamental ways: (i) it examines the economic rectitude of the contract from the point of view of both parties, whereas the efficient breach theory examines the situation from the point of view of the party in breach alone; (ii) it compares the actual losses and actual gains derived from the performance of the contract, whereas efficient breach compares the gains derived from the breach with the sum that would be payable in damages; and (iii) it leaves the decision whether to enforce the contract down to the court (there is no ‘right’ to breach the contract), whereas efficient breach assumes that the decision whether to perform or breach lies with the promisor alone. Finally, one further chapter touches on an important economic aspect of damages, that is, on the currency of the award. Charles Proctor traces the demise of the ‘sterling only’ rule in relation to debt and liquidated damages claims.55 He recognises that the issue is much more complex in relation to unliquidated damages claims because of the difficulty of implementing the principle that damages are to be awarded in the currency in which loss has been suffered or which truly expresses the loss. While taking the view that this principle was probably implemented correctly in Texaco Melbourne56, Proctor suggests that the House of Lords erred in two important respects: (i) by insisting that the date for assessment should be the date of breach (Proctor recognises that the law has already started to evolve in this area—see the discussion of the Golden Victory57 below); and (ii) by failing to appreciate that a loss in one currency can be felt by reference to its value in relation to another currency. Proctor suggests that if awards of See, eg D Friedmann, ‘The Efficient Breach Fallacy’, (1989) 18 Journal of Legal Studies 1. According to Friedmann, a breach is ‘tolerated’ if it is ‘acceptable, even though it is not condoned’. 55 C Proctor, ‘Changes in Monetary Value and the Assessment of Damages’, this volume. 56 [1994] 1 Lloyd’s Rep 473 (HL). 57 [2007] UKHL 12 (HL). 53 54

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damages are really to reflect the economic value of the loss sustained by the aggrieved party a more flexible approach needs to be adopted.

IV

A

THE MEANING AND DEFINITION OF LOSS

General

We believe that the meaning and definition of loss are issues which lie at the very heart of the law of contract damages. One reason for this assertion is that the compensatory purpose of damages cannot be satisfactorily implemented unless there is clarity as to what constitutes a loss. Another reason is that, by discussing the meaning of loss, we inevitably enter the debate about the values, policies and purposes that the law of contract should protect. It is also inevitable that this debate, like a wave, spills over the boundaries beyond those delineating the territory of compensatory damages.58 The questions of meaning and definition of loss are therefore of great complexity, and in order to fully expose and address this complexity, the questions will have to be dealt with on a number of different levels. One level is that of the different heads of loss and the question of whether a particular type of loss should be recognised by the law as sufficiently real, serious or important to qualify for legal protection. Another level is that of the dilemma every legal system faces between the so-called ‘abstract’ and ‘concrete’ approaches to the calculation of damages. This dilemma also poses, in a particularly acute form, other problems relating to the application of some of the methods of limiting damages, such as the mitigation rule.59 The next level, which is not amenable to an easy separation, is that of the nature, meaning and role of the protection of the ‘performance interest’ of the contract. Yet another level, which is once again interlinked with some of the previous ones, relates to the extent to which the law can take into account the gains made by the defaulting party in the calculation of the loss sustained by the aggrieved party. Finally, there is a connection between the meaning of loss and, more broadly, various aspects of the law of damages, on the one hand, and the issue of contractual distribution of risk, on the other. While this volume does not aim to provide an exhaustive treatment of all these issues, many of them are touched upon in the essays contained herein.

See the above discussion on the availability of non-compensatory measures of damages. For the recognition, in some of this volume’s contributions, of the relationship between the foreseeability rule and the issues of ‘abstract’ calculation, see below. 58 59

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B The Recoverability of Losses The recoverability of various heads of loss is addressed in several contributions to this volume. Two essays address the question of whether injury to business reputation and goodwill constitutes a recoverable loss under the CISG. Schwenzer and Hachem argue that this loss should be recoverable as business reputation and goodwill have an economic value in which substantial investments are made. Similarly, Saidov, having examined the nature and the existing definitions of reputation and goodwill, concludes that these phenomena often constitute ‘business assets’ performing a number of important commercial functions and, for this reason, damage to these assets should be recognised as a recoverable loss under the Convention. Saidov also highlights, drawing on the developments in the law and outside it, some possible methods of proving and calculating this loss, with a special emphasis on its relationship with other potentially related losses, such as loss of custom, loss of a chance to enhance reputation and loss of profit. Michael Furmston60 addresses the issue of the recoverability of damages for loss of a chance in the common law. He believes that, in comparison with contract cases, a different line of reasoning has been taken by the courts in medical negligence cases. He suggests that this is wrong and that the same rules ought to apply in relation to both contract and tort. The recoverability of legal fees under the CISG is another issue which has received a large amount of attention (perhaps undeservedly so, considering the number of other unresolved issues that exist in the law of damages).61 Schwenzer and Hachem consider this issue by, first of all, drawing a distinction between litigation costs and pre-litigation costs. They argue that the former should not be recoverable as damages under the Convention, despite the support that the contrary position may derive from the principle of full compensation. The argument follows the premise that recognising litigation costs as recoverable losses would contravene the principle of equality (symmetry) between the buyer and the seller: while the claimant will be able to recover those costs in the event that it wins the case, the respondent will not. So far as pre-litigation costs are concerned, the authors suggest that, while some such costs (eg those incurred in an attempt to mitigate losses) should be recoverable, others, such as those which cannot be neatly separated from litigation costs (eg those incurred to assess the party’s legal position, prospects of litigation and/or settlement negotiations), should not be recoverable. Schwenzer and Hachem also address the question of whether damages for loss of a chance are recoverable—a matter still shrouded by uncertainty See M Furmston, ‘Actual Damages, Notional Damages and Loss of a Chance’, this volume. See sources referred to in nn 51–8 in Schwenzer and Hachem’s chapter in this volume and n 31 in Gotanda’s. 60 61

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under the CISG. Similar to their argument in relation to damage to reputation, the authors submit that a chance has an economic value in the light of the substantial sums often invested in it (eg in taking part in a bid), and therefore damage to it should be treated as a loss. They also argue that, because the sole difference between loss of a chance and loss of profit lies in the level of certainty with which they can be proven (ie loss of a chance involving a greater degree of speculation), the recoverability of loss of a chance can be inferred from Article 74 of the CISG, which expressly allows damages for ‘loss of profit’. In the authors’ view, this wording ‘naturally encompasses’ the recoverability of damages for loss of a chance. In the age of constantly fluctuating exchange rates, the question of whether exchange rate losses arising from a breach of contract are recoverable is of great practical importance. Charles Proctor’s chapter is a helpful contribution in this respect. It addresses, amongst other issues, the recoverability of exchange rate losses arising from delay in payment. Having analysed the relevant body of case law, Proctor demonstrates that currency exchange losses are in principle recoverable as damages for breach of contract, subject to the usual rules of foreseeability (remoteness). However, as Proctor notes, in President of India v Lips Maritime Corporation,62 exchange rate losses arising from the late payment of demurrage was held not to be recoverable as damages. Proctor regards this result as somewhat unfortunate considering that: damages may be awarded for late payment of freight, but not for late payment of demurrage, in spite of the fact that they will both be expressed as liquidated amounts which are payable under the same contract.

C

‘Concrete’ v ‘Abstract’ Calculation

As noted above, at the heart of the current debate on the meaning of loss is the question of whether a ‘concrete’ or an ‘abstract’ approach to the calculation of damages ought to be applied.63 The former approach aims to assess damages by reference to the injured party’s actual circumstances, while the latter, in its pure form, does not look at the party’s actual position but is instead based on the presumption that loss consists of the amount determined on the basis of a fixed formula, thereby awarding damages ‘in abstract’. For example, these formulae include those which, in cases of non-delivery or non-acceptance of goods, assess damages by reference to [1988] AC 395. Although there is a degree of controversy surrounding such terms as ‘abstract/concrete’ or ‘subjective/objective’ approaches to calculation (see n 57 in Cunnington’s chapter), considering the international and comparative scope of this volume the terms ‘concrete’ and ‘abstract’ are used as they appear to be more widely used in legal literature relating to the international instruments (particularly, in relation to the CISG). 62 63

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the difference between the contract price and the market or current price,64 or, in cases of defective goods, calculate damages as the difference between the market value of conforming goods and the value of the goods actually delivered.65 Making a choice between the two approaches has proven to be quite difficult and the essays in this volume reveal that, even in the context of English law and some other common law systems where the starting point is often the ‘abstract’ approach, tension still persists both in the case law and amongst commentators. So far as sale of goods cases are concerned, Bridge generally favours the ‘abstract’ approach. While recognising that there is a policy for damages to express the injured party’s true loss and noting that modern developments can be characterised by ‘moving away from simple rules and [being] guided by judicial discretion’, he argues that the market rule, which might be seen as a characteristic of commodity markets, generally works well in practice and that it should be derogated from only in exceptional circumstances. He suggests that, so far as commercial practice is concerned, there is a need for simple and easily administered rules, and that: [d]amages rules cannot sensibly be tailor-made for the particularities of each and every dispute if the assessment of damages is to be treated as a matter of law and not factual discretion.

In relation to the CISG, Bridge believes that the Convention is unlikely to share the experience of English law in terms of its reliance on the ‘abstract’ measure because it demonstrates a general preference for the ‘concrete’ approach to calculating damages. Furmston addresses the question of whether the recent decision in The Golden Victory66 corresponds best with the ‘concrete’ or the ‘abstract’ approach to calculation and identifies a seeming inconsistency in the decision in this respect. He suggests that the case reflects a tension between the ‘abstract’ calculation and taking into account the actual facts by arguing that: [t]he basic calculation took no account of what the owners had actually done after the charterers’ repudiation but in the view of the majority, the actual outbreak of war was of decisive importance.

Furmston also appears to imply that the method of calculation relied upon in the case was not truly ‘abstract’ either because, if it had been, the question would have arisen as to whether a notional charterer would have terminated the contract in March 2003. However, as Furmston notes, that question was not raised. 64 See, eg ss 50 and 51 of the Sale of Goods Act and Arts 76 CISG, 7.4.6 UPICC and 9:507 PECL. 65 See, eg § 2-714 UCC and s 53(3) SGA. 66 Golden Strait Corp v Nippon Yusen Kubishika Kaisha [2007] 2 WLR 691. The facts are recorded in the chapters by McLauchlan and Furmston.

Introductory Remarks D

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The Role of Mitigation and Events Subsequent to the Breach

Making a choice between ‘concrete’ and ‘abstract’ approaches does not simply concern the calculation of damages; it also impacts upon the mitigation rule. In fact, although the mitigation rule is traditionally viewed as a ‘method of limiting damages’, various considerations surrounding this rule cannot be separated from the problems of calculation. The relationship between the two is, perhaps, best described as that of ‘reciprocal influence’. On the one hand, the mitigation rule influences the formulae the law adopts for calculating damages. To take sales law as an example, the ‘concrete’ formula (the difference between the contract price and the price in a substitute transaction)67 is often viewed as an expression of a typical exercise of the ‘duty’ to mitigate.68 The ‘abstract’ formula (the difference between the contract price and the market or current price)69 is also said to incorporate the mitigation rule.70 In other words, the mitigation rule is ‘built in’ as part of the ‘abstract’ formula.71 In English sales law, it is also well recognised that a reference to the date of the breach when applying the market rule formula is based on the idea that the date of the breach (or shortly thereafter) is the time when the innocent party is expected to go into the market to procure a substitute. On the other hand, the role and functioning of the mitigation rule are directly influenced by whether a particular legal system prefers a ‘concrete’ or an ‘abstract’ approach to calculation. The former is in absolute harmony with the mitigation rule. For instance, Article 75 of the CISG requires, following the reasonableness standard underlying the mitigation rule, that a replacement transaction be made within a reasonable time and in a reasonable manner. Most importantly, the formula is based on the injured party’s actual conduct and, arguably, a true application of the mitigation rule would likewise require an assessment of the party’s actual conduct. By contrast, the reliance on the market formula causes mitigation to lose ‘its identity’ and because mitigation is ‘built into’ the market formula it ‘does not expressly appear as a separate issue’.72 Thus, the need to determine the market price as of the breach date would appear to dictate that the innocent party’s actual situation after that date be ignored. This would mean that all subsequent See, eg Arts 75 CISG, 7.4.5 UPICC and 9:506 PECL. In relation to the CISG, see, eg P Schlechtriem Uniform Sales Law: The UN-Convention on Contracts for the International Sale of Goods (Vienna, Manz, 1986) 97. 69 See, eg Arts 76 CISG, 7.4.6 UPICC and 9:507 PECL, and ss 50(3) and 51(3) of the Sale of Goods Act. 70 See R Goode, Commercial Law (London, Penguin, 3rd edn, 2004) 368 (taking this view with respect to s 51(3) of the Sale of Goods Act). 71 See H McGregor, ‘The Role of Mitigation in the Assessment of Damages’, this volume. For the view that mitigation strengthens the ‘abstract’ approach to calculation, see Friedmann, above n 46. According to both Friedmann and Bridge (this volume), the same can be said about the rule of remoteness. 72 Ibid. 67 68

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events and losses avoided or benefits gained since that time would have to be disregarded for the purpose of calculating damages. The innocent party may, under this approach, find itself either over- or undercompensated. Although the common law in general, and English law in particular, has had an immensely rich experience of dealing with these matters, the battle between those seeking to achieve perfect compensation by looking at the party’s actual situation and the events that followed breach, on the one hand, and those who adhere to the values of certainty and symmetrical compensation as well as encourage speculation (by not being required to disgorge the fruits of speculation after the breach and describing them, for example, as ‘circumstances peculiar to the plaintiff’), on the other, is still ongoing. These positions are formulated in their extreme manifestations for the purposes of clarity; but, of course, neither the common law nor the positions of commentators have been that extreme. Instead they have strived, albeit not always satisfactorily, towards striking some kind of balance. In relation to the issues of losses avoided and benefits gained after the breach, the common law position is that benefits gained after the breach are to be taken into account to the extent that a subsequent transaction, giving rise to such benefits, arises as a consequence of the breach and is not an independent or disconnected transaction.73 Harvey McGregor formulates this rule as follows: for the benefit to be taken into account, it ‘must arise out of the mitigating act itself’.74 There appears to be no agreement as to whether the distinction between benefits arising from breach and mitigation, on the one hand, and those independent of breach and mitigation, on the other, is a sound and workable one. While McGregor treats it with implicit approval, David McLauchlan75 believes that the relevant cases are ‘replete with distinctions’, many of which are ‘irreconcilable’. In essence, McLauchlan’s view would appear to be that, although the said rule has been used to distinguish cases where different results have been achieved, the truth is that different ideological positions have been taken. With reference to some of the leading cases, he summarises his position as follows: There is an obvious tension between the approach to assessment in British Westinghouse and Wertheim and the approach in Rodocanachi and Williams Bros. The former emphasises the compensatory purpose of damages. Its concern is the actual position of the plaintiff if the contract had been performed and the actual consequences of the breach. A court should never compensate the plaintiff for a loss which it knows has not been suffered. To award more than the 73 British Westinghouse Electric and Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673 (HL) 690. 74 See McGregor, this volume. 75 D McLauchlan, ‘Expectation Damages: Avoided Loss, Offsetting Gains and Subsequent Events’, this volume.

Introductory Remarks

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‘real’ loss is, by definition, to allow an unjustifiable windfall. The Rodocanachi and Williams Bros approach, on the other hand, favours a simpler, convenient and seemingly even-handed market price test to determine the level of recovery. The disadvantages of occasional overcompensation or undercompensation are outweighed by the advantages of having a uniform rule which is more certain in its application and thus more likely to facilitate settlements.

Although McGregor might take a different view on the value of the distinction between benefits which arise from breach and mitigation and those which do not, he is critical of the results in Rodocanachi, Sons & Co v Milburn Bros76 and Williams Bros v Ed T Agius Ltd77 and agrees with the result in Wertheim v Chicoutimi Pulp Co,78 arguing that the result should only be different: if the seller’s failure to deliver at the contractual time could have put the buyer into breach of his sub-sale contract, requiring him, to avoid breach, to buy substitute goods while the market was still high or to face an action from his sub-buyer.

Regarding the choice between the ‘concrete’ and ‘abstract’ measures, McGregor puts forward a ‘middle-ground’ position which has been formulated thus: Whatever the breach, whether it be by non-delivery, delayed delivery or defective delivery, the presumption should be that the buyer is entitled to have his sub-sale at the higher price ignored but the seller is also entitled to rebut this presumption if he can show positively that the buyer neither has bought the substitute goods after the breach nor is subject to a damages claim from his sub-buyer. This is in accordance with the rule that the burden of proof on the issue of mitigation is on the party in breach.

McLauchlan suggests that the benefit received by the innocent party after the breach must be taken to offset the loss thereby reducing damages if: (a) it is received as a result of entry into the transaction in respect of which damages are claimed and it, or an equivalent benefit, would likely not have been received but for that breach; or (b) it is a direct result of a dealing with the subject matter of the contract or action taken to avoid the consequences of the breach.

So far as the date of assessment of damages is concerned, it ought to be noted that several of the contributors to this volume consider that the decision in The Golden Victory79 signifies a move further away from the traditional position of adhering to the ‘breach date rule’ (ie assessing (1886) 18 QBD 67 (CA). [1914] AC 510 (HL). [1911] AC 301 (PC). Golden Strait Corp v Nippon Yusen Kubishika Kaisha [2007] 2 WLR 691. The facts are recorded in the chapters by McLauchlan and Furmston. 76 77 78 79

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damages by reference to the date of the breach)80 and demonstrating a judicial willingness to take into account events subsequent to the occurrence of the breach. McLauchlan, while stating that ‘it is now axiomatic’ that the breach date rule is not an inflexible one and may be departed from where justice so requires, nevertheless disagrees with the result in The Golden Victory. He argues that, just as in market cases where the breach date rule serves as a reference point (because it is presumed that the innocent party will be able to procure a substitute at that time), in the case itself the award of damages should have been made assuming the owners had procured a substitute charterparty: by failing to do so they were taking their own risk or advantage. The crucial question, according to McLauchlan, is whether the termination for repudiation or breach has the effect of reallocating the risk to the innocent party. Where this is the case, the consequences of all subsequent changes and events must be at the innocent party’s risk. This position: not only promotes certainty and efficiency of settlement, it makes good economic sense by placing responsibility for dealing with market risk in the hands of those best able to deal with.

E The Role of the ‘Performance Interest’ The discussion of the meaning of loss would be far from complete if the volume did not address the nature and role of the party’s interest in and right to performance—often referred to as the ‘performance interest’. What impact does the performance interest have on the assessment of damages? This crucial question is particularly relevant where the performance rendered by the breaching party does not conform to the contractual requirements. If the breaching party fails to construct a swimming pool of the required depth, can the innocent party be said to have suffered any loss where the value of the property has been unaffected?81 Is the buyer entitled to damages if the seller supplies a wedding ring of greater market value than that agreed upon in the contract but which comes as a great disappointment to the buyer because of an emotional attachment to a cheaper ring? Of course the example can be reversed and the question asked whether a buyer, who received a cheaper wedding ring than the one 80 See the chapters by Proctor (stating, after referring to The Golden Victory, that ‘[o]ne is left with the impression that the supposed “breach date rule” is firmly in retreat’) and McGregor (‘the majority may have opened the way to the revisiting of some of the cases in which a transaction entered into by the aggrieved party subsequent to the breach has been left out of account in the assessment of damages’). Furmston, however, doubts whether the decision has added any clarity as to when the ‘breach date rule’ should be departed from. 81 See Ruxley Electronics and Construction Ltd v Forsyth [1996] AC 344 (HL).

Introductory Remarks

25

contracted for, might be denied damages because his wife actually preferred the ring received than the ring contracted for?82 At first sight, it may be thought that these questions can be resolved simply by reference to the legal system’s choice between the ‘concrete’ and ‘abstract’ approaches to calculation: if a legal system relies strictly on the ‘abstract’ approach, and if there is a difference between the value of the goods delivered and their market value in the conforming state, damages can be awarded on the basis of the market formula. This would mean that a pure ‘abstract’ approach would not lead to damages in the case of the non-conforming swimming pool or the delivery of a more expensive wedding ring than the one contracted for. The ‘concrete’ approach, on the other hand, may, but not necessarily will, lead to different results since the question of what loss the party has actually suffered will still have to be answered. The answer will depend on whether the law is prepared to compensate the party for some kind of ‘subjective’ value it places on the performance, or, in other words, for a non-economic interest83 it may have in the performance of the contract. If so, and if the innocent party manages to prove that it did have such an interest, then arguably the ‘concrete’ approach will allow damages. Thus, from the standpoint of the ‘concrete’ approach, the buyer might be entitled to damages in the first two examples (assuming he or she proves the existence of the said interest),84 but not in the last one since the buyer seems perfectly happy with what he or she received despite the ring being of a lesser value. We suggest, however, that these cases cannot be adequately understood simply from the standpoint of a choice between the ‘concrete’ and ‘abstract’ approaches to calculation. This standpoint, in our view, does not provide an appropriate analytical framework for rationalising that question. As we have seen, the ‘concrete’ approach in itself does not provide the answers needed; while the ‘abstract’ measure may sometimes be a convenient vehicle for placing a monetary value on the damage to the performance interest, its inability to rationalise the meaning of loss in such cases is demonstrated by its failure to produce consistent results. For instance, assuming that in all three cases above the party’s performance interest has been damaged, the market formula will lead to damages only in the last case, where a cheaper ring than that agreed upon has been 82 The example involving a ring was given by one of the participants at the conference and was used on several occasions during the conference. Earlier, the example was posted by Robert Stevens on the Obligations Discussion Group, 28 March 2007, at http://www.ucc.ie/law/odg/ admin/2007.htm (accessed 18 October 2007). 83 See D Harris, A Ogus and J Phillips, ‘Contract Remedies and the Consumer Surplus’ (1979) 95 LQR 58. 84 The recovery is, of course, subject to the requirements of limiting damages and, in the second example in particular, the mitigation rule is likely to prevent the award of damages since it can be argued that the buyer was in the position to mitigate its loss by selling a more expensive ring and purchasing a cheaper one which he/she preferred.

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delivered. Thus, although the role of the performance interest in assessing damages is in some ways linked to the choice between ‘concrete’ and ‘abstract’ calculations, it is nevertheless an independent issue requiring separate treatment. We also suggest that its relevance lies only with cases potentially involving some kind of subjective and non-economic interest in the performance.85 This does not mean, however, that the ‘performance interest’ issue will be irrelevant so far as commercial transactions are concerned, as demonstrated by Schwenzer and Hachem’s chapter. The authors argue, by drawing on interesting commercial law examples, that the performance interest is relevant to and must be recognised under the CISG, and that ‘the scope of losses to be compensated has to reflect the very purpose of the duty that has been breached’. They also suggest ways of dealing with the difficulty of placing a monetary value on such losses, and the formulae based on both ‘concrete’ and ‘abstract’ approaches appear suitable for this purpose.86

F

Gain-based Damages

Schwenzer and Hachem further suggest that, in the context of the CISG, damage to the party’s performance interest may, in some cases, justify damages being measured by reference to the gains made by the breaching party. This argument is based on two reasons. First, the authors assert that, in the examples they give, gains made by the breaching party can be presumed to reflect the loss suffered by the innocent party. Secondly, they argue that if the CISG is interpreted as disallowing an award of damages calculated by reference to the gains made by the breaching party, this may result in the courts resorting to concurrent domestic remedies. Such a situation, in the authors’ opinion, would undermine the Convention in the core area of damages. The authors make it clear, however, that their 85 The standpoint of choice between ‘abstract’ and ‘concrete’ calculations is perfectly capable of dealing with the remaining cases where no such interest in the performance exists (these are cases similar to an example given in the contribution by Bridge (see the text following n 44)). 86 Thus, authors refer, amongst other things, to the market difference formula (the ‘abstract’ approach) and to costs of cure which, we suggest, can be a vehicle for implementing both ‘concrete’ and ‘abstract’ approaches. For instance, costs of cure which have not yet been incurred and which are estimated on the basis of costs which are reasonable in the circumstances can indicate the difference in value between the goods actually delivered and the value of conforming goods, which is often perceived as an ‘abstract’ measure (see Goode, Commercial Law, above n 71, 378–9). At the same time, the costs of cure actually incurred can be viewed as a concrete measure since they are based on the party’s actual position. However, because these costs need to be reasonable to be recoverable, this measure may become very similar to the case where the ‘cost of cure’ formula implements the ‘abstract’ measure. In other words, in this context both ‘concrete’ and ‘abstract’ measures seem to converge (for further discussion of these issues, see Saidov, above n 24).

Introductory Remarks

27

suggestion is still within the realm of compensatory damages and that awarding damages with reference to the gains acquired by the breaching party is simply a method, in appropriate cases, of implementing the compensatory purpose of damages. Such a recommendation is not alien to English law. Recently, in WWF—World Wide Fund for Nature v World Wrestling Federation Entertainment Inc,87 Chadwick LJ insisted that gain-based damages are nothing more than ‘a flexible response to the need to compensate the claimant for the wrong which has been done to him’.88 This view has been criticised by a number of contributors to this volume. Jaffey insists that: it is implausible to think that the measure of the benefit received by the defendant can be an appropriate proxy for the claimant’s loss. There is no necessary connection between the two at all.

Cunnington agrees, noting that a compensatory rationalisation of account of profits cannot explain the cases in which an account has been ordered even though the claimant’s loss was easy to measure. Waddams is less critical of the decision in WWF, insisting that their lordships did not actually deny the distinction between the concepts of compensation and gain-based award. Instead, in Waddams’s view, the court merely recognised that ‘the two concepts [might] in practice operate simultaneously and cumulatively in relation to a single legal question’. Such an approach to understanding the case is, however, rejected by Burrows, who insists that neither the remedy of account nor Wrotham Park damages (licence fee damages) can be rationalised as compensatory awards.89 It seems likely that WWF will not be the last word on this subject, and it remains to be seen whether the contract breaker’s gains have any role to play in the assessment of compensatory damages.

G

Contractual Distribution of Risk

The question of what loss can be claimed as damages for breach of contract will also often depend on the contract itself since parties often agree on excluding certain heads of loss from being recoverable. Such contractual provisions are usually referred to as clauses exempting or limiting liability.90 While such clauses are clearly important for identifying which losses can be claimed as damages in a particular case, it is probably more [2007] EWCA Civ 286 (CA). Ibid, [59]. Cunnington agrees that Wrotham Park damages should be viewed as a gain-based award but acknowledges that they are susceptible to alternative analysis as substitutive compensation. 90 Clauses can exempt from or limit liability not only by reference to particular types or heads of loss, but also by reference to obligations or by setting the maximum amount which can be claimed as damages. 87 88 89

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appropriate to consider them within a broader framework of the scope of liability assumed by the parties, or, in other words, under the umbrella of the parties’ distribution of risks associated with a breach of contract. From this standpoint, a contract can be viewed as a tool for allocating the risk between the parties with far-reaching implications for the issue of liability in general and for the exercise of the right to claim damages in particular. This view of contract underlies Jan Ramberg’s chapter,91 which demonstrates, from a practical perspective, a close link between the scope of contractual obligations and a contractual limitation (or exemption from) liability for breach. According to Ramberg, the party’s ultimate liability depends not on whether a provision defines the scope of an obligation or whether it exempts from or limits liability, but on the analysis of the contract’s distribution of risk complemented by the test of reasonableness. In a similar vein, Adam Kramer’s chapter92 revisits the test of remoteness (foreseeability) by justifying the existence of the test on the basis of the implied assumption of risk by the promisor—what he labels an ‘agreement-centred’ approach. This has significant implications in two categories of case. First, in cases of concurrent liability, Kramer suggests that the contractual allocation of risks ought to displace the concurrent tortious allocation if the tortious obligation covers a matter that is central to the contract and to the risks allocated in it. By analogy of reasoning, the contractual remoteness test also ought to apply to Hedley Byrne liability since such liability is based on a voluntary assumption of responsibility in much the same way as a contractual obligation. Secondly, Kramer suggests that, while the application of the foreseeability test by reference to the date of agreement is also based on the ‘assumption of risk’ rationale, his ‘agreement-centred’ approach to remoteness allows for the possibility that, in some cases (those involving a variation of the contract and long-term contracts which are terminable at will), the scope of responsibility may have to be assessed at a date much later than the time when the contract was made.

V

CO N C L U S I O N

This book and the conference from which its essays are drawn benefited from the generous support and assistance of numerous people. First, we would like to thank the contributors for their careful research and attention both to the papers that were presented at the conference and to the essays that now appear in this volume. We would also like to thank the delegates who attended the conference and contributed so enthusiastically to the 91 92

See J Ramberg, ‘No Need to Limit where There is No Promise’, this volume. See A Kramer, ‘Remoteness: New Problems with the Old Test’, this volume.

Introductory Remarks

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debate that took place. A number of organisations have supported this project financially. Thanks are due to the conference sponsors: UNCITRAL, Bird & Bird, DLA Piper and the Modern Law Review. We are also grateful to Richard Hart and Rachel Turner, from Hart Publishing, and Tanya Corrigan, from the University of Birmingham, for their invaluable assistance in the preparation of this manuscript for publication, and to Mrs Emer McKernan for her help in organising the conference. We would also like to thank those who chaired sessions at the conference and, in particular, Lord Mance, who chaired the conference and generously agreed to provide a foreword to this volume. Finally, we would like to thank our wives, Sanam and Anna, for their steadfast love and support, without which we would not have been able to organise the conference and edit this collection. We very much hope that you enjoy reading these essays and are confident that they will be of benefit to anyone interested in the law of contract damages. As we hope this volume demonstrates, discussion in this area of the law remains both stimulating and important.

1 The Law of Damages: Rules for Citizens or Rules for Courts? THE LAW OF DAMAGES

S T E P H E N A S M ITH * S TEPHEN A S MI TH

I

I NTRO DUCTION

A complete explanation of any rule or set of rules must address two broad categories of questions. The first category, which is comprised of what I shall call analytic questions, has as its general aim the identification of the rules’ subject matter. In the case of legal rules, analytic questions are usually framed as questions about the kinds of rights that are created or regulated by the rules. Thus, legal scholars examining contract law will ask whether it is concerned with (to give two possibilities) promissory or reliance-based rights. The answers to this and other analytic questions provide the basis for distinguishing (or refusing to distinguish) legal categories such as contract, tort and unjust enrichment, as well as for distinguishing individual rules within these categories. The second category comprises normative questions. Normative questions are concerned with the justification for the relevant rules. Thus, contract scholars interested in normative questions might ask whether contractual obligations are (or should be) based on a principle of maximising social welfare or a principle of respecting individual rights. Within the core private law fields of contract, tort, unjust enrichment and property, one or the other of these questions has, at different times, attracted more attention, either from individual authors or more generally. But overall, each question has received considerable attention in the scholarly literature.1 The literature on the law of damages reveals a different picture. Although common law scholars have devoted significant

William Dawson Scholar and Professor of Law at McGill University. I discuss the distinction between analytic and normative questions, and its relevance for understanding contract scholarship, in S Smith, Contract Theory (Oxford, Clarendon Press, 2004) ch 2. *

1

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attention to damages law,2 the critical scholarship is concerned almost entirely with normative issues.3 Legal scholars have devoted considerable effort to determining what, if any, normative foundations do or should underlie damages rules.4 They have also paid considerable attention to the question of whether the damages rules are effective in achieving the desired normative principles.5 However, they have spent little time considering what (if anything) is distinctive about the law of damages as a legal subject. Indeed, the question of what kinds of rights are dealt with by damages law is rarely even asked.6 This neglect has had significant consequences.7 Most obviously, it has impoverished our understanding of damages law. We cannot claim to understand the rules on damages unless we know what kinds of rights they 2 In addition to the extensive discussion of damages found in contract and tort books, there are entire treatises devoted to the subject (H McGregor, McGregor Damages (London, Sweet & Maxwell, 17th edn, 2003); S Waddams, The Law of Damages (Toronto, Canada Law Book, 4th edn, 2004); A Tettenborn, The Law of Damages (London, Butterworths Tolley, 2003); J Cassels, Remedies: The Law of Damages (Toronto, Irwin Law, 2000)), and even to specific aspects of damages (J Edelman, Gain-based Damages (Oxford, Hart Publishing, 2002); EC Martin, Personal Injury Damages Law and Practice (John Wiley & Sons, 1990); Judicial Studies Board, Guidelines for the Assessment of General Damages in Personal Injury (Oxford University Press, 2004); LL Schlueter and KR Redden Punitive Damages (Charlottesville, VA, Lexis Publishing, 4th edn, 2000)). The theoretical and critical literature on damages is equally abundant. Many common law scholars have found within the law of damages the key to understanding the law of obligations: eg LL Fuller and WR Purdue, ‘The Reliance Interest in Contract Damages’ (1934) 46 Yale Law Journal 53; E Weinrib, The Idea of Private Law (Cambridge, MA, Harvard University Press, 1995) esp ch 3; E Weinrib, ‘The Gains and Losses of Corrective Justice’ (1994) 44 Duke Law Journal 277; JL Coleman, Risks and Wrongs (Oxford University Press, 2003) esp ch 10; CJ Goetz and RE Scott, ‘Enforcing Promises: An Examination of the Basis of Contract’ (1980) 89 Yale Law Journal 7; CJ Goetz and RE Scott, ‘The Mitigation Principle: Toward a General Theory of Contractual Obligation’ (1983) 69 Virginia Law Review 967; R Craswell, ‘Contract Remedies, Renegotiation, and the Theory of Efficient Breach’ (1989) 61 Southern California Law Review 629; D Friedmann, ‘The Performance Interest in Contract Damages’ (1995) 111 LQR 628. The first substantive topic in many contracts casebooks is damages for breach of contract; see, eg HG Beale, WD Bishop and MP Furmston, Contract: Cases and Materials (London, Butterworths, 3rd edn, 1995); J Swan, BJ Reiter and NC Bala, Contracts: Cases, Notes & Materials (Markham, ON LexisNexis Butterworths, 7th edn, 2006); SM Waddams, MJ Trebilcock and MA Waldron, Cases and Materials on Contracts (Toronto, Emond Montgomery, 2nd edn, 2000); RS Summers and RA Hillman, Contracts and Related Obligation (St Paul, MN, West Group, 4th edn, 2001). 3 This chapter focuses on the damages law in common law regimes. A similar observation could be made of damages law in civilian regimes although the explanation of how and why damages law is not well-understood differs. 4 See, eg Weinrib (1995), above n 2; Coleman, above n 2; Goetz and Scott, above n 2; Craswell, above n 2. 5 See, eg Law Commission Report No 247, Aggravated, Exemplary and Restitutionary Damages (1997); G Jones, ‘The Recovery of Benefits Gained From a Breach of Contract’ (1983) 99 LQR 443; J Stapleton, ‘Negligent Values and Falls in the Property Market’ (1997) 113 LQR 1. 6 Important exceptions include R Zakrzewski, Remedies Reclassified (Oxford University Press, 2005) 165–79 and D Friedmann, ‘Rights and Remedies’ in N Cohen and E McKendrick (eds), Comparative Remedies for Breach of Contract (Oxford, Hart Publishing, 2005). 7 The importance of analytic questions about damages is discussed in more detail below in section VI.

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deal with and how these rights are like or unlike the rights dealt with by other parts of the law. Even if one is interested exclusively in normative questions, analytic questions remain important. Perhaps the most fundamental principle of justice is that like cases should be treated alike. We cannot determine if this principle is satisfied in the law on damages without engaging in an analytic inquiry. This chapter begins—but only begins—to attempt to fill the gap in our comprehension of damages law described above. The chapter’s primary objectives are introductory in nature: to introduce an analytic perspective on the law of damages;8 to explain why this perspective is important; and to develop a framework for answering the questions it raises. The chapter also makes three substantive arguments. The first is that the most basic unanswered analytic question about the law of damages is whether damages rules are directed at citizens or at courts. Bluntly put, is the law of damages concerned with private law rights or public law rights? The second argument is that damages law, viewed from an analytic perspective, is complex. In particular, the question of whether damages rules are directed at citizens or courts cannot usefully be asked of damages law as a whole, but must instead be directed at particular categories of damages rules—and even then the answer is not straightforward. The final argument is that the law of damages is almost certainly composed in part of rules directed at citizens and in part of rules directed at courts. The law of damages, as presently conceived, is a mixture of private and public law.

II

T H E L AW O F DAM AG E S : A PR E L I M I N A RY D E F I N I T I O N

Analytic inquiries in law are essentially classificatory exercises; their conclusions tell us where the rules in question fit within the law, and why. Not surprisingly, such inquiries often lead to revisions in the conventional view of the inquiry’s subject matter. Thus, the common law’s view of a ‘contract’ or an ‘unjust enrichment’ has evolved as lawyers’ views about the kinds of rights that are the focus of contract law and unjust enrichment law have evolved. But an analytic inquiry must begin with the conventional view of the subject matter. In the case of damages law, the conventional view9 is that damages law is the law of ‘damages orders’. More specifically, 8 Except where otherwise indicated, ‘damages’ refers to damages orders in general and not just damages orders for breach of contract. The main theoretical questions raised by contract damages are identical to those raised by other damages orders. 9 This account of the conventional view is based on the coverage of damages in the leading textbooks rather than on such definitions as are provided in these texts. Waddams, above n 2, gives no definition. McGregor, above n 2, states that it is impossible to provide a comprehensive definition, but suggests that the following, which is non-comprehensive on its face, covers most situations: ‘Damages in the vast majority of cases are the pecuniary compensation, obtainable by success in an action, for a wrong which is either a tort or a breach of contract, the

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it is the law that courts apply to determine whether a defendant who has been found to have infringed the plaintiff’s rights10 should be required to pay ‘damages’ to the plaintiff and, if so, how much. There is an obvious tautology in defining the law of damages as the law governing damages awards, but this tautology is unavoidable without a better understanding of the kinds of rights that are the focus of damages law. It is precisely because analytic questions about damages law have been neglected that damages law is currently ‘defined’, if that is the appropriate word, in entirely formal terms. At present, the only distinctive feature of all damages orders is that they are labelled damages orders by courts.

III

O R D I N A RY R I G H T S , RE M E D I A L RI G H T S , A N D C O U RT- O R D E R E D RI G H T S

In the Western legal tradition, rights are typically categorised on the basis of three questions: 1. Against whom may the right be asserted (eg a promisor)? 2. What is the ‘event’11 that gives rise to the right (eg a promise) 3. What is the content of the right (eg to the performance of the promise).12 The first question is actually two questions: 1(a) Is the right a right against the state or a right against a citizen? 1(b) If the latter, is it a right held against everyone in the jurisdiction (a ‘proprietary’ right) or is it held only against a specific individual or individuals (a ‘personal’ right)? compensation being in the form of a lump sum awarded at one time, unconditionally and in sterling’. Tettenborn, above n 2, says ‘there is no categorical definition of damages in English law, and it is probably idle to try to provide one’, but goes on to observe that ‘Broadly, however, the subject of damages can be regarded as covering any monetary award made by a court or arbitrator in respect of a wrong committed against the claimant by the defendant, in order to compensate the claimant or otherwise vindicate his interests’. 10 The requirement of a rights-infringement is important because ‘damage’ is sometimes used as a synonym for ‘loss’ in cases where a loss must be proven to establish a legal wrong, such as the tort of negligence. Thus, Fleming, describing the elements of the cause of action for negligence, states that ‘damages is of the gist of liability’: JG Fleming, The Law of Torts (Sydney, Law Book Company, 7th edn, 1987) 95. The rules describing when a loss must be proven, and what qualifies as a loss, are conventionally understood as part of the substantive law of negligence and of other wrongs that have this requirement. Exceptionally, a defendant who has merely threatened to infringe a plaintiff’s rights may be required to pay damages, as, for example, where a court awards damages in lieu of a quia timet injunction to prevent a future wrong; see, eg Hooper v Rogers [1975] ch 43 (CA). 11 As used here, the term ‘event’ is intended to include both ‘discrete’ events, such as making a contract or transferring money by mistake, and ‘status’ events, such as entering a jurisdiction or being born. 12 See generally, P Birks, ‘Introduction’ in P Birks (ed), English Private Law (Oxford University Press, 2000).

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Which of these questions is emphasised in any particular discussion will depend on the aims of the discussion, but for most purposes the first question to ask, and the focus of the present inquiry, is whether the right is held against the citizen or against the state.13 The answer to this question effectively determines whether the right is a matter of private or public law.14 If the right is held against a citizen, then the correlative duty is a duty imposed on a citizen. Stated differently, if the right is held against a citizen, then the relevant rules are fundamentally directed at citizens: they tell citizens how they should behave. On the other hand, if the right is held against the state, then the correlative duty is a duty imposed on the state. In this case, the relevant rules are fundamentally directed at the state: they tell state actors how they should behave. The first step when examining damages law from this perspective is to identify the different kinds of rights that courts must think about when they are contemplating damages awards and to classify these rights as private or public. Once this is done, we can begin the task of determining which kinds of rights damages rules deal with. There are three main categories of rights that courts must take into account when they make damages orders:15 (i) the rights that citizens enjoy against other citizens prior to any action by the court (‘ordinary rights’); (ii) the rights that citizens enjoy against courts (‘remedial rights’); and (iii) the rights that citizens enjoy against other citizens by virtue of orders made by courts (‘court-ordered rights’).

A

Ordinary Rights

Ordinary rights are rights that citizens hold against other citizens (or ‘individuals’) that arise from events other than court orders (ie from ‘ordinary’ events). Examples include the right to the performance of a contractual obligation and the right to the return of money paid by mistake. In each case, the right arises because of an ordinary event in the world (making a promise, transferring money by mistake) and is held against another individual (the promisor, the transferor).16 In each case, the correlative duty The significance of this question is discussed below in section VI. See, eg M Loughlin, The Idea of Public Law (Oxford University Press, 2003) 153; G Slapper and D Kelly, The English Legal System (Abingdon, Routledge Cavendish, 2006) 5; McEldowney, Public Law (London, Sweet & Maxwell, 2002) 6. 15 These categories are not exhaustive; they do not include, for example, procedural rights. 16 Throughout this chapter, tort examples are avoided not just because the theme of the volume is contract damages, but also because of the controversy over whether primary (ordinary) tort duties, such as a duty not to trespass or a duty to take care not to injure another, actually exist. For a compelling argument that such duties exist, see NJ McBride, ‘Duties of Care—Do They Really Exist?’ (2004) 24 OJLS 417. 13 14

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(the performance of a contract, the return of money received by mistake) arises at the moment of the event. Ordinary rights are a sub-category of ‘substantive rights’—the category comprising all the rights that individuals hold against other individuals (the other main sub-category of substantive rights is court-ordered rights). The distinctive feature of ordinary substantive rights is that they exist prior to any order by a court (and are therefore sometimes described as ‘preexisting’ or ‘already-existing’ rights). Ordinary rights are the substantive rights that plaintiffs possess when they come to court.

B Remedial Rights The second category, remedial rights, comprises rights to court orders (ie to ‘remedies’).17 Remedial rights arise from events (traditionally labelled ‘causes of action’18) that typically involve the infringement or, less frequently, the threatened infringement of the right-holders’ ordinary rights.19 An example is a creditor’s remedial right to a court order compelling a debtor to pay a debt: the creditor obtains such a right on proof that the debtor owes the debt, the debt is not paid and the action is within the limitation period.20 When a creditor argues that she has a right to a court order on proof of these facts, she is asserting a remedial right. Like ordinary rights, remedial rights arise from ordinary (or ‘nonjudicial’) events. Thus, the creditor’s right in the previous example arose from the non-payment of a valid debt. The contents of remedial rights are also similar, in broad terms, to the contents of ordinary rights. In each case, the duty correlative to the right is to do or not do something (eg perform a contract, make a court order). The difference between ordinary 17 On the appropriateness of describing non-declaratory court orders as ‘remedies’, see S Smith, ‘Rights, Wrongs, And Causes of Action’ in R Grantham and C Rickett (eds), Structure and Justification in Private Law—Essays for Peter Birks (Oxford, Hart Publishing, 2008). 18 A cause of action is ‘every fact which it would be necessary for the plaintiff to prove, if traversed, in order to support his right to the judgment’: Lord Escher in Read v Brown [1889] 22 QBD 128 (CA) 131. Diplock LJ gave a similar definition in Letang v Cooper [1965] 1 QB 232 (CA) 242–3: ‘A cause of action is simply a factual situation the existence of which entitles one person to obtain from the court a remedy against another person’. 19 This is true not just for damages orders, but for all coercive orders. Thus, while a remedial right to the repayment of money paid by mistake is a right to a court order that replicates the defendant’s pre-existing duty to repay the money, this remedial right only arises because the defendant has not fulfilled his pre-existing duty: see Smith, above n 17. 20 The normal ‘remedy’ for the infringement of a remedial right is the right to have the relevant judicial decision overturned by a higher court. But, in exceptional circumstances (eg where a judge refuses to grant a court order out of malice), it is possible that damages might be available for the breach of this right. In some cases, it might also be possible to make a claim for breach of a constitutional right or a right provided by human rights legislation, eg Art 6(1) of the European Convention on Human Rights. It should be stressed, however, that the existence of a legal right, whether ordinary, remedial or court-ordered, is not dependent on the willingness of a court to enforce that right.

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rights and remedial rights lies in their exigibility, that is, against whom the right may be asserted. Ordinary rights are rights against other individuals; the duty correlative to an ordinary right is a duty owed by a citizen or citizens to the right holder.21 The rules that govern ordinary rights are thus directed fundamentally at citizens: they tell citizens how they should behave. By contrast, remedial rights are rights against particular organs of the state (ie courts). The duty correlative to a remedial right is the court’s duty to award an appropriate remedy if the cause of action is proven.22 The content of a remedial right is therefore fundamentally an instruction telling courts how they should behave. It follows that remedial rights are essentially public law rights: they are rights held by citizens against state institutions. By contrast, ordinary rights are private law rights: they are rights held against individuals.

C

Court-ordered Rights

The third kind of right that courts must take into account when contemplating making an award of damages are ‘court-ordered’ rights. These are rights that arise from court orders. An example is a plaintiff’s right to payment of $1,000 from the defendant that arises when the court orders the defendant to pay the plaintiff $1,000. Like ordinary rights, court-ordered rights are a sub-category of substantive rights; a court order gives the plaintiff a legal right against the defendant to the performance of the order. The distinctive feature of court-ordered substantive rights is that they arise by virtue of a judicial act—making a court order. Of course, the content of court orders often replicate the content of ordinary rights (eg where the order is to perform a contractual obligation), but where this happens the order replaces the ordinary right. This is why a sheriff or bailiff will execute the order (or take other action) solely on proof that the order exists and was not fulfilled. Once the court order has been made, the plaintiff relies upon the existence of that order (rather than on earlier events, such as entering a contract) as the source of her right. Court orders are therefore a distinct source of legal rights. Court-ordered substantive rights, like ordinary substantive rights, are private law rights. Although court-ordered rights are enforced by different means than ordinary rights, each is identical in terms of content and

21 ‘Citizens’ includes artificial citizens (eg corporations) and state actors when they are acting as ordinary citizens. 22 Though not expressed in the same terms, the idea that at least some of the rules dealing with remedial orders are rules directed at courts is discussed by B Zipursky, ‘Philosophy of Private Law’ in J Coleman and S Shapiro (eds), Jurisprudence and Philosophy of Law (Oxford University Press, 2002) and Friedmann, above n 6.

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exigibility: both court-ordered rights and ordinary rights are rights held against individuals to the performance of an action.

IV

A

C O U RT- O R D E R E D RI G H T S AS D E R I VAT I V E RI G H T S

The Role of Remedial Rights in Explaining Court Orders

The distinction between ordinary, remedial and court-ordered rights naturally leads to the suggestion that the law of damages is the law of court-ordered rights to pay damages. Damages are court orders, and thus it might seem obvious that the law of damages is the law concerning this kind of court order. Understood in this way, court orders appear closely related to contracts and other ‘intentional norm-creating’ events. Viewed as an ‘event’, a court order to pay damages is closely related to a contractual promise. In each case, an intentional23 norm-creating event (a court making an order, an individual making a contractual promise) is the source of a private law duty and a correlative private law right.24 Upon reflection, this suggestion cannot be right. The analogy just drawn between court-ordered rights and contractual rights makes this clear. The law of contracts is the law governing the validity, meaning and performance of contracts. The analogous law that deals with damages orders would be law that governs the validity, meaning and performance of damages orders. There is a body of law that deals with these issues (though it is not extensive and most of it is not unique to damages orders). In a different world it might legitimately be called the ‘law of damages’, but this law bears no resemblance to the law conventionally understood as the law of damages. More to the point, recognising this body of law, and even renaming it the law of damages, provides little help in classifying the current rules on damages. Indeed, the current damages rules bear an entirely different relation to court orders than the law of contract bears to contracts. Rather than explaining the validity, meaning, or performance of a damages order, the rules on damages explain why the order was made. In broad terms, this explanation is that the plaintiff had a legal right to the court order. Specifically, the

23 ‘Intentional’ because it is not ordinarily possible to make a contract or a court order by mistake (though it is possible to be mistaken about the content of a valid contract and, perhaps, a valid court order: see Smith, above n 1, 173, 366). 24 This conclusion fits neatly with Peter Birks’s treatment of court orders as just another example of a right-creating event, similar in kind to making a contract or transferring money by mistake: P Birks, ‘Rights, Wrongs, and Remedies’ (2000) 20 OJLS 1, 27; P Birks, ‘The Concept of a Civil Wrong’ in DG Owen (ed), Philosophical Foundations of Tort Law (Oxford, Clarendon Press, 1995) 29, 50.

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explanation (exceptional cases aside25) is that the plaintiff had a remedial right to the order that was made. By contrast, in the case of a typical contract, wrong or unjust enrichment, there is no legal explanation for the event: contracts, wrongs and unjust enrichments are simply events that happen in the world.26

B The Role of Ordinary Rights in Explaining Remedial Rights The observation that court-ordered rights are normally derived from remedial rights leads to a second suggestion: the law of damages is concerned with remedial rights to damages. According to this view, damages rules are exclusively rules about remedial rights. As we will see later, a compelling argument could be made that, in future, the law of damages should indeed be defined in this way.27 At present, however, although it is theoretically possible that damages rules are all rules about remedial rights, this suggestion cannot be accepted without a great deal more argument. Nearly all of damages law deals with the content of damages orders, ie with the assessment and quantification of damages. It is clear that a judge must take such rules into account in establishing the content of a plaintiff’s remedial right to damages. But it is entirely possible that these rules are fundamentally rules for determining the content of ordinary rights, and are merely incorporated by reference into the law of remedial rights. This would be the case wherever the plaintiff’s remedial right is a right to a court order that confirms the plaintiff’s ordinary rights. It seems incontrovertible that many remedial rights are indeed rights to orders that confirm ordinary rights. An example is a remedial right to an order compelling a defendant to pay a sum equal to the sum that the defendant owes the plaintiff by virtue of a valid contract. In this case, the existence of the plaintiff’s remedial right to the order is not derived from the plaintiff’s ordinary right to payment of the debt. The plaintiff’s ordinary right to payment does not itself justify a third party commanding, on threat of punishment, that the payment be made. It is perfectly coherent for a court to say ‘the defendant owes the plaintiff a duty to do X, but we will not order the defendant to do X’. Indeed, courts say this all the time; 25 As discussed later in this chapter, it is theoretically possible (though practically unlikely) that the only explanation for why some court orders are made is that the judge ‘willed’ that they should be made. In such cases, the court order resembles a contract. Where this happens, the award is not governed by damages rules or any other rules. 26 Specific contractual terms (as opposed to entire contracts) are sometimes required by law (eg the terms implied by the Sale of Goods Act, 1979). The rights created by such terms, though not strictly court-ordered, are similar in that they arise from an act by an organ of the state. The possibility that the very existence of a contract could be mandated by law seems a contradiction in terms, though it is sometimes argued that such contracts exist, as, for example, where ‘contracts’ are forced upon unwilling common carriers. 27 See the final paragraph.

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for example, when they refuse to order specific performance of a valid contract. A further independent explanation for the order’s existence is therefore required. The content of a plaintiff’s remedial right to an order to pay a debt is, however, derivative: the content is derived from the content of the plaintiff’s ordinary right to payment. Thus, the explanation for why the remedial right is a right to an order to pay X sum of money is that the defendant contractually agreed to pay that amount. This is true for all specific performance orders: the explanation of the content of an order of specific performance is found in the rules that explain the plaintiff’s ordinary contractual rights. If some or all damages orders are similar, then it would be misleading to describe the ‘damages’ rules that govern the content of such orders as remedial rules; they are rules about ordinary rights.

C

The Possibility of Non-derivative Remedial or Court-ordered Rights

The basic analytic question about damages can be described as the question of whether court orders to pay damages are like court orders to pay debts. If they are, then the answer to the question posed at the beginning of this chapter is that the rights dealt with by the law of damages are partly remedial rights and partly ordinary rights. The (few) rules that determine when a court will make a damages order are remedial (public law) rules, while the (many) rules that govern the content of such orders are ordinary (private law) rules. This is indeed a natural interpretation of some damages orders. An order to pay for the repair of damaged or defective property, for example, appears merely to give effect to an ordinary duty, arising on commission of the relevant wrong, to pay for the repair.28 It cannot be assumed, however, that all damages orders are analogous to orders to pay a debt. Consider an order to pay punitive damages. It is theoretically possible that such an order replicates the defendant’s ordinary duty to pay punitive damages— but this would be a very odd conclusion. Punishment only serves its punitive role if it is pronounced by someone other than the wrongdoer, such as a court. To suppose that a wrongdoer has a duty from the moment of committing his wrong to pay damages by way of punishment seems morally incoherent. It is impossible to self-punish. The more plausible interpretation, therefore, is that the duty to pay punitive damages arises at the moment that the order to pay punitive damages is pronounced. If this is correct, then neither the existence nor the content of an order to pay punitive damages is derived from the plaintiff’s ordinary rights. They are either derived from the plaintiff’s remedial rights, assuming such rights 28

See below section VIII.E.

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exist, or are non-derivative, that is, created afresh by the order.29 Orders to pay punitive damages and orders to pay debts are qualitatively different.

V

F O U R KI N D S O F C O U RT O R D E RS

The law of damages, as currently conceived, governs the availability and content of damages orders. In the previous section, the possibility was raised that this law might be a mixture of remedial law and ordinary law. Whether this is the case and, if so, what is the content of the mixture depend on the extent to which court-ordered rights to damages are derived in whole or in part from ordinary rights or remedial rights. The possibility that some court-ordered rights are partly or wholly non-derivative (‘independent’ rights) must also be considered. In this section, I will attempt to give some order to this complex picture by setting out in a more schematic fashion the main ways in which court-ordered rights could be related to ordinary and remedial rights, and by explaining where these possibilities fit within the public law/private law distinction introduced earlier. The discussion will focus exclusively on coercive court orders30 and will assume, as seems true in practice,31 that such orders are only made on proof of an actual or threatened infringement of the plaintiff’s ordinary rights. There appear to be four main ways in which coercive orders might be linked (or not linked) to ordinary and remedial rights.32 Each possibility is described below and illustrated by an example that does not involve the law of damages. It should be kept in mind throughout that in practice most court orders exhibit features associated with more than one category.

A

Category One Orders: a Mixed Private/Public Law Explanation

The first possibility is that the plaintiff’s court-ordered right is wholly derived from a combination of her remedial and ordinary rights. In this case, the legal explanation of the order is that the plaintiff had a remedial right to an order that replicates the content of the plaintiff’s ordinary right against the defendant. In less technical language, the defendant’s breach gave the plaintiff the right to a court order commanding the defendant to do what he should have done already. As mentioned already, this is the 29 Both possibilities must be considered because, while there appears to be a significant body of law dealing with the content of punitive damages (which law must be remedial law), the orthodox view is that the plaintiff has no right to punitive damages, let alone a right to a particular sum of punitive damages: see below section VIII.A. 30 Examples of coercive orders include orders to pay damages, specific performance orders and injunctions. The main example of a non-coercive order is a declaration. 31 See Smith, above n 17. 32 A fifth possibility is discussed below in n 43.

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explanation of an order to pay a debt. The order’s content is explained by the plaintiff’s ordinary right (to payment of such and such a debt), while the order’s existence is explained by the plaintiff’s remedial right to an order. The rules governing category one court orders are therefore a mixture of private law rules (rules directed at citizens) and public law rules (rules directed at courts). The ‘ordinary’ rules that determine the order’s content are private law rules, directed at citizens.33 The public law aspect derives from the remedial rules that explain when the court will make an order that enforces the plaintiff’s ordinary right. These rules direct courts to make orders that enforce ordinary rights on proof of certain facts. In the case of court orders to pay a debt, the relevant facts are that the debt is valid, due and not paid, and that the claim is brought within the limitation period.

B Category Two Orders: a Pure Private Law Explanation The second possibility is that the court order replicates the plaintiff’s ordinary right, but the plaintiff had no remedial right to the order. In this case, the content of the court order is determined by the plaintiff’s ordinary right, but the existence of the order (the fact that the order was made at all) is not determined by the plaintiff’s remedial right or by any other right. Unsurprisingly, there are no uncontroversial examples of category two orders, but if the traditional view that equitable remedies are discretionary remedies is accepted without qualification, then at least some equitable remedies belong in this category. An order of specific performance would be an example. If the availability of specific performance orders is entirely within the court’s discretion, then a plaintiff never has a right to specific performance. Yet, when courts actually make such an order, the order replicates the plaintiff’s ordinary right to the performance of the contract. It follows that, insofar as category two court orders are determined by legal rules, these rules are private law rules. The qualifier is necessary because, if the plaintiff has no right to the order, then there is no ‘law’ that can explain the order’s existence. The order simply happened. In this respect, a category two order is similar to a contract: there are legal rules that explain what qualifies as a contract (just like there are rules, rarely litigated, about what qualifies as a court order), but there are no legal rules that explain why a contract was formed. From the law’s perspective, the 33 A plaintiff creditor normally also has the right to claim interest on the unpaid debt. This right must be explained on other grounds save in those cases where the parties contractually agree that interest is due.

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contract just happens. However (and unlike most, though not all, contracts), there is a significant body of law that explains the content of category two court orders. This law comprises the private law rules that determine the content of the plaintiff’s ordinary right. In the case of orders to perform a contract, these are the rules that govern the validity, content and performance of contracts.34

C

Category Three Orders: a Pure Public Law Explanation

The third category comprises orders that the plaintiff had a remedial right to demand from the court, but whose content does not replicate the plaintiff’s ordinary right against the defendant. Category three court orders thus create new rights, but they do this on the basis of remedial rules that require such a result. If we ignore damages awards, it is not easy to find clear examples of category three orders, but one possibility is an award of monetary restitution in a case where the defendant was unjustly enriched by receiving the plaintiff’s goods. The traditional common law rule is that, where title has passed, courts will order not the return of specific property, but only payment of the monetary value of the property (although exceptions may be made if the property has special value).35 This rule is conventionally explained on the basis that the defendant’s ordinary duty is (merely) to return the monetary value of the property.36 Thus, on the conventional view, an order to make monetary restitution is always a category one order: the plaintiff has a remedial right to a court order that replicates the content of her ordinary right. It is possible, though, and intuitively more plausible, to describe the defendant’s ordinary duty in 34 It is not seriously suggested that specific performance orders are ‘pure’ category two orders. If such orders existed they would be blatantly inconsistent with the rule of law. Not surprisingly, no one seriously supposes the court’s discretion to award specific performance to be unfettered: see, eg A Burrows, Remedies for Torts and Breach of Contract (London, LexisNexis, 3rd edn, 2004) 457; Zakrzewski, above n 6, 94–7. Indeed, there is a large body of legal rules that deals with specific performance (there are entire treatises devoted to specific performance and other equitable remedies: I Spry, The Principles of Equitable Remedies: Specific Performance, Injunctions, Rectification and Equitable Damages (Sydney, LBC Information Services, 6th edn, 2001); J Berryman, The Law of Equitable Remedies (Toronto, Irwin Law Inc, 2000)) and nearly all of these rules deal with the availability (rather than the content) of such orders. At the same time, even if pure category two rules do not exist, the category is useful. The idea of such a category helps to make clear that to the extent courts have genuine discretion regarding the availability of a court order there is simply no law, public or private, that governs the order’s existence. 35 This power to order ‘delivery up’ of goods, which originated in the Courts of Equity, is now enshrined in the UK in the Torts (Interference with Goods) Act 1977; see A Burrows, The Law of Restitution (London, Butterworths, 2nd edn, 2002) 52–5; R Goff and G Jones, The Law of Restitution (London, Sweet & Maxwell, 6th edn, 2002) 94–6. 36 ‘Explained’ may be too strong, as the alleged explanation seems just to be assumed; but see Birks, above n 24, 24.

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cases where specific property was transferred as a duty to return the actual property.37 If this interpretation is correct, then when courts order monetary restitution in cases of this kind, they are not replicating the plaintiff’s ordinary right but, instead, replacing that right with a right to payment of the property’s value.38 The rules that explain category three orders are entirely public law rules: both the existence and content of the court order are determined by the plaintiff’s (remedial) right against the court. They are nonetheless closely linked to private law rights. In practice, remedial rights to ‘rightcreating’ court orders (of any kind) arise only if the plaintiff’s ordinary rights have been infringed or threatened. Further, when a court makes a right-creating order, it creates, by that order, a new (court-ordered) substantive right. Thus, while remedial rights are public law rights, they are both dependent upon and a cause of private law rights.

D

Category Four Orders: No Legal Explanation

The fourth category comprises orders whose existence and content are both within the court’s discretion. In this scenario, the court-ordered right that the plaintiff obtains is one that she had no remedial right to demand and, further, whose content differs from the content of her ordinary rights.39 The only legal explanation that can be given for such orders is that the court willed them into existence (in the same way that an ordinary contract is willed into existence). Unsurprisingly, it is difficult to find examples of category four orders, but possible near-examples can be found where courts have relied on the concept of a remedial constructive trust or a proprietary estoppel. Some Canadian cases in which it was found that the defendant holds property obtained during a common-law relationship on ‘constructive trust’ for his common-law partner arguably involve something close to category four orders.40 In most such cases, the plaintiff’s 37 See, eg K Barker, ‘Rescuing Remedialism in Unjust Enrichment Law: Why Remedies are Right’ [1998] CLJ 301. German law is explicit that in such cases the defendant’s pre-existing duty is to return the very thing that was transferred: s 812(2) BGB. 38 There is an obvious analogy between this example and cases involving the breach of a contractual obligation to deliver goods. In both cases the courts generally refuse to order delivery of the actual property, but then make an exception where the property is unique or has special value to the plaintiff. 39 The difference between category two and category four orders is the distinction between negative and positive discretion. In category two cases, the court’s discretion is a negative discretion to refuse to enforce an ordinary duty. In category four cases, the discretion is a positive discretion to create a new right. 40 Peter v Beblow [1993] 1 SCR 980 (SCC). A constructive trust is not strictly a coercive remedy but, rather, a declaration that the defendant holds property in the capacity of a trustee. But the effect of declaring a trust is that the defendant comes under an obligation to transfer the property to the plaintiff.

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beneficial right under the trust appears to be a new right (because the property is rarely purchased by, or obtained from, the plaintiff).41 Further, the conventional view is that a constructive trust is a ‘discretionary’ remedy. If this interpretation is accepted without qualification, then neither the content nor the existence of the constructive trust order can be explained by the plaintiff’s ordinary or remedial rights.42 In such a case, there is simply no law, private or public, governing the order.43

VI

WHY D OES I T MATTER?

There remain two preliminary issues to look at before we turn to examine damages orders in light of the above framework. The first is to consider why it matters whether damages rules are directed at citizens or at courts. An initial observation is that from a practical perspective this issue may not matter very much to the parties to an actual or potential dispute. With 41 It is sometimes said that these orders are retroactive, so that the defendant is regarded in law as having held the property on trust from the moment it was acquired: Rawluk v Rawluk [1990] 1 SCR 70 (SCC) 91–2. It seems clear that in most cases this conclusion is a fiction. The courts’ repeated invocation that the judge has discretion to determine whether or not the trust arises is inconsistent with the trust arising ‘on the facts’. Further, the constructive trustee will not actually be treated as a trustee until the court order; for example, if a partner in a common-law relationship innocently loses or gambles away property that, were it still in his possession, would be found to be held on constructive trust, the court will not hold the partner liable for the loss (but it will hold him liable if he loses the property after the judgment). Finally, the judicial explanation for why a trust attaches to the relevant property (rather than to other property) is often that the plaintiff developed an attachment to, or need for, the property over the course of the relationship: eg Peter v Beblow [1993] 1 SCR 980 (SCC); Soulus v Korkontzilas [1977] 2 SCR 217 (SCC). 42 The possibility that both the availability and content of an order declaring a constructive trust might lie entirely within a court’s discretion helps to explain why remedial constructive trusts are controversial and why scholars have sought to show that they are (or should be) governed by relatively clear rules: eg P Birks, ‘The End of the Remedial Constructive Trust’ (1999) 12 Trusts Law International 202; but cp P Finn, ‘Equitable Doctrine and Discretion in Remedies’ in W Cornish, R Nolan, J O’Sullivan and G Virgo (eds), Restitution Past, Present and Future (Oxford, Hart Publishing, 1998). In practice, it appears that, while courts have some discretion as to the content and availability of remedial constructive trusts, this discretion, like that regulating equitable remedies generally, is not unfettered. English courts have shown little enthusiasm for the remedial constructive trust: Re Polly Peck (No 2) [1998] 3 All ER 812 (CA). 43 A fifth possible category of court orders is an order that creates a new right, the content of which is determined by a remedial right, but the existence of which is within the court’s discretion. Suppose, for example, that new legislation provided that on proof of a breach of contract the court had the option to order the defendant to write an apology—but only an apology, nothing more or less—to the plaintiff. It seems clear that the right to such an apology is a new right. But if the availability of the order lies within the court’s discretion then the plaintiff has no right to the order. In this case, the content of the order is set by law (remedial law), but its availability is at the discretion of the court. It seems likely that this kind of order exists, but an example or even near example does not come to mind and the category does not appear to be relevant for explaining damages orders.

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rare exceptions,44 it will not matter to someone who has wrongfully injured another (or who is contemplating wronging another) whether the damages rules are directed at courts or directed at him. Regardless of whether the wrongdoer’s duty to pay damages arises at the moment of the injury or at the moment of the court order, the wrongdoer will have an incentive to reach a settlement in advance (or to avoid the wrong altogether) to avoid the expense of going to court. Under either interpretation of the damages rules, the final result, if the wrong is committed and the parties go to court, will almost always be the same: the defendant will be ordered to pay damages. From either a moral or a theoretical perspective, however, the distinction between rules directed at citizens and rules directed at courts is fundamental. Even if it is accepted that there is no general moral obligation to obey the law, it is clear that in at least some situations the best way to do the morally right thing is simply to do what the law requires.45 In such a case, it may matter, morally, whether damages rules are directed at citizens or at courts. If the legal obligation to pay damages arises at the moment of injury, then the potential defendant who seeks to obey the law should pay damages as soon as possible after the injury. Alternatively, if the obligation to pay arises only once the court order has been made, the potential defendant has no moral duty to pay in advance. The distinction between ordinary and remedial rights will also be important to judges (and other lawmakers) who are trying to decide what morality requires them to do. Ordinarily, a judge’s moral obligation is simply to apply the law as it stands. However, there are situations where the law is uncertain or where, even if the law is certain, it should be reformed. In both these cases, it is important to know whether the law in question is directed at citizens or at courts. The principles that underlie (or should underlie) these two categories of rules are different. The principles that explain why a contracting party should perform his contract do not explain why a court should order that party to perform.46 The decision to invoke the state’s power to compel a defendant to do something raises a

44 Conflicts of law rules generally stipulate that only foreign substantive law, as opposed to foreign procedural law, can be applied by a domestic court: Harding v Wealands [2006] UKHL 32, [2006] 3 WLR 83 (HL). If damages rules are directed primarily at courts, they should fall within procedure for the purpose of conflicts of law (and vice versa). A second situation where the distinction between ordinary rights and remedial rights may matter is in the awarding of interest on monetary judgments. If the duty to pay damages arises only at the moment of judgment, then in principle interest should only run from that date. Other areas where the distinction might matter include damages for late payment, tenders and settlements, set-off, assignment and limitation periods. 45 See, eg J Raz, The Morality of Freedom (Oxford, Clarendon Press, 1986) chs 2–4. 46 This does not mean that ordinary rights are irrelevant when thinking about remedial rights. There are undoubtedly good reasons that remedial rights should generally be rights to the enforcement of ordinary rights. However, these reasons must be articulated.

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range of institutional and political considerations that are generally irrelevant when explaining individuals’ duties.47 Finally, it goes without saying that from a theoretical perspective it matters greatly whether damages rules deal with ordinary rights or remedial rights. For legal scholars trying to understand and explain the law, the difference between rules directed at citizens and rules directed at courts is fundamental. For the reasons just given, the explanation for the rules will (or should) be radically different. We cannot claim to understand the law of damages unless we know whether damages rules are directed at citizens or at courts.

VII

W H Y T H E QU E S T I O N I S D I F F I C U LT

The final preliminary task is to explain why the question identified above will not be easy to answer. There are two main reasons.

A

The Methodological Difficulty

The methodological difficulty is that there is no simple test for distinguishing remedial rights from ordinary rights. This is a problem for all legal systems, but it is acute in the common law. Until the abolition of the forms of action in the nineteenth century, legal rights in the common law were all remedial rights in theory (although it was clear that in practice these remedial rights were based on a largely unarticulated set of ordinary rights). Since abolition, the situation has been almost reversed: the law is now organised primarily around ordinary rights (eg rights arising from contracts, trusts or unjust enrichments), and remedial rights are often presented as glosses on ordinary rights. An extreme version of the latter approach is seen in Holmes’s famous account of the duty to perform a contract as a duty to perform or pay damages.48 The important point, however, is that lawyers and judges in both periods rarely clarified whether a particular right was ordinary or remedial.49 Even today, a common law 47 Courts sometimes refuse to grant specific performance on the ground that the order will be difficult to supervise. This is understandable if (as is almost certainly the case) the rules governing the availability of specific performance are remedial, that is to say, public law rules. As public bodies, courts should take into account whether an order they are contemplating making is likely to result in further litigation and, thus, a further drain on the public purse. But it is not at all clear that the issue of supervision should matter when trying to explain or determine whether one individual has an ordinary (private law) obligation towards another to perform a contract. The fact that it might be difficult for a court to supervise a builder’s contractual obligation to build a house does not give the builder a reason not to perform the obligation. 48 OW Holmes, ‘The Path of the Law’ (1897) 10 Harvard Law Review 457, 462. 49 By contrast, most civilian codes include explicit confirmations of an ordinary duty to pay damages: eg Art 1382 Civil Code (France): ‘Any human deed whatsoever which causes harm to

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lawyer who is asked for evidence that an ordinary duty exists will usually respond by looking for evidence of the courts’ willingness to make orders to perform the alleged duty. This practice continues even though it is incontrovertible that some ordinary rights are never enforced directly (eg the right to performance of a personal service contract), while others are not enforced at all (eg the right to performance of a time-barred debt50). The consequence is that any attempt to categorise court orders along the lines described above invariably involves controversial and complex claims about the nature not just of remedial rights, but of ordinary rights as well. The common law therefore lacks both an agreed inventory of ordinary rights and an agreed method for establishing that inventory.

B The Substantive Difficulty The substantive difficulty is that the law of damages is complex and heterogeneous. We can obtain a glimpse of this complexity and heterogeneity by considering the picture that quickly emerges if one attempts to analyse ‘damages’ in general (rather than particular kinds of damages orders) from the perspective of the remedial/ordinary right distinction. As with any inquiry into the nature of legal rules, the relevant evidence falls into three main categories: (i) what courts and legislatures do (fit); (ii) what courts and legislatures say (transparency); and (iii) what makes moral sense of the law (‘morality’).51 In respect of each category, the evidence suggests a complex, if not inconsistent, relationship between damages rules and citizens’ ordinary and remedial rights. (i)

Fit

We have seen that it is rarely necessary for courts to classify rights as ordinary or remedial. Whether the content of a particular court order is established by ordinary or remedial law, the practical result is usually the same: the plaintiff will be granted the order on the terms set out in the relevant rules. However, there are some situations where the distinction matters, in particular in disputes involving conflicts of law, damages and interest for late payment, tenders and settlements, set off, assignment, another creates an obligation in the person by whose fault it was caused to compensate it’. However, it remains an open question whether articles of this kind explain all the damages orders made in civilian systems. For reasons explained below, this seems unlikely (at least if ‘damages’ is understood in the broad common law sense). 50 The traditional position is that ‘the English Limitation Acts bar the remedy not the right’: Donaldson LJ in Ronex Properties LTD v John Laing Construction Ltd [1982] 3 WLR 875 (CA) 879. 51 See generally Smith, above n 1, ch 1.

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limitation periods and limitation clauses. An examination of the rules in these areas reveals that they do indeed make assumptions (though rarely explicitly) about the status of damages rules, typically in the form of assumptions about when the duty to pay damages arises. These assumptions, however, do not reveal a consistent pattern. Sometimes the duty is assumed to arise on injury, but other times it is assumed to arise when the court order is made or even at a moment between these events. The conflicts of laws rules nicely illustrate the general pattern. In a recent English House of Lords case,52 it was held that the rules on the quantification of damages are ‘procedural’53 rather than ‘substantive’ law (and thus are governed by the lex fori). This decision suggests that the content of a damages order is set by the plaintiff’s remedial rights, that is, by public law rules, and that the duty to pay only arises when the order is made. The House of Lords’ decision, however, is highly controversial.54 Not only are there conflicting English decisions55 (including the decision of the Court of Appeal56 in the same case), but the highest courts in Australia57 and Canada58 have both held that the rules for quantifying damages are substantive law. Overall, no settled view as to whether damages rules are ordinary or remedial can be drawn from the Commonwealth conflicts of law decisions. The decisions regarding late payment, tenders, etc lead to the same conclusion.59 Harding v Wealands [2006] UKHL 32 (HL). The term ‘procedural’ has a wider meaning in conflict of law cases than ‘remedial’, but it clearly includes remedial rules. 54 See, eg P Rogerson, ‘Quantification of Damages—Substance or Procedure’ [2006] CLJ 515. 55 Eg Cope v Doherty (1858) 4 K & J 367 (ch) 384–5. 56 [2004] All ER 280 (CA). 57 John Pfeiffer Pty Ltd v Rogerson (2000) 210 CLR 503 (HCA). 58 Tolofson v Jensen (1994) 120 DLR (4th) 289 (SCC) 321. 59 Briefly, the rule that damages are available for late payment of a debt but not for late payment of damages (The Lips [1988] AC 395 (HL) 475) suggests the duty to pay damages arises only when a court order is made. But it is dangerous to place much weight on this rule. The late repayment of money transferred by mistake also does not support a claim in damages. The current rules on claims for interest on damages, which provide that interest is available from the moment of injury, point in the opposite direction. Again, it is dangerous to place much weight on this rule. Until relatively recently, interest could not be recovered in claims for damages or for debt. Further, and paradoxically, in Edmunds v Lloyd Italico SpA [1986] 1 Lloyd’s Rep 326 (CA) the court held that, in contrast to the rule applied to claims based on a debt, in claims for damages the payment in advance of the full amount that the court finds due does not prevent the court from awarding interest under the relevant Act because it does not extinguish the plaintiff’s right to damages and, thus, technically the court can still give judgment for the plaintiff. A final wrinkle arises from Pickett v British Rail Engineering Ltd [1980] AC 136 (HL), where it was held that interest on damages for pain and suffering should arguably be calculated from the date the plaintiff instituted proceedings. The rules on tender and settlement suggest that the duty to pay damages arises only at the moment of the court order. In IM Properties Plc v Cape & Dalgleish [1998] 3 WLR 457 (CA) 464 (Waller LJ) it was held that, unlike in the case of debt, in claims for damages the tender of the full amount claimed is not a defence to the action. The rules on set-off and assignment also distinguish between debts and damages, those options being less available (though not entirely 52 53

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(ii) Transparency In view of how rarely the issue arises directly it is not surprising that common law judges rarely say explicitly whether they regard damages rules as directed at courts or at citizens. But judges have not been completely silent. Perhaps the best-known statement on the nature of obligations to pay damages is by Lord Diplock in Photo Production Ltd v Securicor Transport Ltd.60 Lord Diplock explicitly describes a duty to pay damages as a duty that arises from the date of the breach (rather than from a subsequent court order): Every failure to perform a primary obligation is a breach of contract. The secondary obligation on the part of the contract breaker to which it gives rise by implication of the common law is to pay monetary compensation to the other party for the loss sustained by him in consequence of the breach.

This statement is important, but its significance for the general law of damages is limited by the fact that Lord Diplock is only referring to damages for breach of contract, and then only to damages for rescinded contracts.61 Moreover, there are hundreds, if not thousands, of less-famous decisions in which judges describe or at least treat damages rules as directed at courts, not citizens. A typical example of the courts portraying the task of assessing damages as one of determining what they should do now (rather than what the defendant should have done earlier) can be found in unavailable) in respect of damages than debt: see Tettenborn, above n 2, 10. Pointing in the opposite direction is the traditional English position that the expiration of a limitation period bars the remedy but not the right (Ronex Properties LTD v John Laing Construction Ltd [1982] 3 WLR 875 (CA) 879), which implies that a right to damages arises from the moment of injury (since limitation periods clearly apply to claims for damages). The language of the Limitation Act, 1980 itself is ambiguous (it merely states that ‘no action may be brought’) and, further, it is not clear that any of the cases in which this rule has been applied involve claims for damages. Finally, the power to limit liability for certain kinds of losses by agreement with a potential victim might be thought to show that the duty to pay damages is originally a duty owed to the victim. But this power is not inconsistent with the view that damages orders create new duties. It is entirely appropriate for remedial rules to direct courts to take into account any arrangements between the parties when they are determining whether the defendant should be placed under a (new) duty to pay damages to the plaintiff. [1980] AC 827 (HL) 847. This is clear from the sentences following the above quote and also from Lord Diplock’s earlier statement in Moschi v Lepp Air Services Ltd [1972] 2 WLR 1175 (HL) 1185: ‘Generally speaking, the rescission of the contract puts an end to the primary obligations of the party not in default to perform any of his contractual promises which he has not already performed by the time of the rescission. It deprives him of any right as against the other party to continue to perform them. It does not give rise to any secondary obligation in substitution for a primary obligation which has come to an end. The primary obligations of the party in default to perform any of the promises made by him and remaining unperformed likewise come to an end as does his right to continue to perform them. But for his primary obligations there is substituted by operation of law a secondary obligation to pay to the other party a sum of money to compensate him for the loss he has sustained as a result of the failure to perform the primary obligations. This secondary obligation is just as much an obligation arising from the contract as are the primary obligations that it replaces.’ 60 61

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Lord Bingham’s judgment in Jaggard v Sawyer62: ‘the court will not value the right at the ransom price . . .’. Similar language is frequently found in decisions involving the assessment of damages for personal injuries: The court has to perform the difficult and artificial task of converting into monetary damages the physical injury and deprivation and pain and to give judgment for what it considers to be a reasonable sum. It does not look beyond the judgment to the spending of the damages.63 The assessment requires the judge to make a value judgment. That value judgment has been increasingly constrained by the desire to achieve consistency between the decisions of different judges. Consistency is important, because it assists in achieving justice between one claimant and another and one defendant and another.64

Statutory provisions for assessing damages are also frequently framed as directions for courts. The language of the Damages Act is not atypical: 1.—(1) In determining the return to be expected from the investment of a sum awarded as damages for future pecuniary loss in an action for personal injury the court shall, subject to and in accordance with rules of court made for the purposes of this section, take into account such rate of return (if any) as may from time to time be prescribed by an order made by the Lord Chancellor.65

Admittedly, these statements could be read as directions about what courts should do in order to determine the parties’ (pre-existing) ordinary duties. But the more natural interpretation is that they are directions for creating new duties. (iii) Morality The third and final factor that must be taken into account when classifying damages rules is whether the proposed classification makes moral sense of the law. Of course, it cannot be assumed that the law is morally justified. But morality plays an important role in the explanation of the law because the law’s claim that it provides morally valid reasons for action, which is central to our very conception of law, is one of its features that we need to explain.66 This claim may be mistaken. However, unless we are to suppose [1995] 2 ALL ER 189 (CA) 203. H West & Son Ltd v Shephard [1964] AC 326 (HL) 364 (Lord Pearce). Heil v Rankin [2001] QB 272 (CA) 294 (Lord Woolf MR). The Sale of Goods Act 1979 describes rights to damages and rights to satisfactory goods, delivery on time, etc using different kinds of language. The latter rights are expressed in terms of duties directed at the parties. Thus, s 29(6) states that ‘Unless otherwise agreed, the expenses of and incidental to putting the goods into a deliverable state must be borne by the seller’. By contrast, rights to damages are expressed in terms of the parties’ rights to bring an action for damages; eg s 51(1): ‘Where the seller wrongfully neglects or refuses to deliver the goods to the buyer, the buyer may maintain an action against the seller for damages’. 66 See J Raz, Ethics in the Public Domain (Oxford, Clarendon Press, 1994) 210–24; Smith, above n 1, 13–24. 62 63 64 65

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that legal officials are all deluded or involved in a massive conspiracy, any explanation of the law should at least show how the claim could be sincerely made. The moral perspective on damages is therefore important. Perhaps unsurprisingly, though, it is not obvious whether it makes more sense, morally, to interpret damages orders as creating new duties or as confirming pre-existing ordinary ones. At first blush, two main views of the moral foundations of liability for damages67—the ‘rights-based’ view and the ‘utilitarian’ (or ‘economic’) view—appear to provide clear, albeit directly opposing, perspectives on this issue. According to the dominant interpretation of the rights-based view, individuals who have wrongfully harmed others have a duty, grounded in the concept of corrective justice, to repair or undo the harm they have caused.68 The authors who defend this view say little specifically about court orders, but it seems clear they regard the courts’ role as that of simply confirming the above duties. Their justification for damages orders is framed entirely in terms of the parties’ relationship. In stark contrast, the competing utilitarian view regards damages orders as incentives to encourage individuals to behave appropriately in the future.69 The defendant is ordered to pay damages not to undo a wrong, but rather to deter the defendant and other individuals from acting inappropriately in the future (and to encourage the plaintiff and others to take appropriate precautions). From a utilitarian perspective, what happened in the past is irrelevant. Like rights-based theorists, utilitarian theorists have not explicitly addressed the question posed in this chapter, but their focus on the court’s role of creating proper incentives suggests that they regard damages rules as directed at courts. The purpose of a damages award, in this view, is to send a message to the citizenry at large. On closer inspection, however, both the rights-based and utilitarian perspectives are more complex than the above descriptions suggest. From the rights-based perspective, even if is accepted that there is an ordinary duty, grounded in corrective justice, to repair wrongs, this duty does not explain what courts should do if the duty is breached. The concept of corrective justice is silent on the role of courts in our legal system. A different normative theory is needed to explain courts and court orders. Moreover, it is entirely possible that this theory will suggest that in at least some cases courts should do something other than merely enforce plaintiffs’ ordinary rights. It cannot be assumed in advance that courts should act simply as rubber stamps; each case must be examined individually.

See generally Smith, above n 1, chs 2–4. See, eg Weinrib, above n 2, 134–40; Coleman, above n 2, 285–302, 361–76. See, eg Goetz and Scott, above n 2; R Craswell, ‘Two Economic Theories of Enforcing Promises’ in P Benson (ed), The Theory of Contract Law (Cambridge University Press, 2001). 67 68 69

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The utilitarian account faces a parallel challenge. Even if it is accepted that the courts’ only duty is to promote future utility (rather than to correct past wrongs), it is possible that this goal might be best achieved by forcing individuals to do what they should have done already. The utilitarian account of damages focuses entirely on what courts should do. Of course, utilitarians also have views on how individuals should act, which views can easily be expressed (and often are expressed) in the language of legal duties. Indeed, the two sets of views fit together: if there are good utilitarian reasons for courts to dissuade individuals from stealing, then there must also be good utilitarian reasons for individuals not to steal. Once this point is accepted, it then becomes an open question whether courts will better promote utility by setting incentives for the future rather than by simply ordering individuals to do what they should have already done. If it is optimal or efficient for an individual to do X, then it may also be optimal for a court to order that individual to do X. These observations should not be taken to imply that it is a waste of time to ask whether it makes more sense, morally, to suppose that damages rules are directed at courts as opposed to citizens. The point, rather, is that, even if one believes wholeheartedly in either corrective justice or utility, it is not obvious what position one should take on this question.70 The relationship between either of these concepts and particular court orders depends on the specific features of those orders. The issue becomes even more complex if other moral perspectives are introduced. The conclusion suggested by this brief tour of what courts do, what courts say and what makes moral sense of the law is that it is unwise to make sweeping statements about the classification of damages rules. To say anything useful about whether damages rules are ordinary rules or remedial rules, it is necessary to focus on particular kinds of damages rules.

VIII

C L A S S I F Y I N G DA M AG E S : AN I N I T I A L E X P L O R AT I O N

In this last section, specific examples of damages orders are examined from the perspective introduced above. The discussion’s main aim is to give a preliminary idea of the kinds of evidence and arguments that need to be considered when asking if a particular damages rule is an ordinary rule or a remedial rule. A secondary aim is to further demonstrate the necessity, when addressing this question, of distinguishing between different kinds of damages orders. Six categories of orders are examined. The focus is on awards that might be made in contract cases, though in each case the 70 Of course the question becomes even more difficult if, like most people, one believes in both corrective justice and utility.

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award is also available for some non-contractual claims.71 Neither the list nor the discussions of individual categories is exhaustive.

A

Punitive Damages

Although punitive damages are only available for breach of contract in some common law jurisdictions,72 they provide a particularly clear example of an order that appears to create a new substantive right. As was discussed earlier, the punitive purpose of such awards can only be achieved if the punishment is pronounced by someone other than the wrongdoer. It is not clear what a duty to punish yourself could even mean. From an analytic perspective, the main issue concerning punitive awards is whether the plaintiff’s new substantive right is derived from a remedial right or whether it is a ‘non-derivative’ right, ie a right created simply as a matter of the court’s discretion. In principle, the position of English law is that the choice to award punitive damages and the amount of the award is at the discretion of the judge or jury. The plaintiff has no right to punitive damages.73 If this view were accurate, then punitive awards would be a category four order, for which there simply is no law (public or private) that explains the awards. In light of the extensive discussions of the principles governing punitive damages in damages textbooks, however, the reality appears to be that punitive awards are only partly discretionary. There is a considerable body of law dealing with both the availability and amount of punitive damages.74 This is therefore remedial law, directed at courts.

B Nominal Damages An award of nominal damages appears to be a second clear example of an order that creates a new substantive right. As a general rule, plaintiffs have a right to nominal damages when their ordinary rights have been infringed (eg a breach of contract) but the infringement caused no loss. Unlike the case of punitive damages, therefore, the plaintiff’s remedial right to the order is clear. But orders are similar to punitive awards in that the order itself does not appear to compel the defendant to do what he should have 71 There do not appear to be any categories of damages awards that are available only for claims based on breach of contract. 72 Notably Canada (Whiten v Pilot Insurance Co [2002] 1 SCR 595) and the United States (Freeman & Mills Inc v Belcher Oil Co 900 P2d 669 (1995)). 73 Cassell v Broome & Co Ltd [1972] AC 1027 (HL) 1060; A B v South West Water Services Ltd [1993] QB 507 (CA) 527, 528, 533. 74 See, eg McGregor, above n 2.

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done already: the plaintiff’s right is to an order that the defendant do something different—pay nominal damages. Admittedly, it is logically possible that individuals might have ordinary duties to pay nominal sums wherever they have infringed another’s rights without causing any loss, but, like a duty to punish oneself, this would be a very odd duty. It is generally accepted that the primary purpose of nominal damages awards is to provide a public declaration (or ‘vindication’) of the plaintiff’s rights.75 Like punishment, this purpose cannot be achieved except through a public statement, such as a court order. An award of nominal damages is symbolic: it is understood to convey the message that the plaintiff’s rights were infringed. In theory, an individual’s private decision to pay a nominal sum could have a similar meaning (though it would not be publicised), but at present it does not, and so the act of sending a nominal sum to someone whose rights you have infringed does not serve the same purpose as an order to pay nominal damages.76 If this view is correct, then the rules governing both the existence and the content of nominal damages awards are remedial rules, directed at courts.

C

Damages in Lieu of Specific Relief

Courts regularly order damages in situations where it would be possible for them to order the defendant to perform the ordinary duty that he was found to have breached (or to have threatened to breach). Most contractual obligations, for example, are enforceable only by an award of damages. A plaintiff who sues for breach of an obligation to deliver goods normally only obtains an award of damages, and this is the case even if the contract has not been rescinded.77 The same is true, although it happens less frequently, in cases involving duties not to interfere with property rights. Thus, courts will sometimes refuse an injunction to prevent a trespass, nuisance or other tort and order damages in lieu.78 Another example is a claim for the return of goods belonging to the plaintiff: courts frequently refuse to order ‘delivery up’, and instead order

Burrows, above n 34, 589; Tettenborn, above n 2, 26. A further reason for thinking that an order to pay nominal damages creates a new duty is that courts appear to have considerable discretion regarding the amount of nominal damages: see Waddams, above n 2, 464–6. If there is an ordinary duty to pay nominal damages it is a duty the content of which cannot be known in advance of a court order. 77 Eg CN Marine Inc v Stena Line A/B and Regie Voor Maritiem Transport, The Stena Nautica (No 2) [1982] 2 Lloyd’s Rep 323 (CA). 78 Eg Behrens v Richards [1905] 2 ch 614 (ch). Where the contract is rescinded, damages cannot be given in lieu of specific relief because the obligation to perform the contract no longer exists. 75 76

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damages or give the defendant the choice of paying damages or handing over the goods.79,80 In cases of this kind, where damages are awarded even though performance is possible and desired, it appears again that the court order creates a new right. Until the court order is made, the defendant’s duty is to perform his contractual obligation, not trespass, not cause a nuisance, etc. We know this because, if the defendant performs his ordinary duty prior to judgment, then he will only be liable for the expenses arising from late performance. It therefore appears that an award of damages in such cases simultaneously extinguishes the defendant’s ordinary duty and replaces it with a duty to pay a specified sum. If this is correct, then both the existence and the content of such orders are governed by the plaintiff’s remedial rights, that is to say, by rules directed at courts. This remains true even if it is accepted that courts have discretion over the granting of specific relief. A plaintiff who wants damages rather than specific relief has a right to damages, and a court which has refused specific relief must award damages in lieu (even if only nominal damages). Damages in lieu of specific relief therefore appear to be governed entirely by rules directed at courts.81

D

Damages for Non-pecuniary Harm Damages may be available for such things as pain and suffering, distress or loss of reputation. Harms of this sort cannot of course be directly valued in money, or for that matter repaired by it. In the absence of any yardstick, there is no reason to regard the pain and suffering caused by a broken leg, or the stigma of a ruined reputation, as ‘worth’ £10, £10,000 or for that matter any other figure.

79 The common law historically had no equivalent to the civilian ‘vindicatio’ (basically an order that property in the defendant’s possession should be returned to the plaintiff), although the Courts of Equity would sometimes make an equivalent order. Today, the right to what the common law calls an order of ‘delivery up’ is governed by the Torts (Interference with Goods) Act, 1977, s 3 of which provides that delivery up may be ordered as ‘appropriate’. In Cohen v Roche [1927] 1 KB 169 (KB) the court held that the principles governing the availability of such orders were the same as those governing the availability of orders for the specific performance of contractual obligations to deliver goods: see generally Tettenborn, above n 2, 301. 80 Another example is an award of damages given in lieu of rescission under s 2(2) of the Misrepresentation Act, 1967. 81 This conclusion may appear odd, given that the rules for quantifying damages in such cases are almost identical to the rules governing ‘cost of cure’ awards and the latter awards are described below as replicating an ordinary duty to pay damages. An alternative explanation, therefore, is that the award of damages in a case where performance is still possible must be interpreted as having two legal consequences. The first is that the order effectively rescinds the contract. Once the contract has been rescinded, it is no longer possible for the defendant to perform and thus, as in cases involving ordinary rescission, the defendant’s duty to perform is replaced by an ordinary duty to pay for substitute performance. The second effect of the court order is then to merely confirm this ordinary duty: see S Smith, ‘Substitutionary Damages’ in Rickett (ed), Justifying Remedies in Private Law (Oxford, Hart Publishing, 2008).

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Indeed it is unreal to regard affectations of this type as losses at all in the same sense as, say, a quantifiable deprivation of profits is a loss. Neither money nor anything else can cure them: all it can do is to provide comfort or solace of a sort.82

Awards for intangible harm (eg loss of amenity, pain and suffering, loss of reputation) are not easily classified, but it is tentatively suggested that, like the previous examples, they create new rights rather than confirm existing ones. It has already been noted that courts often describe the rules for quantifying damages for personal injuries as instructions to courts. This way of characterising damages is particularly common where the rules concern damages for pain and suffering.83 More importantly, it is difficult to find a moral justification, whether in corrective justice, utility or any other normative principle, for a pre-existing duty to pay damages for pain and suffering. From a corrective justice perspective, no payment of money can ‘correct’ or ‘repair’ a plaintiff’s pain and suffering.84 From a utilitarian perspective, it is not clear what value is served by such payments, given that plaintiffs do not themselves appear to place a monetary value on their pain and suffering, as evidenced by the absence of insurance against pain and suffering. The rationale for pain and suffering awards is not obvious, but it appears that they too serve a kind of symbolic or declaratory purpose. They symbolically recognise that, even if pain and suffering cannot be corrected or compensated by money, unlawfully causing pain and suffering is a serious wrong.85 If something like this explanation is correct, then pain and suffering awards are similar to punitive and nominal awards in that their purpose can only be achieved if they are mandated by a court (or similar body). This conclusion is consistent with another feature of pain and suffering awards, which is that it is usually not possible to determine in advance, even roughly, the amount that a court will order by way of a pain and suffering award unless one has detailed knowledge of the relevant law (and often not even then). Of course, there are various situations in which it is difficult to know one’s ordinary duties unless one knows the law. The content of our ordinary duty to drive safely is found in part in traffic safety regulations. But as a general rule, it is assumed that it should not be Tettenborn, above n 2, 17. Eg H West & Son Ltd v Shephard [1964] AC 326 (HL) 364 (Lord Pearce); Heil v Rankin [2001] QB 272 (CA) 294 (Lord Woolf MR). 84 A Ripstein, ‘As If It Had Never Happened’, University of Toronto Legal Studies Research Paper No 906130, available at http://ssrn.com/abstract=906130 (accessed 27 June 2007). 85 The distinction between pain and suffering and pecuniary losses is reflected in ordinary moral reasoning. The appropriate and normal response to accidentally breaking your neighbour’s window is to either fix the window or to pay for the cost of repair. It would be considered very odd to give the neighbour a sum of money by way of compensation for the inconvenience suffered as a result of a broken window (even if the inconvenience was serious). Rather, the appropriate response to causing ‘pain and suffering’ to the neighbour is to make an apology and perhaps to deliver a symbolic ‘gift’, such as a bottle of wine. 82 83

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necessary to obtain a law degree to be able to determine what is required to act within the law (and, of course, you do not need a law degree to know the rules of the road; this is one reason that speed limits are posted). Yet if court orders to pay damages for pain and suffering confirm ordinary duties to pay such damages, this assumption is unfounded. To determine whether (and in what amount) an individual is under an ordinary duty to pay damages for pain and suffering, it is generally necessary to consult a specialist in personal injuries law.

E Cost of Cure Awards Perhaps the most common damages award is a ‘cost of cure’ award. In cases where the plaintiff can show that the defendant’s breach led to the damage, destruction, loss, theft or non-provision of property (or a service) that the plaintiff owned or was owed by the defendant, then the plaintiff will normally be awarded the cost of repairing, replacing or obtaining a substitute for that property or service. In other words, the plaintiff will be awarded the cost of ‘curing’ the breach.86 In a contractual action for non-delivery of goods, for example, the buyer will be typically awarded a sum equal to the cost of purchasing similar goods elsewhere. Likewise, in a tort action for damage to goods, the claimant is typically awarded (often in combination with another award) a sum equal to the cost of repairing or replacing the goods. In many of these cases, the cost of purchasing a substitute is equal to the monetary value that the plaintiff attaches to the relevant property or service. It is not uncommon, however, for the cost of cure to exceed this value, and where this is the case, the courts will generally still award the higher sum.87 The plaintiff is not required to mitigate her loss by abandoning her claim for the replacement cost. As I have argued elsewhere,88 ‘cost of cure’ awards are best explained as a form of substitute specific relief; their aim is not to compensate the See, eg Waddams, above n 2, ch 1. See, eg Radford v De Froberville [1977] 1 WLR 1262 (ch); Williams v Agius [1914] AC 510 (HL); Rodoconachi, Sons & Co v Milburn Bros (1886) 18 QBD 67 (CA); Mouat v Betts Motors Ltd [1959] AC 71 (PC); Jones v Stroud District Council [1986] 1 WLR 1141 (CA); Joyner v Weeks [1891] 2 QB 31 (CA); Mertens v Home Freeholds Co [1921] 2 KB 526 (CA). The court will not award the cost of cure where the sum is extravagantly higher than the value of cure: Ruxley Electronics and Construction Ltd v Forsyth [1995] 3 WLR 118 (HL). Consistent with the above explanation of cost of cure awards, this limit appears to serve the same purpose as the ‘hardship’ defence to requests for specific relief. 88 Smith, above n 81; see also B Coote, ‘Contract Damages, Ruxley and the Performance Interest’ [1997] CLJ 537; E McKendrick, ‘The Common Law at Work: The Saga of Alfred McAlpine Construction Ltd v Panatown Ltd (2003) 3 Oxford University Commonwealth Law Journal 145; M Eisenberg, ‘Actual and Virtual Specific Performance, The Theory of Efficient Breach, and the Indifference Principle in Contract Law’ (2005) 93 California Law Review 975; and C Webb, ‘Performance and Compensation: An Analysis of Contract Damages and Contractual Obligation’ (2006) 26 OJLS 41. 86 87

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plaintiff for the value or utility of whatever was lost, but to eliminate or undo the physical change in the plaintiff’s world that has been or will be brought about by the defendant’s breach of duty. Cost of cure awards are designed to place the plaintiff in the actual, not metaphorical, position she would have been in had the breach not happened. If this is correct, then a cost of cure award appears to be founded on an ordinary duty to pay for the cost of cure. Individuals who have wrongfully harmed or injured others should, so far as possible, do whatever is required to undo the effects of their wrong. Where performance of the original ordinary duty is no longer possible (either because it is physically impossible or because the duty no longer exists legally, as where a contractual obligation is rescinded), the best way to undo the wrong is to pay for the cost of curing it. Payment of the cost of cure is the closest possible substitute for what the defendant should have done originally. Having failed in his primary substantive duty (to perform a contract, to not injure), there arises at the moment of failure a substitute duty to achieve the same end (as near as possible) by paying for substitute performance. If this interpretation of cost of cure awards is correct, then these are category one orders. Like specific performance orders, the rules that explain the availability of cost of cure orders are remedial rules, directed at courts, but the rules that explain the order’s content are derived from ordinary rules, directed at citizens. The court order replicates an existing ordinary duty.

F

Value of Loss Awards (‘Consequential Damages’)

A ‘value of loss’ award is what lawyers usually have in mind when they describe damages orders as designed to ensure that the defendant compensates the plaintiff for the losses suffered as a result of the defendant’s breach, subject to the qualification that the losses must be reasonably foreseeable and unavoidable. A value of loss award is measured by the abstract value, to the plaintiff, of the property (or service) that was damaged, destroyed, lost, taken or not provided as a result of the defendant’s breach of duty. An award for consequential losses, such as the loss of profits arising from a failure to deliver contractually promised goods, is a value of loss award. Indeed, if ‘consequential’ is defined sufficiently broadly, it is equivalent to value of loss. Given the focus on value of loss awards in the conventional understanding of damages, it is perhaps not surprising that these awards are difficult to categorise. When corrective justice and utilitarian theorists argue about damages, the damages order that they typically have in mind

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is a value of loss award. This debate cannot be resolved here, but a few comments can be offered as to why it continues. Value of loss awards are qualitatively different from other damages awards. Unlike cost of cure awards, value of loss awards cannot be explained as a form of substitute specific performance. The loss that is the focus of such an award is only causally related to the defendant’s original ordinary duty. A contractual duty to deliver a machine is just that—a duty to deliver a machine. It is not a duty to deliver the benefits that the purchaser expects to obtain from the machine. This is why value of loss awards (but not cost of cure awards) are subject to remoteness and mitigation principles.89 Another way of making this same point is that a value of loss award, unlike a cost of cure award, is not designed to eliminate or undo the relevant loss; instead, the aim is to provide compensation (or something similar) for the loss. It is equally difficult to compare value of loss awards to pain and suffering awards, punitive damages, nominal damages, etc. Value of loss awards have a real, and not merely symbolic, value. Further, there is a fairly straightforward sense in which a value of loss award (unlike, say, damages for pain and suffering) compensates for losses. Both the incurring of expenses and the foregoing of profits can be compensated by an award of money. Related to this feature is the fact that the amount awarded is relatively predictable (falling somewhere between pain and suffering and cost of cure awards in this regard). From a moral perspective, value of loss awards fit neatly with both corrective justice and utilitarian accounts of damages. If there is an ordinary legal duty to repair or correct a loss, distinct from the duty not to cause the loss in the first place, then it should find expression in an ordinary duty to pay for the value of the plaintiff’s loss. Indeed, if the interpretations given above of the other categories of damage awards are correct, value of loss awards appear to be the only awards the content of which can be explained using the idea of corrective justice. The same observation applies to the utilitarian account of damages. The basic idea underlying the utilitarian explanation is that damages awards should internalise the expected ‘disvalue’ of the defendant’s action (except where the disvalue is too remote or could have been avoided at less cost by the plaintiff). The only damages awards that appear to satisfy these criteria are value of loss awards. For these reasons, the proper classification of value of loss awards seems likely to turn, in the end, on broader arguments about the appropriateness and plausibility of corrective justice and utilitarian legal theories. I have presented my view on this debate elsewhere.90 89 90

See Smith, above n 81. See Smith, above n 1, ch 4, where I support a corrective justice explanation.

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CONCLUSION

The most pressing question concerning the common law of damages is very basic: what are damages? In particular, are the rules that make up the law of damages directed at citizens or at courts? The preliminary investigation undertaken in this chapter suggests, however, that the answer is complex: some damages orders are orders to perform existing duties, some are orders to perform new duties and some are difficult to classify. The law of damages is correspondingly complex: some of the rules are directed primarily at citizens (the rules governing the content of orders that confirm ordinary duties to pay damages), some are directed primarily at courts (the rules governing the availability of all damages orders as well as those governing the content of orders that create new duties) and some, again, are difficult to classify. The final outcome of the inquiry begun in this chapter will almost certainly be a new conception of damages law. The present conception is a product of the common law’s history, in particular its roots in the old forms of action, and its general lack of interest (until quite recently) in classificatory questions. A common law court that wishes to make a monetary order other than an order to pay a debt or (with some qualifications) to reverse an unjust enrichment has no choice but to describe the order as ‘damages’. The consequence is that qualitatively different kinds of monetary orders are lumped together as damages. In particular, both rules directed at courts and rules directed at citizens are included within this single heading.91 One or the other may eventually need to be classified under a different heading. Which group merits the label of ‘damages’ is a question for the future. For the present, what is important is that the distinction between these two kinds of rules be recognised.

91 Further, rules that govern substantively similar orders are excluded from the law of damages simply because they originated in the Courts of Equity: see Burrows, above n 34, 11–14.

2 Economic Aspects of Damages and Specific Performance Compared ECONOMI C AS PECTS OF DAMAGES AND S PECI FI C PERFORMANCE

DANIEL FRIEDMANN * DANI EL FRI EDMANN

I

I NTRO DUCTION

In Co-operative Insurance Society v Argyll Stores (Holdings)1 the plaintiffs granted the defendants a lease of one of the units in a shopping centre for 35 years to operate a supermarket. The supermarket was the largest shop in the centre and a great attraction. After a few years the defendants decided to close 27 unprofitable supermarkets. Following the decision and in breach of the contract, the defendants closed the supermarket in the plaintiffs’ shopping centre. The plaintiffs sought specific performance of the agreement, which the Court of Appeal by majority decided to grant. The House of Lords reversed the decision, holding that the plaintiffs’ sole remedy is in damages. Lord Hoffmann, who gave the leading speech, listed a number of reasons for the denial of specific performance. These included the difficulty of supervision, the heavy-handed nature of the enforcement mechanism and that the carrying on of business under a potential threat of contempt is oppressive. These are basically noneconomic reasons for denying specific performance and are not within the scope of this chapter.2 However, Lord Hoffmann’s speech referred also to economic elements that support the denial of specific performance, namely that the court will not order the defendant to carry on with a losing business and that the ‘plaintiff will enrich himself at the defendant’s expense’ if an order for specific performance will cause the defendant a loss that is heavier that the * Minister of Justice, Israel. I am grateful to Ofer Grosskopf for comments on an earlier draft. 1 [1998] AC 1, [1997] 2 WLR 898 (HL). 2 There are additional non-economic grounds affecting the choice of remedy for breach, such as undue interference with personal liberty, because of which specific performance is unavailable in a contract of personal service. This non-economic ground is similarly not within the ambit of this chapter.

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loss that the plaintiff would suffer from non-performance.3 I shall revert to these points below.4 At this stage, I would like to emphasise the point that the plaintiffs in the Co-operative Insurance Society struggled to get specific performance, a costly endeavour which they lost, when there was no difficulty in getting damages. Obviously they must have assumed that specific performance would be much more advantageous. It is also important to note that the denial of specific performance and the award of damages in lieu actually constitute a forced sale of the plaintiff’s right of performance. In this respect it does not differ from the denial of a remedy, such as an injunction, that is designed to enforce a proprietary right. The award of damages in lieu of specific enforcement constitutes a forced sale of the claimant’s property5 or contractual right. The following section deals with the indifference principle and examines the reasons for the discrepancy between the assumption which underlies the law of damages and the realities of the law of remedies.

II

T H E E L U S I V E I N D I F F E R E N C E PR I N C I P L E

‘The rule of common law’ regarding the award of damages for breach of contract is that the aggrieved party is, so far as money can do it, to be placed in the same situation with respect to damages as if the contract had been performed.

This classical statement, by Parke B in Robinson v Harman,6 has been quoted innumerable times and can be found in practically every book on contract, as well as in every book on damages. This statement does not describe a rule of law, but rather depicts the purpose or aim of damages.7 Needless to say, the purpose of specific performance is identical, though it is reached by a different route, namely by causing the contract to be performed. [1997] 2 WLR 898 (HL) 906 (Lord Hoffmann). Text accompanying nn 44 and 63. Cf Jaggard v Sawyer [1995] 1 WLR 269 (CA), discussed in text to n 59. See also the cases referred to in n 62. 6 (1848) 1 Exch 850 (Exch) 855. 7 This point has been generally recognised. See J Beatson, Anson’s Law of Contract (Oxford University Press, 28th edn, 2002) 596; A Burrows, Remedies for Torts and Breach of Contract (Oxford University Press, 3rd edn, 2004) 33. In a recent article it has been suggested that the award of damages should not be viewed simply as an alternative to performance. Rather, it is intended to protect another interest, which presumably is narrower than the performance interest, namely the compensation interest: C Webb, ‘Performance and Compensation: An Analysis of Contract Damages and Contractual Obligation’ (2006) OJLS 26. This is an interesting idea. I shall nevertheless assume that the award of damages is meant to serve as a substitute to performance, though, as this article indicates, this purpose is often not achieved. Moreover, examples are conceivable in which damages exceed the value of the performance interest as well as the actual loss to the plaintiff. Examples of this possibility are discussed below. 3 4 5

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Another way of describing the fundamental idea reflected by Parke B’s statement is by the so-called indifference principle, coined by Melvin Eisenberg.8 Under this principle, ‘the remedial regime for breach of bargain contracts should make promisees indifferent between performance and legal relief’.9 The indifference principle reflects the very idea of placing the aggrieved party ‘in the same situation . . . as if the contract had been performed’. The difference between the two relates to the pertinent point of view. The requirement to place the party in the situation he would have been in had the contract been performed reflects the legal system’s point of view. It is a direction to the court to apply rules that would lead to this result. The indifference principle reflects the point of view of the aggrieved party. If the legal rules achieve their purpose, then as a consequence the aggrieved party will become indifferent between performance and damages. Situations are conceivable in which this might indeed happen. The paradigmatic case is a contract to supply goods for which there are perfect substitutes that are readily obtainable on the market. Thus, suppose that X contracts with Y to purchase 50 tons of coal at a price of $100 per ton. When the date of performance arrives, the market price of coal has risen to $130 per ton and Y reneges. X may indeed be indifferent between specific performance and damages that will reflect the difference between the contract price and the market price. It should be emphasised that Parke B’s statement is not concerned with comparing the remedy of specific performance to that of damages. It compares the value of the actual performance under the contract which, because of the breach, did not occur with the remedy of damages. The indifference principle makes a similar comparison except that it is not confined to the remedy of damages. It seeks a remedial regime, which may include specific performance that will render the aggrieved party indifferent between the actual performance and the remedy that the legal system provides him with.10 Viewed in this light, it seems almost certain that in the above paradigmatic case X would prefer actual performance to damages that merely reflect the difference in price. If the party in breach is not willing to offer him the proper amount of damages on the date on which performance was due, he will have to bring an action in court. Needless to say, in addition to the risks of litigation, the action requires time and energy and entails costs. The indifference principle will be satisfied only if these elements are adequately reflected in the amount that X will eventually recover. 8 MA Eisenberg, ‘Actual and Virtual Specific Performance, the Theory of Efficient Breach, and the Indifference Principle in Contract Law’ (2005) 93 California Law Review 975. 9 Ibid, 977. 10 Ibid.

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The present article is mainly concerned not with comparing the remedy with the agreed performance that did not occur but with comparing the remedy of damages to that of specific performance. Viewed in this light, it may seem that in the paradigmatic case described above there is little difference between damages and specific performance, so that the purchaser will be indifferent between these two possibilities. But even this may depend on the circumstances. Thus, if the purchaser in the above example is in urgent need of the coal on the date of performance, he may find that damages are preferable. He could terminate the contract, obtain the coal from another source and claim damages. On the other hand, if his need for the coal is not urgent, he may be indifferent between damages and specific performance. It is thus clear that, even in instances in which the economic value of the two remedies, measured objectively, seem equal, there may be subjective elements that would lead the aggrieved party to prefer the one over the other. There are other important reasons that lead to a difference in the economic value of the remedies. They are based on policy considerations that conflict with the aspiration to place the aggrieved party in the same situation as if the contract had been performed. Obviously, if these policy considerations lead to rules that affect both remedies in precisely the same way, they will retain the same value in relation to one another. This, however, is not necessarily what happens. In the discussion that follows I shall examine the concept of subjective value and the extent to which it is obtainable by either specific performance or damages.

III

S P E C I F I C P E R F O R M A N C E AN D T H E S U B J E C T I V E INTEREST

An award of specific performance includes the following aspects: 1. It grants the plaintiff the subjective value of that which was promised to him, but imposes on him the subjective cost of his performance. 2. It imposes on the defendant the subjective cost of the required performance, but grants him the subjective benefit of the aggrieved party’s performance. 3. It saves the need to appraise the value of the performance that was due.11 4. It absolves the plaintiff from the restrictions imposed by the rules on damages, namely: a elements for which compensation is not available; b issues of remoteness; and 11

This aspect of specific performance is mainly procedural and will not be discussed in detail.

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the burden of mitigation.12

5. Specific performance may benefit third parties for whom damages may not be available. 6. Specific performance does not normally solve the loss inherent in delay in performance, a loss for which only an award of damages can compensate.13 As indicated by features 1 and 2 above, specific performance grants the parties their subjective interest in what they get under the contract and imposes upon them the subjective cost of their performance,14 subject to an important qualification relating to the time of performance (feature 6 above). Subjective value is the value that each party attributes to performance that the other party promised to him, on the date on which performance takes place. Subjective cost is the cost that the party attributes to the performance that is due from him on the date that he has to perform.15 On the other hand, damages are usually measured objectively—a point that is further examined below16—though, as a result of modern developments, the claimant’s subjective position is in some instances taken into account.17 An examination of the subjective loss, which is the real loss, caused by the breach requires a distinction to be drawn between the case in which an exact substitute for the unperformed obligation can be found at a price that can be objectively determined and the case in which such a substitute is not readily available. Broadly speaking, in the first category the 12 The effect of contributory negligence on contractual liability raises issues that bear some similarity to mitigation. Thus, if the claimant failed to take measures to protect himself against potential breach, when such breach was likely to occur, it can be argued that he was negligent and that his negligence contributed to the loss. Yet the question hardly arises. A conspicuous example in which it could conceivably arise is in the case of anticipatory breach, but even in such an instance the issue is framed as one of mitigation; see Burrows, above n 7, 128. In view of the narrow role of contributory negligence in contract, I shall not discuss it in the present chapter. For our purposes it suffices to say that if the role of this defence is eventually extended, its effect on the choice of remedy for breach (damages or specific performance) will be similar to that of mitigation. 13 A question may also arise with regard to defective performance, which at least in theory can be remedied by an order to correct the defect (actually an order for specific performance). 14 Consequently, from the point of view of the aggrieved party, specific performance entails not only advantages but may impose upon him considerable burden. This is also conspicuous in (4)(c) above in the context of mitigation. 15 On subjective value, see DR Harris, AI Ogus and J Phillips ‘Contractual Remedies and the Consumer Surplus’ (1979) 95 LQR 581. Subjective valuation in other contexts is discussed in M Garner, ‘The Role of Subjective Benefit in the Law of Unjust Enrichment’ (1990) 10 OJLS 42; A Burrows, The Law of Restitution, (London, Butterworths 2nd edn, 2002) 23–4; G Virgo, Principles of the Law of Restitution (Oxford University Press, 2nd edn, 2005) 88–9. 16 Subjective measurement is common in cases of death and bodily injury in which recovery for loss of earnings is based on that of the particular victim. A similar approach is reflected in the so-called thin skull principle. However, issues of bodily injury do not usually arise in a contractual context in which the claim is usually for economic loss. 17 See the discussion at n 85 with regard to mitigation.

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subjective value loses its significance and the objective price becomes the dominant factor. Let us examine the following illustration: 1. P agrees on 1 January to purchase a new car from V for $10,000, delivery and payment is to be made on 1 February. Let us also assume that the value of the car to P (subjective value) is $12,000, namely he would be willing to pay up to this amount to acquire it. V breaches the contract and refuses to sell the car to P. If, on 1 February, such a car is available on the market for $10,500, P’s loss is mere $500. In a sense, it can be said that performance would have yielded P a (subjective) benefit of $2,000, but since in reality he can obtain an equal car for $10,500, the subjective loss disappears and the objective loss reflects the damage suffered. The situation is completely different if a perfect substitute cannot be found or if, for some reason, its acquisition is regarded as unreasonable. This possibility is demonstrated by the following illustration, which is based on Ruxley Electronics & Constructions Ltd v Forsyth:18 2. V undertook to build a swimming pool in P’s garden with a diving area 7 feet 6 inches deep at a price of £18,000. In breach of the contract, the diving area was only 6 feet deep. The pool as built was suitable for diving. The breach had no effect on the value of the pool. Hence, there was no objective loss. In other words, according to objective valuation, P got a performance the value of which equalled that of the agreed performance. However, a subjective valuation may lead to a completely different result. P may consider that the value to him of the pool as built is a mere £10,000, or even nil. This subjective valuation means that if he would have been offered a pool with a diving area that is only 6 feet deep he would not have been willing to pay more than £10,000 for it or would not have taken it even for free (subjective value nil). In the case of Ruxley the House of Lords regarded the loss as non-financial and awarded the plaintiff £2,500 for loss of amenities.19 But the loss is non-financial only if we adopt an objective measurement. Viewed from the plaintiff’s point of view, it is conceivable that it could be appraised in monetary terms. Thus, suppose that the depth of the pool is sufficiently important to him and he has sufficient resources to go to another contractor and have him replace the existing pool with one having a deeper diving area. Clearly the loss would then be financial.20 This shows that the so-called loss of amenities can sometimes turn into financial loss. [1996] 1 AC 344 (HL). The case is regarded as an important step towards recognition of the performance interest. See also Farley v Skinner [2002] 2 AC 732 (HL); Hamilton Jones v David & Snape [2004] 1 WLR 924 (Ch). 20 The plaintiff in Ruxley was willing to give an undertaking that he will replace the pool if the damages awarded to him suffice for this purpose. But this is not exactly the same as doing it in any event. 18 19

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At this stage, it suffices to point out that no attempt was made in Ruxley to appraise the plaintiff’s subjective loss or to provide means to remedy it. A possible explanation lies in the difficulty in evaluating this loss. Often the only way of appraising a subjective loss is by relying upon the plaintiff’s word. It is clear that courts are unlikely to accept this method of assessment. At best, they may adopt what may be termed ‘reasonable value’, which is not necessarily equal to the plaintiff’s subjective valuation of his loss. Let us now revert to the rule in Robinson v Harman,21 under which the award of damages is expected to place the plaintiff in the same situation as if the contract had been performed. It is obvious that the plaintiff will not be so placed if damages do not reflect his subjective valuation of the performance that was due to him. A possible solution would be by way of specific performance. This remedy satisfies the plaintiff’s subjective interest, subject to one qualification relating to the element of time, since as a practical matter specific performance will in all probability cause the contract to be performed at a later date than agreed upon.22 In all other respects it meets the subjective interest of the aggrieved party. However, satisfying this interest is not the only consideration. In the case of Ruxley, specific performance would be rather harsh on the defendant and would entail considerable economic waste23 as the existing pool would have to be destroyed and a new one built in its place. These considerations are generally not taken into account in the context of damages, but they are not disregarded in relation to specific performance. Let us now examine these points in addition to some other elements relating to the remedies for breach.

IV

T H E O B J E C T I V E M E A S U R E M E N T O F DAM AG E S

The principle enunciated in Robinson v Harman,24 under which the aggrieved party is, so far as money can do it, to be placed in the same situation with respect to damages as if the contract had been performed

requires that the award of damages be based on the actual (subjective) loss that was caused by the breach. But, as already pointed out, an objective assessment of damages25 is often adopted in preference to the subjective See n 6. This is an important feature which will be examined below. In fact, in Ruxley the plaintiff did not seek specific performance possibly because it was considered that it was unlikely to have been granted. 24 See n 6. 25 On the objective and subjective measurement, see G Treitel, Remedies for Breach of Contract—A Comparative Account (Oxford, Clarendon Press, 1991) 111. The terms used by Treitel are ‘abstract’ (in my terminology ‘objective’) and ‘concrete’ (namely ‘subjective’) assessment. 21 22 23

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approach and the principle of Robinson v Harman is tacitly rejected. This difference between the objective measure, which characterises the remedy of damages, and the subjective interest, which is protected by specific performance, has a significant bearing upon the economic value of these remedies to the parties involved. There are a number of reasons that can lead to the adoption of an objective assessment of damages, one of which has already been mentioned: namely, the difficulty that often arises in appraising the subjective loss. In addition, in the calculation of damages certain elements of the loss to the subjective interest, such as hurt feelings, anger, stress and tension caused by the breach, are not taken into account except in some specific situations. The rules on remoteness and mitigation further strengthen the objective tendency of the law of damages. Thus, in the seminal case of Hadley v Baxendale26 the plaintiff, a mill owner, suffered considerable losses because the carriers who undertook to deliver a broken crankshaft to the makers delayed its delivery. Consequently the mill could be restarted only after considerable delay. The claim for loss of profits during the period of delay (the actual or subjective loss) was dismissed on the ground that the significance of prompt delivery was not communicated to the carriers. The actual loss was therefore considered to be too remote and was therefore disregarded. The assessment of damages was objective, namely based on the loss that could have been reasonably expected by the defendant to occur by the delay that happened. A similar result was reached in Victoria Laundry (Windsor) Ltd v Newman Industries Ltd,27 in which the defendants agreed to sell the plaintiffs a new boiler but supplied it after a delay of some five months. In their claim for loss of profits during this delay the plaintiffs were allowed the normal profits that were usually derived from the use of such a boiler in their business. But the claim for the additional loss that was actually suffered by the plaintiffs from their inability to take advantage of the particularly lucrative contracts they had with third parties was denied as being too remote. The rules on remoteness thus tend to lead to an objective calculation of damages, namely the recovery for those losses that were foreseeable by a reasonable person as arising naturally in the usual course of things from the breach. However, it should be pointed out that while specific performance generally grants the plaintiff the subjective benefit of that which was promised to him even if this benefit is regarded for the purpose of damages as too remote, in this particular context specific performance is unlikely to achieve such a result because the loss was caused by delay and

26 27

(1854) 9 Exch 341, 156 ER 145 (Exch). [1949] 2 KB 528 (CA).

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as a practical matter it is hardly ever possible for this remedy to bring about timely performance.28 Rules on mitigation are also likely to lead to an objective measurement of the loss. Thus, suppose that P contracts to buy certain goods from V at a price of $100. On the date on which the goods ought to have been delivered V breaches the contract and declines to supply them.29 Two months later P purchases similar goods for $150. His actual (subjective) loss is $50, but if it can be shown that P could have acquired the goods for $120 shortly after the breach and that it was reasonable to do so, his recovery will be limited to $20. This is the objective loss, namely the loss that would have been suffered by a reasonable person in that situation. The parties can of course avoid the objective measurement of damages and opt for rules that grant the aggrieved party his real (subjective) loss. They can provide for liquidated damages in an amount reflecting the real loss. Thus, for example, in the case of Ruxley, the parties could have stipulated in the contract that if the diving area of the pool fails by more than one inch to reach the agreed depth, the contractor will have to pay damages in an amount equal to the construction of a new pool. This presumably is not a penalty clause since it reflects a genuine interest even though some may regard it as idiosyncratic. The parties can similarly change the rules regarding remoteness by pointing out in the contract that in a case of breach certain losses, which would otherwise be considered too remote, might ensue. In fact, this possibility is embodied in the second limb of Hadley v Baxendale.30 However, in the absence of such a provision in the contract, the general contract rules, sometimes termed ‘default rules’, apply and they lead to objective measurement of the loss. The examples discussed above were concerned with situations in which the actual (subjective) loss was higher than the loss measured in abstract (objectively). This is not necessarily always the case. Many instances are See also feature (6) above. If the breach occurred at an earlier date, the question may arise whether the market price of the goods should be that which obtained at the date of the breach rather than that which obtained at the date on which delivery ought to have been made. For a discussion of this issue, see PS Atiyah, JN Adams and H MacQueen, The Sale of Goods (Harlow, Longman, 10th edn, 2000) 534–6. The date of breach rule became the focal point in Golden Strait Corp v Nippon Yusen Kubishika Kaisha (‘The Golden Victory’) [2007] 2 WLR 691 (HL), in which the House of Lords held by majority that in calculating damages for wrongful repudiation of a charterparty events occurring after the breach are to be taken into account. In this context it suffices to point out that the owners’ loss in this case consisted of the difference between the charter rate and the market rate, namely loss of future revenues due to be paid periodically over a considerable period of time. The normal rule is that liability for loss or partial loss of such future periodical payments ‘crystallises’ at the time of the breach. The majority decision actually mitigates the ‘crystallising’ rule by holding that events which would have affected the amount of the periodical payments due after the breach and which occurred at the time that these payment would have become due are to be taken into account. For a detailed discussion of this case, see D McLauchlan, ‘Some Issues in the Assessment of Expectation Damages’, this volume. 30 See n 26. 28 29

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conceivable in which an objective appraisal of the loss will yield the plaintiff damages in an amount exceeding his real (subjective) loss. Thus, suppose that, in the above example in which P agreed to buy goods from V, P bought the goods from a third party six months after the breach at a price of $90. If the loss is assessed objectively, P will recover the difference in price on the relevant date, namely the date on which delivery ought to have been made,31 although he may not have suffered any real (subjective) loss.32 It is obvious that in this type of situation the aggrieved party would prefer damages to specific performance, even if specific performance would have been available, and, since the aggrieved party has a choice, he can give up the prospect of specific performance and opt for damages.

V

L OSING CONTRACTS, WASTEFUL PERFORMANCE AND TO L E R AT E D B R E AC H

At the time of forming the contract the parties make their own cost–benefit calculations. However, at a later stage a party may find that he miscalculated or that subsequent developments led to a change in the subjective value of either the cost or the benefits as were originally envisaged. I discussed above an example in which P agreed to purchase a new car for $10,000, the value of which to P at the time of the contract (subjective value) was $12,000. Suppose now that shortly afterwards P suffered a severe financial loss. Consequently the performance due from him, namely 31 S 51(3) of the Sale of Goods Act 1979. The section provides that the measure of damages ‘is prima facie to be ascertained by the difference between the contract price and the market or current price of the goods at the time or times when they ought to have been delivered’. Although the section speaks of a prima facie rule, it is assumed that the fact that the aggrieved party acquired the goods at a later date for a lower price will not be take into account. Cf the rules regarding contracts for resale by the aggrieved party: Atiyah et al, above n 29, 536–9. 32 There is vast literature that shows that compensatory damages usually undercompensate the aggrieved party. See Eisenberg, above n 8. However, there are numerous situations in which such damages over compensate the plaintiff: see, eg Inverugie Investment v Hackett [1995] 1 WLR 713 (PC), in which the defendants, who were the owners of a hotel, wrongfully ejected their lessee (the plaintiff). The average occupancy of the hotel was about 35–40%. The plaintiff obtained an order for possession and brought an action for mesne profits in respect of the period during which the hotel was in the defendants’ possession. The Privy Council applied the so-called ‘user principle’ and held the defendants liable to pay damages for trespass in an amount equal to the rent of all the hotel apartments they wrongfully occupied. The fact that in all probability the plaintiff would not have been able to rent them all during the relevant period was held to be of no moment. Similarly disregarded was the fact that the defendants were merely able to let 35–40% of the apartments. They had to pay rent for all of them. The Privy Council thus applied an objective measurement of the loss (the ‘user principle’) which yielded an award that greatly exceeded the real (subjective) loss, and the Privy Council clearly recognised this (ibid, 718). Recovery in this case was in torts, but this was also a case of breach of contract. The case can be explained as based on recovery of profits, but the award clearly exceeded the amount of profits actually gained by the defendants. For a discussion of the damages aspect as well as the recovery of profits aspect in this case, see D Friedmann, ‘Restitution for Wrongs: The Measure of Recovery’ (2001) 79 Texas Law Review 1879, 1885–7.

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the payment of $10,000, becomes from his point of view much more valuable. When this performance is expressed in monetary terms, the change is best reflected by his willingness to pay less for that which was promised to him. We may thus assume that the subjective value of the car to him was reduced to a mere $5,000. If the other party commits a fundamental breach, it will be in P’s interest to terminate the contract. Indeed, if, by this time, the price of such a car went up to $10,500, P would be able to claim damages reflecting the objective loss, namely the increase of $500 in the car’s price, even though he is no longer interested in it. This is just another example in which an objective measurement of the loss is more favourable to the plaintiff than a subjective evaluation. In this case the result can be justified by the fact that the contract relates to a saleable commodity. If P is not interested in keeping the car, he can, at least in theory, sell it for $10,500 and thus gain the difference between the contract price and the market price.33 There is thus a fundamental difference between the case in which the other party’s performance is saleable and the case in which it is not. Broadly speaking, when the performance of one party is saleable the subjective value that the other party places on it is of little moment as long as the subjective value of the performance is lower than the price obtainable by its sale.34 The issue becomes more complex where the promised performance is not saleable. Let us examine the following illustrations: 3. V contracts to sell P a piece of property for $10,000. The value of this property to P (subjective value) is $12,000. Shortly afterwards T, who for some idiosyncratic reason is greatly interested in this property, offers V $50,000 for it. 4. P undertakes to build a four-storey building on a plot owned by D for $500,000. The expected profits of P are 15% of the cost, namely $75,000. Shortly afterwards a change in the zoning laws makes it possible to build up to thirty stories on this site. Had the four-storey building been constructed, it would have been advantageous to pull it down in order to permit the construction of the higher building.35 Illustration 3 deals with saleable property. If, after a contract has been formed, a third party (T) is willing to pay an exceptionally high price for 33 The use of the concept of market price in this context is somewhat problematic. Even for a commodity that is readily available there is practically always a margin between buying and selling, which for certain commodities may be very substantial. A person who bought a new car would find it almost impossible to sell it the next day for the price he paid for it. 34 The case in which the subjective value is higher than the price obtainable for the performance is discussed below, text following n 64. 35 This illustration is adapted from the one that I gave in D Friedmann, ‘Restitution of Benefits Obtained through the Appropriation of Property or the Commission of a Wrong’ (1980) 80 Columbia Law Review 504, 525.

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the property to which the contract relates, the question arises to whom does this windfall belong? The topic has been long debated and has become the subject of voluminous literature.36 It has also been related to the availability of specific performance,37 though I do not think that the topics are inextricably linked since it is conceivable that restitution of gains by the breach will be allowed even if specific performance is for some reason unavailable.38 For our purposes, it should be noted that from the point of view of the vendor (V) in illustration 3 the contract became a losing contract. Originally he valued the property at an amount less than $10,000. However, once the new potential buyer arrives, the sale at $10,000 must be viewed as entailing a serious loss, at least in the sense of preventing the realisation of a large profit. The crucial point is that this additional gain does not disappear but inures to the benefit of the other party (provided, of course, that we assume that either specific performance or restitution of gains will be allowed39 and that the sale to T could be made by V just as it could have been made by P). In other words, the combined cost–benefit of both parties indicates that there is no loss at all. At most it can be said that the all the additional benefits that accrued after the formation of the contract were gained by the purchaser. Illustration 4 presents a wholly different situation. It is similar to illustration 3 only in one respect, namely that performance is beneficial to one party and entails a loss to the other. The loss in illustration 4 may seem more severe than the one in illustration 3 since in illustration 4 it entails not merely loss of an additional potential gain but actual out-of-pocket 36 The above example is based on the paradigmatic case of ‘efficient breach’ except that it usually relates to goods or commodities (movable) regarding which specific performance is usually unavailable. The proponents of this theory justify a breach and would limit the aggrieved party’s recovery to damages (which apparently do not take into account the possibility that the same sale could be made by the aggrieved party). On the subject of efficient breach, see R Posner, Economic Analysis of Law (New York, Aspen Publishers, 6th edn, 2003); A Schwartz, ‘The Case for Specific Performance’ (1979–80) 89 Yale Law Journal 271, 281; D Friedmann, ‘The Efficient Breach Fallacy’, (1989) 18 Journal of Legal Studies 1; IR Macneil, ‘Efficient Breach of Contract: Circles in the Sky’, (1982) 68 Virginia Law Review 947, 961; J Gordley, ‘A Perennial Misstep: From Cajetan to Fuller and Perdue to “Efficient Breach”’ [2001] Issues in Legal Scholarship Symposium: Fuller and Perdue; R Craswell, ‘Contract Remedies, Renegotiation, and the Theory of Efficient Breach’ (1988) 61 Southern California Law Review 629, 636; R O’Dair, ‘Restitutionary Damages for Breach of Contract and the Theory of Efficient Breach: Some Reflections’ (1993) 46(2) Current Legal Problems 113; L Smith, ‘Disgorgement of the Profits of Breach of Contract: Property, Contract and Efficient Breach’ (1994) 24 Canadian Business Law Journal 121. For an excellent recent discussion, see Eisenberg, above n 8. 37 Cf Schwartz, ibid; SM Waddams, ‘The Choice of Remedy for Breach of Contract’ in J Beatson and D Friedmann (eds), Good Faith and Fault in Contract Law (Oxford, Clarendon Press, 1995) 471. 38 See the examples discussed in Friedmann, above n 35, 520–1, in which employees whose services are unique or extraordinary accept, in breach of their contract, a more lucrative employment. In some of these instances an injunction may be granted. Specific performance is unavailable, but in my view restitution of gains in such situations is conceivable. 39 The award of damages may lead to a similar result if the purchaser’s loss will be calculated on the basis of the sale to the third party.

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loss (payment for a building that will have to be pulled down). But this is not the crucial point. The decisive factor is that the loss to one party greatly exceeds the benefit to the other. The illustration assumes that the profits that P will derive from performance amount to $75,000 while the loss to D will exceed $500,000 (the cost of the building plus the cost of pulling it down). It may well be that by performing the contract P would have gained some additional advantages that are not reflected in his expected profits, such as enhanced reputation, for which he is unlikely to recover damages.40 But, even if we take this element into account, it is clear that performance would lead to sheer economic waste. A possible test that identifies this type of situation is to assume that the parties (in the above example, P and D) become a single entity, P-D (say, by corporate merger).41 It is obvious that in this example the four-storey building will not be erected. The contract has thus become a wasteful contract. It is possible to generalise that in the case of a wasteful contract, namely where the loss to one party that will result from its performance exceeds the benefit which the other party will derive from it, a breach is acceptable, even though it is not condoned. Such a breach can be described as tolerated breach, in which case there is no room for specific performance, nor is there any justification for an award of restitution of gains. The gains in this instance are actually in the form of a loss or expenses saved. In the above example, by breaching the contract the landowner (D) avoids the loss that performance would have imposed upon him (the cost of the building plus the cost of pulling it down). In this illustration there is another type of gain, namely that which derives from the building of a thirty-storey construction on the plot owned by D. But the contractor (P) is not entitled to a share in these profits. His contract gave him no right in the land or in gains that it may yield.42 The problems posed by a wasteful performance did not escape attention and it has been suggested that, if specific performance were available, the party who wished to escape its consequences could buy himself out. Thus, for example, in illustration 4 the landowner could ‘purchase’ a release from the contract by offering the contractor say $250,000, a sum which is between his expected loss from performance and the contractor’s gain.43 40 Performance by a professional seller or provider of services often brings him some gain by way of reputation and may strengthen his position in the market. This is highly conspicuous in such professions as actors, artists, architects and lawyers, but it also exists at least to some extent in many other professions. Cf WJ Gordon and T Frenkel, ‘Enforcing Coasian Bribes for Non-price Benefits: A New Role for Restitution’ (1994) 67 Southern California Law Review 1519. 41 Regarding this test, see Friedmann, above n 36, 9–10. 42 This point as well as those related to limited privilege and good faith are discussed in my article, Friedmann, above n 35, 525–6. 43 Cf the theory of efficient termination developed by Paul Mahoney, under which it is sometimes more efficient to terminate a contract than to perform it: ‘Efficient termination is possible when the amount of money, Y, that [the promisor] would pay to escape performance at

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However, the reaching of such a release agreement may be difficult and in any event the payment of an amount so greatly exceeding the aggrieved party’s loss is likely to be regarded as extortionate. Indeed, this very point was raised by Lord Hoffmann in Co-operative Insurance Society v Argyll Stores (Holdings), discussed at the very beginning of this chapter.44 He quoted a statement by Lord Westbury under which the court should not grant a mandatory injunction that will, ‘deliver over the defendants to the plaintiff bound hand and foot, in order to be made subject to extortionate demand that he may by possibility make . . .’ Lord Hoffmann also referred to the view that the court will not order the defendant to carry on with a losing business,45 and added that the ‘plaintiff will enrich himself at the defendant’s expense’ if an order for specific performance will cause the defendant a loss that is heavier that the loss that the plaintiff would suffer from non-performance. Not all these arguments point in the same direction. Thus the mere fact that the defendant is required to carry on with a losing business does not mean that the performance of the contract is wasteful. If the loss from the defendant’s business is lower than the gain that will be derived by the plaintiff from its continued operation, then it may make sense to keep it going, though there may be other, non-economic reasons that would justify denial of a mandatory injunction.46 There are additional concepts that can be applied to the tolerated breach. One is that of incomplete privilege developed by Professor Bohlen in the field of torts.47 This concept asserts that a person is entitled to infringe another’s property rights in order to avert bodily injury or more serious damage to himself. The invader is, however, required to compensate the party whose rights were infringed for the loss suffered. This approach can a fortiori apply to contractual rights and lead to the recognition of a qualified right to terminate subject to the payment of damages. As already indicated, such a right has to be confined to a particular point in time is greater than the amount of money, Z, that the promisee . . . would accept in lieu of performance. In that situation there is a potential gain of Y–Z from terminating the contract’: PG Mahoney, ‘Contract Remedies and Option Pricing’ (1995) 24 Journal of Legal Studies 139, 141. See also Eisenberg, above n 8, 1000; cf L Kaplow and S Shavell, ‘Fairness versus Welfare’ (2001) 114 Harvard Law Review 961, 1120–30. Above text to n 1. The reference was to Braddon Towers Ltd v International Stores Ltd [1987] 1 EGLR 209, 213 that speaks of a practice not to grant mandatory injunction requiring persons to carry on business (without adding the element that the business is suffering losses). Cf also Burrows, above n 7, 541. 46 Indeed, in such a case it is conceivable that damages to the plaintiff will be higher than the loss suffered by the defendant from carrying on with the business. 47 FH Bohlen, ‘Incomplete Privilege to Inflict Intentional Invasions of Property and Personality’ (1926) 39 Harvard Law Review 307. The article is based on an analysis of Vincent v Lake Erie 124 NW 221 (Minn SC 1910). For a discussion of this case, see also E Weinrib, The Idea of Private Law (Cambridge, MA, Harvard University Press, 1995) 196–203 and Friedmann, above n 35, 540–6. 44 45

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situations in which the loss to one party from the performance exceeds the benefits that the other party is likely to derive from it. Indeed, there are legal systems that expressly recognise a unilateral right to terminate such a contract subject to payment for work done, expenses and lost profits. Thus Article 1794 of the French civil code provides: The master can terminate at will an agreement for work to be done (marché à forfait) although the work had already begun, by compensating the contractor for all his expenses, all his work, and all that he would have gained in the enterprise.48

Anglo-American law has not gone so far as to give an explicit right of termination, though the parties are of course free to include in the contract a provision allowing such termination. But in the absence of such a provision there is no default rule that permits one party unilaterally to bring the contract to an end. The matter is usually relegated to the law of remedies. The contractor is unlikely to get specific performance of his contract and his claim for damages will be subjected to the rules on mitigation. Thus it has been decided in a number of American leading cases that the rules on mitigation preclude the recovery by a contractor of the full contractual price or expenses incurred after he learned that the other party no longer needs his performance.49 Mark Gergen pointed out that there are only a handful cases in which a contractor continues work and sues for the full contract price after the other party tells him to stop.50 This is understandable. Normally a party will not continue to make expenditures when he knows that the other party is unwilling to pay for them and the only way to get paid is via an action in court. Yet the aggrieved party may be able to recover the contract price if he continued work to avoid uncompensated loss.51 The well-known decision of the House of Lords in White & Carter (Councils) Ltd v McGregor52 is seemingly not in line with this approach. In that case, the plaintiff agreed with the defendant, a garage proprietor, to display his advertisement for three years. The defendant repudiated the contract on the very date it was made. The plaintiff disregarded the repudiation, displayed the advertisement and claimed the amount due under the contract. The House of Lords by a majority upheld the claim. It is not clear, however, whether in that case there was a substantial divergence between the agreed sum and an award of damages. Such a divergence is likely to occur if performance entails considerable costs, as, A similar provision is included in the German civil code: BGB §649. Rockingham County v Luten Bridge Co 35 F 2d 301 (4th Cir 1929); Clark v Marsiglia 1 Denio 317 (NY 1845). 50 MP Gergen, ‘Exit and Loyalty in Contract Disputes’ in N Cohen and E McKendrick (eds), Comparative Remedies for Breach of Contract (Oxford, Hart Publishing, 2005) 75, 86. 51 Ibid, 86–7, referring to O’Hare v Peacock Dairies Inc 79 P 2d 433 (1938) and other cases. 52 [1962] AC 413 (HL). 48 49

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for example, in the case of agreement to construct a building, or if the plaintiff could have mitigated his loss. In White & Carter the amount due under the contract, which the plaintiff recovered, was fairly modest, namely £187 4s, and it is not clear whether damages would have been substantially lower.53 Moreover, Lord Reid, who was one of the majority judges, stated that a different result would have been reached if the aggrieved party had ‘no substantial or legitimate interest’ in continuing performance.54 This statement is generally taken to form part of the White & Carter rule.55 Consequently White & Carter is of very limited application. It has hardly been followed and often distinguished.56 The rule under which the aggrieved party, who continues to work after the breach, can recover the contract price only if he has a substantial or legitimate interest in completing performance leads us to the requirement of good faith. An important aspect of good faith is reflected in the imposition of certain restraints upon self-interest in deference to a much heavier interest of another party. A legal right or power is not to be used excessively or in an oppressive manner, or for a purpose for which it was not intended. Excessive use means use which exceeds that required for the protection of one’s legitimate interest while imposing disproportionate loss on another party.57 English law has not adopted a general doctrine of good faith. The function that this doctrine fulfils in other legal systems has in English law been relegated to the law of remedies.58 The court will generally deny a remedy that imposes upon the defendant a burden or a loss that greatly exceeds the benefit that it is likely to grant the plaintiff. Conspicuous examples can be found even in the field of property. Thus, in Jaggard v Sawyer59 the plaintiff bought a house that was part of a residential development served by a private cul de sac. Each plot, together with the roadway in front of it, had been conveyed subject to a covenant not to use any part of the unbuilt land other than as a private garden. The defendants also bought a house served by this cul de sac and subsequently bought a plot of land contiguous to their property and started to build a house on it. The only way to reach the new house was via the cul de sac, but this would involve a continuing trespass and breach of the covenant. Nevertheless Judge Jack declined to grant an injunction and awarded damages in lieu. The plaintiff claimed that the decision grants the defendants ‘a right of way in perpetuity over my land for a once and for all G Treitel, The Law of Contract (London, Sweet & Maxwell, 11th edn, 2003) 118. Ibid, 431. Cf also the American approach, nn 49–50 and accompanying text. See the detailed analysis in Treitel, above n 53, 116–19. Burrows, above n 7, 435–40. D Friedmann, ‘Good Faith and Remedies for Breach of Contract’ in Beatson and Friedmann, above n 37, 399, 400–1. 58 Ibid. 59 [1995] 1 WLR 269 (CA). 53 54 55 56 57

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payment’ and ‘effectively expropriates my property . . .’.60 Despite this, the decision was affirmed by the Court of Appeal in view of the relatively small loss suffered by the plaintiff and the huge loss that an injunction would have imposed upon the defendants.61 A doctrine of good faith might have conceivably required the plaintiff to sell the defendants a right of way. No such doctrine is recognised by English law. Yet, a result similar to a forced sale was reached via the law of remedies.62 In the contractual context it can be said that, if in the case of a wasteful contract the losing party is asked to pay for his release an amount based on his potential loss, the demand is not in good faith and is in fact extortionate. The reason is that the contract is intended to grant the party his performance interest. This interest does not encompass a right to exploit the other party’s loss. Hence, if a party tries to use his right to performance in order to take advantage of the other party’s expected loss, he abuses his contractual right. Such use of a legal right for a purpose for which it was not intended is a breach of the duty of good faith. This is also the explanation of Lord Hoffmann’s seemingly paradoxical statement in Co-operative Insurance Society,63 under which specific performance may enable the aggrieved party to enrich himself at the defendant’s expense. This seemingly paradoxical statement can be correct under the following conditions: (i) the contract became a wasteful contract; and (ii) the aggrieved party receives payment exceeding his loss in order to release the other party. But there is no unjust enrichment if the aggrieved party merely gets what was promised to him. Thus, suppose that specific performance is ordered in circumstances like those of Co-operative Insurance Society and as a result the plaintiff (the landlord) gains £100 per annum while the defendant suffers a loss of £150 per annum from carrying on with his losing business. It is arguable that in this case specific performance is unjustified and makes no economic sense. It is also arguable that the plaintiff was not in good faith in insisting on specific performance. But there is no unjust enrichment. The plaintiff got the performance to which he was entitled under the contract. This cannot be considered unjust enrichment. An argument of unjust enrichment could be made if the defendant bought his release from the contract by paying an exorbitant price of £140. However, in Co-operative Insurance Society there has been no attempt to compare the loss that would have been suffered by the defendants had they carried on with their business with the loss suffered by the plaintiffs from the breach. Ibid, 286. On the award of damages in lieu of injunction, see generally Burrows, above n 7, 362–7. Cf also Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798 (Ch); Woolerton and Wilson Ltd v Richard Costain Ltd [1970] WLR 411 (Ch) discussed in Friedmann, above n 57, 404. 63 See text following n 1. 60 61 62

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Another point that deserves to be mentioned in the context of both Jaggard and Ruxley64 relates to the measure of recovery. Both represent a forced sale of a protected interest. In Jaggard it was a propriety interest and in Ruxley it was a contractual right to the other party’s performance. In Jaggard recovery was clearly based on an objective measure, namely an amount that ‘the defendants might reasonably have paid for a right of way and the release of the covenant’.65 There is obviously no room to award such an exorbitant amount as the defendants might have been compelled to pay in their predicament, but there is every reason to believe that the plaintiff valued the right of way and the covenant at an amount well above the market price. The recovery of an amount that ‘the defendants might reasonably have paid’ points to an objective measurement of a price that might have been agreed between a willing (‘reasonable’) seller and a ‘reasonable’ buyer. The fact that the plaintiff’s subjective valuation of that which was taken from her was higher than the objective value was disregarded. In contrast, the plaintiff in Ruxley was awarded £2,500 for loss of amenities. This amount exceeds the objective loss, which was assumed to be nil since the value of the pool as supplied was equal to that which was promised. The award of £2,500 may thus be regarded as partial compensation for the plaintiff’s subjective loss. We may thus conclude that enforcement will be denied where it entails a loss to one party that exceeds the benefit to the other. The question is how the benefit to the plaintiff should be measured. The answer seems to be that there is a strong tendency to measure it objectively, namely by finding a ‘reasonable’ price or a price that ‘reasonable’ parties would have agreed upon. One reason for this approach lies in the difficulty in ascertaining the subjective value that a party places on a particular interest, though in a contractual context a party can at the time when the contract is formed define this interest and presumably can also put a price tag on it. The other reason is probably that courts are unwilling to offer protection to a subjective valuation that is out of proportion to an objective valuation unless the contract clearly points out that a subjective measure should be adopted.

VI

TO L E R AT E D B R E AC H V E F F I C I E N T B R E ACH

The concepts of tolerated breach introduced above (as well as that of wasteful performance, to which it is related) may seem similar to that of efficient breach, to which I object.66 Admittedly, in some instances both 64 65 66

See nn 18–20 and accompanying text. See n 59, 275. A similar approach was adopted in Wrotham Park, above n 62. Friedmann, above n 36.

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may lead to similar results. Nevertheless there are fundamental differences. The efficient breach theory examines the situation from the point of view of the party in breach. If his gains from the breach exceed the amount of damages that will be awarded to the aggrieved party, then the breach is efficient. Thus, in illustration 3 discussed above, in which V contracts to sell P a piece of property for $10,000 and shortly afterwards T offers V $50,000 for it, the breach is considered ‘efficient’ if we assume that the damages which V will be required to pay are less than his gain from the sale to V. On the other hand, the wasteful performance approach examines the situation from the point of view of both parties and, as already indicated, in this example performance of the contract is not wasteful and its breach is not a tolerated one. Another difference between the tolerated breach approach and that of efficient breach is that the test of efficient breach is based upon a comparison between the gains derived by the breach and the award of damages while the test of wasteful performance (and that of tolerated breach) is based on comparison between actual losses and actual gains derived from the performance of the contract, including losses and gains that may be disregarded by the law of damages. Finally, the theory of efficient breach assumes that the decision whether to perform or breach is that of the party involved and that the only consequence of the breach is liability in damages. In other words, the party who lost interest in the contract has a ‘right’ to breach it subject to the payment of damages. The theory of wasteful contract does not recognise such a right to breach the contract. Under this approach the discretion is that of the court that can order specific performance or restitution of profits gained by the breach. Only if the court is convinced that the breach was ‘tolerated’ will it limit the liability of the party in breach to the payment of damages.

VII

SP ECI FI C PERF O RM A N C E A N D T H E L I M I TAT I O N S U P O N T HE AWARD O F DAM AG E S

I examined above the effect of high subjective value upon specific performance and damages. Broadly speaking, specific performance grants the plaintiff the subjective value that he places upon the promised performance while damages will probably be assessed objectively. However, where for some reason the value that the plaintiff places upon the promised performance (the subjective value) greatly exceeds the objective value, such a subjective value may be disregarded not only for the purpose of damages but also for the purpose of specific performance. Consequently specific performance may be denied if it imposes upon the defendant a loss that greatly exceeds the benefit to the plaintiff (measured objectively) even if the

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plaintiff places a very high (subjective) value on receiving it unless the contract specifically clarifies that the plaintiff’s subjective value be respected. Thus, it can be safely assumed that in the case of Ruxley67 specific performance, which would have required the defendants to replace the existing pool by a new pool at a very high cost, would have been denied. Let us now examine a number of other limitations on the award of damages and their conceivable effect on specific performance.

A

Types of Losses for Which Damages are Not Allowed

The award of damages generally includes economic losses; damages are generally not recoverable for ‘any distress, frustration, anxiety, displeasure, vexation, tension and aggravation’ caused by breach of contract.68 Thus, a person who is wrongfully not admitted or expelled from a trade union, club or association may have a right to claim damages.69 He may find, though, that the damages fall short of compensating him for his non-economic sufferings. Enforcement of the contract, to the extent that it is available and practical, will redress such grievances. A similar result ensues regarding other limitations on the recovery of damages, such as injury to reputation for which recovery was once disallowed,70 though in modern times this rule has been greatly eroded.71

B Date of Assessment and Remoteness72 Damages will not be awarded for loss that is too remote. It is, however, obvious that if specific performance is granted the plaintiff will enjoy all the ensuing advantages even if those advantages would not have been taken into account in the assessment of damages. This point can be demonstrated by the following illustration: 5. P contracts to purchase a house from V for $50,000. P has a plot of land contiguous to this house. The acquisition of the house will enable P to combine the two plots and add to the value of P’s present plot some $15,000. V declines to perform. The value of the house on the date of the See n 18 and accompanying text. Watts v Morrow [1991] 1 WLR 141 (CA) 1445 (Bingham LJ); Beatson, above n 7, 593–4, who also discusses instances to which the rule that limits recovery does not apply. 69 Cf Bonsor v Musician’s Union [1956] AC 104 (HL). 70 Addis v Gramophone Co Ltd [1909] AC 488 (HL). 71 Malik v Bank of Credit & Commerce International SA [1998] 1 AC 20 (HL), and the discussion in Beatson, above n 7, 594–5. 67 68

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breach is $60,000. P files an action in court. The evidence shows that the value of the house is $80,000. Judgment is rendered one month after the hearings at which time the value of the house is $85,000. In this type of situation the purchaser is usually entitled to specific performance. Performance will grant P the subjective value that he attributes to the house, which may be well above $85,000. But even if the value is assessed objectively it will be $85,000 plus the increase value of his adjacent plot, namely $15,000. Let us now assume that under the circumstances an order of specific performance is problematic73 and the court considers awarding damages in lieu. How are damages to be assessed? Under the common law the decisive date for assessment is prima facie the date of the breach.74 However, in Wroth v Tyler75 Megarry J held that when damages are awarded in lieu of specific performance in accordance with Lord Cairns’ Act they should ‘constitute a true substitute for specific performance’.76 Consequently the assessment of such damages can be made by reference to the date of judgment, a result which in Wroth v Tyler and in illustration 5 above is much more favourable to the claimant. It should however be pointed out that though damages so assessed are in economic terms very close to specific performance, there remain some important differences. First, specific performance grants the claimant the subjective value that he places on the performance while damages are based on an objective (market value) assessment. Second, damages assessed by reference to the date of judgment are actually assessed by reference to the date on which the relevant evidence as to the value was heard. Fluctuation in value between this date and the date on which the judgment is rendered cannot as a practical matter be taken into account. On the other hand specific performance grants the plaintiff the value of that which was promised to him on the date on which performance is actually carried out. An additional question relates to remoteness. Damages are not awarded for a loss that is too remote. Thus in illustration 5 it is assumed that the acquisition of the property promised under the contract will enhance the value of another piece of property owned by the purchaser. If the vendor does not perform, the loss resulting from the failure to realise this gain may well be regarded as too remote.77 In Wroth v Tyler Megarry J quoted See also text to n 26. Cf Wroth v Tyler [1974] Ch 165 (Ch), [1973] 1 All ER 897 (specific performance denied on the ground that, in order to perform, the defendant would have to take legal action against another party—in this case his wife). 74 Treitel, above n 53, 959. 75 See n 73. 76 [1974] Ch 30 (Ch) 58. See also the discussion in Treitel, above n 53, who points out that the purpose of common law damages is similar, namely to put the plaintiff in the same position as if the contract has been performed. Cf also Johnson v Agnew [1980] AC 367 (HL). 77 It is unlikely to be within the first limb of Hadley v Baxendale and is assumed that there were no factors that could bring it within the second limb of Hadley. 72 73

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a statement by Fry J to the effect that ‘damages cannot be adequate substitute for an injunction unless they cover the whole area which have been covered by the injunction . . .’.78 Nevertheless it seems that even if the damages are awarded in lieu of specific performance they will not include losses that are considered too remote.79 It is obvious, however, that if specific performance is ordered the plaintiff will obtain any additional gain that performance entails. The fact that the additional gain is considered to be too remote for the purpose of damages does not change the reality of its existence and the ability of specific performance to lead to its acquisition. In this context let us revert to Co-operative Insurance Society v Argyll Stores (Holdings),80 in which the owners of the supermarket decided, in breach of their contract, to close the supermarket that operated in the plaintiffs’ shopping centre. Two types of losses can be envisaged. One is the direct loss of the defendants’ rent and the other is the consequential loss reflected in the effect on other stores in this shopping centre. Such an effect may reduce the rent receivable from other stores either if the rent is payable as a percentage of their revenue or because they may suffer losses that will cause them to close. Specific performance would have prevented both types of losses. Damages are clearly available for the loss of the defendants’ rent. Recovery of the consequential losses is more problematic and depends on whether they are within the second limb of Hadley v Baxendale, namely within the contemplation of the parties.81 It is therefore submitted that in the appropriate case the existence of losses that are too remote for the purpose of damages but would be remedied by performance should be taken into account in deciding whether specific performance is to be granted.

C

Mitigation82

The rule on mitigation imposes a burden upon the aggrieved party. If he does not comply he will be deprived of his right to recover damages for losses that he could by acting reasonably have avoided. The rule may thus lead to an award that falls short of the loss actually suffered.83 The rule on mitigation is related to the one on the date by reference to which damages are to be assessed. The normal way by which mitigation is carried out is by making a substitute transaction and the question is when ought this Fritz v Hobson (1880) 14 Ch D 542 (Ch) 556–7. See the references in n 76. See n 1 and accompanying text. However, mitigation of the loss by getting another tenant would reduce both the direct loss as well as the consequential one. See text following n 94. 82 See also text to n 29. 83 The defense of contributory negligence, to the extent that it is available in contractual context, has a similar effect. See also n 12. 78 79 80 81

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transaction to be made? The rule of the law of damages is that it ought to be made as soon as possible after the fundamental breach has occurred.84 Thus, if the party in breach of the contract does not supply goods on the date agreed upon, the aggrieved party is expected to mitigate the loss by purchasing such goods from a different source without delay. If he fails to do so and purchases the goods after many months at a time when their price has substantially increased, he will not be compensated for the subsequent increase in their price. The result may be explained by reference to either the rule regarding the date relevant for the computation of the loss or the rule on mitigation. It is clear that they are interrelated. Hence, if it is impossible or impractical to make an alternative transaction, for example because such goods are unavailable or because the claimant lack the funds needed for the transaction,85 damages may be assessed by reference to a later date conceivably even the date of the judgment.86 While the claim for damages is subject to the burden of mitigation,87 specific performance is not. The reason seems self-evident. The claimant who seeks performance cannot be expected to make an alternative transaction. In fact, if he makes another similar transaction he may be entitled to claim that this is an additional transaction and not one made in substitution to the original transaction.88 The issue of mitigation arose in White & Carter (Councils) Ltd v McGregor,89 which was concerned not with the equitable remedy of specific performance but with an action for the agreed sum, namely a common law action for performance. In that case the plaintiffs performed their part of the contract although they were aware that the defendants ceased to be interested in it. In the House of Lords, the dissenting justices90 considered that recovery of the agreed sum was not in line with the requirement of mitigation.91 It should, however, be noticed that strictly speaking we are not concerned with mitigation. The rule on mitigation 84 I shall not examine the specific rule that may apply in the case of anticipatory breach, discussed in Burrows, above n 7, 128. 85 Wroth v Tyler, above n 73. In Owners of Dredger Liesbosch v Owners of Steamship Edison (‘The Liesbosch’) [1933] AC 449 (HL) the House of Lords held that loss resulting from the plaintiff’s lack of financial resources is irrecoverable. But this is no longer the law: Langden v O’Connor [2004] 1 AC 1067 (HL); Burrows, above n 7, 144–7. Hence damages will not be reduced on the ground that the claimant should have mitigated the loss if his financial position did not enable him to do so. The change in the law reflects a movement from an objective assessment of damages, which assumed that money is always available, to a subjective approach the looks at the particular claimant who may not be able to raise the funds needed to mitigate the loss. 86 Regarding this possibility, see text following n 76. 87 I describe the requirement of mitigation as ‘burden’. The term ‘duty’ to describe it is misnomer: Beatson, above n 7, 615–16. 88 A person who contracted to purchase a house can, if the contract is breached, buy another house and yet insist on the performance of the original contract. 89 See n 52 and accompanying text. 90 Lord Morton and Lord Keith: [1962] AC 413 (HL) 462. 91 See also Burrows, above n 7, 435–40.

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requires the aggrieved party to act in order to reduce the losses that result from the breach. In the White & Carter situation the breach, namely the repudiation of the contract, did not cause any loss. The loss was caused by the performance of the contract, not by its breach. Nevertheless the issues are close. The idea that is common to both is that the aggrieved party should at least to some extent take the interest of the other party into account and that he ought not to impose on the party in breach expenses that do not serve the interest of the aggrieved party. Both reflect the concept of good faith which, as we have seen, imposes some restrictions on the use of legal rights in deference to the interests of the other party.92 The rule on mitigation limits the aggrieved party’s right to damages. The rule under which the aggrieved party may not insist on performance in the case of a wasteful contract,93 namely where the loss to the party in breach that will result from performance exceeds the benefit to the aggrieved party and limits the right of performance of this party as well as his right to keep the wasteful contract open. In this respect, the possibility of mitigation has to be taken into account in assessing the value of performance to the aggrieved party. Let us revert once again to Co-operative Insurance Society v Argyll Stores (Holdings).94 The benefit that the aggrieved party was expected to derive from the defendants’ performance consisted mainly of the rent payable by them as well as the effect of their supermarket on other stores in the shopping centre. If, however, it is possible to find another tenant,95 both losses may be considerably reduced or even disappear. In such a case the value of the contract to the aggrieved party is merely the value of the defendants’ performance less the value of the new tenants’ performance. If the outcome of this calculation is less than the loss that the defendants would have suffered from their performance of the contract, then the performance of the contract with the defendants became wasteful and should not have been carried out.

D

Third Parties’ Interests

Where a third party acquired rights under the contract,96 he may be entitled to contractual remedies in case of a breach,97 though many contracts affect See text to n 57. Regarding wasteful contracts, see text to n 40 et seq. See n 1 and accompanying text. In fact it is clear from the decision that another tenant was found and that the lease was assigned to him. 96 The Contracts (Rights of Third Parties Act) 1999. 97 N Cohen, ‘Remedies for Breach through the Lens of the Third Party Beneficiary’ in N Cohen and E McKendrick (eds), Comparative Remedies for Breach of Contract (Oxford, Hart Publishing, 2005) 157. 92 93 94 95

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third parties without conferring upon them any legal rights. Where such a contract is breached the question arises whether the other party to the contract can recover damages for the loss suffered by the third party.98 The issue is complex and is not within the ambit of this chapter.99 For our purposes, it suffices to refer to Lord Millett’s statement that ‘the general rule of English law is that in an action for breach of contract a plaintiff can only recover substantial damages for the loss that he himself sustained’.100 This rule is subject to exceptions, described by Lord Millett as ‘apparent’, adding: ‘I say “apparent” exceptions for I regard most of them as explicable in a manner consistent with the rule’.101 Specific performance will obviously grant the third party that which is beyond the reach of damages. This technique of protecting the third party was utilised even before the introduction of legislation on contract for the benefit of third parties.102 Such a technique may not be needed in instances in which the third party acquired rights under the contract by virtue of the new legislation103 or in jurisdictions in which his right to sue under the contract is recognised. But specific performance is likely to protect the interests of third parties even where the contract did not intend to confer upon them legal rights. Let us revert once again to Co-operative Insurance Society v Argyll Stores (Holdings),104 in which the owners of the supermarket, in breach of their contract with the shopping centre owners, closed the supermarket and left the shopping centre. It is clear that the parties to the contract did not intend to confer legal rights on other shop owners, but it may be assumed that the supermarket attracted clients to the area and had thus affected other business in the centre, and also that the owners of the shopping centre had an interest in the success of the other businesses. Specific performance would thus have protected the interest of those third parties to whom the remedy of damages was not available. This means that if the effect on third parties is taken into account then the economic benefits of specific performance may be higher than that reflected by its economic value to the claimant. It is unlikely, however, that this element will be taken into account.105 98 If such recovery is possible, the damages reflecting this loss will presumably be held in trust for the third party. Cf Albacruz (Cargo Owners) v Albazero (Owners) (‘The Albazero’) [1977] AC 774 (HL), Hepburn v A Tomlinson (Hauliers) Ltd [1966] AC 451 (HL). 99 For a detailed discussion, see H Unberath, Transferred Loss—Claiming Third Party Loss in Contract Law (Oxford, Hart Publishing, 2003). 100 Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 AC 518 (HL). 101 Ibid. 102 Beswick v Beswick [1968] AC 58 (HL). 103 See n 96. 104 See n 1. 105 It is also conceivable that performance will be detrimental to third parties, an element which is unlikely to be taken into account. However, where performance is beneficial to third parties, the claimant is often interested in granting them this benefit.

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CONCLUSIONS

The following points can be made by way of conclusion: 1. Specific performance grants the plaintiff the subjective value of that which was promised to him, but imposes on him the subjective cost of his performance. Damages are generally based on objective assessment; subjective elements are taken into account only in some specific situations. In addition, specific performance will ordinarily remedy those elements like distress, vexation and aggravation for which monetary compensation is not available in cases of breach of contract.106 2. Specific performance is thus more advantageous to the claimant if the subjective value that he places upon the performance promised to him exceeds its objective value and if a substitute for the promised performance cannot be obtained for a price equal to the objective value. 3. There are, however, situations in which the subjective loss to the claimant is lower than the loss objectively assessed for the purpose of damages. In these instances damages are more advantageous to the plaintiff since they grant him compensation in an amount that exceeds his real loss. A typical example is that in which damages are assessed by reference to the date of the breach when the price of the property, promised under the contract, subsequently declined.107 4. Specific performance protects the claimant from losses that under the law of damages are considered too remote. 5. The award of damages is always subject to the burden of mitigation. The effect of mitigation upon specific performance is more complex. In some instances the mere possibility of mitigation is regarded as irrelevant and will have no effect on the right to specific performance. In these instances specific performance will fully compensate the claimant and the defendant will bear his full cost of performance even though the claimant could have mitigated the loss. But there are situations in which the fact that the claimant could have mitigated the loss will lead to a denial of specific performance. 6. Specific performance may benefit third parties for whom damages may not be available. 7. Where performance of the contract imposes on one party costs that exceed the benefit that the other party will gain from such performance there is no room for specific performance. The contract is a wasteful contract and its breach is tolerated. In this type of situation there is also no room for restitution of the benefits (acquired by way of loss avoidance) that the party in breach gained by the non-performance of the contract. 106 107

See n 68. See n 32 and accompanying text.

3 The Scope of the CISG Provisions on Damages CI S G PROVI S I ONS ON DAMAGES

I N G E B O R G S C H W E N Z E R * AND PAS CAL HACHEM * * I NGEBORG S CHWENZER AND PAS CAL HACHEM

I

GENERAL

In the same way as under domestic laws, questions of damages have been among the most discussed issues under the Convention during the last 10 years.1 Recently, the Advisory Council on the CISG (CISG-AC) published a special opinion on the calculation of damages under Article 74 CISG.2 Why are damages such a debated issue? The history of Article 74 CISG can be traced back to its predecessor, Article 82 of the Uniform Law of International Sales (ULIS). Both during the preparation of the CISG and at the Vienna Conference, there were hardly any discussions about the damages provisions. The wording of Article 82 ULIS remained practically unchanged.3 What guidelines can be derived from the wording of Article 74 CISG? As Honnold has described it, the standard established by Article 74 is brief * Dr. iur. (Freiburg i. Br.), LL.M. (UC Berkeley), Professor of Private Law, University of Basel, Switzerland. ** Ref. (Freiburg i. Br.), Research and Teaching Assistant, University of Basel, Switzerland. 1 See JY Gotanda, ‘Awarding Damages under the United Nations Convention on the International Sale of Goods: a Matter of Interpretation’ (2005) 37 Georgetown Journal of International Law 95; D Saidov, ‘Damages: The Need for Uniformity’ (2006) 25 Journal of Law and Commerce 393 (hereinafter ‘Damages’); D Saidov, ‘Standards of Proving Loss and Determining the Amount of Damages’ (2006) 22 Journal of Contract Law 1 (hereinafter ‘Standards’); MW Brölsch, Schadensersatz und CISG (Frankfurt, Lang, 2006); B Zeller, Damages under the Conventions of Contracts for the International Sale of Goods (New York, Oceana, 2005). 2 CISG-AC Opinion No 6, Calculation of Damages under CISG Article 74, rapporteur Professor JY Gotanda, available at www.cisg-online.ch/cisg/docs/AC-opinion%206.pdf (accessed 27 June 2007). 3 Of course, Art 82 ULIS was confined to cases where the contract has not been avoided; see H Stoll and G Gruber in P Schlechtriem and I Schwenzer (eds), Commentary on the UN Convention on the International Sale of Goods (CISG) (Oxford University Press, 2nd edn, 2005) Art 74, para 6; U Magnus ‘Wiener UN-Kaufrecht (CISG)’ in J Staudinger (ed), Kommentar zum Bürgerlichen Gesetzbuch mit Einführungsgesetzen und Nebengesetzen (Berlin, Sellier/de Gruyter, 13th edn, 2005) Art 74, para 6.

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but powerful.4 According to this provision, damages ‘consist of a sum equal to the loss, including loss of profit, suffered . . . as a consequence of the breach’. It is unanimously held that the standard laid down in this article is designed to place the aggrieved party in as good a position as if the other party had properly performed the contract.5 The essential basic concept is the principle of full compensation. Thus, the loss for which compensation is to be granted includes both the lost expectation of performance as well as losses incurred in reliance on performance.6 Whereas these basic principles remain undisputed, the details have become more and more controversial. This is due to several developments in domestic legal systems and uniform law projects, such as the UNIDROIT Principles of International Commercial Contracts (PICC) and the Principles of European Contract Law (PECL). For example, in the UK, the last 20 years have been characterised by a real upheaval in the law of damages; to mention but a few of the leading cases: Ruxley,7 Blake8 and Farley.9 In Germany, the German Forum of Jurists (Deutscher Juristentag)—the most influential group for enhancing the development of legal policy—dedicated a whole session of its 2006 conference to ‘New Perspectives in the Law of Damages’.10 On an international level, both the UNIDROIT PICC and the PECL must be mentioned here. In the first place, both sets of rules are, in essence, based on the same principle as the CISG, namely the principle of full compensation.11 However, they go beyond the wording of the CISG. They not only expressly provide that the 4 JO Honnold, Uniform Law for International Sales under the 1980 United Nations Convention, (The Hague, Kluwer International Law 3rd edn, 1999) para 403. 5 See Secretariat Commentary, ‘Art 70, para 3’ in Official Records 59; GH Treitel, ‘Remedies for Breach of Contract’ (Oxford, Clarendon Press, 1989) 82; Honnold, above n 4, para 403; CISG-AC, above n 2, para 1.1; Gotanda, above n 1, 98. 6 See Case No 7 Ob 301/01t, 14 January 2002, Oberster Gerichtshof (Austria Supreme Court), available at http://cisgw3.law.pace.edu/cases/020114a3.html (accessed 28 June 2007); Stoll and Gruber, above n 3, Art 74, paras 2 et seq; Magnus, above n 3, Art 74, para 6; P Huber in K Rebmann, FJ Säcker and R Rixecker (eds), Kommentar zum Bürgerlichen Gesetzbuch (Munich, Beck, 4th edn, 2004) Art 74, para 18; D Saidov, ‘Methods of Limiting Damages under the Vienna Convention on Contracts for the International Sale of Goods’, (2002) 14 Pace International Law Review 307; cf W Witz in W Witz, HC Salger and M Lorenz (eds), International Einheitliches Kaufrecht: Praktiker-Kommentar und Vertragsgestaltung zum CISG (Heidelberg, Verlag Recht und Wirtschaft, 2000) Art 74, para 12. 7 Ruxley Electronics and Construction Ltd v Forsyth [1996] AC 344 (HL). For comment and analysis, see B Coote, ‘Contract Damages, Ruxley, and the Performance Interest’ (1997) 56 CLJ 537. 8 Attorney General v Blake [2001] 1 AC 268 (HL). For comment and analysis, see G Jones, ‘Must the Party in Breach Account for Profits from his Breach of Contract’ in I Schwenzer and G Hager (eds) Festschrift für Peter Schlechtriem zum 70. Geburtstag (Tübingen, Mohr Siebeck, 2003) 763. 9 Farley v Skinner [2002] 2 AC 732 (HL). For comment and analysis, see R Holmes, ‘Mental Distress Damages for Breach of Contract’ 35 (2004) Victoria University Wellington Law Review 699 et seq. 10 For a report on this session, see S Manner, ‘Tagungsbericht, Abteilung Zivilrecht’ [2007] Juristen Zeitung 232. 11 Art 7.4.2(1) PICC; Art 9:502 PECL.

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term ‘loss’ includes non-pecuniary loss,12 but they also provide guidelines as to when future loss is to be compensated for.13 These developments give rise to and, at the same time, are part of a general discussion of the aims and tasks of the law of damages in a modern world. Whereas, up until a few years ago, the main focus was on a very narrow notion of compensation, recent developments indicate that different aspects are now gaining importance. The pure ‘economic benefits’ principle has yielded to the ‘performance’ principle;14 issues of prevention and deterrence have emerged, demanding, among other things, disgorgement of profits from the breaching party or other punitive mechanisms. All of these issues are accentuated by other emerging developments of modern global sales law, such as the protection of human rights by private companies in all sectors of international trade.15 These new challenges cannot go unnoticed when applying and interpreting the CISG. The CISG began as a great endeavour to harmonise international sales law and has achieved this aim to a large extent.16 If it does not respond to current demands and continues to focus on the state of discussion prevalent in the 1970s (or, more accurately, the nineteenth century), it risks falling back into obscurity. The necessary adjustments will then be made by the concurrent application of domestic remedies to precisely those cases for which the CISG was originally designed. The battle for uniformity fought by the CISG would be lost. Although the following remarks are based upon the status quo, we see it as our task to contribute to the necessary, cautious and moderate modernisation of the CISG provisions on damages.

II

‘ECONOMIC BENEFITS’ PRINCIPLE V ‘PERFORMANCE’ PRINCIPLE

Although everybody seems to talk about the principle of full compensation, its precise meaning is far from clear. Full compensation or compensation for pecuniary loss is usually limited to the ‘economic benefits’ principle or, as it is called under Germanic legal systems, the Art 7.4.2(2) PICC; Art 9:501(2)(a) PECL. Art 7.4.3 PICC; Art 9:501 PECL Comment F. See Coote, above n 7, 541 et seq. See I Schwenzer and B Leisinger, ‘Ethical Values and International Sales Contracts’ in R Cranston et al (eds), Commercial Law Challenges in the 21st Century, Jan Hellner in Memoriam (Stockholm, Iustus Förlag, 2007); A Burrows, Remedies for Torts and Breach of Contract (Oxford University Press, 3rd edn, 2003) 16 (in the context of English law). 16 For a list of member states, see www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/ 1980CISG.html (accessed 27 June 2007). Until now the CISG has entered into force in 70 states. The Convention thereby covers more than two-thirds of all world trade. Nearly 2000 court decisions and arbitral awards rendered are published. 12 13 14 15

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‘difference theory’.17 All other losses of the aggrieved party that do not directly appear on the balance sheet are simply deemed to be non-pecuniary and thus not compensable. The only acknowledged exception to this principle is found in Article 76 CISG, which allows the aggrieved party to calculate its damages for the loss in the value of the goods according to the current price on an abstract level, regardless of whether it has actually undertaken any cover transaction or not.18 The consequences of this strict interpretation of pecuniary loss may be best illustrated by three hypotheticals. Hypothetical 1: Suppose that the buyer is a commercial carrier buying 10 trucks for transportation. If they are not delivered in time, it rents substitute trucks to carry on its business. Rental costs will unanimously be recognised as pecuniary loss under the economic benefits principle. However, let us change the facts slightly. The buyer is no longer a professional carrier but a non-governmental organisation (NGO) transporting food to the Sahel. As no substitute trucks can be rented where they are needed, no loss in this sense occurs. Hypothetical 2: Suppose that a Swiss company, conscious of human rights, buys T-shirts from a seller in India on the contractual condition that no children are to be employed in manufacturing the goods. The buyer is willing to pay a price 100% higher than the market price to ensure that such basic human rights are complied with. If the seller breaches the contract by employing children, this fact does not fundamentally change the tangible properties of the goods. If the buyer resells the goods without anybody becoming aware of the breach of contract, its revenues will be the same as if the seller had complied with the terms of the contract. Thus, in the strict sense, no pecuniary loss could be ascertained. Hypothetical 3:19 Imagine that a professional photographer buys a Ferrari in a flashy pink colour, paying extra for this special paintwork for photo shootings. The Ferrari is delivered in ordinary standard red. As nobody else would buy a flashy pink Ferrari, the resale price of a standard red one is even higher than that of the car bargained for. Does this mean that the photographer has suffered no loss and cannot claim damages? The majority view that no damages are to be awarded in such cases because of the absence of pecuniary loss is not convincing. If one confines damages to the economic loss caused by the non-performance, one ignores the fact that the aggrieved party has paid the price precisely to obtain the correct performance of the contract. This is, indeed, a pecuniary loss and not just a 17 See I Schwenzer, Schweizerisches Obligationenrecht Allgemeiner Teil (Bern, Stämpfli, 4th edn, 2006), para 14.03. 18 See Honnold, above n 4, 414; Stoll and Gruber, above n 3, Art 76, para 1; Huber, above n 6, Art 76, para 1; Brölsch, above n 1, 92 et seq. 19 This case is comparable to the well-known case Ruxley, above n 7.

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non-pecuniary loss. It is precisely this notion that distinguishes contractual damages from tortious damages. There can be no doubt that the scope of losses to be compensated for has to reflect the very purpose of the duty that has been breached. It may be conceded that duties arising in tort primarily protect integrity and against economic losses resulting directly from infringements of these duties. Contractual duties, on the other hand, aim at securing performance.20 The creditor must receive what it has bargained and paid a price for. A further argument advanced in favour of the economic benefit approach, namely that any damages for losses that cannot be qualified as pecuniary losses in the traditional sense yield a windfall profit to the aggrieved party,21 can easily be discarded as well. Even if it were assumed that, according to the pure balance sheet such a windfall profit arises, the question has to be asked as to who is to get the windfall profit if one denies damages for the aggrieved party. Should the breaching party in our hypotheticals really get off scot-free because it contracted with an NGO instead of a professional carrier; because the breach was never made public; or because the common Ferrari buyer prefers standard red over the extravagant flashy pink? The answer is a clear ‘no’. This solution is further underscored by the necessity to prevent breaches of contract. If damages in these cases were to be denied, all the breaching party would have to face would be the avoidance of the contract, which presupposes a fundamental breach, thus merely depriving it of the purchase price. If there is no fundamental breach (Article 25 CISG), in some cases—as in the Ferrari hypothetical, where the resale price of the flashy pink Ferrari is lower than that of the standard red one—even a reduction of the price (Article 50 CISG) would fail. This follows from the majority view that the potential resale price is decisive not only for the remedy of damages, but also for the reduction of the purchase price.22 Ultimately, the possibility to contract for a penalty and thus recover, notwithstanding the fact that no pecuniary losses in the narrow sense can be ascertained, does not solve the problem in the cases discussed here. First, it is a circular argument as often the otherwise applicable domestic law requires there to be a pecuniary loss under the CISG for the validity of the penalty clause. Secondly, the aggrieved party may not always be in the economic position to bargain for a penalty. Admittedly, the solution of awarding damages in the aforesaid cases does not, in principle, solve the crucial question of how to calculate these See Coote, above n 7, 540, 566. On this issue, see Coote, ibid, 548 et seq. See M Müller-Chen, in Schlechtriem and Schwenzer, above n 3, Art 50, paras 8, 9; Magnus, above n 3, Art 50, para 20; Honnold, above n 4, para 312; H Salger in Witz et al, above n 6, Art 50, para 3; F Enderlein, D Maskow and H Strohbach, Internationales Kaufrecht (Berlin, Haufe, 1991) Art 50, para 5. 20 21 22

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damages. Still, even though the calculation of damages may be much more difficult than in clear-cut cases, it is still possible. In cases of loss of use (hypothetical 1), damages may be calculated by reference to a hypothetical market for the goods involved. For goods generally subject to the CISG, such a hypothetical market will usually be available. Nowadays, there is a rental market for almost everything; one may even rent a tank for warfare! And this holds true not only for fungible goods—one may also rent a Picasso painting for an exhibition. Thus, just as calculating damages for loss in value in relation to a market price is possible under Article 76 CISG, loss of use may be calculated by the same method of referring to a market price and rental market under Article 74 CISG. If the focus is shifted from the economic consequences of non-performance to the ‘performance’ principle, there is also an easy way to calculate these damages in hypotheticals 2 and 3. If the buyer pays twice as high a price to have T-shirts manufactured without child labour, the minimum loss it sustains is half of the purchase price, as this represents its interest in the correct performance. Usually this calculation can also be done by referring to the relevant markets. Today there are markets for products manufactured under any—including inhumane—conditions, as opposed to markets for products produced in compliance with basic human rights, or products that are fairly traded. Likewise, the Ferrari hypothetical can be solved. Damages consist of the difference between a Ferrari with standard red painting and the costs necessary for flashy pink paintwork. This hypothetical raises another question: may the buyer in this case calculate its damages according to the costs of corrective paintwork? If the buyer has, indeed, had the colour changed and ensued corresponding costs which appear on the balance sheet, there can be no doubt that this is a possible basis of calculation. However, if the buyer resigns itself to the standard red colour, is it then prevented from claiming damages in the amount of the potential repair costs? Again, if the buyer refrains from actual repair, it cannot be to the benefit of the breaching seller. The seller owes performance in any case; it is up to the buyer to decide whether or not it uses the damages obtained for actual repairs. The necessary protection of the seller can be achieved through the mitigation principle laid down in Article 77 CISG. If the repair costs are grossly excessive compared with the interest a reasonable buyer would have in the strict performance of the contract, the buyer would breach its duty to mitigate losses if it were to claim these costs as damages for non-performance.23 This duty to mitigate, however, applies regardless of whether the buyer chooses to have the goods repaired or not. 23 See I Schwenzer and S Manner, ‘The Pot Calling the Kettle Black: The Impact of the Non-Breaching Party’s (Non-)Behavior on its CISG-Remedies’ in UG Schroeter and C Baasch-Andersen (eds) Festschrift for Albert H Kritzer (London, 2008); Stoll and Gruber, above n 3, Art 77, para 9.

CISG Provisions on Damages III

A

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L O S S O F P RO F I T A N D L O S S O F RE P U TAT I O N

Loss of Profit and Loss of Reputation as Pecuniary Losses

Within the different losses possible, Article 74 CISG emphasises the loss of profit. The word ‘loss’ alone might be read narrowly to refer to out-of-pocket reliance expenses, but the mention of ‘loss of profit’ makes it clear that this is not what was intended.24 If, at the time of the decision of the court or tribunal, no further losses are to be expected, the calculation of loss of profit usually causes no further problems. Thus, if the buyer repudiates the contract, the seller’s lost profit equals the purchase price minus the costs incurred by the seller. Today, it is also unanimously held that this loss of profit can also be claimed in the so-called ‘lost volume’ cases. Such a lost volume situation arises when the seller has more goods in stock than it needs to serve its contracts, thus losing the profit on an additional transaction it could have carried out had the contract been performed.25 If the seller does not deliver the goods and the buyer is thus unable to fulfil contracts with its customers, the loss of profit consists of the resale price minus certain costs. However, there is no agreement as to which costs are to be deducted.26 Special problems arise in today’s international sales in connection with corporate groups where, typically for tax purposes, the contractual partner is a domestic subsidiary, but the loss may be—at least ultimately— sustained by the parent company. In those legal systems that do not recognise undisclosed agency and thus do not give the principal a contractual right of recovery of its own, there can be no doubt that such a shift of loss cannot free the obligor from liability.27 The contractual partner may liquidate the loss sustained by the parent company. Difficult problems arise where damages for future losses are claimed. Whereas Article 9:501(2)(b) PECL as well as Article 7.4.3(1) PICC allow for the recovery of future losses, Article 74 CISG does not expressly state that such losses may be recovered. However, the principle of full compensation certainly demands recovery in these cases, subject to the principles of foreseeability and mitigation. How to prove future losses is another question that will be discussed later. Closely connected to the question of loss of profit is the concept of loss of a chance.28 Suppose that the famous architects Herzog & de Meuron 24 EA Farnsworth, ‘Damages and Specific Relief’ (1979) 27 American Journal of Contract Law 249. 25 For the discussion of lost volume cases under the CISG, see Stoll and Gruber, above n 3, Art 75, para 11; Saidov, above n 6, I.2(c); Brölsch, above n 1, 87 et seq. 26 See CISG-AC, above n 2, 3.10. 27 But see Stoll and Gruber, above n 3, Art 74, para 26. 28 See CISG-AC, above n 2, 3.15; Saidov, ‘Standards’, above n 1, 39 et seq; Saidov, ‘Damages’, above n 1, 400 et seq.

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are bidding for the erection of the Olympic stadium in Beijing. As they depend on the delivery of certain goods to finish their bid and the seller fails to deliver in time, they miss the deadline for entering the competition. May they claim damages for the loss of a chance to win the competition? Some authors strictly deny the recoverability of this loss.29 Yet, there can be no question that such chances have an economic value in the light of the significant sums of money invested in biddings. To give just one example: in Germany the German Football Association (Deutscher Fussballbund) invested around €10 million in bidding for hosting the 2006 FIFA World Championship. The only difference between the ‘loss of chance’ and the traditional ‘loss of profit’ is the level of certainty with which it can be proven. Therefore, the wording ‘loss of profit’ in Article 74 CISG naturally encompasses the recovery of ‘loss of a chance’. Similar problems arise in connection with ‘loss of goodwill’ or ‘damage to reputation’. Again, there can be no doubt that they do have an economic value having regard to the sums spent to enhance reputation in the market.30 Therefore, the principle of full compensation demands recovery of losses in this respect.

B Burden and Standard of Proof As already mentioned, the crucial question surrounding ‘loss of profit’ is not whether the aforesaid losses are recoverable in principle, but rather what standard of proof is necessary for recovery. (i)

Proof as a Matter Governed by the Convention

There has been controversy surrounding the issue of whether questions of proof are a procedural matter to be resolved in accordance with domestic law or whether they are implicitly regulated by the CISG.31 Whereas currently the clear prevailing opinion regards the burden of proof as a matter governed by the Convention,32 courts and commentators have 29 Stoll and Gruber, above n 3, Art 74, para 22; K Neumayer and C Ming, Convention de Vienne sur les contrats de vente international de merchandises, Commentaire (Lausanne, CEDIDAC, 1993) Art 74, para 1. See also Delchi Carrier SpA v Rotorex Corp, 6 December 1995, US Circuit Court of Appeals (2d Cir), available at http://cisgw3.law.pace.edu/cases/ 951206u1.html (accessed 28 June 2007). 30 Cf P Schlechtriem, Internationales UN-Kaufrecht (Tübingen, Mohr, 4th edn, 2007) para 299. 31 See CISG-AC, above n 2, 2.1 et seq. 32 CISG-AC, above n 2, 2.1; C Brunner, UN-Kaufrecht—CISG. Kommentar zum Übereinkommen der Vereinten Nationenüber Verträge über den internationalen Warenkauf von 1980 (Bern, Stämpfli, 2004) Art 74, Rn 58; Huber, above n 6, Art 74, para 58; Magnus, above

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rejected the notion that the standard of proof is also governed by the Convention, as these questions were qualified as being procedural.33 Yet, the mere qualification of these rules as procedural or substantive cannot be the decisive factor.34 The principle of full compensation constitutes the core of all damages provisions of the CISG. Allowing different domestic rules on the level of proof would undermine not only the uniform interpretation of the CISG norms, but the core principle of full compensation itself. (ii) Standard of Proof With respect to the required standard, it is now widely held that a standard derived from the notion of reasonableness should be applied. Such reasonableness is, for example, laid down in Article 9:502(2)(b) PECL, as well as in Article 7.4.3(1) PICC; reasonableness is also a standard used by various CISG provisions themselves.35 The aggrieved party has to prove with reasonable certainty both the fact and the extent of loss. However, mathematical precision cannot be required. The aggrieved party must only provide a basis on which a court or tribunal can reasonably determine the extent of damages, be it by expert testimony, economic and financial data, market surveys and analysis, or business records of similar enterprises.36 It is then up to the court or tribunal to exercise its discretion in estimating the loss sustained.

C

Minimum Loss

If no possibility at all exists to ascertain the actual loss, the expenditures the obligee made in expectation of performance must be taken as the minimum loss that must be compensated for. It is reasonable to assume that the n 3, Art 74, para 62; Brölsch, above n 1, 50; Saidov, ‘Standards’, above n 1, 53 et seq. But see Case No C/12709/2001, 15 November 2002, Cour de Justice Genève (Appellate Court, Geneva, Switzerland) para 4, available at http://cisgw3.law.pace.edu/cases/021115s1.html (accessed 27 June 2007). 33 For the United States see Delchi Carrier SpA v Rotorex Corp, above n 29; for Switzerland, see Case No T 171/95, 20 February 1997, Bezirksgericht der Saane (Zivilgericht) (District Court, Saane) para 6.4, available at http://cisgw3.law.pace.edu/cases/970220s1.html (accessed 27 June 2007). See further Stoll and Gruber, above n 3, Art 74, para 53; Huber, above n 6, Art 74, para 57; Magnus, above n 3, Art 74, para 61. 34 CISG-AC, above n 2, 2.5; Gotanda, above n 1, 109 et seq; CG Orlandi, ‘Procedural Law Issues and Law Conventions’ 5 (2000) Uniform Law Review 23, 24 et seq. 35 See Arts 8(2) and (3), 25, 35(1)(b), 60, 72(2), 75, 77, 79(1), 85, 86 and 88(2); for ‘reasonable time’, see Arts 18(2), 33(3), 39(1), 43(1), 47, 49, 63, 64, 65 and 73(2). See also CISG-AC, above n 2, 2.6 et seq; Gotanda, above n 1, 126 et seq. 36 See CISG-AC, above n 2, 2.9.

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expenses incurred by a business person reflect what it may at the very least expect as payment.37

IV

N O N - P E C U N I A RY L O S S E S

As has been shown, many of the losses usually characterised as non-pecuniary are in fact pecuniary losses if the performance principle is relied upon. Therefore, the distinction between pecuniary and nonpecuniary losses, or material and immaterial losses, has to be established differently. The only remaining losses that are traditionally considered as non-pecuniary are ‘pain and suffering’, ‘mental distress’ and ‘loss of amenities’. Although Article 9:501(2)(a) PECL38 and Article 7.4.2(2) PICC provide for the recovery of such losses in general, many of these losses already fall outside the scope of the Convention, since they flow from death or personal injury and therefore are already excluded by Article 5 CISG. But even where such losses are in no way connected to personal injury, for example, emotional distress following the simple non-delivery or diminished enjoyment of the goods because of a defect, they are still comparable to personal injuries as they constitute at least a psychological injury. They thus fall clearly outside the scope of the Convention. Furthermore, unlike travel agents who get paid for procurement of the enjoyment of holidays and who, consequently, may be liable to pay general damages for disappointment,39 parties to international sales contracts do not contract and pay for the enjoyment and the amenities of life.

V

D I S G O R G M E N T O F P RO F I T S AN D G A I N - B A S E D DAM AG E S

As discussed extensively by other contributions in this collection,40 the last decade has seen many court decisions and much academic debate in connection with the disgorgement of profits derived from a breach of contract. This debate is closely linked to the discussion about the purposes and aims of the law of damages in general, namely the transition from pure 37 Schlechtriem, above n 29, para 308; N Schmidt-Ahrendts, ‘Der Ersatz „frustrierter Aufwendungen“ im Fall der Rückabwicklung gescheiterter Verträge im UN-Kaufrecht’ [2006] Internationales Handelsrecht 69. 38 Comment E. 39 See Jarvis v Swan Tours [1973] 2 QB 233; Jackson v Horizon Holidays [1975] 1 WLR 1468 (United Kingdom); BGH, NJW 1956, 1234 and now § 651 f BGB (Germany); Art 14 PauRG (Switzerland). 40 See A Burrows, ‘Are “Damages on the Wrotham Park Basis” Compensatory, Restitutionary or Neither?’, this volume; R Cunnington, ‘The Measure and Availability of Gain-based Damages for Breach of Contract’, this volume.

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compensation of economic loss to mechanisms of deterrence in order to strengthen the principle of pacta sunt servanda. It can be encapsulated by the following sentence: ‘Breach of contract must not pay.’ What stand does the CISG take on these developments? Except for the few authors who have laconically stated that under the CISG such disgorgement of profits may not be awarded,41 this question has yet to be addressed by the CISG community. First of all, it has to be noted that cases comparable to the well-known Blake42 case are hardly conceivable in an international sales context. However, in sales law the disgorgement of profits may play a role in the following cases: the seller who is already bound by the contract with the buyer sells the goods for a second time at a higher purchase price, realising a higher profit than that in the first contract. Can the buyer claim the revenue of the second sales contract? Another example would be the already-mentioned hypothetical in which the buyer contracts for goods manufactured without child labour. Can the buyer claim a sum equal to the amount that the seller saved in the production process by employing children instead of adults? Finally, consider the case that formed the basis for a decision by the Grenoble Court of Appeal (France).43 Jeans were bought by the US buyer to be delivered to the buyer’s customer in South Africa. The contract contained a provision prohibiting the buyer from selling the goods on the European market as the seller had exclusive contracts with its European customers. The buyer subsequently resold the goods on the European market. Can the seller ask for the proceeds of the sales undertaken in breach of the contractual duty? In these cases, the CISG should not prevent the aggrieved party from demanding the proceeds made by the other party in its breach of contract. Two reasons justify this. First, in all these cases, the gains by the breaching party can easily be viewed as nothing more than a presumption of what the aggrieved party has actually lost. Thus, we are still in the realm of compensatory damages. In the first example, of the seller selling the same goods twice, the higher purchase price that the breaching seller was able to realise can be seen as an indication and proof of what the true market conditions must have been at the time of the breach. The performance interest of the buyer, who has the right to the goods, compels granting it this amount. The same holds true for the second hypothetical—the child labour case. As has been 41 Stoll and Gruber, above n 3, Art 74, para 31; Huber, above n 6, Art 74, para 16; Magnus, above n 3, Art 74, para 18; Brölsch, above n 1, 44; H Honsell, ‘Die Vertragsverletzung des Verkäufers nach dem Wiener Kaufrecht’ [1992] Schweizerische Juristen-Zeitung 361. On the ULIS, see Adras Building Material v Harlow & Jones GmbH, Supreme Court of Israel, 2 November 1988, (1995) 3 Restitution Law Review 235. 42 Attorney-General v Blake [2001] 1 AC 268 (HL). 43 SARL BRI Production “Bonaventure” v Société Pan African Export, 22 February 1995, CA Grenoble (Court of Appeal, Grenoble, France), available at http://cisgw3.law.pace.edu/ cases/950222f1.html (accessed 27 June 2007).

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shown, the buyer is entitled to damages for the lesser value of the goods, as it has paid a higher price for having them manufactured under humane conditions. If it is difficult or impossible to determine the diminished value of goods produced under inhumane conditions, the savings made by the seller can be taken as a valuable yardstick in calculating the minimum loss of the buyer. Finally, in the case of the reimported jeans, the gains by the reselling buyer made in violation of the contract terms can be viewed as an indication of the seller’s lost profits. Thus, in all of these cases, the question is not one of disgorgement of benefits, but of calculation of damages in accordance with the principle of full compensation. The second reason why the CISG cannot simply negate the issue of disgorgement of profits and gain-based damages is that, otherwise, courts might resort to concurring domestic remedies in order to solve these currently virulent issues. Thereby, the CISG would be undermined in one of its core areas.

VI

P U N I T I VE O R E X E M P L A RY DA M AG E S

Punitive or exemplary damages is another area of the law that has been newly discovered by contract lawyers. Such damages are usually defined as sums awarded in excess of any compensatory or nominal damages in order to punish a party for outrageous misconduct.44 Whereas jurists from the Germanic legal systems, in particular, have been and still are strictly opposed to any form of punitive damages,45 more and more common lawyers tend to advocate the concept of punitive damages, not only in tort, but also in contract law.46 Under the CISG, it is generally held that punitive or exemplary damages may not be awarded47 because Article 74 CISG limits damages to ‘a sum equal to the loss, including loss of profit . . . as a consequence of the breach’. Even the CISG-AC has recently upheld this position in its 2006 44 For a comparative study, see JY Gotanda, ‘Punitive Damages: A Comparative Analysis’ (2004) 42 Columbia Journal of Transnational Law 391. 45 BGH, 4 June 1992, BGHZ 118, 312; F Bydlinski, ‘Die Suche nach der Mitte als Daueraufgabe der Privatrechtswissenschaft’ (2004) 204 Archiv für die Civilistische Praxis 309, 344 et seq. 46 See R Cunnington, ‘Should Punitive Damages be Part of the Judicial Arsenal in Contract Cases?’ (2006) 26 Legal Studies 369 et seq; JA Sebert, ‘Punitive and Nonpecuniary Damages in Actions Based upon Contract: Toward Achieving the Objective of Full Compensation’ (1986) 33 University of California Los Angeles Law Review 1565 et seq. 47 Stoll and Gruber, above n 3, Art 74, para 31; Magnus, above n 3, Art 74, para 17; Huber, above n 6, Art 74, para 16; Brunner, above n 30, Art 74, para 18; Brölsch, above n 1, 43; but see Kirby, ‘Punitive Damages in Contract Actions: The Tensions Between the United Nations Convention on Contracts for the International Sale of Goods and U.S. Law’ (1997) 16 Journal of Law and Commerce 215, 224 et seq.

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opinion on ‘calculation of damages’.48 Nonetheless, however true this position might be from a dogmatic point of view, it overlooks the fact that, in practice, full compensation of the aggrieved party is hardly ever achieved, since all risks in awarding and assessing damages rest with the aggrieved party. It has been rightly pointed out that the aggrieved party is, structurally, left undercompensated.49 Thus, there is a strong argument that, at least in cases where the breach was intentional and in bad faith, punitive damages can serve primarily as a vehicle to assure that the aggrieved party achieves full compensation.50 It follows that, although under the CISG there may not be a possibility of an explicit punitive damages award, this should not preclude the court or tribunal from taking punitive elements into consideration when dealing with intentional and bad faith breaches of contract. This could not only influence the standard of proof to be applied but also the assessment of damages in the individual case, in which the court or the tribunal is usually given a wide discretion. This becomes especially important in cases of loss of profit, loss of a chance or loss of reputation.

VI I

LEGAL COSTS

Apart from the hitherto discussed fundamental questions of damages, there is one group of cases that has received a great deal of attention under Article 74 CISG lately: the recovery of expenses incurred in taking legal measures, in short, attorneys’ fees.51 Article 74 CISG does not expressly address the recovery of legal costs by an aggrieved party in connection with seeking relief for breach of contract. Again, as in the area of questions of proof, the controversy centres on the issue of whether the recovery of legal expenses is a procedural matter or a matter governed by the Convention’s substantive provisions. Those in favour of the latter view, in particular, argue that Article 74 CISG must be broadly interpreted in light of the principle of full compensation; otherwise the aggrieved party would not be adequately recompensed.52 Likewise, as CISG-AC, above n 2, 9.5. Sebert, above n 44, 1568. Ibid, 1647 et seq. The dispute has been further fuelled by the decision in Zapata Hermanos Sucesores, SA v Hearthside Baking Company, Inc d/b/a Maurice Lenell Cooky Company, 19 November 2002, US Ct App (7th Cir), available at http://cisgw3.law.pace.edu/cases/021119u1.html (accessed 27 June 2007). For comment and analysis, see H Flechtner and J Lookofsky, ‘Viva Zapata! American Procedure and CISG Substance in a U.S. Circuit Court of Appeal’ (2003) 7 Vindobona Journal of International Commercial Law and Arbitration 93 et seq. 52 See B Zeller, ‘Interpretation of Art 74—Zapata Hermanos v Hearthside Baking—Where Next?’ [2004] Nordic Journal of Commercial Law 1; Zeller, above n 1, 148 et seq; J Felemegas, ‘The Award of Counsel’s Fees Under Art 74 CISG, in Zapata Hermanos Sucesores v Hearthside Baking Co.’ (2001) 6 Vindobona Journal of International Commercial Law and Arbitration 30, 38. 48 49 50 51

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has been outlined in connection with the standard of proof, the problem of recovery of litigation costs cannot be solved through a substance/procedural distinction. Relying on such a distinction is outdated and unproductive.53 Instead, the analysis should focus on the purposes of damages under the CISG. The principle of full compensation, at first sight, seems to support the view that any expenses connected to the breach of contract, including legal costs, should be recoverable. However, such an interpretation is clearly against the principle of equality between buyer and seller. If legal expenses are awarded under Article 74 CISG, a successful claimant would be able to recover litigation expenses. But, as Justice Posner has rightly asked,54 what if the respondent won? Several proposals allowing the successful respondent the recovery of legal fees have proven unconvincing.55 Thus, the only solution nowadays favoured by courts and scholarly writings is that, under Article 74 CISG, neither party can recover expenses associated with the litigation arising from the breach.56 Up until now, the focus has been on litigation costs. Despite the fact that, today, it is widely acknowledged that litigation costs may not be recovered under Article 74 CISG,57 the prevailing opinion in courts, tribunals and scholarly writings seem to hold that pre-litigation costs may be recovered as incidental damages under Article 74.58 Undoubtedly, this is correct as far as costs for the mitigation of damages are concerned, for See CISG-AC, above n 2, 5.2. Zapata Hermanos Sucesores, above n 51. It has been argued an unsuccessful claimant could be held liable for breach of the duty of good faith and therefore a successful respondent could rely on breach of contract, see J Felemegas, ‘An Interpretation of Art 74 CISG by the U.S. Circuit Court of Appeals’ (2003) 15 Pace International Law Review 91, 126. 56 CISG-AC, above n 2, 5.1ff. See also A Mullis, ‘Twenty-five Years On—The United Kingdom, Damages and the Vienna Sales Convention’ (2007) 71 Rabels Zeitschrift für ausländisches und internationals Privatrecht 35, 44; Huber, above n 6, Art 74, para 43; Brunner, above n 30, Art 74, Rn 31; Brölsch, above n 1, 69; Stoll and Gruber, above n 3, Art 74, para 20; Magnus, above n 3, Art 74, para 52; but see China International Economic & Trade Arbitration Commission (CIETAC), Award of 11 February 2000, available at http://cisgw3.law.pace.edu/ cases/000211c1.html (accessed 27 June 2007). Commentators further advance Judge Posner’s argument that the United States would not have ratified the CISG, if this had led to abolishing the so-called ‘American Rule’ (see Flechtner and Lookofsky, above n 49, 93ff; Schlechtriem, ‘Verfahrenskosten als Schaden unter UN-Kaufrecht’ [2006] Internationales Handelsrecht 49, 52). 57 See n 54. 58 See Zapata Hermanos Sucesores, above n 51); Case No 22 O 38/06, 12 December 2006, LG Coburg (District Court, Coburg, Germany), available at http://cisgw3.law.pace.edu/cases/ 061212g1.html (accessed 27 June 2007); Case No 16 U 17/05, 3 April 2006, OLG Köln (Provincial Appellate Court, Köln, Germany), available at http://cisgw3.law.pace.edu/cases/ 060403g1.html (accessed 27 June 2007); Case No 32 O 508/04, 10 December 2004, LG Bayreuth (District Court, Bayreuth, Germany), available at http://cisgw3.law.pace.edu/cases/ 041210g1.html (accessed 27 June 2007); Case No 6 U 210/03, 22 July 2004, OLG Düsseldorf (Provincial Appellate Court, Düsseldorf, Germany), available at http://cisgw3.law.pace.edu/ cases/040722g1.html (accessed 27 June 2007). See also Stoll and Gruber, above n 3, Art 74, para 20; Magnus, above n 3, Art 74, para 52. 53 54 55

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example, for a cover transaction or costs for examining the goods twice after the delivery of substitute goods. There are, however, pre-litigation costs that are not neatly separated from these costs and that should not be recoverable as damages. These encompass especially the legal costs for the provisional assessment of the legal situation, of the possible outcome of any litigation and settlement negotiations. These costs may easily amount to hundreds of thousands of euros and, again, both parties incur these costs. Therefore, here, too, the above-stated principle of equality between the parties prohibits allowing a successful claimant to be able to liquidate these costs as damages under Article 74 CISG. Hence, not only expenses associated with litigation arising from the breach, but also those pre-litigation costs that are incurred in preparation for or instead of litigation have to fall outside of the scope of Article 74 CISG.

VIII

SUMMARY

In summary, in many areas, the CISG provisions on damages still reflect the discussions prevailing in the mid-twentieth century. As German authors and courts have been, and still are, at the forefront of interpreting the CISG, it comes as no great surprise that traditional notions of the German law on damages have exerted an important influence. They, in turn, are still deeply rooted in the nineteenth century. Under French law, courts have an extremely wide discretion in awarding damages. Thus, there has never been much fundamental discussion, in French court decisions, about the scope of the provisions on damages under the CISG either. Anglo-American courts and scholars have only recently discovered the CISG and there the debate is just starting. Aspiring to the idea that the CISG is to govern international sales transactions on a truly uniform basis, we have to apply and interpret its provisions in such a core area as damages in a truly comparative way. This implies that we observe the discussions and developments in domestic laws and that we try to keep up with changed and still changing demands made by the international globalised market. In the law of damages this requires a shift from the nineteenth-century dogma of pure economic benefit to the performance principle, which includes notions of disgorgement of gains and punitive elements. The consequences of such a shift affect all areas of damages: lesser value of the goods and loss of use, loss of profit, loss of a chance and loss of reputation. It is only in this way that the CISG can be prepared for the twenty-first century and all its demands of a truly modern international sales law.

4 Using the UNIDROIT Principles to Fill Gaps in the CISG THE UNI DROI T PRI NCI PLES

JOHN Y G OTANDA * J OHN Y GOTANDA

I

I NTRO DUCTION

In 1980, the United Nations promulgated the Convention on the International Sale of Goods to provide a uniform set of rules for international commercial transactions. The goal was to increase the efficiency of such transactions and promote the development of international trade.1 To date, 70 countries have adopted the Convention, including Australia, China, France, Germany, Italy, Mexico, Russia and the United States.2 Although the CISG has proved successful in many areas, it has been less successful in the area most important to parties in a dispute: damages for breach of contract.3 Indeed, of all the Articles in the CISG, the Articles on economic * Professor of Law, Associate Dean for Faculty Research, Director, J.D./M.B.A. Program, Villanova University School of Law. 1 United Nations Convention on Contracts for the International Sale of Goods, Preamble, 10 April 1980, UN Doc A/Conf97/18 Annex I (1980) (hereinafter CISG). For a discussion of the CISG, see P Schlechtriem and I Schwenzer, Commentary on the UN Convention on the International Sale of Goods (CISG) (Oxford University Press, 2nd edn, 2005); F Enderlein and D Maskow, International Sales Law: United Nations Convention on Contracts for the International Sale of Goods (New York, Oceana Publications, 1992); J Honnold, Uniform Law for International Sales under the 1980 United Nations Convention (The Hague, Kluwer Law International, 3rd edn, 1999); R Kathrein and DB Magraw (eds), The Convention for the International Sale of Goods: A Handbook of Basic Materials (Chicago, IL, American Bar Association, 1987); A Kritzer, Guide to Practical Applications of the United Nations Convention on Contracts for the International Sale of Goods (The Hague, Kluwer Law International, 1994). 2 For a list of contracting states, see http://www.cisg.law.pace.edu/cisg/countries/cntries.html (accessed 28 June 2007). 3 C Gillette and R Scott, ‘The Political Economy of International Sales Law’ (2005) 25 International Review of Law and Economics 446 (noting judicial disagreement over ‘the calculation of interest rates for damages, the award of attorneys’ fees, and damages in lost volume cases’, among others, and concluding that this results from vague and ambiguous terms in the CISG which over time generate varying interpretations by different courts and will eventually result in ‘a sales law that lacks both substantive and formal uniformity and . . . is likely to result in a net increase in contracting costs’); see also G Cuniberti ‘Is the CISG Benefiting Anybody?’ (2006) 39 Vanderbilt Journal of Transnational Law 1511 (arguing that

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remedies are the most litigated and written about.4 Since uniform rules on specific aspects of damages are lacking, similarly situated parties sometimes receive vastly different results; these disparities undermine the purpose of the CISG and may lead parties to choose to apply a sales law other than the CISG.5 Why has this happened? One of the main reasons is that these provisions of the CISG do not set out specific economic remedies. Instead, they state only a basic framework for the recovery of damages. This should come as no surprise. As John Honnold, one of the principal drafters of the CISG, has commented, a breach of contract can occur in an almost infinite variety of circumstances [and thus] no statute can specify detailed rules for measuring damages in all possible cases.6

What the CISG provisions try to do is ‘state basic principles to govern compensation’ when a breach occurs.7 These principles afford a tribunal broad authority to determine the aggrieved party’s loss based on the circumstances of the particular case. Unfortunately, the lack of specificity has resulted in much litigation, and seemingly conflicting results. Is there a solution? Some have argued that we should fill the gaps in the CISG damages provisions with the UNIDROIT Principles of International Commercial Contracts.8 My view is that the UNIDROIT Principles should not be used of their own force as a gap-filler for the CISG. However, the Principles may still have a role to play. They help us understand the general the two main goals of the CISG have not been met because it contains vague rules that do not provide precise answers, which reduces legal certainty since the rules are likely to be interpreted differently by courts and this ultimately jeopardises harmonisation of the field). 4 See generally B Zeller, Damages under the Convention on Contracts for the International Sale of Goods (New York, Oceana Publications, 2005); C Thiele, ‘Interest on Damages and Rate of Interest Under Article 78 of the U.N. Convention on Contracts for the International Sale of Goods’ (1998) 2 Vindobona Journal of International Commercial Law Arb 3, available at http://www.cisg.law.pace.edu/cisg/biblio/thiele.html (accessed 28 June 2007); C Liu, Remedies for Non-performance: Perspectives from CISG, UNIDROIT Principles and PECL (2003) § 14.2.5, available at http://www.cisg.law.pace.edu/cisg/biblio/chengwei-74.html (accessed 28 June 2007). 5 See CISG Art 6; see also Gillette and Scott, above n 3; Cunibert, above n 3. 6 Honnold, above n 1, 445. 7 Ibid. 8 See MJ Bonell, ‘The UNIDROIT Principles of International Commercial Contracts and CISG—Alternatives or Complementary Instruments?’ (1996) 1 Uniform Law Review 26, 36; A Garro, ‘The Gap-filling Role of the UNIDROIT Principles in International Sales Law: Some Comments on the Interplay between the Principles and the CISG’ (1995) 69 Tulane Law Review 1149, 1153 (arguing that ‘UNIDROIT principles offer the judge or arbitrator a rule that is likely to be more suitable to an international commercial contract than a domestic rule of contract law’); U Magnus, ‘Die allgemeinen Grundsätze im UN-Kaufrecht’ (1995) 59 Rabels Zeitschrift für ausländisches und internationales Privatrecht 469, 493 (arguing that the UNIDROIT Principles can be used to fill gaps in the CISG even if ‘they formulate general principles that cannot be derived directly from CISG.’).

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principles of the CISG that guide courts and tribunals in resolving matters not expressly dealt with in the Convention. In addition, they provide support for solutions to open issues reached through an analysis of the Convention itself. I begin by giving a very brief overview of the damages provisions of the UNIDROIT Principles as compared with the CISG. I then focus on the interplay between the two, ultimately concluding that, while the UNIDROIT Principles should not be used as a formal source of law to formulate principles that cannot be derived from the CISG, they can play an important role in interpreting the Convention.

II

T H E UN I D RO I T PR I N C I P L E S A N D T H E C I S G

The UNIDROIT Principles set forth general rules for international contracts. Their goal is to establish a balanced set of rules designed for use throughout the world irrespective of the legal traditions and the economic and political conditions of the countries in which they are to be applied.9

The drafters of the UNIDROIT Principles intended them to apply in a wide variety of circumstances. The preamble states that: —They shall be applied when the parties have agreed that their contract be governed by them. —They may be applied when the parties have agreed that their contract be governed by general principles of law, the lex mercatoria or the like. —They may be applied when the parties have not chosen any law to govern their contract. —They may be used to interpret or supplement international uniform law instruments. —They may be used to interpret or supplement domestic law. —They may be used as a model for national and international legislators.10 While the UNIDROIT Principles reflect concepts found in many legal systems, they also ‘embody what are perceived to be the best solutions, even if still not yet generally adopted.’11 Thus, they do not simply restate existing rules found in most legal systems; they are also aspirational.12 9 UNIDROIT Principles of International Commercial Contracts (Annandale, NSW, The Federation Press, 2004) xiv. 10 Preamble of the UNIDROIT Principles. 11 UNIDROIT Principles, above n 9. 12 In this way, they resemble the modern Restatements of Law published by the American Law Institute. See K Berger, ‘The Lex Mercatoria Doctrine and the UNIDROIT Principles of

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In a number of circumstances, however, the rules founds in the UNIDROIT Principles are based upon or track language from articles of the CISG.13 For example, UNIDROIT Principles Article 1.9(1), stating that ‘[t]he parties are bound by any usage to which they have agreed and by any practices which they have established between themselves’, is identical to CISG Article 9(1).14 In addition, UNIDROIT Principles Article 5.1.7(1), which sets forth the general rule for determining the contract price when the agreement does not fix or make provision for determining the price, is based upon CISG Article 55.15 In some instances, the UNIDROIT Principles follow a basic approach found in the CISG, but adapt the rule ‘to reflect the particular nature and scope of the Principles’.16 For example, UNIDROIT Principles Article 7.2.2, dealing with the right to require performance of non-monetary obligations, follows the general approach of CISG Article 46, but adds ‘certain qualifications’.17

International Contract Law’ (1997) 28 Law Policy and International Business 943, 946. For a discussion of the original purposes of the Restatement of the Law of Contracts, see E Patterson, ‘The Restatement of the Law of Contracts’ (1933) 33 Columbia Law Review 397. A number of commentators, however, have been critical of the more recent Restatements, arguing that they no longer restate the law. See F Vandall, ‘Constructing a Roof before the Foundation is Prepared: The Restatement (Third) of Torts: Products Liability Section 2(b) Design Defect’ (1997) 30 University Michigan Journal of LawReform 261; D Thomas, ‘Restatements Relating to Property: Why Lawyers Don’t Really Care’ (1994) 38 Real Property, Probate Trust Journal 655; see also F Juenger ‘A Third Conflicts Restatement?’ (2000) 75 Indiana Law Journal 403; P Corboy, ‘The Not-so-quiet Revolution: Rebuilding Barriers to Jury Trial in the Proposed Restatement (Third) of Torts: Products Liability’ (1994) 61 Tennessee Law Review 1043; R Banks, ‘Restating the Restatement (Second), Section 402A—Design Defect’ (1993) 72 Oregon Law Review 411 (1993); WN Keyes, ‘The Restatement (Second): Its Misleading Quality and a Proposal for its Amelioration’ (1985) 13 Pepperdine Law Review 23. UNIDRIOT Principles, above n 9, xv. UNIDROIT Principles Art 1.9(1); CISG Art 9. UNIDROIT Principles Art 5.1.7(1) provides: ‘Where a contract does not fix or make provision for determining the price, the parties are considered, in the absence of any indication to the contrary, to have made reference to the price generally charged at the time of the conclusion of the contract for such performance in comparable circumstances in the trade concerned or, if no such price is available, to a reasonable price.’ CISG Art 55 similarly provides: ‘Where a contract has been validly concluded but does not expressly or implicitly fix or make provision for determining the price, the parties are considered, in the absence of any indication to the contrary, to have impliedly made reference to the price generally charged at the time of the conclusion of the contract for such goods sold under comparable circumstances in the trade concerned.’ The Comment to UNIDROIT Principle Art 5.1.7 states that ‘this article is inspired by Art. 55 CISG’. See also A Chandrasenan, ‘UNIDROIT Principles to Interpret and Supplement the CISG: An Analysis of the Gap-filling Role of the UNIDROIT Principles’ (2007) 11 Vindobona Journal of International Commercial Law and Arbitration 65, 77–8. 16 UNIDROIT Principles, above n 9, xv. 17 See Comments on UNIDROIT Principles Art 7.2.2. In addition, while UNIDROIT Principles Art 1.9(2) is similar to CISG Art 9(2), unlike the CISG, the Principles contains language stating that a trade usage regularly observed by the generality of business people in a particular trade may not be applied if its application in any given case would be unreasonable. See UNIDROIT Principles Art 1.9(2). 13 14 15

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In many ways, the damages provisions of the UNIDROIT Principles are comparable to those found in the CISG. CISG Article 74 sets forth a basic framework for the recovery of damages. It provides: Damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. Such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.18

CISG Article 74 thus provides for the recovery of both actual loss suffered and net gains prevented.19 However, it does not provide specific guidelines for calculating damages.20 Instead, CISG Article 74 allows a tribunal to determine the aggrieved party’s loss based on the circumstances of the particular case, with the goal of placing the aggrieved party in the same economic position it would have enjoyed if the breach had not occurred. 21 In other words, CISG Article 74 is designed to give the aggrieved party the ‘benefit of the bargain’.22 Accordingly, CISG Article 74 should be liberally construed to compensate an aggrieved party for all disadvantages suffered as a result of the breach. However, all claims for damages included under CISG Article 74 are subject to the traditional limitations imposed on the recovery of damages for breach of contract, for example, the doctrines of foreseeability and mitigation.23

18 CISG Art 74; see also CISG-AC Opinion No 6, Calculation of Damages under CISG Article 74 (2006), rapporteur Professor John Y Gotanda, available at http://www.cisg.law.pace.edu/ cisg/CISG-AC-op6.html (accessed 28 June 2007); Schlechtriem and Schwenzer, above n 1, 763. 19 For a discussion of the calculation of damages under Art 74, see CISG-AC Opinion No 6, above n 18. 20 The Secretariat Commentary provides: ‘Since article 70 [draft counterpart to CISG Art 74] is applicable to claims for damages by both buyer and the seller and these claims may arise out of a wide range of situations, including claims for ancillary damages to a request that the party in breach perform the contract or to a declaration of avoidance of a contract, no specific rules have been set forth in article 70 describing the appropriate method of determining “the loss . . . suffered . . . as a consequence of the breach”. The court or the arbitral tribunal must calculate the loss in the manner which best suits the circumstances.’ Secretariat Commentary, Art 70 [draft counterpart to CISG Art 74], ¶ 4, reprinted in J Honnold, Documentary History of the Uniform Law for International Sales (Daventer, Kluwer, 1989) 449 (hereinafter ‘Secretariat Commentary’), also available at http://www.cisg.law.pace.edu/cisg/text/secomm/ secomm-74.html (accessed 28 June 2007). There exists no official commentary on the CISG. The Secretariat Commentary is on the 1978 Draft of the Convention. Nevertheless, the Commentary reflects that Secretariat’s impressions of the purposes and effects of the Commission’s work and provides a helpful analysis of the official text of the CISG. See Kritzer, above n 1, 2. 21 See Schlechtriem and Schwenzer, above n 1, 746 Honnold, above n 1, 445 (quoting G Treitel, Remedies for Breach of Contract (Oxford, Clarendon Press, 1988) 82). 22 See EA Farnsworth, ‘Damages and Specific Relief’ (1979) 27 American Journal of Contract Law 247, 249; J Sutton, ‘Measuring Damages Under the United Nations Convention on the International Sale of Goods’ (1989) 50 Ohio State Law Journal 737, 742. 23 See CISG Arts 74 and 77. ;

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CISG Articles 75 and 76 provide limited alternatives to CISG Article 74. CISG Article 75 sets forth the method for calculating damages when the aggrieved party has avoided the contract and entered into a substitute transaction. Here, the aggrieved party may recover the difference between the contract price and the price in the substitute transaction as well as any further damages recoverable under Article 74.24

By contrast, CISG Article 76 provides that when an aggrieved party has avoided the contract but has not made a substitute transaction under CISG Article 75, it is entitled to damages measured by the difference between the price fixed by the contract and the current price . . . as well as any further damages recoverable under Article 74.25

In many respects, the damages provisions of the UNIDROIT Principles are similar to those found in the CISG. Like CISG Article 74, the UNIDROIT Principles set forth the basic premise that the breaching party is liable to compensate the aggrieved party for all harm that the aggrieved party sustained.26 Similar to the CISG, the UNIDROIT Principles limit damages 24 CISG Art 75. The purpose of CISG Art 75 is to ensure that the aggrieved party will receive the ‘benefit of the bargain’ if the aggrieved party mitigates its damages by engaging in a substitute transaction. One leading treatise explains: ‘If the contract is declared avoided for breach by the buyer, the seller is free to resell the goods. As a rule, it will be in his interest to do so. Analogously, if the contract is avoided for breach by the seller, the buyer will be interested in purchasing the same goods from another seller if possible. If the non-breaching party succeeds in reselling or replacing the goods, his effective loss will thereby be diminished. Art 75 takes this into account and sets forth special rules for calculating damages in such cases.’ CM Bianca and MJ Bonell, Commentary on the International Sales Law: The 1980 Vienna Sales Convention (Milan, Giuffrè, 1987) 594. 25 CISG Art 76(1). Art 76 may be viewed as an exception to both Arts 74 and 75. It is an exception to Art 74 when a contract has been avoided. It is also an exception to Art 75 because it provides a method for calculating damages when the contract has been avoided but (i) in the case of an aggrieved buyer, that party has not bought goods in replacement or (ii) in the case of an aggrieved seller, that party has not resold the goods under Art 75. The purpose of Art 76 has been explained as follows: ‘[Under Art 76,] a concrete demonstration of the non-performance loss is not necessary. The rule is based on the premise that the promisee has the right to make a substitute transaction at the current price. The promisor must bear the costs of a substitute transaction. However, he should not gain an advantage if the promisee has not carried out such a transaction but has instead taken another course of action. The calculation of damages under Article 76 is abstract in the sense that the seller who is liable to pay damages for non-performance, for example, cannot claim that the buyer does not in reality need the goods, has resold them, or will not be exposed to a claim by his customers. Similarly, a seller will not be allowed to argue that a buyer who has received a delivery of goods has agreed to resell those goods below the current price and that his loss was therefore only the profit lost on that transaction and not the greater difference between the contract price and the current price. The buyer may demand to be put into the financial position which would have existed had the contract been performed; any loss which would have been made on a resale is not material.’ See also Schlechtriem and Schwenzer, above n 1, 781. 26 UNIDROIT Principles Art 7.4.1 provides: ‘Any non-performance gives the aggrieved party a right to damages either exclusively or in conjunction with any other remedies except where the non-performance is excused under these Principles.’ In addition, Art 7.4.2 states: ‘(1) [t]he aggrieved party is entitled to full compensation for harm sustained as a result of the non-performance. Such harm includes both any loss which it suffered and any gain of which it

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to those that were foreseeable.27 However, in both situations the UNIDROIT Principles contain more detailed provisions and, in the case of the scope of compensation allowed, the UNIDROIT Principles are broader than the CISG.28 The UNIDROIT Principles also contain provisions analogous to CISG Articles 75 and 76. Like CISG Article 75, the UNIDROIT Principles Article 7.4.5 states: Where the aggrieved party has terminated the contract and has made a replacement transaction within a reasonable time and in a reasonable manner it may recover the difference between the contract price and the price of the replacement transaction as well as damages for any further harm.29

In addition, similar to CISG Article 76, UNIDROIT Principles Article 7.4.6 states: Where the aggrieved party has terminated the contract and has not made a replacement transaction but there is a current price for the performance contracted for, it may recover the difference between the contract price and the price current at the time the contract is terminated as well as damages for any further harm.30

It should be noted that one express difference is that CISG Article 5 specifically excludes claims for damages resulting from personal injury or death, while the UNIDROIT Principles include them.31 was deprived, taking into account any gain to the aggrieved party resulting from its avoidance of cost or harm. (2) Such harm may be non-pecuniary and includes, for instance, physical suffering or emotional distress.’ The UNIDROIT Principles are thus broader than the CISG. 27 UNIDROIT Principles Art 7.4.4 (‘The non-performing party is liable only for harm which it foresaw or could reasonably have foreseen at the time of the conclusion of the contract as being likely to result from its non-performance’). 28 See Comments on UNIDROIT Principles Art 7.4.2. 29 UNIDROIT Principles Art 7.4.5. 30 UNIDROIT Principles Art 7.4.6 and Comment 1. See International Chamber of Commerce Court of Arbitration, Case No 8502, November 1996, available at http://cisgw3. law.pace.edu/cases/968502i1.html (accessed 28 June 2007) (discussing CISG Art 76 and UNIDROIT Principles Art 7.4.6). For a match-up of CISG Art 76 with the counterpart provisions of UNIDROIT Principles, see ‘Use of the UNIDROIT Principles to help interpret CISG Article 76’, available at http://www.cisg.law.pace.edu/cisg/principles/uni76. html#ed11#ed11 (accessed 28 June 2007). 31 CISG Art 5 (‘The Convention does not apply to the liability of the seller for death or personal injury caused by the goods to any person’). It also should be noted that the UNIDROIT Principles are not a panacea to providing solutions to issues not resolved by the text of the CISG. They do not, for example, address whether attorneys’ fees and costs may be recovered as damages under CISG Art 74, which is an issue that has caused considerable controversy and much commentary in recent years. See H Flechtner and J Lookofsky, ‘Viva Zapata! American Procedure and CISG Substance in a U.S. Circuit Court of Appeal’ (2003) 7 Vindobona Journal of International Commercial Law and Arbitration 93 (2003); J Felemegas, ‘The Award of Counsel’s Fees under Article 74 CISG, in Zapata Hermanos Sucesores v. Hearthside Baking Co.’ (2002) 6 Vindobona Journal of International Commercial Law and Arbitration 30; B Zeller, ‘Interpretation of Article 74—Zapata Hermanos v. Hearthside Baking—Where Next?’ (2004) 1 Nordic Journal of Commercial Law 1.

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What are some of the issues that the damages provisions of the CISG do not expressly address but are covered by the UNIDROIT Principles? One is that the CISG does not expressly mandate that damages include any gain received by the aggrieved party resulting from the breach. By contrast, the UNIDROIT Principles expressly include these gains.32 Another is that CISG Article 74 does not address the extent to which the aggrieved party must prove that it suffered a loss in order to recover damages.33 By contrast, the UNIDROIT Principles require that ‘compensation is due only for harm . . . that is established with a reasonable degree of certainty’.34 The CISG also contains no provision on the currency to use in calculating the loss.35 The UNIDROIT Principles state that Damages are to be assessed either in the currency in which the monetary obligation was expressed or in the currency in which the harm was suffered, whichever is more appropriate.36

Perhaps the most litigated provision of the CISG is Article 78, which concerns the payment of interest.37 Although Article 78 requires paying interest whenever a payment is in arrears, it does not specify how to calculate interest owed.38 In contrast, the UNIDROIT Principles contain a very detailed provision on interest. UNIDROIT Principles Article 7.4.9 provides that interest is payable from the time when payment is due.39 With respect to the applicable interest rate, the UNIDROIT Principles set forth a hierarchy for determining the appropriate rate, starting with ‘the average short-term lending rate to prime borrowers prevailing for the currency of payment at the place of payment’.40 If no such rate exists, the Principles provide that interest accrues at the average prime rate in the State of the currency of payment, and, in the absence of such a rate, the rate of interest is to be fixed by the law of the State of the currency of payment.41 In short, in many instances, the damages articles of the UNIDROIT Principles address matters left open by the CISG and, as a result, the question arises as to what extent they can be used to fill gaps in the CISG. UNIDROIT Principles Art 7.4.2. See also CISG-AC Opinion No 6, above n 18. CISG Art 74. UNIDROIT Principles Art 7.4.3. CISG-AC Opinion No 6, above n 18. UNIDROIT Principles Art 7.4.12. See F Mazzotta (2004) ‘CISG Article 78: Endless Disagreement among Commentators, Much Less among the Courts’, available at http://www.cisg.law.pace.edu/cisg/biblio/ mazzotta78.html (accessed 28 June 2007); A Corterier, ‘A New Approach to Solving the Interest Rate Problem of Art 78 CISG’ (2000) 5 International Trade and Business Law Annual 33; Thiele, above n 4, 3. 38 CISG Art 78 (‘If a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under Article 74’). 39 UNIDROIT Principles Art 7.4.9. 40 Ibid. 41 Ibid. 32 33 34 35 36 37

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A P P LY I N G T H E UN I D RO I T PR I N C I P L E S TO I N T E R P R E T T H E CI S G

To date, courts and tribunals have used the UNIDROIT Principles in connection with the CISG in at least three ways. First, when the parties have specified using the UNIDROIT Principles to supplement the CISG, tribunals have typically respected the parties’ agreement.42 Secondly, the UNIDROIT Principles have been used as support for solutions that are reached by applying other sources of authority.43 A third use of the Principles is to use them as a gap-filler for the CISG.44 For example, some tribunals have applied UNIDROIT Principles Article 7.4.9 to resolve questions left open by CISG Article 78, particularly to fix the rate at which interest accrues.45 This use has been controversial and, in my view, improper.

IV

P RO P ERLY I N T E R P R E T I N G T H E CI S G

Article 7 of the CISG sets forth how to interpret the Convention. It states: (1) In the interpretation of this Convention, regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade. (2) Questions concerning matters governed by this Convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based or, in the absence of such principles, in conformity with the law applicable by virtue of the rules of private international law.46

To justify using the UNIDROIT Principles to fill gaps in the CISG, proponents have offered three interpretations of this article. First, the 42 See Bonell, above n 8. A study conducted by the Center for Transnational Law in 2000 found approximately 50 instances in which the UNIDROIT Principles were expressly chosen as the law governing the parties’ agreements. See KP Berger, H Dubberstein, S Lehmann and V Petzold, ’The CENTRAL Enquiry on the Use of Transnational Law in International Contract Law and Arbitration: Background, Procedure and Selected Results’ in KP Berger (ed) The Practice of Transnational Law (The Hague, Kluwer Law International, 2004) 91. For a discussion of cases applying the UNIDROIT Principles, see C Brower and J Sharpe, ‘The Creeping Codification of Transnational Commercial Law: An Arbitrator’s Perspective’ (2004) 45 Virginia Journal of International Law 199. 43 See CISG-AC Opinion No 6, above n 18. 44 See Bianca and Bonell, above n 24, 558, 73–5; Brower and Shape, above n 42, 219–20. 45 See ICC Court of Arbitration Award No 8128 of 1995, available at http://cisgw3.law.pace.edu/cases/958128i1.html (accessed 28 June 2007); Internationales Schiedsgericht der Bundeskammer der gewerblichen Wirtschaft, SCH-4318 (15 June 1994) (Vienna Arbitration proceeding), available at http://cisgw3.law.pace.edu/cases/940615a4.html (accessed 28 June 2007); see also ICC Award No 8769 of December 1996, available at http://cisgw3.law.pace.edu/cases/968769i1.html (accessed 28 June 2007). 46 CISG Art 7.

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UNIDROIT Principles can be used to fill gaps in the CISG because the UNIDROIT Principles are viewed as setting forth general principles of international contract law upon which the Convention is based.47 Secondly, the UNIDROIT Principles can be used to fill gaps only when the relevant article of the UNIDROIT Principles and the relevant provision of the CISG are similar in text and context so that the UNIDROIT Principles are essentially providing ‘meat on the bare bones’ of the principles of the CISG.48 Thirdly, the UNIDROIT Principles can be applied to fill gaps even if the general principles upon which they are based cannot be derived directly from the Convention.49 Proponents of this approach assert that the phrase ‘general principles’ in CISG Article 7 should be interpreted as ‘evolving with and following changes and transitions in international commerce’.50 Thus, they argue that the UNIDROIT Principles are particularly well suited to fill gaps in the CISG, because they set forth general principles of international commercial contracts and their application would further CISG Article 7(1) by helping unify international contract law.51 In my view, it goes too far to apply the UNIDROIT Principles as the primary source of authority for filling a gap in the CISG.52 While articles in the UNIDROIT Principles often correspond to provisions of the CISG, the Principles are not merely a restatement of general principles of international contract law.53 As the Governing Council of UNIDROIT has explained, the Principles not only 47 See MJ Bonell, ‘General Report’ in MJ Bonell (ed) A New Approach to International Commercial Contracts: The UNIDROIT Principles of International Commercial Contracts, XVth International Congress of Comparative Law, Bristol, 26 July–1 August 1998 (The Hague, Kluwer Law International, 1999) 12–13 (noting that ‘there are those who, perhaps too enthusiastically, justify the use of the UNIDROIT Principles for this purpose on the mere ground that they are ‘general principles of international contracts’). 48 This approach has been advocated by Albert Kritzer ‘Observations on the Use of the Principles of European Contract Law as an Aid to CISG Research’, available at http://cisgw3.law.pace.edu/cisg/text/peclcomp.html (accessed 28 June 2007). 49 See Magnus, above n 8, 492–3. I propose to take the quotation out as it essentially repeats what is said in the main text; see also S Salama, ‘Pragmatic Responses to Interpretive Impediments: Article 7 of the CISG, An Inter-American Application’ (2006) 28 University of Miami Inter-American Law Review 225, 241 (‘Interpreting “general principles” as only those derived from the Convention is too narrow of a construction. The clause “on which [the Convention] is based” does not preclude principles that are not expressly or even implicitly stated in the text of the Convention’). 50 Salama, ibid, 241. 51 Ibid 242. 52 See J Fawcett, J Harris and M Bridge, International Sale of Goods in the Conflict of Laws (Oxford University Press, 2005) 933 (‘it should not be forgotten that the UNIDROIT Principles are not the work of UNCITRAL but rather the work of the International Institute for the Unification of Private Law, a quite separate body and not a United Nations agency’ and, ‘[i]n consequence, they cannot represent a formal source of law for the purpose of supplementing the Vienna Convention’); see also M Van Alstine, ‘Dynamic Treaty Interpretation’ (1998) 146 University of Pennsylvania Law Review 687, 784–85 (‘[T]he UNIDROIT Principles . . . will take on relevance only to the extent that they can inform the contemporary understanding of general principles . . . first articulated through an analysis of the relevant convention itself’). 53 UNIDROIT Principles, above n 9.

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reflect concepts found in many . . . legal systems . . . they also embody what are perceived to be best solutions, even if not yet generally adopted.54

Thus, it cannot be said that the Principles as a whole reflect general principles on which the Convention is based. I am also wary of an overly expansive reading of Article 7(2) to justify using the UNIDROIT Principles to fill gaps in the CISG. The text of that article clearly states that Questions concerning matters governed by this Convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based.55

As John Honnold has pointed out, the text of CISG Article 7(2) requires that a ‘particular general principle must be moored to premises that underlie specific provisions of the Convention’.56 In my view, if the drafters wanted the Convention to be interpreted according to general principles of international commercial contract law, they could easily have said so. It seems inappropriate to reach that result through a strained reading of CISG Article 7(2).57 The subject of interest illustrates my point. The provisions of the UNIDROIT Principles on the rate at which interest should accrue do not reflect the general practice, which is to use applicable national law to determine the appropriate interest rate.58 In addition, it can be argued that Ibid. CISG Art 7(2) (emphasis added). Honnold, above n 1, 667–91. I am similarly wary of an overly expansive reading of CISG Art 7(1) to justify using the UNIDROIT Principles to fill gaps in the CISG. By its terms, CISG Art 7(1) deals with the interpretation of the provisions of the Convention. By contrast, CISG Art 7(2) provides the basis for gap-filling. To be sure, there is some overlap between the two (see, eg Schlechtriem and Schwenzer, above n 1, 103). Still, it seems inappropriate to disregard the gap-filling rules of CISG Art 7(2) and apply a rule from the UNIDROIT Principles to resolve a matter not expressly settled by the Convention simply because the rule laid down by the UNIDROIT Principles was international in character and its application would promote uniformity under CISG Art 7(1). Such a practice would eviscerate and render meaningless CISG Art 7(2). 58 See, eg Case Law on UNCITRAL Texts (CLOUT) Case No 132 (16 August 1996), available at http://www.uncitral.org/uncitral/en/case_law/abstracts.html (accessed 28 June 2007); CLOUT, Case No 97 (12 July 1995), available at http://www.uncitral.org/pdf/english/clout/ abstracts/A_CN.9_SER.C_ABSTRACTS_7.pdf (accessed 28 June 2007); see also Landgericht Hamburg Case No 5 O 543/88 (26 September 1990) (Germany, Hamburg District Court), available at http://cisgw3.law.pace.edu/cases/900926g1.html (accessed 28 June 2007); Vienna Arbitration proceeding SCH-4318, above n 45. See also Mazzotta, above n 37 (’there is not enough of a springboard to create the kind of uniformity that the Convention was designed to produce. It’s an area that is too amorphous to think that [this view] would produce a basis for the kind of uniform rule that a world-wide body of people... would be obliged to follow’). Cf ‘Transcript of a Workshop on the Sales Convention: Leading CISG Scholars Discuss Contract Formation, Validity, Excuse for Hardship, Avoidance, Nachfrist, Contract Interpretation, Parol Evidence, Analogical Application, and Much More’ (1999) 18 Journal of Law and Commerce 191, 235–6 (remarks of John Honnold on filling gaps under the CISG with the approaches that are not yet widely adopted). 54 55 56 57

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it does not reflect the CISG’s general principle of full compensation for the loss resulting from the breach of contract; the UNIDROIT Principles provide for interest to be paid at a lending rate.59 The problem with using a lending rate is that CISG Article 74 awards the aggrieved party actual damages, including any loss from borrowing money to continue operations upon the debtor’s default.60 Thus, an aggrieved party that incurs financing charges because of the breach can be made whole through CISG Article 74.61 CISG Article 78 provides for interest in alternative cases when the aggrieved party does not borrow money to continue operating after the debtor’s breach.62 When the aggrieved party does not obtain third-party financing to replace the funds owed, the aggrieved party might hold the money, use some savings instrument or reinvest the money in the company. Thus, the UNIDROIT Principles’ approach may overly compensate an aggrieved party.63 So then how should the Convention be interpreted and how can the UNIDROIT Principles play a role? In my view, gaps in the CISG are to be resolved first according to the literal text or the plain and natural reading of the applicable article.64 If the result is not formally imposed by the relevant article, then it must be determined whether the issue was one that was deliberately left to national laws.65 If not, then, according to CISG Article 7(2), a court or tribunal must attempt to resolve the issue ‘in conformity with the general principles on which [the Convention] is based’.66 In this situation, the court or tribunal should try to resolve the unsettled question by liberally applying specific provisions of the CISG by 59 UNIDROIT Principles Art 7.4.9; CISG Art 74; see also J Gotanda, ‘Awarding Interest in International Arbitration’ (1996) 90 American Journal of International Law 40, 51. 60 CISG Art 74. 61 Of course, in order to recover interest paid as damages under Art 74, the aggrieved party must meet the various requirements for recovery under that article. See Schlechtriem and Schwenzer, above n 1, 754. By contrast, CISG Art 78 does not require, among other things, that the creditor prove that it has suffered a loss in order to recover interest (see ibid, 797). 62 CISG Art 78. 63 It actually seems more in line with Art 78 to award interest at a market savings rate because this method would put the aggrieved party in the same position as if it had invested the money. In fact, a number of tribunals deciding investment disputes have awarded compound interest at a savings rate under the principle of full compensation. See Compañía del Desarrollo de Santa Elena SA v Costa Rica, ICSID Case No ARB/96/1 (2000), available at http:// www.worldbank.org/icsid/cases/awards.htm (accessed 28 June 2007); Azurix Corp v Argentine Republic, ICSID Case No ARB/01/12 (14 July 2006), available at http://www.worldbank.org/ icsid/cases/awards.htm (accessed 28 June 2007); Siemens AG v Argentine Republic, ICSID Case No ARB/02/8 (3 August 2004), available at http://www.worldbank.org/icsid/cases/awards.htm (accessed 28 June 2007). 64 See generally Vienna Convention on the Law of Treaties (23 May 1969) 1155 United Nations Treaty Series 331, Art 31 (‘A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given the terms of the treaty in their context and in light of its object and purpose’). 65 See Bianca and Bonell, above n 24, 75; Honnold, above n 1, 108. 66 CISG Art 7(2).

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analogy.67 In the event that the issue cannot be resolved using this analysis, the court or tribunal should then turn to domestic law to settle the matter.68 What role do the UNIDROIT Principles then play? I believe that while the UNIDROIT Principles should not exert influence of their own force in interpreting the CISG, they can facilitate an understanding of the general principles and help support a gap filling rule derived from general principles of the CISG.69 I would like to illustrate this approach by addressing the issue of whether the CISG imposes a certainty of loss requirement. An analogical interpretation of the Convention would impose on the aggrieved party the need to show with reasonable certainty that it has suffered damage as a result of the breach of contract, and the UNIDROIT Principles support this result. It will be recalled that CISG Article 74 does not address a certainty of loss requirement, and the CISG does not explicitly dispense with it. However, the language of CISG Article 74 states that damages for breach of contract consist of ‘a sum equal to the loss suffered, including lost profits, as a consequence of the breach’.70 Thus, CISG Article 74 recognises that, for the aggrieved party to recover, it has to have sustained damage as a result of the breach of contract (‘loss suffered’) or it must prove that damage is likely to occur (such as in the case of lost profits).71 Another part of CISG Article 74 also helps resolve this issue. Specifically, CISG Article 74 addresses the related issue of foreseeability (remoteness of loss), thus recognising explicitly that there are limits to the principle of full compensation and that a breaching party is not liable for certain losses.72 In addition, the CISG imposes the requirement of causation of damage.73 Thus, the principle that damage must be certain in order to be recoverable can be derived from the CISG. Once we establish that certainty of loss is required, we can deduce the requisite standard by analysing various articles of the CISG to see if a relevant standard exists.74 This analysis leads to the conclusion that the aggrieved party must show with ‘reasonable certainty’ that it has suffered damage as a result of the breach of contract. The ‘reasonableness’ standard with regard to the certainty of loss can be inferred from other provisions and would be consistent with the CISG as a whole.75 Indeed, Michael 67 See J Gotanda, ‘Awarding Damages under the United Nations Convention on the International Sale of Goods: a Matter of Interpretation’ (2005) 37 Georgetown Journal of International Law 95, 121. 68 See CISG Art 7(2). 69 They are an interpretative tool as opposed to a primary legal authority. Cf Van Alstine, above n 52, 784–5. 70 CISG Art 74. 71 Ibid. 72 Ibid. 73 See Art 74 CISG. 74 Gotanda, above n 67, 127. 75 Ibid (quoting Bianca and Bonell, above n 24, 80–1).

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Joachim Bonell writes that over two dozen provisions in the CISG provide for reasonableness, and that These references demonstrate that under the Convention the ‘reasonableness’ test constitutes a general criterion for evaluating the parties’ behaviour to which one may resort in the absence of any specific regulation.76

Here, the UNIDROIT Principles can inform an understanding of the CISG’s principles and support the conclusion derived from them. Article 7.4.3 states that ‘[c]ompensation is due only for harm, including future harm, that is established with a reasonable degree of certainty’.77 The comments explain that this article reaffirms the well-known requirement of certainty of harm, since it is not possible to require the non-performing party to compensate harm which may not have occurred or which may never occur.78

Thus, Article 7.4.3 is based on the same principle underlying the CISG: full compensation is subject to limitations, including the limitation that one can recover damages only for harm that is actually suffered or is likely to occur. In this circumstance, the UNIDROIT Principles aid in understanding the doctrine of certainty of harm as well as supporting the requirement of ‘reasonable certainty’ that can be articulated through the Convention itself. Importantly, the UNIDROIT Principles also show that the ‘reasonable certainty’ requirement can be in accord with an internationally recognised principle.79 Thus, the Principles reinforce ideals of maintaining the CISG’s international character and promoting uniformity in the Convention’s application.80

V

AP P LY I N G T H E UN I D RO I T PR I N C I P L E S A S T R A D E USAG E S

Some have also argued that the UNIDROIT Principles can be made applicable to a contract governed by the CISG as trade usages pursuant to CISG Article 9(2).81 I disagree with the broad application of the UNIDROIT Principles in this manner. As noted, CISG Article 9(2) provides: 76 Ibid. A more exacting standard would be contrary to the purpose of Art 74 of providing full compensation. Requiring a party to prove damages with mathematical precision would, in many instances, prevent a party from being fully compensated for its loss. In particular, it could preclude claims for lost profit, the only type of loss specifically mentioned as being recoverable in the CISG. In fact, Art 74 specifically included a reference to lost profit to ensure that it would be recoverable and an exacting certainty of loss requirement would thus be contrary to Art 74. 77 UNIDROIT Principles Art 7.4.3. 78 Comment 1 on UNIDROIT Principles Art 7.4.3. 79 Cf Van Alstine, above n 52, 784–5. 80 CISG Art 7(1). 81 See generally Fawcett et al, above n 52, 935–6 (discussing cases and authorities).

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The parties are considered, unless otherwise agreed, to have impliedly made applicable to their contract or its formation a usage of which the parties knew or ought to have known and which in international trade is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned.

CISG Article 9 is not an appropriate vehicle to apply the UNIDROIT Principles in their entirety to fill gaps in the CISG’s damages provisions for two reasons.82 First, general contract rules typically do not qualify as trade usages, which are practices of commerce that are regularly observed by those involved in a particular industry or marketplace.83 Secondly, the UNIDROIT Principles simply cannot represent a trade usage in their entirety. In order to qualify for incorporation in toto pursuant to CISG Article 9(2), all of the articles of the UNDROIT Principles would have to be shown to be regularly observed and widely known.84 This is not the case. To be sure, there may be cases where an individual provision of the UNIDROIT Principles may be deemed a trade usage if the particular rule prescribed by the Principles is a usage of which the parties knew or ought to have known and which in international trade is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade concerned.85

This determination, however, typically involves an individualised factual analysis.86 Furthermore, in many cases, it would be difficult to show that a contract rule is a usage that is widely known to and regularly observed by parties to contracts of the type involved. For example, some have claimed that because the CISG is silent on the rate at which interest should accrue, the UNIDROIT Principles Article 7.4.9, which provides, inter alia, that the rate of interest should be fixed at the average bank short-term lending rate to prime borrowers, could fill the void as a trade usage.87 However, as noted, there exist differing views on how the rate of interest should be fixed under the CISG and most courts have applied national law to determine the 82 Of course, as noted, the parties could expressly agree to apply the UNIDROIT Principles to fill gaps in or supplement the CISG. 83 See Fawcett et al, above n 52, 936 (stating ‘general contract rules hardly qualify as usages, which are trade practices and understandings’). 84 See Schlechtriem and Schwenzer, above n 1, 147–53 (stating that, in the case of sets of rules, it is necessary to examine individually whether the requirements of CISG 9(2) are met for each rule concerned and noting that even the INCOTERMS, which contain standard trade definitions most commonly used in international sales contract, cannot be used to supplement the CISG in their entirety unless ‘secured through express and precise agreement’). 85 CISG Art 9(2); see also ICC, ‘Award No 8873 of 1997’ [1998] Journal de droit international (ruling that the UNIDROIT Principles hardship provisions did not correspond to prevailing practice in international trade). 86 See Schlechtriem and Schwenzer, above n 1, 147–9. 87 See Thiele, above n 4; see also E Diederichsen, ‘Commentary to Journal of Law & Commerce Case I; Oberlandesgericht, Frankfurt am Main’ (1995) 14 Journal of Law and Commerce 177, 181.

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applicable interest rate.88 Thus, the approach advocated by the UNIDROIT Principles cannot be said to be a universal trade usage. In order to be applicable, proponents would have to show that the rule prescribed by UNIDROIT Principles Article 7.4.9 was regularly observed by and widely known to parties to contracts for the particular trade concerned.89

VI

CONCLUSION

In summary, while the UNIDROIT Principles should not be used as the primary source of authority to fill gaps in the CISG, they can play a role in finding solutions to questions unresolved by the text of the Convention. It is my hope that a proper dialogue between the two will ultimately lead to more uniform and equitable results under the Convention.

See generally Mazzotta, above n 37. Cf Elastar Sacifia v Bettcher Industries Inc, Juzgado Nacional de Primera Instancia en lo Comercial No 7 (Buenos Aires) (20 May 1991), Argentina, National Commercial Court of First Instance, available at http://cisgw3.law.pace.edu/cases/910520a1.html (accessed 28 June 2007) (determining in a case governed by the CISG the amount of interest payable according to the relevant trading custom). Because the CISG is silent on the currency in which damages are to be assessed, one might be tempted to treat as a trade usage UNIDROIT Principles Art 7.4.12, providing that ‘[d]amages are to be assessed either in the currency in which the monetary obligation was expressed or in the currency in which the harm was suffered . . .’ I simply cannot believe that such a rule of decision would qualify as a trade usage under CISG Art 9(2). Nevertheless, such an approach could be consistent with a solution reached through an analogical interpretation of the Convention as outlined above. See, eg M Bonell, ‘The UNIDROIT Principles and CISG’, available at http://cisgw3.law.pace.edu/cisg/biblio/ bonell.html (accessed 28 June 2007) (‘the principle of full compensation can be considered to be a general principle underlying CISG’ and that this can provide the basis to fill the gap in the CISG with UNIDROIT Principles Art 7.4.12, which is also ‘inspired by the same principle’). See also Schlechtriem and Schwenzer, above n 1, 761–2 (arguing in principle damages should be calculated in the currency in which the injured party suffered his loss or in which the profit would have been made). 88 89

5 The Economic Basis of Damages for Breach of Contract: Inducement and Expectation DAMAGES FOR BREACH OF CONTRACT

ANTHONY OGUS * ANTHONY OGUS

I

CO M I N G F ULL- CI R C L E ? A N A U T O B I O G R A P H I C A L INTRODUCTION

In June 1972, I was hard at work writing my first book, a textbook on the law of damages.1 Thirty-five years later I have been asked to return to the same topic. It might have been agreeable to have reached the conclusion that even if my perspective on the law has changed, my evaluation of it remains basically the same. Unfortunately, this is not the case: both my perspective and my evaluation have fundamentally altered. The book was written from the normative conviction that the sole purpose of a damages award for breach of contract is to compensate the claimant (plaintiff as he then was). I was, at that time, critical of principles of law, such as those allowing exemplary or punitive damages, which led to overcompensation.2 My exposure to economic reasoning did not, at first, lead me to abandon that position. The economic framework for analysis provided a helpful rationalisation of the way in which the law could secure appropriate compensation. Take, for example, the question whether damages for defective performance of a contract should be based on the difference in value between the performance as provided and that agreed, or rather on the cost to the promisee of remedying the defect. In a paper published in 1979, Don Harris, Jenny Phillips and I sought to show how the answer to that question could be given by reference to the subjective value attributed by the promisee to performance and what economists refer to as the * Professor of Law, University of Manchester. I am grateful to Ralph Cunnington for comments on an earlier version of this chapter. 1 A Ogus, The Law of Damages (London, Butterworths, 1973). 2 Ibid, 26–38.

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‘consumer surplus’, the difference between that value and the objective market value of performance.3 As I soon came to learn,4 the economic perspective on compensation for breach of contract was far broader than this and led to a radically different evaluation of the law. Economists are less concerned with what the disappointed promisee should receive ex post the breach: compensation is treated mainly as a transfer payment and, as such, has little significance for economic welfare generally. They are more concerned with what the breaching promisor should pay, since that has important implications for how promisors behave ex ante, and consequentially for trade and welfare more generally.5 In short, they are concerned with the capacity of the sanction for breach of contract to induce economically appropriate behaviour. The purpose of this chapter, then, is to explore and explain the economic perspective on damages for breach of contract and the extent to which its implications are compatible with the established principles based fundamentally on the compensatory goal.

II

T H E E C O N O M I C F U N C T I O N O F A DA M AG E S AWA R D : I N DU C E M E N T O F E F F I C I E N T PE R F O R M A N C E

An economic analysis of law involves relating the area of law in question to economic goals, notably that of maximising welfare, and more specifically inducing situations where the resources in society are put to their most valuable use, generally referred to as allocatively efficient outcomes. In the context of contract law, that can be interpreted as using the law to generate ‘Pareto-improvements’, changes in resource use which result in welfare gains to at least one individual without anyone being made worse off.6 Since, in general, parties voluntarily entering an agreement expect gains from it, a contract is normally efficient in this sense, provided that third parties are not adversely affected. If that is the case, then, to achieve the envisaged welfare improvement, the contract has to be performed. The primary function of the contractual remedies is to induce performance of the contractual obligations, and that should be secured if the sanction for breach imposes costs on the promisor greater than the cost of performing the obligations. To achieve this effect, the size of the award of damages 3 DR Harris, AI Ogus and J Phillips, ‘Contractual Remedies and the Consumer Surplus’ (1979) 95 LQR 581. 4 See DR Harris and D Tallon (eds), Contract Law Today (Oxford University Press, 1991) ch 6. 5 A Ogus, ‘What Legal Scholars Can Learn from Law and Economics’ (2004) 79 Chicago-Kent Law Review 383, 388–92. 6 On this, see A Ogus, Costs and Cautionary Tales: Economic Insights for the Law (Oxford, Hart Publishing, 2006) 26–9 and 205–9.

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does not, in principle, matter, provided that it exceeds the cost of performance;7 in practice, if the sum payable on breach is extortionate, this may give rise to unnecessary disputing costs.8 Notice that in all other respects correlating the sum with what the promisee has lost, as required by the compensatory approach, is irrelevant. The reasoning in the previous paragraph is, as was made explicit, based on the assumption that the contract generates gains for both parties. For this to arise, the value (V) of contract performance to the promisee must exceed the cost (C) of performance to the promisor: clearly if C is greater than V, the promisor would demand a price which the promisee would not be prepared to pay. In some contractual situations, what will occur in the future, including the costs of performance and its consequences for the promisee, is known with such a degree of certainty that the efficient outcome is assured. If that is the case, then the only important implication for the assessment of damages payable for breach is that the sum should exceed C. However, in the great majority of executory contracts there is some degree of uncertainty regarding circumstances occurring between the time of agreement and the time of performance. In particular, there may be uncertainty as to whether, at that second point of time, V will exceed C; and in consequence there is the possibility that the contract will no longer be efficient. The important normative question then arises: should the law induce inefficient performance of the contract or, rather, should it tolerate, perhaps even encourage, efficient breach?

III

E X P E C TAT I O N DA M AG E S A S T H E D E FAULT R E M E DY

The notion that the law should encourage or tolerate wrongdoing may at first sight seem bizarre, and the so-called doctrine of ‘efficient breach’ has provoked criticism from a non-economic, legal perspective, reflecting the alleged moral basis of the law of contract.9 But the doctrine has deep roots: at the end of the nineteenth century Justice Holmes famously wrote: The only universal consequence of a legally binding promise is that the law makes the promisor pay damages if the promised event does not come to pass. 7 JH Barton, ‘The Economic Basis of Damages for Breach of Contract’ (1972) 1 Journal of Legal Studies 277; S Shavell, Foundations of Economic Analysis of Law (Cambridge, MA, Harvard University Press, 2003) ch 13. 8 PH Rubin, ‘Unenforceable Contracts: Penalty Clauses and Specific Performance’ (1981) 10 Journal of Legal Studies 231. 9 C Fried, Contract as Promise: A Theory of Contractual Obligations (Cambridge, MA, Harvard University Press, 1981) 113–23. See also D Friedmann, ‘The Efficiency Breach Fallacy’ (1989) 18 Journal of Legal Studies 1; F Menetrez, ‘Consequentialism, Promissory Obligation, and the Theory of Efficient Breach’ (2000) 47 UCLA Law Review 859; F Cuncannon, ‘The Case for Specific Performance as the Primary Remedy for Breach of Contract in New Zealand’ (2004) 35 Victoria University of Wellington Law Review 657.

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In every case it leaves him free from interference until the time for fulfilment has gone by, and therefore free to break his contract if he chooses. 10

While this may be a caricature of the law,11 it nevertheless constitutes an important recognition that, in some circumstances, wrongdoing may generate economic advantages.12 Unstated in the Holmes dictum, but a crucial condition of the efficient breach doctrine, is the requirement that neither the victim of the breach nor, indeed, any third party should lose by the breach; in other words, the damages payable by the promisor should constitute perfect compensation for the promisee, so that, in effect, that party is indifferent between performance of the obligation and breach of it with damages. In short, the breach must be ‘Pareto-efficient’. The measure of damages which satisfies the condition is that normally referred to as ‘expectation interest damages’, whereby the promisee is paid the full value of what was promised in the contract. We can see now the economic function of that award.13 It serves to ensure that the promisee is not made worse off by any breach. But that is not all: because it limits the sanction payable on breach to the value that the promisee attributes to the contract, it ensures that valuable resources are not spent on costly performance when such performance is not justified by the promisee’s expectations. Take the following example. A promises to supply certain machinery to B for £10,000. The machinery when delivered to B is worth £12,000 and, at the time of the making of the contract, the estimated cost of supply is £9,000. After the contract, but before performance begins, the cost of the latter increases unexpectedly to £14,000. Breach is now efficient since C exceeds V—the parties would not have made a contract if that information had been available at the time of formation, because to cover the promisor’s costs, a price of at least £14,000 would have been asked, and B would not have been prepared to pay that amount. Notice that arguments for compelling performance on the ground that A should take the risk of any increase in the cost of performance are not to the point, since by our definition of expectation damages B will be no better off with performance than with the damages award, and is not therefore disadvantaged by the outcome. The reasoning in this section thus leads to the proposition that awarding expectation damages for breach creates appropriate incentives for the promisor both to perform efficient contracts and to break ineffi10 OW Holmes, ‘The Path of Law’ in OW Holmes, Collected Papers (Boston, MA, Harcourt, 1920) 167, 175. 11 CS Warkol ‘Resolving the Paradox between Legal Theory and Legal Fact: The Judicial Rejection of the Theory of Efficient Breach’ (1998) 20 Cardozo Law Review 321. 12 I generalise on this in Ogus, above n 6, ch 7. 13 Shavell, above n 7; BE Hermalin, AW Katz and R Craswell, ‘Contract Law’ in AM Polinsky and S Shavell (eds), Handbook of Law and Economics (Amsterdam, North Holland, 2006) ch 1.

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cient contracts. Of course, the parties could themselves, by inserting relevant provisions into the original contract, induce the same outcomes, but, by providing the expectation measure as the default remedy, the law enables them to economise on transactions costs. We can conclude by some brief observations on the economic implications of other contractual measures of damage. Reliance interest damages put the promisee in the position she would have been in if the contract had not been made by reimbursing all expenditure incurred, and investment made, in anticipation of the performance of the contract. But because the award does not compensate for the lost value of contractual performance, it enables inefficient breach to occur. Put in other language, the sanction does not internalise to the promisor the full value of the promisee’s loss and therefore does not provide the correct signal for the promisor as to the efficiency, or inefficiency, of breach. Exceptionally, the reliance measure might be used as a proxy for the expectation interest measure where the latter is difficult to estimate.14 But care must be taken here because, if the promisee is given the option to claim the reliance measure, this can be used in situations where the expectation interest has a negative value and inappropriately protect the promisee against the consequences of having entered a loss-making contract.15 Requiring the promisor to disgorge all profits made by breach is a relatively unfamiliar contractual remedy but has come into prominence recently as a consequence of the House of Lords’ decision in the Blake case16 and may be adopted where breach is perceived by courts to have been committed in bad faith. As we shall see in the next section, this may be appropriate where the promisor has actively attempted to impede enforcement of the contract; and, as with reliance interest damages, it may sometimes serve as a proxy for expectation interest damages when these are difficult to estimate. But, adopted as a general principle, it would be inconsistent with the economic analysis since it would deter promisors from breach when this is efficient.17

IV

M O D I F I CAT I O N S TO T H E D E FAULT R E M E DY

If, for the reasons outlined in the last section, the economic goal of allocative efficiency justifies awarding expectation damages as the default remedy for breach of contract, we have now to take account of a variety of considerations which might explain some modifications to that rule. Anglia Television v Reed [1972] 1 QB 60 (CA). An outcome which the courts will not permit: C and P Haulage v Middleton [1983] 1 WLR 1461 (CA). 16 A-G v Blake (Jonathan Cape) [2001] AC 268 (HL). 17 Hermalin et al, above n 13, 113. 14 15

130 A

Anthony Ogus Imperfect Monitoring and Enforcement

It is not always easy for promisees to monitor performance of the contract by promisors and some, particularly minor, breaches may escape detection. Even when a breach is detected, it does not follow that enforcement action of some kind will be taken since the promisee may wish to avoid the cost and the hassle involved. Imperfect enforcement affects the inducement characteristics of the damages remedy. Suppose that, in relation to a given contractual obligation, C is £800 and V is £1,000. The obligation is efficient and the prospect of paying £1,000 on breach should induce the promisor to perform. But suppose that the promisor realises that there is a 1 in 4 chance that the promisee will not claim compensation, either because she will not detect breach or will not pursue a claim. In such circumstances, the promisor will discount by 25% the liability costs of breach and will no longer have an inducement to perform, since £750 is less than £800. One might not expect courts to address this problem by routinely adding to their estimate of the expectation interest an amount reflecting imperfect enforcement. Nevertheless the case for doing so might be strong where the promisor has deliberately attempted to conceal the breach; punitive damages to deter such behaviour might then be acceptable.18 English courts have traditionally been reluctant to award punitive (or exemplary) damages for breach of contract, but a recent decision of the Supreme Court of Canada has pointed the way forward, noting in particular that such an award may be appropriate where ‘the defendant concealed or attempted to cover up its misconduct’.19 In other situations, an appropriate modification to the default rule might simply be for the courts to err on the side of too much, rather than too little, compensation.

B Inducements for Efficient Promisee Behaviour For efficient outcomes, account must be taken of the behaviour of the promisee, as well as that of the promisor.20 Different considerations and therefore analysis apply according to the time period during which the relevant behaviour might take place, but, as we shall see, the common thread is to aim at what the parties would have agreed ex ante as to the appropriate outcome if they had been fully informed of the circumstances. 18 D Farber, ‘Reassessing the Economic Efficiency of Compensatory Damages for Breach of Contract’ (1980) 66 Virginia Law Review 1443; B Chapman and MJ Trebilcock, ‘Punitive Damages: Divergence in Search of a Rationale’ (1989) 40 Alabama Law Review 741, 818–19. 19 Whiten v Pilot Insurance Co. [2002] 1 SCR 595 (SCC) para 113 (Binnie J). 20 EA Posner, ‘Contract Remedies: Foreseeability, Precaution, Causation and Mitigation’ in B Bouckaert and G De Geest (eds), Encyclopedia of Law and Economics, Vol III (Cheltenham, Edward Elgar, 2000) 162–78.

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Promisee Behaviour Post-breach

The promisee’s behaviour after the breach of contract has occurred can influence the size of the loss relative to the expectation value of the contract. Suppose it to be the case, for example, that she can purchase in the market an equivalent to the contractual undertaking. Assuming that this has become cheaper than performance by the promisor, whether direct or else by obtaining a substitute in the market, the purchase by the promisee is the efficient outcome because the parties would have opted for it ex ante (with consequential changes to the contract price) if the information had then been available. Limiting the expectation measure to the cost of purchasing the equivalent plus any difference in value between what is purchased and what was promised in the contract should, indeed, induce that outcome. This approach to quantification is familiar as a consequence of the doctrine of mitigation.21 The economic rationalisation of the doctrine is thus clear,22 as also for the standard measure prescribed by legislation for non-delivery in a sale of goods contract: the difference between the contract price and the market price of the good at the date of breach.23 If the mitigating market purchase can be made, the promisee has not been deprived of the expectation in the contract but rather any specific advantage provided by the contract with the promisor, including the purchase price, relative to the subsequent transaction in the market place. (ii) Promisee Behaviour Post-contract but Pre-performance or Breach There are two principal ways in which promisee behaviour between the time of the contract and the date when performance is due can affect efficiency. First, there is the possibility of the promisee taking precautions which can avert, or reduce the risk of, breach. If the gain from such precautions, in terms of reduced risk of loss, exceeds the costs incurred, it is in the interests of both parties that they should be taken.24 As a lover of opera, I know from bitter experience that there is a risk that one or more singers under contract with an opera company to sing a particular performance will be sick on the night, and some companies arrange cover with other singers to deal with the contingency. By parity of reasoning with post-breach mitigation, one might expect the law to encourage promisees to take pre-breach precautions when they are efficient, but it appears to do 21 British Westinghouse Electric v Underground Electric Railways [1912] AC 673 (HL) 689 (Lord Haldane). 22 CJ Goetz and RE Scott, ‘The Mitigation Principle: Toward a General Theory of Contractual Obligation’ (1983) 69 Virginia Law Review 967. 23 Sale of Goods Act 1979, s 51(3). 24 RD Cooter, ‘Unity in Tort, Contract and Property: The Model of Precaution’ (1985) 73 California Law Review 1.

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so only imperfectly. Of course, the courts will normally25 enforce any attempt by the parties explicitly to allocate the risk, or part of it, to the promisee, but they will be reluctant to engage in implicit risk allocation to this effect just because the promisee is the cheaper risk-avoider.26 And the device of reducing the promisee’s damages on grounds by reference to contributory negligence has, in the context of breach of contract, been given a narrow application in English law: it is available only if the relevant breach of contract is also actionable in tort.27 The economic argument for allowing more generally damages for breach of contract to be reduced on grounds of contributory negligence is a compelling one.28 The courts would, of course, enforce a term in, for example, an insurance contract, requiring that adequate care be taken by the promisee to avoid a given loss. It is a short step from that for the courts to recognise the appropriateness of reducing damages for contributory negligence where it was manifestly cheaper for the promisee to take relevant precautions, given that this would reduce the transactions costs of explicit ex ante risk allocation. The second possibility of inefficient promisee behaviour between contract formation and breach relates to reliance expenditure. In most contracts, the promisee engages in some expenditure prior to the date of performance of the contract, knowing that if the promisor duly performs, the value of the contract will thereby be increased. Often reliance expenditure, or a substantial proportion of it, is wasted if the contract is not performed. Given that there is always some risk of non-performance and wasted reliance expenditure, in theory there is an optimal level of reliance where the sum invested by the promisee prior to the anticipated performance by the promisor is proportionate to the risk of breach and what will be lost if that breach occurs.29 Unfortunately, the conventional remedy of expectation damages generates no incentives for the promisee to have regard to the optimal level of reliance, because whatever sum is invested will be reimbursed by the promisor on breach, given the aim of the award to put the promisee in the position she would have been in if the contract had been performed. Some commentators conclude that there is no sanction for breach which can, at the same time, induce both efficient performance (or breach) and

Subject to the legislative provisions governing exemption and limitation clauses. There would have to be clear evidence that the parties would have intended to allocate the risk in this way: Ultraframe (UK) v Tailored Roofing Systems [2004] EWCA Civ 585, [2004] BLR 341 (CA). 27 Barclays Bank v Fairclough Building [1995] QB 214 (CA). 28 W Bishop, ‘The Contract–Tort Boundary and the Economics of Insurance’ (1983) 12 Journal of Legal Studies 241, 263–4. 29 S Shavell, ‘Damage Measures for Breach of Contract’ (1980) 11 Bell Journal of Economics 466. 25 26

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efficient reliance.30 This may be too pessimistic. Some constraint on very excessive reliance expenditure may result from the Hadley v Baxendale31 principle, which requires notice of special, unforeseeable losses to be given to the promisor at the time of making the contract. The application of that principle has included cases denying recovery of unforeseeable reliance losses.32 (iii)

Promisee Behaviour Pre-contract

The principal economic rationalisation of Hadley v Baxendale is somewhat different, and relates to communication of information by the promisee to the promisor prior to the making of the contract.33 Information plays a key role in the planning of efficient contracts. Clearly, in deciding what resources to spend to avoid defective performance, the promisor must take into account the likely loss that such a performance would cause the promisee, and therefore the damages that potentially would be payable. The costs of the precautions, to the extent that they are economically justifiable, given the risk of defective performance, and any remaining potential liability costs, need to be reflected in the price if the contract is to remain profitable. In the absence of any special information provided by the promisee, the promisor will base calculations on reasonably foreseeable losses to the promisee from defective performance. Where therefore the promisee would incur, on breach, an unforeseeably high level of losses, efficiency requires that information relating to those losses is communicated to the promisor prior to the making of the contract in order that the latter can make appropriate decisions regarding precautions and the contract price. That is precisely the requirement imposed by the second limb of the Hadley v Baxendale principle.

C

Problematic Damage Assessment and Ex Ante Risk Allocation

As we have seen, for the expectation measure to ensure efficient outcomes, it must provide perfect compensation to the promisee for the value of the contract. This is a stringent requirement and, necessarily, trivial imperfections must be tolerated. On the other hand, substantial divergences from the standard will undermine efficiency. It is thus important to identify some problematic features of assessment and to see how they can be addressed. 30 Ibid, 483; PG Mahoney, ‘Contract Remedies: General’ in Bouckaert and De Geest, above n 20, 123. 31 (1854) 9 Ex 341 (Exch). 32 See eg Victoria Laundry (Windsor) v Newman Industries [1949] 2 KB 528 (CA). 33 LA Bebchuk and S Shavell, ‘Information and the Scope of Liability for Breach of Contract: the rule of Hadley vs Baxendale’ (1991) 7 Journal of Law Economics and Organization 284.

134 (i)

Anthony Ogus Subjective Value and Non-pecuniary Losses

Perhaps the most important such situation is where there is a significant subjective dimension to the promisee’s interest in performance, which my colleagues and I referred to in our 1979 paper as the ‘consumer surplus’.34 In most contracts, particularly those occurring in commercial environments, there is available an objective, market evaluation of what is to be supplied and this will frequently constitute an evaluation of performance adequate for the promisee. However, where performance confers a significant amount of non-financial utility on the promisee, typically because what is supplied is for the promisee’s own consumption or enjoyment, it is impossible for the court to quantify this accurately, because only the promisee has the relevant information and has every incentive to exaggerate the value on presenting evidence to court. Understandably, the English courts have traditionally been reluctant to award damages in contract cases for the loss of non-pecuniary benefits,35 and the judges have experienced difficulty in formulating and explaining the principles as to the circumstances in which such awards may be made.36 Economic reasoning, with its reference to what fully informed parties would have agreed ex ante, can assist here.37 The starting point is, indeed, the fact that an efficient contract can include a liquidated damages clause, specifying the amount of compensation payable for breach. Where the contract confers a significant consumer surplus on the promisee, the latter has the opportunity to stipulate a sum which reflects the loss of the subjective, non-pecuniary benefits of performance.38 However, it is important to recognise that if this clause leads to the promisor taking additional precautions against breach or an increase in the potential liability costs, these costs will be reflected in the contract price and, because of this, it may be cheaper for the promisee herself to deal with the subjective element in the loss. If that element is relatively small, or can be alleviated by other means, she may not be See, above n 3. The leading authority is Addis v Gramophone Co [1909] AC 488 (HL). For example, the formulation of Bingham LJ in Watts v Morrow [1991] 1 WLR 1421 (CA) 1445 (‘where the very object of a contract is to provide pleasure, relaxation, peace of mind or freedom from molestation, damages will be awarded if the fruit of the contract is not provided or if the contrary result is produced instead’) leaves much scope for interpretation and, in any event, can be regarded as too narrow. See Farley v Skinner (No 2) [2002] AC 732 (HL). 37 S Rea, ‘Non-pecuniary Loss and Breach of Contract’ (1982) 11 Journal of Legal Studies 35. 38 A potential problem with this solution is that, if the amount stipulated is regarded by the court as excessive, relative to what a court would have awarded, it might be treated as a penalty clause and will not be enforced: Dunlop Pneumatic Tyre Co v New Garage & Motor Co [1915] AC 79 (HL). The penalty doctrine has been criticised on economic grounds (see eg A Hatzis, ‘Having the Cake and Eating It Too: Efficient Penalty Clauses in Common and Civil Contract Law’ (2002) 22 International Review of Law and Economics 381 and G De Geest and F Wuyts, ‘Penalty Clauses and Liquidated Damages’ in Bouckaert and De Geest, above n 20, 141–61), but the doctrine does not come within the scope of this chapter. 34 35 36

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prepared to pay the increased price.39 Putting the same point in a more concrete form, supposing that the promisee purchased insurance cover against the losses from the breach of contract, would that cover, at an additional premium, have included non-pecuniary losses, or would those losses be, in effect, self-insured? Of course, explicit provision in the contract for compensation may be costly and is unlikely to be adopted by large numbers of promisees, notably consumers, for whom the subjective value may be important. But, in quantifying a claim for damages made by the promisee, the court can ask itself, hypothetically, if the parties had agreed on a liquidated damages clause, whether, in accordance with the above reasoning, it would have included compensation for non-pecuniary benefits. If the contract price is higher than that which is typically charged in the market, that may provide some hint as to how the question should be answered. But the absence of such an indication should not be treated as decisive. The reasoning and solution here is linked to what was said earlier on the impact of information on the pricing of the contract and the Hadley v Baxendale principle. If the existence and extent of the non-pecuniary loss were reasonably foreseeable at the time of the contract, it should be awarded because the impact of such liability could have been reflected in the price. If they were not reasonably foreseeable, the price could not have been modified and award of the loss would be inappropriate. The above analysis also helps us to address the familiar issue arising from defective contractual performance: whether the damages should be assessed by reference to the diminution in value to the promisee or rather to the cost of curing the defect to provide what was promised.40 The problem only arises where the promisee has a non-financial interest in performance; in other cases, the award of the diminution of value, if accurately assessed, will create the appropriate incentives for efficient performance and efficient breach. Where the subjective value is significant, the cost of cure measure may constitute an appropriate alternative to the court attempting to assess the non-pecuniary benefit of performance. The English courts tend to adopt this approach,41 but subject to the important qualification that the cost of cure must not be disproportionately high relative to the benefit to be obtained.42 The economic rationalisation of this condition is that, had the parties addressed the issue at the time of making the contract, the promisee would not have been prepared to pay 39 D Harris, D Campbell and R Halson, Remedies in Contract and Tort (Cambridge University Press, 2nd edn) 596–7. 40 TJ Muris, ‘Cost of Completion or Diminution in Market Value: The Relevance of Subjective Value’ (1983) 12 Journal of Legal Studies 379. 41 Ruxley Electronics and Construction v Forsyth [1996] AC 344 (HL) 42 Ibid. See also Darlington Borough Council v Wiltshier Northern Ltd [1995] 3 All ER 895 (CA).

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the increase in price necessary if liability were to be based on the cost of cure. Note, finally, another possible solution to the subjective value problem. The court can order specific performance and the promisor might then negotiate with the promisee for a release from the order, for a price which the promisee is willing to accept as adequate compensation for the breach. That price will, of course, reflect the subjective value of performance. While this solution is attractive, as with liquidated damages, there may be a problem of transactions costs. I take the matter no further since it is a subject of another chapter within this volume.43 (ii) Seller’s Loss of Volume When a buyer repudiates a sale of goods contract, should the seller’s damages be assessed by reference to the profit that would have been made (the ‘lost volume measure’), on the assumption that the number of profitable sales has been reduced? Or should it be assumed that a substitute purchaser would be found, that the number of sales would not be reduced and that therefore the seller should receive only the difference between the contract price and the market price at the time of breach, plus incidental expenses (the ‘market measure’)? The question has given rise to some debate.44 Applying the reasoning above and adopting a policy of inducing the promisee (here the seller) to take appropriate mitigating steps ex post the breach would lead us to relate the solution to the state of the market at the time of breach: if demand exceeds supply, the seller can be expected to find another buyer and the market measure should be awarded; if supply exceeds demand, no additional sale can be found and the lost volume measure is appropriate. That, indeed, appears to be the approach taken by the English courts.45 Nevertheless, determining the conditions of the market in respect of particular sellers at the time of breach is not always easy and can render the application of the principle uncertain. An alternative is to ask how the parties did allocate, or would have allocated, the risks relating to market conditions.46 One possibility is that sellers would prefer not to respond to buyers’ defaults by mitigating the loss and finding an alternative sale. If buyers would be prepared to accept this, and the higher price to which it would give rise, given the increase in potential liability costs, that would 43 See D Friedmann, ‘Economic Aspects of Damages and Specific Performance Compared’, this volume. 44 C Goetz and RE Scott, ‘Measuring Sellers’ Damages: The Lost Profits Puzzle’ (1979) 31 Stanford Law Review 323; VP Goldberg, ‘An Economic Analysis of the Lost-volume Retail Seller’ (1984) 57 Southern California Law Review 283. 45 WL Thompson Ltd v R Robinson (Gunmakers) Ltd [1955] Ch 177 (Ch) (market measure); Charter v Sullivan [1957] 2 QB 117 (CA) (lost volume measure). 46 Ogus, above n 6, 142–54, from which this discussion is derived.

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suggest the appropriateness of the lost volume measure. But, of course, many buyers would not accept this, particularly since the amount of the sellers’ profit on the transaction is unlikely to be known to them. Another possibility is that both parties would treat the transaction primarily as an allocation in the risk of fluctuations in the price of the goods.47 The contract fixes the price in advance of the date of payment. If, on that date, the market price is lower than the contract price, sellers are protected against the buyer defaulting, while if the price is higher, buyers are protected against the seller defaulting. If both parties would have agreed to this characterisation of the contract, then the ‘market’ measure would be appropriate. In many transactions, particularly in wellfunctioning markets, this latter interpretation would seem to be the more likely approximation to the parties’ preferences, not the least because information on market prices is more readily available, and thus potential liability costs can be more easily predicted.

V

CO N C L U S I O N S : CO M PAT I B I L I T Y W I T H E S TAB L I S H E D PRINCIPLES

I have not attempted, in this chapter, to provide a systematic economic appraisal of English law on the measure of damages for breach of contract. Rather, I have been concerned mainly to work through the implications of the goal of inducing efficient behaviour by both the promisor and the promisee. Given the contrast between that goal and the traditional legal rationalisation of contractual damages, that of providing appropriate compensation for disappointed promisees, it is perhaps striking, if not surprising, that in general the principles serve the economic purpose well. We can nevertheless identify three aspects in relation to which the economic analysis gives rise to some criticism of English law. Ironically, the first of these, the proposition that the rules governing entitlement to substantial damages for non-pecuniary benefits may be too narrowly drawn, could be made by reference to the compensation function as well as the efficiency goal. For reasons given above, a radical change to the existing law is not called for and the award is justified only where it is to be assumed that the promisee was willing to pay, and perhaps did pay, an additional premium to the promisor effectively to insure against the loss. Nevertheless the issue to some extent overlaps with the second shortcoming, the problem that the conventional expectation award may take insufficient account of the under-enforcement of claims for breach of contract. To deal with this I have suggested that courts should, in general, 47 Cf RE Scott, ‘The Case for Market Damages: Revisiting the Lost Profits Puzzle’ (1990) 57 University of Chicago Law Review 1155.

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err on the side of too large, rather than too small, an estimation of the expectation interest and that, following the Canadian example,48 some resort to punitive damages, exceeding compensation for the promisee’s loss, might be appropriate where the promisor creates obstacles to the detection and enforcement of breach.49 A third possible reform derived from the economic analysis would be to grant the courts an unequivocal power to reduce damages on the grounds of contributory negligence where it was manifestly cheaper for the promisee to take relevant precautions to avoid, or reduce the adverse consequences of, a breach. This would generate an incentive for promisees to engage in efficient behaviour before the breach and would extend the logic of the doctrine of mitigation which applies only to post-breach behaviour.

See n 19 and accompanying text. The Anglo-Saxon doctrine preventing the enforcement of penalty clauses can also be criticised from an economic perspective: see n 38. 48 49

6 Damages and the Protection of Contractual Reliance DAMAGES AND THE PROTECTI ON OF CONTRACTUAL RELI ANCE

PETER J AFFEY *

PETER J AFFEY

I

I NTRO DUCTION

Various pecuniary remedies may be available to a contracting party when the other party has not performed. There is the claim for damages for loss in the expectation measure, meaning loss measured relative to the position the claimant would have been in if the contract had been performed. Sometimes there is a claim for damages for loss in the reliance measure, meaning, broadly speaking (I will qualify this later), the measure of loss incurred by the claimant in reliance on the contract, or in other words loss measured relative to the position the claimant would have been in if he had not entered into the contract. Also, the textbooks refer to claims to a ‘restitution measure’ or more generally to claims for restitution, though these are not regarded as damages claims. Whereas the expectation and reliance measures are understood to be different measures of loss, claims for restitution are generally taken to be concerned with benefit received by the defendant.1 In fact, the description of restitution has been applied to three quite distinct types of case, as will be discussed below. The usual measure is the expectation measure,2 and in the contract textbooks most of the discussion of damages and of remedies in general is devoted to this. But is the expectation measure also more basic or fundamental than the other measures? Is it intrinsic to contract in some way that the other measures are not, or in some way logically prior to them? One might take the view that none of the measures of recovery is more basic in this sense. Each of the measures can be available, and the measure will be selected that is appropriate, in the particular circumstances, to protect the Professor of Law, Brunel University. Fuller and Perdue famously devised the classification of three distinct ‘interests’ in contract, corresponding to these measures: LL Fuller and WR Perdue, ‘The Reliance Interest in Contract Damages’ (1936) 46 Yale Law Journal 53. 2 Robinson v Harman (1848) 1 Exch 850 (Exch). *

1

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claimant’s rights under the contract.3 It may be that the expectation measure is most often the appropriate measure, but this does not make it a more basic measure in this sense. More commonly it is thought that the expectation measure is indeed the basic measure.4 Without disputing that the expectation measure is and should be the usual measure, I am going to argue that the basic measure of damages is the reliance measure. The argument is not based on a detailed scrutiny of the case law, nor is it focused on the law of damages. It is based on a consideration of the whole range of contract remedies, in broad outline, with a view to understanding them as a single coherent body of law.

II

T H E ARG UM EN T F O R T H E E X P E C TAT I O N M E A S U R E A S THE B ASIC MEASURE

I will begin with what appears to be a strong argument that the expectation measure is indeed the basic measure of recovery in contract. The argument draws on the relationship between a primary and a remedial legal relation. The argument runs as follows. When contracting parties make a contractually binding agreement, the claimant acquires a primary right to performance and the defendant a correlative primary duty to perform it. This is the primary legal relation in contract. The defendant’s failure to perform in accordance with the contract is a breach of his primary duty, and this generates a remedial relation. The claimant’s remedial right is his claim to pecuniary compensation, and the defendant has a correlative remedial duty to pay compensation. When the matter reaches court, the court-ordered remedy implements, as it were, the remedial relation. In general, a remedy remedies an injustice, and the injustice to be remedied is not an injustice in the abstract, but the particular injustice arising in the circumstances by virtue of the primary relation. The function of a remedial right, in other words, is to give effect to or fulfil the primary right, so far as possible in the circumstances.5 In contract, the claimant’s remedial right should provide him, so far as is possible, with the value of the performance to which he was entitled under the primary relation—the amount that will put him in the position he would have been in if the contract had been performed—in other words, the expectation measure.6 3 A possible example is G Treitel, The Law of Contract (London, Sweet & Maxwell, 11th edn, 2003) 941. 4 This seems to be taken for granted in most of the contract textbooks. Recently, in Golden Strait Corp v Nippon Yusen Kubishka Kaisha [2007] UKHL 12 (HL) [9], Lord Bingham described the expectation measure rule as the ‘governing principle’. 5 This argument is pursued more generally and at greater length in P Jaffey, Private Law and Property Claims (Oxford, Hart Publishing, 2007) ch 2. 6 C Fried, Contract as Promise (Cambridge, MA, Harvard University Press, 1981) 17–21; D Friedmann, ‘The Performance Interest in Contract Damages’ (1995) 111 LQR 628.

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The entitlement to the expectation measure thus follows simply from, first, the nature of the primary relation between the parties to a contract, and, secondly, the function of a remedy. An understanding along these lines seems to me to be widely assumed, and I will refer to it as the ‘orthodox analysis’, though it is not to be equated with orthodox legal doctrine or black letter law, with which, as I argue below, it is sometimes in conflict. In my view, if the primary relation is rightly characterised in this way, the argument for the expectation measure follows. The problem lies in the formulation of the primary relation. On the face of it, there is a problem under the orthodox analysis in explaining the other measures of recovery. The argument seems to imply that only the expectation measure should ever be available. The reliance measure is not designed to put the claimant in the position he would have been in if the contract had been performed, and so does not, it would appear, serve to fulfil or give effect to the primary relation. However, the reliance measure is consistent with the orthodox analysis if it is understood as a proxy or surrogate for the expectation measure, which is indeed how it is often understood.7 Contractors generally make profitable contracts under which the benefit they receive through the other party’s performance exceeds the cost of their own performance, so the expectation measure generally exceeds the reliance measure. If the expectation measure is difficult to establish, but the claimant can show that he has suffered loss in reliance on the contract, it is reasonable to allow him to recover his reliance loss on the assumption that this is no more than the expectation measure that he is entitled to, especially since the defendant’s wrong has given rise to the evidential difficulties. However, it is possible that, owing to a misjudgement in making the contract or in agreeing its terms, or because of unforeseen circumstances, the benefit that the claimant would have made through the contract falls short of his own cost of performance—the contract is a bad bargain for him, in other words. In such a case the reliance measure may exceed the expectation measure. If the reliance measure is allowed only as a proxy for the expectation measure, the claimant should not be able to recover in excess of the expectation measure. This is indeed the position: if the defendant can show that the claimant’s reliance loss exceeds the expectation measure, the claim in the reliance measure is capped at the expectation measure.8 Thus this rule appears to confirm the orthodox analysis. What about claims for restitution in contract? I will come back to this below, but for the moment it is relevant to note that claims for restitution are often said not to be contractual claims at all, but unjust enrichment claims, implying that the claim does not arise out of the primary Anglia Television v Reed [1972] 1 QB 60 (CA). C & P Haulage v Middleton (1983) 1 WLR 1461 (CA); CCC Films (London) v Impact Quadrant Films [1985] QB 16 (QB). 7 8

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contractual relation. One reason for this may be that claims for restitution are taken to be based on the benefit received by the defendant, and it is difficult to see how such a claim can be explained as a claim arising to protect and fulfil the primary contractual relation in accordance with the orthodox analysis.9 For my part, I find it very difficult to understand how a claim arising on the termination of a contract and by virtue of its non-performance can be justified at all if it is not justifiable as a contractual claim. This seems to me a serious problem for the orthodox analysis, and I will come back to it later.

III

T H E RE L I A N C E T H E O RY A N D T H E M E A S U R E O F DAMAG E S

There are various forms of the reliance theory of contract,10 but broadly speaking one can say that according to the reliance theory the function of contract law is to protect contractual reliance. Under the reliance theory, the object of the law should be to protect reliance loss as such, and not as a proxy for the expectation measure. This is at odds with the orthodox analysis, as I discuss below. But, first, it is on the face of it at odds with the established legal position on expectation damages. The first question for the reliance theory is whether it can account for the rule that the expectation measure of damages is the usual measure: generally, as I mentioned above, the reliance loss incurred through performing the contract will fall short of the expectation measure. The standard response to this is the opportunity cost argument.11 Often the claimant would have made another contract if he had not made the contract with the defendant. The benefit he would have made through this contract is the opportunity cost of the contract he actually made with the defendant. If there is a competitive market in the goods or services to be supplied under the contract, then the expectation measure is a good approximation of this opportunity cost, and so the expectation measure (rather than the costs incurred by the claimant in performing the contract) is a good measure of the claimant’s reliance loss. In other cases, in the absence of a competitive market, it might seem that the expectation measure is liable to exceed the reliance measure, 9 See P Birks, ‘Restitution and the Freedom of Contract’ [1983] Current Legal Problems 141. 10 Eg LL Fuller and WR Perdue, above n 1; P Atiyah, The Rise and Fall of Freedom of

Contract (Oxford, Clarendon Press, 1979); G Gilmore, The Death of Contract (Columbus, OH, Ohio State University Press, 1974); J Raz, ‘Promises in Morality and Law’ (1982) 95 Harvard Law Review 916. My own version is at P Jaffey, ‘A New Version of the Reliance Theory’ [1998] Northern Ireland Legal Quarterly 107 and P Jaffey, The Nature and Scope of Restitution (Oxford, Hart Publishing, 2000) ch 2. 11 Fuller and Perdue, ibid, 62; see also S Smith, Contract Theory (Oxford University Press, 2004) 416.

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maybe by a large margin. However, it may be very difficult to say what the claimant’s opportunity cost is, that is to say, how the claimant might otherwise have applied his money or his labour and resources, and what benefit they might have brought him. Even if there was nothing equivalent to the contract that the claimant made, there may well have been another quite different opportunity that the claimant gave up that was only marginally less valuable to him. Given the difficulty of establishing the true opportunity cost, and since it was the defendant who created the evidential problem by his failure to perform,12 it seems reasonable to adhere to the expectation measure as the general measure of recovery in respect of reliance loss, even though it may sometimes err in the claimant’s favour.13 One apparent problem for the reliance theory concerns the expectation measure cap. If the reliance measure is justified as such, rather than as a proxy for the expectation measure, why is it subject to the expectation measure cap? I will come back to this below.14 More generally, Friedmann has made the following objection to the opportunity cost argument.15 Say C has spent £300 performing his side of a contract with D, and he would have received a benefit worth £1,000 if D had performed, but he has actually received nothing. C is entitled, let us say, to his reliance loss, but rather than claiming only £300 actual expenditure he claims the expectation measure of £1,000 as an opportunity cost, on the ground that if he had not made the contract with D he would have made an equivalent contract, contract T, with a third party. According to Friedmann, the opportunity cost ‘is obviously dependent upon the nature of the entitlement and the ensuing measure of damages in [contract T]’.16 If C would have been entitled to recover only reliance loss in the form of actual expenditure in a claim under contract T, then the value to him of contract T is only £300 (at the most), and accordingly this is the opportunity cost of the contract C actually made with D. C can argue that the opportunity cost is £1,000 only on the basis that he would have received the expectation measure on contract T, and to argue this he must invoke the opportunity cost argument here again, and argue that if he had not made contract T, he would have made another equivalent contract, contract T2. But then he has to argue that contract T2 would have been worth £1,000 to him, and so he has to postulate a further contract, contract T3, and so on, ad infinitum. C has to show that there were an indefinite number of other contracts that he might have entered into instead of the contract he actually made with D, on the same terms, and this he cannot do. This 12 Compare the situation discussed below in connection with claims in the ‘restitution measure’ where there is no reason to apply a presumption against the defendant. 13 Fuller and Perdue, above n 1. 14 See below, text following n 66. 15 D Friedmann, ‘A Comment on Fuller and Perdue’ (2001) 1 Issues in Legal Scholarship 11. 16 Ibid.

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suggests to Friedmann that proponents of the opportunity cost argument have fallen prey to a circular or ‘bootstrapping’ argument: in purporting to show that the opportunity cost is the expectation measure, they are actually relying on the assumption that this is the case. This objection seems to me unsuccessful. The argument that the opportunity cost is £1,000 does not depend on showing that C would have been entitled to this measure of recovery in a claim under contract T. If C had made contract T and it had been performed, C would have received a benefit worth £1,000 (having spent £300), and this is the case whatever the measure of recovery would have been if the contract had not been performed. It would be the case even if there were no legal remedies at all in contract. Since (I take it) we can assume that contracts are usually performed, it follows that the expectation measure is a good approximation to the opportunity cost of a contract, at least where there are opportunities to make a comparable alternative contract. I will make one more, tentative point about the expectation measure rule. The rule has different rationales under the two approaches: under the orthodox analysis, the expectation measure is intrinsically the right measure, whereas under the reliance theory the expectation measure operates as a proxy for reliance loss. Under the reliance theory, although it may be justifiable to apply the expectation measure rule, there may nevertheless be cases where it significantly overcompensates for reliance loss. An example might be where a party makes a contract and then immediately repudiates it. Here the other party may well not yet have acted in reliance on the contract in such a way as to incur any opportunity cost.17 It is worth asking whether in a case of this sort the expectation measure seems excessive, in the sense that it goes beyond what seems, in an intuitive way, a fair and reasonable measure of recovery. The reason for asking this is not to compare the two approaches according to a crude test of fairness. The point is that contracting is a practice designed to give effect to the parties’ own intentions, so one might expect contracting parties to have a rough sense of the legal position created by their agreement, and given that (as the orthodox analysis assumes) the remedy should be consonant with the primary relation created by the agreement, one might expect this to include what remedy is appropriate. If contracting parties sometimes take the view that the expectation measure is excessive—that the claimant has got a lucky windfall—the implication is that the orthodox analysis is at odds with the understanding that contracting parties have of their own agreements. My sense is that sometimes this will be the case, but for 17 In such a case, the measure of recovery is likely to be reduced under the doctrine of mitigation, and it is open to question whether this is consistent with the orthodox analysis. Atiyah regarded this as a particular strength of the reliance approach: P Atiyah, Essays on Contract (Oxford, Clarendon Press, 1986) 124.

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obvious reasons I will not make too much of this.18 The point comes up in a different way below.19 In my view, the opportunity cost argument can explain the expectation measure rule. Nevertheless, if we are concerned only to account for this rule, there is little reason to adopt the reliance theory. The orthodox analysis provides a simpler and more direct explanation. This may be the main reason for scepticism about the reliance theory, because damages are in practice the main focus of the remedial regime in contract. The reliance theory comes into its own when the focus is widened to encompass remedies other than damages. The arguments below imply that in contract the remedial regime as a whole is best explained in terms of the reliance theory, which means that, if damages are to be understood as part of a single coherent regime, they should be understood in this way as well. The discussion of damages and the opportunity cost argument in this section suggests that this is at least a possible interpretation of the law.

IV

T H E PRO B L E M O F S P E C I F I C P E R F O R M A N C E

Specific performance is not generally available to enforce a contract; generally a claimant is confined to damages. The basic rule is that specific performance is available where ‘damages are inadequate’.20 One might think that if specific performance is available where damages are inadequate, the claimant is necessarily adequately protected, and so the absence of a general right to specific performance is not of great consequence. However, the absence of specific performance is an important feature of the law. First, the measurement of damages can be haphazard, and it is always possible that it will not reflect the claimant’s true loss (whatever the measure); but if he has a right of specific performance he can waive it for an agreed sum that he is satisfied does truly cover his losses. More importantly, if the claimant has a right to specific performance, he may be able to secure a payment in return for a waiver of specific performance that exceeds the actual value to him of the performance of the duty. The amount of the payment would in practice depend on the benefit the defendant might make if he were freed from the contract. In effect, it gives the claimant a claim to some part of the benefit that the defendant would be able to obtain if he were not bound by the contract. Thus, if specific performance were generally available, the practice of contracting would be quite different from the practice we are familiar with. 18 Atiyah also points to empirical evidence suggesting that commercial contractors often do not assume that the expectation measure is appropriate: ibid, 172. 19 See text at n 47. 20 The leading modern case is Co-operative Insurance Society v Argyll Stores [1998] AC 1 (HL).

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The absence of a general right to specific performance presents a problem for the orthodox analysis. Under the orthodox analysis, the argument for the expectation measure as the basic measure begins from the position that the defendant has a primary duty to perform the contract. The expectation measure is justified because it represents the value of the performance to which the claimant is entitled. However, if the defendant has a duty to perform the contract, one would think that the court should, as a rule, order him to perform it. There is an inconsistency between the orthodox analysis and the actual law of contract in this important matter. Some may think this an obviously misconceived point. It is often thought that the remedial question is quite separate from the primary relation. The defendant may have had a primary duty to perform, but this does not mean that he has a remedial duty to render specific performance and that he should be ordered to perform. But this goes against the argument for the expectation measure above. If the rationale for the expectation measure is, so far as is possible, to fulfil and give effect to the duty of performance, the same argument surely implies that, as a general rule, there should be a remedial right to specific performance.21 One might also point out that it is commonplace for the defendant to have breached a legal duty and yet not to be ordered to perform it. Often this is because it is now impossible or because it would be unduly burdensome. This is the case, for example, where the defendant caused personal injury or property damage by the breach of a duty of care in tort. It is obviously impossible to order the defendant now to perform the original duty not to act in the way that caused the harm. It is also sometimes the case in contract, as, for example, where information has been disclosed that the contract provided should be kept confidential. More commonly, though, the position after the defendant has failed to perform a contract is more or less the same as it was beforehand, and if his failure to perform was a breach of duty, there is no reason why the court should not still compel him to perform that duty.22 Take the case of an ordinary supply contract. The defendant has contracted to supply goods, and has failed to do so. The position is (let us say) just as it was: not impossible or even any more burdensome for the defendant than it was before he failed to perform. Can one say that the defendant really had a contractual duty to perform at all in those circumstances, if the court now declines to order him to perform (assuming that the claimant seeks such an order)? In reality the position is that the defendant can negate his

See further Jaffey, above n 5, ch 2. The position may be quite different when the matter reaches court; if specific performance is then impossible or inappropriate, the court’s response should, if it is to be consistent with the orthodox analysis, reflect in other ways the characterisation of the defendant’s conduct as wrongful, for example by disgorgement, as considered below. 21 22

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duty by not performing it, which amounts to saying that he has no duty at all.23 One might object that if the defendant has not committed a breach of duty, there can be no reason to hold him liable in damages either. But in my view it is a mistake to think that a claim in private law always arises from a wrong or breach of duty by the defendant. Sometimes a claim does indeed arise because the defendant committed a wrong by failing to act as he was legally required to act, but there are also claims not based on a breach of duty, which do not arise as a result of the defendant’s having failed to act as he was legally required to act. In such cases there is a ‘primary liability’ rather than a primary duty.24 Where there is a primary liability, the law allocates responsibility for loss in certain circumstances, without imposing a duty to avoid the loss or prevent it. In my view, non-performance of a contract can be and typically is an event that generates a claim against the defendant by virtue of a primary liability rather than a primary duty. This analysis gains support from the character of some of the arguments in the literature and case law against the general availability of specific performance. It is argued, for example, that it is in the public interest to promote wealth generation through contracting,25 and that this will be achieved if contracting parties are not compelled to perform; or that it is fair to allow a party to withdraw because if the parties had applied their minds to the issue they would have agreed to such an arrangement.26 However they are framed, in substance these arguments do not go to purely remedial questions. The concern is not that the remedy of specific performance is not the appropriate response to the breach of duty, but that the defendant should be at liberty not to perform, subject only to a liability for compensation to the other party. In other words, they imply that the primary relation is what I have called a primary liability relation, not a primary duty relation. This distinction between a primary duty and a primary liability presupposes that a duty is a genuine requirement to act, not merely a condition for a claim or remedial liability to arise. ‘Duty’ is often understood in the latter sense, but this is an artificial or fictional sense that corresponds to what I have called a primary liability rather than a primary duty. If ‘duty’ is understood in this sense, a distinction appears necessary between a genuine and a merely technical or formal wrong. One might say that the Atiyah makes this point in connection with mitigation: Atiyah, above n 17, 124. A primary liability is not the same thing as a ‘strict liability duty’. See further P Jaffey, ‘Duties and Liabilities in Private Law’ (2006) 12 Legal Theory 137, and Jaffey, above n 5, 22–9. In other situations the primary liability may not be concerned with loss. 25 For an account of the theory of ‘efficient breach’, see eg D Harris, D Campbell and R Halson, Remedies in Contract & Tort (London, Butterworths, 2nd edn, 2002) 11–21. Efficient breach is discussed briefly below. 26 Ibid, 227. 23 24

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non-performance of a contract is a technical or formal wrong; or that it is not generally wrongful to commit a breach of a duty of performance in contract; or that, though wrongful, it is not ‘illegitimate’.27 But in the true sense of ‘wrong’ and concomitantly of ‘duty’ it is surely inconsistent to say that a legal wrong or the breach of a legal duty is not illegitimate in law, or that the law should not treat it as a wrong. This usage obscures the important distinction between two different types of legal rule: one that imposes a requirement to act by way of a primary duty, and one that, by way of a primary liability, provides for a claim to arise against the defendant in specified circumstances that do not involve a breach of duty by him. Why should the primary relation in contract consist in the usual case of a primary liability rather than a primary duty, leaving contracting parties at liberty not to perform? It is explicable on the basis that, rather than giving a contractor in the usual case a right to performance (correlated with a duty of performance), contract law confers a right of protection for contractual reliance. This means that a contracting party should not generally have a duty to perform the contract, because generally giving the other party a right to actual performance of the contract exceeds what is necessary to protect him in respect of his contractual reliance; compensation will be sufficient. A contracting party should generally be at liberty not to perform, though subject to a liability to satisfy the claimant’s reliance loss by way of damages if he chooses not to perform. However, under the reliance theory, the defendant should incur a duty to perform when the circumstances are such that only actual performance, as opposed to pecuniary compensation, can ensure that the claimant is protected against reliance loss. Where the contract is an ordinary contract for the supply of goods, say, there is no problem in protecting the claimant adequately by pecuniary compensation in the expectation measure, which will enable him to acquire substitute goods on the market. But consider the case where the contract is for the supply and maintenance of specialised software produced only by the defendant.28 Once the software has been installed in the claimant’s business and the claimant has adapted his business to use it, he cannot obtain a substitute and is dependent on the defendant for maintenance. There is no market that can (at least in the short term) provide the claimant with the benefit he contracted for, and if the claimant does not receive actual performance he is liable to end up worse off than if he had never made the contract at all, to some possibly dramatic extent that may be difficult to determine. The defendant should be ordered to perform (at least for a reasonable period), because only actual performance secures adequate protection for the claimant’s reliance 27 28

430.

This is the approach taken in Harris et al, ibid, 12–20. See H Collins, The Law of Contract (London, LexisNexis Butterworths, 4th edn, 2003)

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loss.29 Specific performance is appropriate for the same reason where the claimant has transferred property to the defendant subject to a negative covenant covenant constraining the defendant’s behaviour which by its nature cannot be performed by anyone else;30 where the defendant has transferred a business to the defendant subject to a liability to make a regular payment to a third party;31 where the defendant’s contractual performance is intended to protect against a risk of harm to the claimant; or where the contractual provision in question is a restriction on the release of sensitive information.32 In my view, this is the explanation of the ‘damages are inadequate’ test for specific performance. The test does not pertain to whether in the particular circumstances specific performance is the appropriate remedy for a breach of duty, but to whether the defendant has incurred a duty to perform. The test makes no sense under the orthodox analysis, because under the orthodox analysis the defendant always has a duty to perform and there is no reason why, as a general rule, he should not be ordered to perform. I am not suggesting that this formulation of the law in terms of primary liabilities and the protection of contractual reliance corresponds to the ordinary language of contract law. My point is that this understanding of contract law explains the usual rule on specific performance and the orthodox analysis does not. And this is not the only aspect of the law of contract that is better explained by the reliance theory.

V

T H E P RO B L E M O F ‘ D I S G O R G E M E N T ’

A closely related and currently topical problem for the orthodox analysis is the newly developing law of disgorgement in contract. By ‘disgorgement’, I mean the removal of a benefit received by the defendant as a result of a wrong, pursuant to the principle that a wrongdoer should not be allowed to benefit through his wrongdoing—the disgorgement or ‘wrongdoer’s profits’ principle. This is surely an entirely sound principle, though it is not consistently recognised in the law. One reason for this may be that disgorgement is not, in a strict sense, a remedy at all, because it is not designed to fulfil or protect the primary relation. Its function is to prevent the defendant from profiting through wrongdoing, which promotes the public interest rather than protecting the claimant’s private interest. This is 29 For a case along these lines, see Sky Petroleum v VIP Petroleum [1974] 1 WLR 576 (Ch); cf. Freeman & Mills v Belcher 900 P 2d 669 (Cal 1995). 30 The case of negative obligations was discussed in Blake in the Court of Appeal [1998] 2 WLR 805. 31 Beswick v Beswick [1968] AC 58 (HL). 32 See further P Jaffey, ‘Disgorgement and “Licence Fee Damages” in Contract’ (2004) 20 Journal of Contract Law 57.

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why disgorgement gives the claimant a windfall, and why it is sometimes considered anomalous in civil proceedings.33 I will assume here that it should in principle be available. In contract, disgorgement is in issue where the defendant has acted wrongfully in failing to perform a contract and has profited as a result, for example by making an alternative more lucrative contract.34 Traditionally disgorgement in this sense has not been available in contract; the position has been that a contracting party who does not perform can keep any profit made after satisfying his liability for compensation. But it seems clear that disgorgement was in issue and was allowed in Attorney-General v Blake.35 Disgorgement understood in this sense is sometimes conflated, under the head of ‘unjust enrichment’ or ‘restitution’, with two other, quite distinct types of claim or measure. (These are the three distinct claims or measures mentioned above that are often described as restitutionary.) First, there is what is variously called licence fee damages, hypothetical bargain damages, restitutionary damages, Wrotham Park damages or claims under the user principle.36 These are damages in the form of a sum that might reasonably have been agreed between the parties as the price of non-performance, usually measured as a small fraction of the benefit gained by the defendant through non-performance.37 This measure cannot be explained in terms of the principle that a wrongdoer should not be allowed to profit through a wrong; if this is the principle at issue, it makes no sense to remove only a fraction of the profit. Licence fee damages are distinct from disgorgement, and they cannot be satisfactorily understood as variants of the same sort of measure or remedy.38 They are best understood in the light of their origin in cases concerning the unauthorised use of property. I will not discuss them further here.39 Secondly, there are the claims that sometimes arise when a claim for expectation damages is See further Jaffey, above n 5, 61–3. Or where he has withdrawn from the contract because performance has become so expensive for him that it would be cheaper to pay damages instead. 35 [2000] 3 WLR 625. The expression used in Blake was ‘account of profits’, but not all cases of accounts of profits are cases of disgorgement, and conversely disgorgement is sometimes effected in the form of a constructive trust or in some other form. 36 Wrotham Park Estates v Parkside Homes [1974] 2 All ER 321 (Ch). ‘User principle’ was used in Stoke City Council v Wass [1988] 1 WLR 574. 37 On top of any loss, if any, suffered by the claimant. 38 Though this is the view taken in Blake and later cases, and also by A Burrows, ‘Are “Damages on the Wrotham Park Basis” Compensatory, Restitutionary or Neither?’, this volume, under the influence of the theory of unjust enrichment. Burrows attributes the distinction between restitutionary damages and disgorgement to J Edelman, Gain-based Damages (Oxford, Hart Publishing, 2002). It is also found in P Jaffey, ‘Restitutionary Damages and Disgorgement’ [1995] Restitution Law Review 30. See also D Friedmann, ‘Restitution of Benefits Obtained through the Appropriation of Property or the Commission of a Wrong’ (1980) 80 Columbia Law Review 504. 39 I have discussed them elsewhere: P Jaffey, The Nature and Scope of Restitution (Oxford, Hart Publishing, 2000) ch 4 and above at n 32. 33 34

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unavailable, or as an alternative to it, to recover a payment made under the contract or for payment for work done under the contract. These claims have long been available, though controversy surrounds them. They are usually described as restitutionary claims, though unfortunately this expression is sometimes understood to cover disgorgement and licence fee damages as well. I will come back to them below. To return to disgorgement, under the orthodox analysis there is always a duty to perform the contract, and a failure to perform is always wrongful (unless the contract has been frustrated). Once the wrongdoer’s profits principle is accepted, it follows that disgorgement should be available whenever a contractor has profited by not performing. If this position were accepted, there would be a dramatic effect on the law of contract; by removing the incentive to withdraw from the contract, it would tend to have the same effect as allowing specific performance. Blake did not suggest that disgorgement should be generally available in contract, but it left the position unclear, and the possibility that contract law might be moving in this direction was a matter of concern for some commentators.40 Under the influence of the literature on restitution and unjust enrichment, it has sometimes been thought that the availability of disgorgement should be analysed under a general framework for ‘unjust enrichment for wrongs’, as part of a theory of unjust enrichment, and on this basis the approach seems to be to ask which wrongs should attract disgorgement, or in what circumstances a wrong should attract disgorgement.41 This has not proved to be a fruitful approach, and, furthermore, it has diverted attention away from what is really the crucial question, which is when it is wrongful not to perform a contract. This is the natural question to ask with respect to disgorgement in contract, but it is ruled out by the orthodox analysis. However, the reliance theory makes sense of it and provides an answer. Under the reliance theory, disgorgement is not appropriate in the ordinary case, because in the ordinary case there is no duty to perform and contracting parties are free to choose not to perform. Disgorgement is appropriate only where the defendant incurred a duty to perform and so might have been subjected to an order of specific performance, but such an order was not feasible, was refused for some other reason, or was not sought. The test for disgorgement should be, as for specific performance, whether, at the time when the defendant failed to perform, actual performance was necessary to protect the claimant against reliance loss: in other words, the adequacy of damages test. Thus the examples of specific 40 See D Campbell and D Harris, ‘In Defence of Breach: a Critique of Restitution and the Performance Interest’ (2002) 22 Legal Studies 208. 41 This approach is derived from P Birks, An Introduction to the Law of Restitution (Oxford, Clarendon Press, rev edn, 1989) ch X.

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performance given above are apt here also. There is support for the adequacy of damages test in the judgments in Blake.42 In that case, the defendant released sensitive information contrary to his contract with the claimant. It is clear that a contractual provision against releasing sensitive information must take effect as a primary duty, not as a primary liability, because compensation is an inadequate remedy. The adequacy of damages test has sometimes been misunderstood. It might be thought to be based on the idea that disgorgement is a crude measure of compensation for loss and serves as a proxy for ordinary compensatory damages where the actual measure cannot be readily measured, just as the reliance measure can sometimes act as a proxy for the expectation measure or vice versa. But it is implausible to think that the measure of the benefit received by the defendant can be an appropriate proxy for the claimant’s loss. There is no necessary connection between the two at all.43 The function of disgorgement is not to provide a substitute compensatory remedy for a breach of duty, but to remove the profits of wrongdoing (actually giving the claimant a windfall). Accordingly, as discussed above in connection with specific performance, the test serves to determine not what remedy is appropriate for a breach of duty, but whether the defendant had a duty of performance or was at liberty not to perform.

VI

T H E B A S I S O F T H E RE L I A N C E T H E O RY

Contract is based on agreement. The contracting parties themselves create the legal relation between them, on terms determined by them, by their agreement, in order to regulate an exchange or other transaction between them. Nowadays one would say that they exercise a normative power to create the relation; at one time the same point would have been expressed under the ‘will theory’ by saying that the contract arose by ‘act of will’. More particularly, an agreement is generally understood as an exchange of promises or undertakings: the parties say, ‘Party A hereby undertakes a duty to do X, and Party B hereby undertakes a duty to do Y’. This seems to imply, unless we deny that contracts are based on agreement, that the primary relation in contract law must be a duty of performance, and a contractual claim must be a claim arising from a wrong in accordance with the orthodox analysis. It appears to follow from this, as noted earlier in the discussion of the expectation measure, that a claim for compensation for reliance loss cannot be a contractual claim (except where the reliance measure is used [2000] 3 WLR 625, 639 (Lord Nicholls). These points are discussed by R Cunnington, ‘The Measure and Availability of Gain-based Damages for Breach of Contract’, this volume. 42 43

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as a proxy for the expectation measure), because compensation for reliance loss does not remedy the failure to perform the contractual duty to the claimant. Instead, it seems, claims for reliance loss must arise in tort, from a tortious principle of liability for reliance. Then the issue is presumably whether it is reasonable in the circumstances for the defendant to be responsible for the claimant’s reliance loss, taking account of whether the defendant acted reasonably in inducing reliance from the claimant and whether the claimant acted reasonably in relying on the defendant.44 If, as the reliance theory of contract holds, all the claims generally described as contractual are actually claims in respect of reliance loss, then what is on the surface a distinct body of contract law is in reality no more than an aspect of tort law. So-called contract claims are really tort claims, and the parties’ agreement is relevant to a claim only in an indirect way as a factor going to the reasonableness of the parties’ actions. The terms of the agreement have only a crude influence on the legal position, and indeed it is not crucial whether there is actually an agreement or not. Following this line of argument, some commentators equate the reliance theory with the theory of ‘contract as tort’ or ‘death of contract’.45 This version of the reliance theory is thoroughly implausible, and is completely at odds with the usual understanding of contract. I will argue in favour of a different version of the reliance theory,46 which recognises the fundamental role of agreement in contract law. An agreement can be understood as a different sort of commitment, by which the parties do not undertake duties to perform as the orthodox analysis assumes. Instead, their agreement should be understood in the following sense: We each of us, A and B, hereby accept responsibility for the reliance incurred by the other party in proceeding on the assumption that Party A is to do X and Party B is to do Y.

This is an agreement-based approach. It involves the creation of a legal relation between the parties by the exercise of a normative power or ‘act of will’, but it is not an exchange of promises or undertakings, at least not in the usual sense, and it is certainly not an exchange of promises or undertakings to carry out the specified contractual performance, X and Y. It amounts to a different understanding of what a contractual agreement means, and what sort of commitment it creates. As argued above, the reliance interpretation supports the remedial regime that we actually find in the law of contract, whereas the first interpretation, which corresponds to 44 See Smith, above n 11, 81–2; M Spence, Protecting Reliance (Oxford, Hart Publishing, 1999) 25–65. 45 This approach is associated with Atiyah and Gilmore, above n 10. Smith equates the reliance theory with this approach: see Smith, ibid, 44. 46 I have presented this previously, Jaffey, above n 10. There are, of course, other aspects of contract law that I have not discussed here that might be thought to count in favour of or against the reliance theory.

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the orthodox analysis, on the face of it supports a stricter regime under which specific performance and disgorgement are available as a matter of course. Is this reliance interpretation a realistic understanding of a contractual agreement? Surely when contracting parties make their agreement they make promises or give undertakings to carry out the performance specified? Whatever the language contracting parties use in making their agreements, and however it is described by their lawyers, if contracting parties are familiar with the actual remedial regime in contract, and consider it to be consonant with their agreement, the implication is that the reliance interpretation of the agreement does reflect what they intend.47 One might then ask, why should contracting parties contract in this way, by making an agreement in the form of mutual acceptance of responsibility for reliance rather than by way of an exchange of promises or undertakings to perform? These two forms of agreement are two ways for parties to coordinate or regulate an exchange or other transaction between them.48 The orthodox understanding of agreement, according to which the contracting parties make promises and incur duties of performance, so that specific performance and disgorgement should in principle be generally available, gives them a greater degree of security of actual performance than the reliance version. Under the reliance version, it is generally possible for a party to withdraw from the contract, subject to the payment of damages, so there is more flexibility for a contracting party with respect to his own performance. A contracting party will generally prefer flexibility for himself, and he will presumably be willing to accept a lower price for his performance in return, and if the other contracting party prefers to pay a lower price and accept the lower security of performance that goes with the reliance form of agreement, then this form of agreement will be a preferable arrangement for these parties. If the current contractual regime reflects business needs and expectations, it seems reasonable to infer that this is the position for contracting parties in general, and that the law has developed to reflect this. This account will be familiar as a version of the law-and-economics theory of ‘efficient breach’ of contract,49 but problems arise in the way that the theory of efficient breach is usually expressed. According to the usual formulation, a contracting party is in the usual case legally at liberty not to perform the contract, in order to avoid the performance of inefficient contracts; but at the same time it is assumed that a contract arises 47 Cf the above concerning the expectation measure discussed above in the text leading to n 19. 48 It might be more accurate to say that there are a range of possible regimes reflecting different ways of balancing the opposing factors. If so, these would have to be understood under the umbrella of the reliance theory. 49 See n 25.

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from an exchange of promises giving rise to duties of performance, so that the contractor commits a breach of duty by not performing. This formulation is implicit in the expression ‘efficient breach’. Expressed in this way, the argument is open to a powerful objection: it appears to be self-contradictory, since it implies that at one and the same time a contracting party has a duty to perform and also a liberty not to perform.50 Opponents of the theory of efficient breach have seized on this inconsistency and argued, in accordance with the orthodox analysis, that contracting parties are not in principle free to withdraw from the contract, though the traditional remedial regime may not properly reflect this,51 and the implication is that the remedial regime in contract should be tightened up to make specific performance and disgorgement generally available. The economic argument for ‘efficient breach’ would not be vulnerable to this objection if it abandoned the idea that agreements ordinarily generate duties of performance. What it requires instead is the concept of an agreement that gives rise to liabilities in the sense above rather than duties, so that being bound by a contract is consistent with a liberty not to perform it (subject to a liability for compensation), and the law can provide incentives not to perform the contract without providing incentives to act wrongfully. This is what the reliance theory offers.52 Although the economic analysis of law is invariably understood to be opposed to the reliance theory, this is at least in part because the reliance theory is understood along the lines of the ‘death of contract’ theory, which is antagonistic to agreement as the basis for contract law, and more particularly to the freedom of contracting parties to determine for themselves the terms on which they contract.

VII

CL A I M S I N T H E ‘ R E S T I T U T I O N M E A S U R E ’

There is another controversial aspect of contract law that provides support for the reliance approach to contract law. Usually a contractual claim is for expectation damages resulting from the defendant’s failure to perform. According to the orthodox analysis, the defendant has breached his duty of performance and the expectation measure follows directly; according to the 50 One might say instead that, although a contracting party acts wrongfully by breaching his contract, nevertheless the law should give him an incentive to do so by withholding specific performance and disgorgement: see A Ogus, ‘The Economic Basis of Damages for Breach of Contract: Inducement and Expectation’, this volume. But it surely cannot be right to say that the law should impose on D a duty to do X but also give him an incentive in some circumstances not to do X. Another approach treats the law purely as a matter of incentives, and avoids any recognition of legal relations or duties at all. 51 Eg D Friedmann, ‘The Efficient Breach Fallacy’ (1998) 18 Journal of Legal Studies 1; LD Smith, ‘Disgorgement of the Profits of Breach of Contract: Property, Contract and “Efficient Breach”’ (1994) 24 Canadian Business Law Journal 21. 52 I am not, of course, suggesting that the two can be equated with each other.

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reliance theory, in the usual case the defendant has not breached a duty of performance, but he is responsible for the claimant’s reliance loss and the expectation measure is an appropriate proxy measure. There are circumstances in which, as mentioned above, the claimant has a different sort of claim, commonly referred to as a restitutionary claim or claim in the restitution measure, of which the standard examples are the claim to recover a payment made under the contract53 and the claim for reasonable payment for work done under the contract.54 It appears that where the claimant has a claim for damages in the expectation measure in respect of goods or services supplied he may also have a claim of this sort as an alternative,55 though generally the expectation measure will be preferable for him. Possibly a claim of this sort can arise in favour of a party who has himself failed to perform, if the other party, having received a benefit from the contract, would otherwise be left with a benefit that he has not paid for—the so-called ‘wrongdoer’s claim’.56 However, the situation where claims of this sort seem most often called for is frustration. It seems right that a claim should arise when the claimant has paid the defendant in advance and the defendant has not begun performance by the time of frustration, and similarly when at the time of frustration the claimant has done work for the defendant but no liability for payment has yet accrued under a contractual payment clause, and of course there are less clear-cut and more complex variations and combinations of these situations where a claim may seem justified as well. I will not consider precisely the circumstances in which claims of this sort are available under English law. For present purposes what is relevant is the basis, as a matter of principle, on which such claims can arise.57 Under the orthodox analysis, it would appear that there is no basis for them in principle. They cannot be contractual claims under the orthodox analysis because they do not serve as remedies for the primary duty of performance. They do not put the claimant in the position he would have been in if the contract had been performed. Furthermore, in the case of frustration or the wrongdoer’s claim, the defendant has not committed a breach of duty.58 The historic position with respect to frustration was Eg Ebrahim Dawood Ltd v Heath (Est 1927) Ltd [1961] 2 Lloyds Rep 512 (QB). Eg Powell v Braun [1954] 1 All ER 484 (CA); Planché v Colburn (1831) 8 Bing 14 (CA). The expression ‘restitution’ is apt for the case where the claimant recovers a prepayment, or more generally where the remedy serves to restore money or property transferred or its value. It is not so apt where the remedy is reasonable payment for supplying goods or services, ie a quantum meruit. Here the effect of the remedy is to complete an exchange of payment for goods or services—in the case of contractual part performance, part of the exchange envisaged under the contract—rather than reversing a transfer: see further Jaffey, above n 39, 41ff. 55 For a recent discussion, see J Bailey, ‘Repudiation, Termination and Quantum Meruit’ (2006) 22 Construction Law Journal 217. 56 The leading case of Sumpter v Hedges [1898] 1 QB 673 (CA) denies this, though there is some support for it elsewhere, eg Miles v Wakefield MDC [1987] AC 539 (HL). 57 There is a fuller account of the argument in Jaffey, above n 39, ch 2. 58 Birks, above n 9. 53 54

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largely to allow losses to lie as they fall,59 which is consistent with the orthodox analysis; but in the end it became clear that sometimes this was unfair and a claim should arise, and for many years there has been a statutory regime in English law providing for claims on frustration.60 The difficulty in accounting for these claims under the orthodox analysis goes some way to explain why, where they are allowed, they are nowadays widely regarded as unjust enrichment claims, outside the law of contract. Here, as in other situations, the description of the claims as restitutionary is now taken to imply this. I will come back to this argument; first, I will consider what seems to me the far more plausible suggestion that they are contractual reliance claims. According to the reliance theory, the contract allocates to each party responsibility for loss incurred by the other party in reliance on the agreed basis for proceeding under the contract. A contracting party who departs from his specified performance, though he has not in the usual case acted wrongfully, incurs a liability to compensate the other for his reliance loss. In a case of frustration, the circumstances were not contemplated in the contract, and responsibility for reliance loss when the contract terminates in those circumstances has not been allocated to either party. But, given that the parties have accepted a mutual responsibility for reliance loss, it seems right that this risk should be shared, and the parties’ reliance losses should be redistributed evenly between them. For this type of claim, there is no reason to operate an evidential presumption favouring the claimant, which would justify the expectation measure as a proxy measure of reliance loss. If a benefit has been received by one of the parties or both of them, this should be factored into account as well; in general, there should be a claim that depends on an overall ‘accounting’, so far as possible, of the losses and benefits of the two parties under the contract. This seems the natural implication of an agreement involving the mutual acceptance of responsibility for reliance loss. It explains the basis in principle for claims arising on frustration, and it can account also for a claim arising as an alternative to an expectation damages claim, or in favour of a non-performing or wrongdoing party, to the extent that the other party has been left with a benefit that exceeds his contractual expectation.61

Cutter v Powell (1795) 6 TR 320 (KB); Whincup v Hughes (1871) LR 6 CP 78 (CP). Law Reform (Frustrated Contracts) Act 1943. It is also sometimes thought that a claim arising from a contingency not allocated by the contract, meaning not actually dealt with in the contract by the parties expressly or by implication, cannot be contractual and so must be an unjust enrichment claim; this seems to be the assumption, for example, in J Beatson, ‘The Temptation of Elegance: Concurrence of Restitutionary and Contractual Claims’ in W Swadling and G Jones, The Search for Principle (Oxford University Press, 1999), 152. But all contracts leave some contingencies unaddressed and it is a principal task of contract law to determine what the consequences should be if such a contingency arises. 59 60 61

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However, as I said, there is now support, in the courts as well as in the academic literature, for the view that these claims are not contractual, but unjust enrichment claims.62 The problem in invoking unjust enrichment to explain why these claims arise is not just the vagueness in the idea of unjust enrichment.63 The problem is to discern a non-contractual principle or rationale for a claim arising from the receipt of a benefit in these circumstances.64 In other words, it is difficult to see what the content and basis of the primary relation might be, or the injustice arising by virtue of it, if it does not lie in the contract, and there is nothing in the literature on the supposed principle of unjust enrichment that gives any indication of what sort of non-contractual injustice might be at issue in this type of case.65 It is often said that the ‘unjust factor’ is ‘failure of basis’ or ‘failure of condition’, but, in the end, this seems to mean that there has been a departure from the basis on which the parties agreed to proceed. Even disregarding the suggested reliance theory analysis, it seems evident that this is in essence a contractual basis for a claim. It is only if one assumes, in the light of the orthodox analysis, that no claim can arise from a contract apart from a claim for expectation damages based on a wrong that it seems necessary to characterise the claim as non-contractual. The reliance analysis shows how there can be a claim in contract that does not arise from a wrong and is not for expectation damages. The point is illustrated by the two recent cases discussed below. Another awkward consequence of the unjust enrichment approach is that it implies that there are two quite distinct remedial regimes governing claims arising from the breakdown of a contract, and the issue arises of how the two regimes interact. On the contractual reliance approach, a contractual claim always serves to protect contractual reliance, though in varying ways according to the circumstances. In the ordinary case of expectation damages, the expectation measure is a proxy for the reliance measure, in circumstances where the defendant bears responsibility for the claimant’s reliance loss and it is justified to apply a presumption that favours the claimant; where the court orders specific performance, this is 62 It is the position commonly taken in the restitution textbooks, and it represents the current trend in the courts, illustrated by the cases discussed below, Roxborough v Rothmans [2001] HCA 68 (HCA) and Cressman v Coys of Kensington [2004] 1 WLR 2775 (CA). There is also authority for a contractual analysis: eg Dies v British and International Mining and Finance [1939] 1 KB 724 (KB). 63 This is the usual criticism directed at the theory of unjust enrichment: a much-cited example is Baylis v Bishop of London [1913] 1 Ch 127 (CA) 140 per Hamilton LJ. 64 The theory of unjust enrichment calls for some principle that can account for the whole range of ostensibly different claims arising from the receipt of a benefit. This point is developed in Jaffey, above n 39, especially ch 8. 65 In addition, it appears that a claim can arise without any actual benefit having been received by the defendant where work is done by the claimant the benefit of which has not actually accrued to the defendant by the time the contract terminates: Planché v Colburn (1831) 8 Bing 14 (CA). Of course, this presents no problem for the reliance theory.

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because the defendant became subject to a duty of performance in order to protect the claimant from uncompensatable reliance loss; where the court orders disgorgement, this is because the defendant profited from the breach of such a duty; and where the claim is in respect of expenses incurred, for reasonable payment for work done or to recover a prepayment, it is a simple contractual reliance claim (incorporating where necessary an overall accounting of benefits and losses). Furthermore, under the unjust enrichment approach these supposed unjust enrichment claims arising out of a contract are treated under a standard framework that is also supposedly applicable to quite different types of claim that have no connection with contract law, including claims to recover a mistaken payment, equitable proprietary tracing claims, maritime salvage claims, claims to recover overpaid tax and claims in respect of mistakenly provided services, as if these claims have more in common than the various types of claim that arise out of a contract.66

VIII

T H E E X P ECTAT I O N M E A S U R E CAP AN D T H E ‘ CO N T RAC T UAL VA L UAT I O N ’

Say the claimant has made a bad bargain, meaning that the value of the benefit of the performance rendered or to be rendered to him falls short of the cost to him of his own performance. The claimant may have agreed to pay a price that turns out to be higher than the value to him of the goods and services provided to him, or he may have agreed to provide goods or services at a price that turns out to fall short of his cost of providing them. If the contract is completed, the claimant will make a loss, and at some stage during his performance his reliance loss will exceed the expectation measure. Under the orthodox analysis, it is clear, as mentioned earlier, that if the defendant breaches the contract the claimant cannot escape from the bad bargain by recovering for reliance loss in excess of the expectation measure. The defendant is liable only for loss caused by his breach, not for loss that the claimant would have suffered anyway as a result of entering the contract. If the claimant makes a claim for the reliance measure, it will be treated as a proxy for the expectation measure and capped accordingly. To put it another way, the claimant cannot escape from the contractual allocation of risk, which allocates to him the risk that his costs might be higher than he had envisaged when he made the contract, or that the value of the benefit he contracted for might be less. 66 The restitution textbooks on the whole treat all or most of these under a single framework purportedly governed by a common principle.

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One might think that enforcing the allocation of risk and preventing the claimant from escaping from a bad bargain through a claim for reliance loss is necessarily linked to the orthodox analysis. Under the orthodox analysis, remedies are designed to put the parties in the position they would have been in if the contract had been performed. In effect, the remedial regime simulates, as far as it can with pecuniary remedies, the completion of the contract, and therefore necessarily gives effect to the contractual allocation of risk. Under the reliance theory, by contrast, the claimant can claim for reliance loss as such, not as a proxy for expectation loss, and so it seems that he should not be subject to the expectation measure cap. It is said that, rather than ‘looking forwards’ to the position contemplated in the terms of the contract, the reliance theory ‘looks backwards’ to the position as it was or would have been if the contract had not been entered into. Thus the claimant should be able to escape from a bad bargain and undo the contractual allocation of risk.67 This is presumably the position under the death of contract version of the reliance theory, but in fact it is not the case under the agreement-based version suggested above. Under the agreement-based version, the contracting parties each accept responsibility for the other party’s loss in reliance on the agreed basis for proceeding, which specifies the performance of each party. However, it is implicit in this that each party has accepted responsibility for the other’s reliance loss measured in the light of the envisaged exchange, which means that reliance loss should be measured on a contractual scale or contractual valuation that equates the claimant’s total envisaged reliance loss, if he were to perform the whole contract, with the value of the benefit he would receive from the completed contract. Thus the measure of reliance loss should be determined as a proportion of the total envisaged reliance loss and then translated into a proportion of the value of the expected benefit, and consequently the measure of recovery cannot exceed the expectation measure.68 This means that reliance loss has an artificial sense, amounting to the reliance loss that the claimant would have suffered if the circumstances had been as they were perceived or envisaged to be at the time of the contract. This agreement-based version of the reliance theory does give effect to an allocation of risk, though not necessarily by putting the parties in the position they would have been if the contract had been completed. 67 This is rightly what happens when there is a void contract, or a voidable contract is rescinded ab initio. 68 If the claimant has made a payment in advance and the defendant has not performed at all (a total failure of consideration), the claimant can recover the whole payment even if it exceeds the expectation measure. If the defendant has done nothing, he has incurred no reliance loss himself and so the payment he has received is, as it were, entirely surplus to his entitlement under the contract. Here the suggested approach justifies removing it from him and restoring it to the claimant. See further Jaffey, above n 39, 56 ff.

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The idea of a contractual scale or contractual valuation has emerged in the literature on unjust enrichment.69 Some commentators argue that, in the case of a claim for reasonable payment for work done under the contract, a contractual valuation should be applied broadly along the lines suggested above, though the issue is understood to be how to measure the benefit received by the defendant for the purposes of an unjust enrichment claim, not the claimant’s reliance loss.70 The argument appears to be that, although the claim is not contractual, the contract provides convenient evidence of the value placed by the defendant on the benefit he has received. But the contractual valuation is not necessarily a good measure of the actual value of the benefit received, just as it is not necessarily a good measure of the actual reliance loss. (For this reason, ‘valuation’ may be a misleading expression.) Applying the contractual valuation imposes on the parties a valuation consistent with what they agreed when they made the contract, even though the circumstances, and the value of the benefits to the parties, may now be quite different. In this way it enforces the contractual allocation of risk. There is no justification for this if the claim is not contractual. In truth, the recognition that the contractual valuation is relevant in this way amounts to a concession that the claim is really contractual. Other commentators deny that the contract is relevant to the measure of the unjust enrichment claim, on the basis that the unjust enrichment claim is independent of contract.71 This means that the unjust enrichment approach is liable to subvert the contractual allocation of risk,72 and this might be defensible if there is indeed an independent, non-contractual claim. Unfortunately for this approach, it is, as I have said, difficult to find a plausible argument to that effect, and none is provided in the restitution and unjust enrichment literature.

IX

T WO PRO B L E M AT I C CAS E S

Finally it is worth considering a couple of recent decisions of senior courts in which the issues have been dealt with in terms of a principle of unjust 69 See the so-called ‘bargained-for’ test in A Burrows, The Law of Restitution (London, Butterworths, 2nd edn, 2002) 23. Cf Atiyah’s theory of ‘promises as admissions’ in P Atiyah, Promises, Morals and Law (Oxford, Clarendon Press, 1981) 184ff. 70 This was Birks’s view in Birks, above n 41, 288. A distinction is sometimes made between a contractual ‘ceiling’ and a contractual ‘valuation’, which I will not pursue here. 71 This was Birks’s view in P Birks, ‘In Defence of Free Acceptance’ in A Burrows, Essays on the Law of Restitution (Oxford, Clarendon Press, 1991) 136. It is illustrated by the famous US case of Boomer v Muir (1933) 24 P 2d 570; see also Lodder v Slowey [1904] AC 442 (PC). 72 See Harris et al, above n 25, 235ff. It is often said that the unjust enrichment claim cannot arise before contractual termination because this would subvert the contract. But the argument applies equally after termination.

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enrichment but would have been better dealt with in terms of reliance along the lines suggested above. In Roxborough v Rothmans in the High Court of Australia,73 the defendant was a tobacco wholesaler who sold tobacco to the claimant retailer. Under a statutory scheme, the defendant wholesaler paid a fee to the state government for a licence to distribute tobacco, and the defendant passed on a proportionate part of the fee to the claimant retailer as part of the price of the tobacco. The contract between the claimant and the defendant explicitly allocated part of the price to the licence fee. It turned out that the statutory licensing scheme was void as an illegal form of taxation, and the defendant was able to recover the fee it had paid to the state. Now the claimant in turn sought to recover from the defendant the portion of the contract price it had paid that was attributable to the licence fee. It was held that the claimant did have such a claim, but in unjust enrichment and not contract. The claim is readily explained as a contractual reliance claim under the reliance theory suggested above. In the case of a standard claim for expectation damages, the claim arises because the defendant has departed from his own specified performance, and he is responsible for the claimant’s reliance loss. In a case of frustration, where neither party is responsible for the departure from the agreed or contemplated course, the risk should be shared and reliance loss redistributed between the parties, as discussed above. Rothmans is in this respect analogous to the case of frustration. There were unforeseen circumstances that involved a departure from the agreed basis, though the defendant was not responsible for them. Because the circumstances were unforeseen, the risk was not allocated by the contract and so it should be shared between the parties. Reliance loss should be redistributed, which means here reversing the portion of the price paid by the claimant to the defendant in respect of the licence fee. Can the claim be satisfactorily explained instead as an unjust enrichment claim? As I have already mentioned, the problem on this approach is to identify the nature of the injustice or ‘unjust factor’ that generates a claim. Following the approach taken in the unjust enrichment literature,74 the court in Rothmans said that it lay in the fact that there had been a ‘failure of basis’ or ‘failure of condition’, meaning that the claimant had rendered his contractual performance (payment of the price) on a basis that, as it turned out, did not obtain, or subject to a condition that, as it turned out, had not been fulfilled (the licensing scheme).75 But this can only mean that a claim was justified because the circumstances that arose were not contemplated in the contract and so were not covered by the contractual allocation of risk. This is what gives rise to a contractual 73 74 75

[2001] HCA 68 (HCA). Derived in particular from Birks, above n 41, ch VII. Paras 60–1 (Gummow J).

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reliance claim. As I have said already, the reason why it seems necessary to present the claim as a non-contractual, unjust enrichment claim is the misconception that a contractual claim must be a claim for expectation damages arising from a wrong.76 In Cressman v Coys of Kensington in the Court of Appeal,77 the claimant had a car with a personalised registration number. He wanted to sell the car to the defendant, but retain the registration number. According to the applicable statutory provisions, ownership of a registration number passes on the sale of the car unless a form is duly submitted, before the sale, to the statutory authority, the DVLA. It was an express term of the contract of sale to the defendant that the personalised registration number would not pass on the sale, and the defendant would get a substitute number instead. However, the form submitted to the DVLA on behalf of the claimant was defective and ownership of the registration number passed to the defendant.78 It was held that there was no claim in contract to recover the registration number or its value, but there was a claim in unjust enrichment for its value. Again, the claim is easy to explain as a contractual reliance claim under the reliance theory. The contract provided that the registration number would not pass, but it was not part of the defendant’s contractual performance to arrange for this. He was not principally responsible for the claimant’s reliance loss in the way that a contracting party is when he fails to perform (where under the orthodox analysis one would say that he has committed a breach of duty). Nevertheless, the circumstances departed from the agreed basis for the transaction, as a result of which the claimant suffered an additional reliance loss and the defendant received an additional benefit, and this justified a contractual reliance claim, just as in a case of frustration. According to the court, applying the unjust enrichment approach, the ‘injustice’ was that the defendant had received a benefit under the contract that he had not bargained for or paid for,79 which is presumably a more explicit way of putting the ‘failure of basis’ or ‘failure of condition’ argument. This formulation makes it all the more evident that the only relevant injustice is the purely contractual injustice that gives rise to a contractual reliance claim.

76 See P Jaffey, ‘Failure of Consideration’ (2003) 66 Modern Law Review 284. The court rejected a contractual analysis on the ground that there was no implied term to support a claim: cf Beatson, above n 61. 77 [2004] 1 WLR 2775. 78 The sale was by auction, though as far as I can see this does not affect the issues discussed. 79 Para 37. The court thought it relevant that the defendant knew this was the case.

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Peter Jaffey CO N CLUD I N G RE M A R K S O N T H E RE L I A N C E T H E O RY O F CONTRACT AND RELIANCE DAMAGES

I began by discussing contract damages and the opportunity cost argument for the expectation measure, and I concluded that, although the opportunity cost argument can explain the expectation measure rule, if we consider only the law of damages we are unlikely to find a compelling reason to prefer the reliance theory. The orthodox analysis provides a simpler account of the expectation measure rule, but it cannot explain other aspects of the law of contract remedies. Although a contracting party is said to have a duty to perform the contract, consistently with the orthodox analysis, the remedial position in English law implies, to the contrary, that a contracting party is generally free to withdraw from the contract, subject to a liability to pay damages: there is no general right to specific performance or disgorgement. By contrast, the reliance approach explains why the defendant has a duty to perform only in a limited range of cases, to which specific performance and disgorgement should be confined. Similarly the orthodox analysis cannot explain, as a contractual claim, the claim that arises on termination to recover a payment under the contract, or the claim for reasonable payment for work done under the contract. The implication of the orthodox analysis is that these claims are non-contractual, even though they arise from the non-performance of the contract and their justification must lie in the fact that the contracting parties committed themselves to it. Again, the reliance theory provides an account of these claims that shows them to be a natural part of an overall remedial regime based on the protection of reliance. In recent years, the courts have increasingly resorted to the theory of unjust enrichment to supplement the orthodox analysis in these problematic cases. Unfortunately the theory of unjust enrichment does not help in solving them, and furthermore it threatens to undermine the traditional remedial position. It is the reliance theory, in the agreement-based version suggested above, that can solve these problems, and it does so by providing a theoretical basis for the traditional remedial position. I conclude that the reliance theory provides a coherent account of contract claims and remedies, and certainly a better account than what I have called the orthodox analysis, whether or not this is combined with the theory of unjust enrichment. It follows that, although the expectation measure is, and ought to be, the usual measure of recovery in contract, the basic or fundamental measure of recovery in contract is the reliance measure. This conclusion appears implausible so long as the focus is exclusively on damages. It is only when one looks for a general approach to contract that explains the whole body of remedial law that the superiority of the reliance theory becomes apparent.

7 Are ‘Damages on the Wrotham Park Basis’ Compensatory, Restitutionary or Neither? ‘ DAMAGES ON THE WROTHAM PARK BAS I S ’

ANDREW BURROWS* ANDREW BURROWS

I

I NTRO DUCTION

In recent years, English judges and commentators have increasingly had to grapple with what in the judicial jargon have become known as ‘damages on the Wrotham Park basis’ or ‘Wrotham Park damages’. Controversy and confusion reigns as to the exact nature of these damages and as to their relationship with the account of profits remedy accepted in the context of a breach of contract in Attorney-General v Blake.1 In World Wide Fund for Nature v World Wide Wrestling Federation, Peter Smith J2 reasoned that, while there was a close link between Wrotham Park damages and the Blake account of profits, the former are compensatory while the latter are restitutionary (that is, gain-based). In the Court of Appeal, both were treated as compensatory. Chadwick LJ said: The circumstances in which an award of damages on the Wrotham Park basis may be an appropriate response, and those in which the appropriate response is an account of profits, may differ in degree. But the underlying feature, in both cases, is that the court recognises the need to compensate the claimant in circumstances where he cannot demonstrate identifiable financial loss. To label an award of damages on the Wrotham Park basis as a “compensatory” remedy and an order for an account of profits as a “gains-based” remedy does not assist an understanding of the principles on which the court acts. The two remedies should, I think, each be seen as a flexible response to the need to compensate the claimant for the wrong which has been done to him.3 * Norton Rose Professor of Commercial Law in the University of Oxford; Fellow of St Hugh’s College; Barrister, Fountain Court Chambers. I am grateful to James Edelman and Robert Stevens for their comments on an earlier version of this chapter. 1 [2001] 1 AC 268 (HL). 2 [2006] EWHC 184 (Ch). 3 [2007] EWCA Civ 286 (CA) [59].

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The purpose of this chapter is to try to solve the puzzle of whether ‘Wrotham Park damages’ are compensatory, restitutionary or neither. In particular, I wish to use this topical issue as a convenient peg on which to hang an examination of the novel ‘rights-based’ approach to damages that some commentators, especially my friend and colleague Robert Stevens, have been peddling.

II

T HE CAS E L AW O N WROTHAM PARK DAMAG E S

In Wrotham Park Estate Co Ltd v Parkside Homes Ltd4 land belonging to the defendants was subject to a restrictive covenant, registered as a land charge, forbidding development of the land except with the approval of the current owner of the Wrotham Park Estate (the claimant). A building scheme had been approved and acted on decades before, so that houses had been built on the land. But, crucially, a central green area had been left undeveloped. The defendants, the new owners of the land, built fourteen houses and a road on the green area without seeking the approval of the claimant and hence in breach of the restrictive covenant. As soon as the development work began, the claimant, which was anxious to ensure that the land was not built on for the benefit not only of itself and its employees, but also those living in houses under the originally agreed scheme which adjoined and looked out onto the green area, warned the defendants of its rights. Shortly after the development work started, it sought a final injunction restraining the work and seeking the demolition of any houses constructed. The defendants were advised that the restrictive covenant was unenforceable and therefore pressed on with the building work, albeit aware that they were taking some risk in so doing. At trial, Brightman J refused to grant the mandatory restorative injunction sought because demolition would constitute a waste of much needed housing, but he awarded substantial damages in substitution for that injunction under Lord Cairns’s Act. That was so even though the claimant accepted that it had suffered no loss in the sense that the value of its land had not been diminished by the construction of the houses. The damages were assessed using a hypothetical bargain approach. The reasoning was as follows: 1. There were two ways in which the defendants could have complied with the restrictive covenant. One was not to build. The other was to build having sought from the claimant, and been granted, a release from the covenant. 4

[1974] 1 WLR 798 (Ch).

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2. In line with the second hypothesis, damages should be awarded on the basis of what would have been a reasonable price for the claimant to have accepted for releasing the defendants. 3. In assessing that reasonable price, it was relevant to consider, inter alia, what the defendants’ actual profit from the development had been. The actual profits were conceded to be £50,000 and Brightman J held that a reasonable price would have been 5% of that, which was £2,500. Damages of £2,500 were therefore awarded. It is important to note the following two facts or sets of facts. First, it was accepted that the claimant would not have granted the defendants a release from the covenant. Moreover, even if there had been some price at which the claimant would have been prepared to grant such a relaxation, it was clearly not the price of £2,500 fixed by the court. Secondly, from early on the claimant was aware of the defendants’ building plans and had written to the defendants drawing their attention to the restrictive covenant as soon as preliminary building work had started. A month later, it issued a writ seeking a final injunction to stop the defendants building on the site. This was therefore not a case of defendants ‘stealing a march’ on the claimant in the sense of secretly achieving what they wanted, in breach of their duty to the claimant, without the claimant knowing anything about it. Moreover, as Brightman J explained,5 the claimant had deliberately chosen not to seek an interim injunction to stop the work for three reasons. First, it did not wish to offer the cross-undertaking in damages required for an interim injunction. Secondly, it thought (mistakenly in the light of developments in the law on interim injunctions) that it needed to show a strong prima facie case. Thirdly, it believed that the issue of the writ would be sufficient to stop the work. ‘Wrotham Park damages’—which we can now more precisely describe, in the light of Brightman J’s reasoning, as damages based on a hypothetical release bargain—have since been awarded in a range of tort and contract cases where the duty in question has been concerned to protect real or personal property or interests analogous to property. So, for example, they have been awarded for breach of a restrictive covenant over land, as in Wrotham Park itself;6 for breach of a collateral contract restricting the development of land;7 for tortious trespass to land;8 for the tort of nuisance by infringement of the right to light;9 and for breach of negative Ibid, 810. Amec Developments Ltd v Jury’s Hotel Management (UK) Ltd (2000) 82 P & CR 286 (Ch). Lane v O’Brien Homes Ltd [2004] EWHC 303 (QB). Bracewell v Appleby [1975] Ch 408 (Ch); Jaggard v Sawyer [1995] 1 WLR 269 (CA); Severn Trent Water Ltd v Barnes [2004] EWCA Civ 570 (CA). 9 Carr-Saunders v Dick McNeil Associates Ltd [1986] 2 All ER 888 (Ch); Tamares (Vincent Square) Ltd v Fairpoint [2007] EWHC 212 (Ch). 5 6 7 8

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contractual obligations concerned to restrict the defendants’ use of master tapes10 or of particular initials.11 Again, although not expressly rationalised at the time by reference to a hypothetical release bargain, Brightman J drew on a number of proprietary tort cases concerning the wrongful use of another’s real, personal or intellectual property as support for his approach. In each, the claimant had not obviously suffered any financial loss, yet substantial damages were awarded assessed according to the reasonable price or hire for the use. Brightman J cited Lord Shaw’s judgment in Watson, Laidlaw & Co Ltd v Pott, Cassels and Williamson,12 an infringement of patent case, in which he had famously referred to B taking and riding A’s horse, and then returning it saying, Against which loss do you want to be restored? I restore the horse. There is no loss. The horse is none the worse; it is better for the exercise.

In Stoke-on –Trent CC v W&J Wass Ltd13 Nicholls LJ referred to these tort cases as applying ‘the user principle’, and he added to the range of cases exemplifying that principle the damaged lightship case of The Mediana.14 In that case, Lord Halsbury LC had given the other classic problematic example for those insisting on loss, of the taking away of a chair from a room for 12 months where the owner would not have used the chair because there were plenty of others in the room. In Blake, Lord Nicholls drew a close link between the ‘user principle’ in tort and the account of profits awarded for infringement of intellectual property rights, before going on to build a similar link in relation to breach of contract between Wrotham Park damages and an account of profits. We will therefore assume for the purposes of our enquiry that Wrotham Park damages embrace ‘the user principle’. We now turn to the different possible analyses of Wrotham Park damages.

III

C O M P E N SATO RY A N A LYS E S

On a conventional view, Wrotham Park can be explained as awarding compensation so that, albeit an exceptional method of assessment, it fits

10 Experience Hendrix LLC v PPX Enterprises Inc [2003] EWCA Civ 323; [2003] 1 All ER (Comm) 830 (CA). 11 WWF—World Wide Fund for Nature v World Wide Wrestling Federation [2006] EWHC 184 (Ch) (reversed on appeal: [2007] EWCA Civ 286 (CA)). 12 (1914) 31 RPC 104 (HL) 120. 13 [1988] 3 All ER 394 (CA). 14 [1900] AC 113 (HL).

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within the dominant compensatory model of damages.15 That is, although there is clearly no financial loss in the usual sense—because there is no difference in value (of the property) and no incurred or likely to be incurred cost of cure—this approach seeks to explain the damages as nevertheless being compensatory. There are various ways in which one might analyse there as being a financial loss in these types of case. In now considering each of these ways in turn, we shall be asking the question, how convincing are they?

A

Compensation for a Lost Opportunity to Bargain

The best known compensatory analysis argues that what the claimant has lost was the ‘opportunity to bargain with the defendant’. This interpretation takes the literal wording of the judges’ reasoning regarding the hypothetical bargain and treats the loss of the opportunity to conclude that bargain as the claimant’s loss. This was most famously the approach offered by Sharpe and Waddams in their groundbreaking article, ‘Damages for Lost Opportunity to Bargain’.16 It also has the explicit support of a number of judges. The obvious problem with this approach, as many commentators have pointed out,17 is that, while sometimes realistic,18 in many situations the claimant would not have made that bargain: either it would not have made any bargain to release its rights or it would not have done so at the reasonable price fixed by the courts.

15 See, especially Sir Thomas Bingham MR’s views in Jaggard v Sawyer [1995] 1 WLR 269 (CA) 281. After referring to Steyn LJ’s views in Surrey CC v Bredero Homes Ltd [1993] 1 WLR 1361 (CA) 1369 that the damages in Wrotham Park were restitutionary and not compensatory, he said: ‘I cannot . . . accept that Brightman J’s assessment of damages in Wrotham Park was based on other than compensatory principles’. See also Millett LJ’s judgment in that case, although five years later he appeared to have changed his mind about this in Attorney-General v Blake [1998] Ch 439 (CA) 458. 16 (1982) 2 OJLS 290. 17 I first made this point in the first edition of Remedies for Torts and Breach of Contract (London, Butterworths, 1987) 275. See, to the same effect, J Edelman, Gain-based Damages (Oxford, Hart Publishing, 2001) 99–102; R Cunnington, ‘A Lost Opportunity to Clarify’ (2007) 123 LQR 48, 50. 18 Eg in Severn Trent Water Ltd v Barnes [2004] EWCA Civ, [2004] EGLR 95 the CA looked at what these parties would realistically have agreed in a situation where the defendant, had it known that its water pipe was trespassing on a small part of the claimant’s land, could have obtained statutory authority for that trespass. In addition to what a lands tribunal would have awarded (£110), the CA upheld an award of £500 for loss of the opportunity to bargain, given that the defendant would have paid that sum to avoid the ‘nuisance’ of the claim. Although the judge at first instance had additionally awarded a fair percentage of the defendant’s profits as restitutionary damages of £1,560, these were overturned on the basis that, first, they could not be awarded in addition to the compensation and, secondly, assessing the profits made from the trespassing pipe was too speculative.

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Of course, the law of compensatory damages standardly operates on a false hypothesis as regards the defendant’s conduct in that, in aiming to put the claimant into as good a position as if the wrong had not been committed, we posit—in the face of the truth—that the defendant would not have committed the wrong. But here we must assume not merely that the defendant would have been willing to ‘buy the right’, so as not to commit a wrong, but also that the claimant would have been willing to ‘sell the right’. In other words, we are operating hypothetically as regards the claimant as well as the defendant and usually, albeit not always, that hypothetical willingness of the claimant runs counter to the facts. Wrotham Park itself is a clear example. Brightman J expressly made the point: On the facts of this particular case the plaintiffs, rightly conscious of their obligations towards existing residents would clearly not have granted any relaxation but for present purposes I must assume they could have been induced to do so.19

No doubt it was for this reason that Steyn LJ in Surrey CC v Bredero Homes Ltd dismissed the loss of opportunity to bargain explanation of Wrotham Park as a fiction.20 Similarly in Penarth Dock Engineering Co Ltd v Pounds21 the claimants were desperately trying to have the defendants remove their pontoon and would not have accepted a price for the defendants to have continued using the dock legitimately. Even if claimants would have been willing to bargain away their rights, it is clear that the courts are normally not seeking to fix the actual fee that the claimant would have accepted. Courts seek to fix a reasonable price even though in reality in most cases the claimant would have only released its rights for an extortionate fee. In the light of such criticisms, even Stephen Waddams has accepted that the ‘loss of opportunity to bargain’ approach cannot be an explanation in all the relevant cases. In Dimensions of Private Law22 he writes the argument that in many of the cases the plaintiff has suffered a real loss . . . by being deprived of the opportunity to bargain with the wrongdoer for rent, licence charge or fee . . . might in some cases, though not in all,23 support an award purely on compensatory principles . . .

But if one takes account of the need for the theory to explain not only the type of loss but also its quantum, it would seem that the number of cases explained by ‘loss of opportunity to bargain’ is small. 19 20 21 22 23

[1974] 1 WLR 798 (Ch) 815. [1993] 1 WLR 1361 (CA) 1369. [1963] 1 Lloyd’s Rep 359 (QB). (Cambridge University Press, 2003) 108. My emphasis.

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Nor does it help to widen the relevant ‘loss of opportunity to bargain’ to encompass the ‘loss of opportunity to bargain with a third party’ (rather than with the defendant). This would merely overcome an objection that the claimant was not willing to bargain with the particular defendant. It does not overcome the objection that the claimant may not have been willing to bargain away its rights with anyone or, even if willing to do so, would not have been willing to do so at the market price. Moreover, there is an added possible objection here because sometimes the defendant’s wrong does not deprive the claimant of an opportunity to bargain with a third party. For example, if the defendant has been trespassing on the claimant’s land without the claimant’s knowledge, this is unlikely to have deprived the claimant of the opportunity to sell a right of way over his land to a third party.

B Compensation for a Lost Opportunity to Apply for an Injunction One might alternatively think of the loss as being the ‘loss of the opportunity to apply for an injunction’. This was the language adopted by Gabriel Moss QC in assessing Wrotham Park damages in Tamares (Vincent Square) Ltd v Fairpoint.24 In this case he refused a mandatory restorative injunction for the demolition of part of a new office building in London which, in a minor way, was infringing the claimant’s right to light in its next-door office building. In awarding damages in lieu of an injunction on the Wrotham Park basis using a hypothetical bargain, the judge saw himself as compensating for ‘loss of the ability to obtain an injunction’,25 for ‘loss of the ability to prevent an infringement of a right to light at the point just before any infringement takes place’,26 for ‘loss of the right to stop the infringement’27 or for ‘the price of avoiding an injunction for infringing the claimant’s rights’.28 The advantage of any of these formulations, as against seeing the loss as the lost opportunity to bargain, is that there is no fiction involved. The hypothetical bargain is seen as a way of putting a value not on the loss of opportunity to bargain but on the loss of opportunity to apply to court for an injunction. The price of the bargain is not posited as the actual fee the claimant has lost; rather, it is a means of valuing the lost opportunity to apply to court. Again there are difficulties. While this approach seems realistic and attractive where the claimant had a strong interest in protecting its rights and the defendant has stolen a march without the claimant’s knowledge 24 25 26 27 28

[2007] EWHC 212 (Ch). Ibid, [3]. Ibid, [22]. Ibid, [29]. Ibid, [38].

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(for example, where the claimant did not know that its property had been taken or otherwise had no time to go to court), it is not an explanation wherever the claimant did have the opportunity to apply for an injunction but did not take it or where the court has ruled against an injunction. In such situations it is false to say that the claimant lost the opportunity to seek an injunction: the claimant had that opportunity and either did not take it or took it and lost in court. So, in the Tamares case itself, the claimant knew of the development as it was progressing but chose not to apply for an interim injunction. Moreover, it did apply for a final mandatory injunction but that was refused by the court. It was therefore odd for the judge to analyse the damages as compensating the claimant for the loss of the opportunity to obtain a (final) injunction when it was the judge applying the law, not the defendant, who had deprived the claimant of that injunction. Similarly, in Wrotham Park itself the claimant knew the development was going on and therefore did have the opportunity to apply for an interim injunction. It chose not to seek such an injunction for the three reasons set out above;29 and the court itself refused to grant the final mandatory injunction sought.

C

Compensation for a Lost Right

Professor McInnes, in a characteristically lucid and illuminating article,30 has recently argued that the ‘user principle’ is best explained as compensating ‘for the value of the lost right’.31 The right in question, he explains, is ‘the right of dominium (ie the right to control access and use)’.32 The hypothetical bargain seeks to put a market valuation on that ‘lost right’. That the hypothetical bargain is a fiction is not a valid objection to this analysis of compensation because that hypothetical bargain is merely a method of assessing the value of the lost right. In McInnes’s words, [By] rejecting the loss-based alternative [to a restitutionary analysis] Burrows errs in both precedent and principle . . . The fatal error consists in the assumption that the only possible loss in such circumstances is the loss of an actual bargain . . . Where a property right has been violated without any other adverse effects, damages are not intended to replicate the contract the parties actually would have created if given a chance. The court aims instead to restore the value of the lost right per se. The focus is not on the hypothetical bargain that the parties might have reached, but rather on the reason why the claimant could have demanded a bargain in the first place.33 29 30 31 32 33

Text following n 5. M McInnes, ‘Gain, Loss and the User Principle’ [2006] Restitution Law Review 76. Ibid, 85. Ibid. Ibid, 83–5.

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The principal difficulty with this is in understanding why it is thought to reinstate a loss. It is inaccurate to say that the claimant has lost its rights. Certainly the claimant’s (proprietary) rights have been infringed. That is precisely what a wrong is. But to say that a (proprietary) right has been lost seems to slide into a false use of the word ‘lost’. The claimant retains exactly the same rights as it had before the wrong. No rights have been lost. What McInnes may in reality have in mind is that the claimant has lost the opportunity to exercise the control over property that proprietary rights give. This, however, runs into the same objections as the loss of opportunity to apply for an injunction that we have considered above. This is not surprising because the main judicial remedy for exercising a right of control over property is an injunction. It fails to be a convincing explanation in many cases because that opportunity to exercise control has not been lost. So, for example, in Wrotham Park and Tamares the claimant knew of the development and had the opportunity to exercise the control over the defendant’s use of the land. It did not lose that opportunity, but chose not to take it. Alternatively, one can say that the claimant was deprived of the opportunity to exercise control over the property not by the defendant but by the court’s decision not to grant the mandatory injunction. A further problem with McInnes’s theory is that it is hard to see why he confines it to proprietary rights. If it has force, it should surely apply to all rights. Followed logically through, one would end up with the infringement of every type of right leading to substantial compensation for the value of the ‘lost right’. That is not our present law and acceptance of it would shatter our conventional approach to damages. We shall examine this further below when examining the ‘rights-based’ approach of Robert Stevens. For the present, all that needs to be said is that McInnes’s explanation for the ‘user principle’ cannot logically be confined to that area of the law and that, when extended as logic dictates, the objections to Stevens’s thesis that we explore below apply equally to that of McInnes.

D

Compensation for Lost Objective Benefits

A final compensatory analysis, which may come very close to what McInnes is arguing but avoids talking about the loss of a ‘right’, is to examine whether a claimant, objectively, has lost factual benefits as a result of the infringement of the right. Instead of asking what financial loss has this claimant (subjectively) suffered, one might instead ask whether the claimant has been deprived of factual benefits that objectively have a market value. Take, for example, the wrongful borrowing of the claimant’s horse or car which the claimant would not in the interim have been using and would not in the interim have hired out to anyone else. And assume

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that the horse or car is returned undamaged. While at first sight this claimant appears to have suffered no financial loss, one could say that objectively the claimant has suffered a financial loss: he has been deprived of the possession or use of the horse or car. As the right to possession or use of goods can be bought and sold, this loss of possession and use can be given a market value. This is to take an objective, rather than a subjective, approach to a loss of wealth. Objectively the claimant has suffered a financial loss. This may be regarded as the analogous flip-side of the debate in the law of unjust enrichment as to whether a defendant who has been objectively benefited can subjectively devalue that benefit. On the compensation side, we are focusing not on the gains made by the defendant but on the benefits lost by the claimant. Assuming an objective (that is, market) valuation of a lost benefit, one is asking to what extent should that objective valuation be overridden by evidence of the claimant’s likely non-realisation of that benefit. A purely objective approach would reject entirely the relevance of the claimant’s subjective devaluation of the loss. It is instructive to focus on permanent deprivation of property. Say, for example, a car has been stolen or destroyed or a house has been destroyed and the owner has not replaced it. There is evidence that the owner never used the car or house and would never have sold it. Despite that evidence as to the owner’s own purposes and intentions in relation to the property, we would surely want to say that the claimant has suffered a loss of wealth. People would naturally say that the claimant has ‘lost’ his car or house, and would naturally treat that as a loss of wealth. Not surprisingly, therefore, the courts, in a claim for damages (for example, for conversion or trespass to goods), regard the claimant as having suffered a financial loss. The claimant is regarded as having lost the factual benefits comprising his car and his house. Those are items of wealth and their loss is measured objectively by their market value. If that is the position taken in relation to a permanent deprivation of property, one can see that the same approach may be thought to follow on naturally where the claimant has been temporarily deprived of his property.34 There is equally a loss of factual benefit—the possession or use—which can be measured objectively by the market value of the right to that temporary possession or use. Applying this objective approach to a loss of wealth, the award of compensatory damages for the loss of use or possession in cases like The Mediana35 (where the claimant had a spare lightship which it could and did use while its main lightship was being repaired) seems no more contro34 Although one can argue that a distinction between the two is that, with a permanent deprivation, there is uncertainty as to what the claimant would in the future have done. With temporary deprivation, we have much clearer evidence that, for example, the claimant would not in the interim have used the asset. 35 [1900] AC 113 (HL).

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versial than standard damages for a permanent deprivation in the tort of conversion measured, irrespective of the claimant’s own intentions in relation to the goods, by the market value of the goods. It may be thought that this ‘objective loss of benefit’ analysis is more difficult to apply where a claimant is neither permanently nor temporarily deprived of property. In the classic ‘user’ case, the defendant has trespassed across or under land but the owner has not lost possession of the land. But again the same analysis can be applied. The factual benefit lost is exclusive possession and, objectively, that has a market value. Apart from justifying a compensatory analysis of the ‘user principle’, this ‘objective loss of benefit’ approach can also explain a contract case like Experience Hendrix LLC v PPX Enterprises Inc,36 where one can say that the claimant had lost the possession or use of the master tapes. Indeed, it is significant that Mance LJ precisely referred to the objective and subjective approach to compensation. He said: Whether the adoption of a standard measure of damages represents a departure from a compensatory approach depends upon what one understands by compensation and whether the term is only apt in circumstances where an injured party’s financial position, viewed subjectively, is being precisely restored. The law frequently introduces objective measures (eg the available market rules in sale of goods) or limitations (eg remoteness). The former may increase or limit a claimant’s ability to recover loss actually suffered.37

On the other hand, it is not clear that this objective approach can explain all cases in which ‘Wrotham Park damages’ have been awarded. That is, it cannot explain those cases where the infringement of the right has not resulted in the loss, objectively, of factual benefits. Wrotham Park itself seems to be an example of this, as does WWF—World Wide Fund for Nature v World Wrestling Federation,38 where the defendants continued to use the initials WWF in breach of their agreement with the claimants not to do so. In neither case could the claimants show a loss of profits or costs incurred as a result of the breach of contract. But more importantly for the point here being made is that in neither case did the infringement of the right lead to a loss of possession or use of property, so that there was no loss of wealth that could be objectively measured. It appears that there was simply a bare infringement of a right not causing any loss of wealth even in the objective sense set out here. In any event, one can argue that the objective approach to compensation is inappropriate. While it has the merit of certainty, in that it can be applied without careful consideration of the claimant’s position, and while 36 37 38

[2003] EWCA Civ 323; [2003] 1 All ER (Comm) 830 (CA). Ibid, [23]. [2007] EWCA Civ 286 (CA).

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the courts may regard it as a useful way of ensuring a substantial monetary remedy in circumstances where it is thought inappropriate for a wrong to go unremedied, it is hard to see in principle why a claimant should receive compensation that does not reflect the evidence as to its own position. It is submitted that, at best, the objective approach should either be a default position that lightly gives way to contrary evidence as to the claimant’s position or be seen as an exceptional measure of damages to be used only where compensatory damages assessed in the ordinary subjective way are inadequate.

IV

R E S T I T U T I O N A RY A N A LYS I S

In the light of the numerous difficulties that a compensatory analysis of ‘Wrotham Park damages’ runs into, we now turn to ask whether a restitutionary analysis offers a more convincing explanation. A restitutionary analysis shifts the focus away from the effect of the wrong on the claimant’s position to the effect of the wrong on the defendant’s position. Since the ‘creation’ of the law of restitution by Goff and Jones in 1966, a great deal has been written on restitution for wrongs and I do not wish to rehearse arguments of precedent, principle and policy that have been made elsewhere for the recognition of restitution for wrongs. Rather, I want to focus on the specific strengths and weaknesses of the restitutionary interpretation of ‘Wrotham Park damages’. I confine myself here, therefore, to three general points: 1. As a matter of terminology, I am content to treat restitutionary damages as synonymous with ‘gain-based damages’ or ‘disgorgement damages’. In other words, I am content to treat restitution as covering both a giving up and a giving back, and I do not think it necessary or indeed helpful to distinguish, as many do, between restitution and disgorgement. On the other hand, whether principled or not, one has to recognise that the courts do still distinguish between, on the one hand, restitutionary damages and, on the other hand, an account of profits. 2. Having decided that restitutionary damages are appropriate, the measure of those damages is, at this stage in the law’s development, at the discretion of the courts. Very few clear principles for this assessment have emerged. While one admires James Edelman’s sophisticated attempt to draw a principled distinction between restitutionary damages on the one hand and disgorgement damages on the other,39 it seems more accurate to accept that, putting to one side an account of profits, both negative and positive gains can be, and are, removed by an award of restitutionary 39

Gain-based Damages (Oxford, Hart Publishing, 2002).

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damages.40 The measure of restitutionary damages may therefore be the ‘expense saved’ by the wrong or, more commonly, a ‘fair proportion of profits made’ by the wrong, taking into account a number of discretionary factors. 3. Contrary to Chadwick LJ’s confused obiter dicta in the WWF case,41 an account of profits is a ‘gain-based’ remedy (by definition it looks at the defendant’s gains and not the claimant’s losses). It therefore belongs on the same scale as restitutionary damages. However, under the present law, as laid down in the infringement of patent case of Celanese International Corpn v BP Chemicals Ltd,42 an account of profits cannot be awarded if no profits (but instead losses) have been made by the wrong. This is so even if the losses would have been greater but for the wrong. In other words, an account of profits deals only with positive and not negative gains. Although I am unaware of any authority dictating this, it is also the case that no award of damages has been made which strips the defendant of all the profits it has causally made from the wrong. So the relationship between restitutionary damages and an account of profits is that, while they are both restitutionary, damages can award an expense saved43 or a fair proportion of profits made,44 but not all profits made, while an account of profits can award all the profits made45 or, through the technique of making an allowance for the wrongdoer’s skill time and effort,46 a fair proportion of profits made, but cannot award an expense saved. Put another way, an account of profits operates at the top of the restitutionary scale while restitutionary damages operate at the bottom: in the middle (where a fair proportion of profits is being stripped) they can both operate. The great strength of the restitutionary analysis is, it is submitted, that it can realistically explain all the cases in which ‘Wrotham Park damages’ have been awarded and yet a compensatory analysis is unrealistic. Those damages have been measured by the fair proportion of the profits made by the wrong (although it is possible, in some cases, to say that the measure corresponds to the expense saved by the wrong). On this approach the hypothetical bargain is merely an assessment mechanism for arriving at 40 For my detailed criticism of Edelman’s thesis see A Burrows, Remedies for Torts and Breach of Contract (Oxford University Press, 3rd edn, 2004) 374–5 and The Law of Restitution (London, Butterworths, 2nd edn, 2002) 461–2. See also C Rotherham, ‘The Conceptual Structure of Restitution for Wrongs’ [2007] CLJ 172. 41 Set out above at n 3. 42 [1999] RPC 203 (Ch). 43 Taking a restitutionary interpretation, this is the best analysis of the award in eg Strand Electric Engineering Co Ltd v Brisford Entertainments Ltd [1952] 2 QB 246 (CA). 44 As in Wrotham Park itself and also in eg Bracewell v Appleby [1975] Ch 408 (Ch) (£2,000 out of a notional £5,000 profits awarded) and Experience Hendrix LLC v PPX Enterprises Inc [2003] EWCA Civ 323, [2003] 1 All ER (Comm) 830 (CA). 45 As in Attorney-General v Blake [2001] 1 AC 268 (HL). 46 As in Boardman v Phipps [1967] 2 AC 46 (HL).

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what is a fair proportion of profits to strip away. Moreover, a restitutionary interpretation is not just an ex post facto rationalisation of the results. On the contrary, it is consistent with most of the judicial reasoning which, insofar as it has viewed a compensatory analysis as problematic, has tended immediately to switch across to considering the benefit made by the wrongdoer. So, from Lord Denning in the Strand Electric and Penarth Dock cases, through Brightman J in Wrotham Park, to Mance LJ and Peter Gibson LJ in Experience Hendrix, we see highly respected judges either moving clearly from compensation to restitution or, at least, flirting with both. Perhaps most importantly of all, it appears that Lord Nicholls took a restitutionary interpretation of Wrotham Park in Attorney-General v Blake, in which he saw Wrotham Park as the bridge to the account of profits. Speaking in discussion extra-judicially, he is reported as having made clear that, in the context of breach of contract, he did not regard Wrotham Park as compensatory and saw there being a sliding scale between expense saved through a fair proportion of profits and on to an account of all profits. Lord Nicholls thought that the measure of recovery could extend from expense saved through to stripping a proportion of the profits made through to stripping all of the profits made from breach. The Wrotham Park Estate case (where 5 per cent of the profits had been stripped) was therefore based on the same principles as A-G v Blake (where all the profits had been stripped).47

If the restitutionary analysis is both realistic and supported by the judges’ reasoning, why has it not been straightforwardly accepted? Wherein lie its possible weaknesses? A first possible problem is that some are simply unconvinced that there is ever a good reason to strip gain for a wrong as opposed to compensating the claimant. This is not the place to rehearse the justifications for restitution as a response to a wrong. Suffice it to say that the compensation-only dogma is borne out neither by principle nor policy nor authority, albeit that one may wish to rank restitution behind compensation so that it is a secondary response available only where compensation is inadequate. A second problem is that some commentators who support the restitutionary analysis would significantly qualify the simple picture that has been presented above. In particular, in the writings of James Edelman and Mitchell McInnes one may detect a scepticism towards the view that the courts may be concerned to strip a fair proportion of the wrongdoer’s profits. Edelman’s distinction between ‘disgorgement damages’ and ‘restitutionary damages’ is based on the view that the former are exceptional, to be awarded only where compensation is inadequate, and are concerned to effect deterrence of wrongdoing by stripping profits. In 47

A Burrows and E Peel (eds), Commercial Remedies (Oxford University Press, 2003) 129.

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contrast, the latter are concerned to reverse an enrichment that has been acquired at the expense of the claimant (in the sense that value has been transferred from the defendant to the wrongdoer), are non-exceptional and straightforwardly rest on corrective justice. The idea that there may be a sliding scale of quantum so that some, but not all, of the benefits acquired by the wrongdoer may be stripped away is alien to his thesis. Disgorgement is all or nothing: all the profits of the wrongdoer causally acquired must be stripped or none. But it is hard to see why this should be so. Removing a fair proportion of profit from a wrongdoer seems a sensible mid-position, whether justified by a policy of reasonable deterrence or corrective justice, and is, it is submitted, a valid interpretation not only of the discretionary allowance afforded in some account of profits cases but also of the award of damages, using a hypothetical bargain approach, in a case like Wrotham Park. In similar vein to Edelman, McInnes criticises my restitutionary analysis of Wrotham Park by saying that it is fictional to regard the defendants as having saved themselves expense.48 He points out that they had not saved themselves paying the claimant because (for reasons that have been discussed above in relation to compensation) any such bargain is a fiction; but it is also unrealistic, he argues, to say that they had saved themselves the expense of acquiring a third party’s permission to build the same houses on a different piece of land because every piece of land is unique and, in any event, the wrongdoers might have found land unaffected by a restrictive covenant. I agree with those points. An ‘expense saved’ analysis of Wrotham Park is unrealistic. But McInnes’s criticism fails to meet my argument that, on the facts of Wrotham Park, Brightman J was concerned, through the damages award, to strip away a fair proportion (there 5%) of the wrongdoer’s profits. McInnes never considers that as a possible restitutionary measure. A third difficulty with the restitutionary analysis is that its relationship to compensation remains unclear. On the best view, restitution and compensation for a wrong are alternatives and cannot be combined so as to give double recovery;49 and, while in some areas (for example, for equitable wrongs and intellectual property torts) the choice between them is entirely a matter for the claimant, in others restitution remains an exceptional remedy that is available only where compensation is inadequate. So it is submitted that Wrotham Park damages are best viewed as exceptional in the same way as an account of profits was laid down to be exceptional in Blake, albeit that the latter are more exceptional simply because stripping away all the wrongdoer’s profits, rather than a proportion, is more extreme. Over time, it is possible that, as with the development of concurrent liability, a consistent approach to remedial measures across all 48 49

M McInnes, above n 30, 83–4. Burrows, Remedies, 3rd edn, above n 40, 14–16, 388–90.

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civil wrongs will be applied favouring party choice; however, at the present time, and for as long as restitutionary damages for the common law wrongs remain controversial, it would seem that the better strategy is to treat them as exceptional ranking behind compensation. A final possible problem with the restitutionary analysis of Wrotham Park damages is that restitution is plainly an appropriate response only where the wrongdoer has made a gain from the wrong. Just as compensation runs out where the claimant has suffered no loss, so restitution runs out where the wrongdoer has made no gain. On the cases awarding Wrotham Park damages so far this has not proved a problem because, where a compensatory analysis has been unrealistic, the defendant’s wrong has proved profitable. But Mance LJ did flag this as a potential problem in the Experience Hendrix case.50 He said: In a case such as the Wrotham Park case the law gives effect to the instinctive reaction that, whether or not, the appellant would have been better off if the wrong had not been committed, the wrongdoer ought not to gain an advantage for free, and should make some reasonable recompense. In such a context it is natural to pay regard to any profit made by the wrongdoer (although a wrongdoer surely cannot always rely on avoiding having to make reasonable recompense by showing that despite his wrong he failed, perhaps simply due to his own incompetence, to make any profit). The law can in such cases act either by ordering payment over of a percentage of any profit or, in some cases, by taking the cost which the wrongdoer would have had to incur to obtain (if feasible) equivalent benefit from another source.51

The ‘no profit’ restriction does not, of course, stop an ‘expense saved’ restitutionary analysis where that is realistic. To that extent, restitution is not completely neutered by the lack of profit. However, it is a valid point that if one appropriate response to a wrong is to remove the wrongdoer’s gain, that response is not available where no gain has been made from the wrong. So in Wrotham Park itself, had the defendant made a loss on the development, rather than a profit, no restitutionary remedy would have been appropriate given that an expense-saved analysis was unrealistic. Underlying Mance LJ’s concern, therefore, may be the instinct that, even if 50 See also his further comment on what he had said in the Experience Hendrix case in Sempra Metals Ltd v Her Majesty’s Commissioners of Inland Revenue [2007] UKHL 34 (HL) [230]. Although not concerning an award of Wrotham Park damages as such, the award of ‘mesne profits’ for the tort of trespass in Inverugie Investments Ltd v Hackett [1995] 1 WLR 713 (PC) illustrates the problem. The Privy Council there awarded substantial damages against the defendant hotelier for trespass even though they accepted that (i) the defendant’s occupancy of some rooms in a hotel had caused the claimants no loss and (ii) the defendant had made no gain because the hotel only had an average occupancy of 35% and was running at a loss. It is hard to explain the award in this case other than as applying an objective view of compensation. Clarity was not enhanced by Lord Lloyd’s comment at 718 that the principle on which he was operating ‘need not be characterised as exclusively compensatory, or exclusively restitutionary; it combines elements of both’. 51 [2003] EWCA Civ 323, [2003] 1 All ER (Comm) 830 (CA) [26].

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compensation and restitution are inappropriate, one still has a need for an appropriate remedy to mark the wrongdoing. I would argue that, at that point—and leaving aside the possibility that the wrong was so outrageous that punitive damages are merited—one should accept that nominal damages alone are justified. However, this leads naturally on to the ‘rights-based’ approach favoured by some commentators in preference to both compensation and restitution.

V

A ‘ R I G H T S - B A S E D ’ A P P ROAC H TO DAM AG E S

In his recently published book,52 Robert Stevens argues that ‘Wrotham Park damages’ are neither compensatory nor restitutionary. They are instead damages awarded in substitution for the right that has been infringed. They are concerned to value the right infringed, and the appropriate measure is therefore the market value of the right assessed by the methodology of constructing a reasonable hypothetical bargain between the parties. It is irrelevant to these damages whether the claimant has suffered any loss or the defendant has made any gain, although, where they have, these can be added as consequential compensatory or restitutionary damages. The purpose of the award is to vindicate the right infringed. One may regard this thesis as purifying the compensatory approach by applying compensation subjectively to true losses while recasting the ‘objective approach’ to compensation as having a different purpose, namely as a substitute for, and vindication of, the right infringed. This analysis again fits with some of the language used by the courts: for example, Sir Thomas Bingham MR’s reference in Jaggard v Sawyer to Wrotham Park as being concerned to ‘value the right’.53 It avoids all the difficulties one has had above with a compensatory or restitutionary analysis, and it treats cases like The Mediana as straightforward awards of damages for the value of the right infringed. This analysis therefore has many attractions. It also runs into serious difficulties. These are as follows: 1. It undermines the whole conventional analysis of damages. On Stevens’s approach, every infringement of a right would trigger an award of damages for the value of that right. Stevens does not shy clear of the radical nature of his thesis. On the contrary, he proudly turns on its head the traditional analysis and argues that careful examination of the cases shows that that conventional approach is flawed. Importantly for the theme of this paper, Wrotham Park damages, rather than being exceptional, constitute for Stevens the basic award in all damages cases. 52 R Stevens, Torts and Rights (Oxford University Press, 2007) ch 4. I am grateful to him for sending me the electronic file of that chapter in advance of publication. 53 [1995] 1 WLR 269 (CA) 282.

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Compensatory damages in all cases are merely additional consequential damages insofar as losses have been suffered. The same analysis is applied to all examples of damages in contract and tort. So, for example, a personal injury award in the tort of negligence is seen as awarding damages for the value of the infringed right to bodily integrity, objectively assessed, plus consequential compensatory damages for financial losses and for non-financial losses, such as pain and suffering. Damages for false imprisonment are awarded for the value of the infringed right to freedom plus consequential compensatory damages for non-financial and any financial loss caused. Damages for breach of contract are awarded for the value of the contractual right infringed, objectively assessed, plus consequential compensatory damages for financial losses caused. This explains why, in his view, in a contract made for a third party’s benefit the promisee is entitled to an award of damages for the value of the contractual right, objectively assessed, even if the loss has been suffered by the third party (for whom compensatory damages may be appropriate).54 So my first objection—although one may retort that this is nothing more than an observation as to the unlikelihood that we have all been wrong for so long—is that the thesis cannot, and does not, stop short of undermining the whole of our conventional understanding of damages.55 It may explain Wrotham Park but only at the expense of shattering conventional judicial and academic understanding by removing it from the sidelines, as an exceptional case, and setting it centre-stage. 2. The Stevens thesis appears to contradict the law on mitigation and the duty to mitigate. Say an employee has been wrongfully dismissed with a year left on her contract. The employee sues for damages but has mitigated her loss, or ought reasonably to have mitigated her loss, by accepting a better paid job the day after dismissal. As I understand the Stevens approach, the employee would still be entitled to substantial damages for the infringement of her contractual right even though she has suffered no loss. Or take a case like British Westinghouse Electric and Manufacturing 54 For Stevens, therefore, the reasoning of Lords Goff and Millett in the much-discussed case of Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 AC 518 (HL) is to be supported. The claimant was entitled to substantial damages for the infringed right to performance even though it was the third party (UIPL) not the claimant (Panatown) that suffered the loss consequent on the non-performance. 55 J Edelman, ‘Gain-based Damages and Compensation’ in A Burrows and A Rodger (eds), Mapping the Law: Essays in Memory of Peter Birks (Oxford University Press, 2006) 141, 153–8 argues that the ‘rights-based approach’ to damages (which, unlike Stevens, he regards as compensatory) explains damages for infringement of rights held for non-commercial purposes but not for commercial purposes. As my focus here is essentially on rights held for commercial purposes, the validity of such a ‘middle way’ is not explored. Suffice it to say that the law ought to be, and in my view is, consistent whether rights are held for commercial or non-commercial purposes (which in any event is a difficult distinction; for example, on which side of the line does the Wrotham Park case fall?)

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Co Ltd v Underground Electric Rlys Co of London Ltd,56 where the defendant had delivered defective turbines which the claimant had replaced by turbines that turned out to be more efficient and profitable than the old turbines would have been even if non-defective. The principle laid down by the House of Lords in this case was that, in assessing the purchaser’s damages, one should take into account the greater efficiency of the replacement turbines. In other words, one balances loss and gain, and it follows that if all the losses (including those in purchasing the replacements) were outweighed by the gains, no substantial damages at all would be awarded. Yet on Stevens’s approach, substantial damages ought still be awarded in that situation for the infringement of the right to delivery of non-defective turbines (presumably measured by the difference in market price between the turbines delivered and those that should have been delivered). It is true that the law has traditionally had difficulty in deciding the extent to which compensating advantages should, or should not, be deducted.57 There are pockets of case law where mitigating advantages have not been deducted and a claimant has been left overcompensated. These offer some support for the Stevens thesis, even though they can be equally well explained as cases where objectively the claimant may be said to have suffered a pecuniary loss. However, the trend in modern law is for compensating advantages to be more widely deducted, so that the pure (subjective) compensatory approach is more widely adhered to than in the past.58 In any event, where compensating advantages are not deducted this has usually been rationalised on policy grounds (for example, not discouraging benevolence or that one has ‘paid for’ double compensation, or that the advantage is too indirectly related to the breach) that do not appear to have anything to do with ensuring an award that vindicates the claimant’s rights. 3. Closely linked to the last point is that in the modern law the courts take account of events subsequent to the breach of contract or tort as this may increase or reduce the claimant’s loss.59 A rigid ‘date of breach’ or ‘date of tort’ rule for the date of assessment for damages has been replaced by a more flexible approach that seeks to ensure true compensation while not undermining the duty to mitigate. As Oliver J said in Radford v De Froberville, [1912] AC 673 (HL). See H McGregor, ‘The Role of Mitigation in the Assessment of Damages’, this volume; D McLauchlan, ‘Expectation Damages: Avoided Loss, Offsetting Gains and Subsequent Events’, this volume. 58 See, eg the excellent decision in Bence Graphics International Ltd v Fasson UK Ltd [1998] QB 87 (CA). 59 The leading case is Johnson v Agnew [1980] AC 367 (HL). See generally Burrows, Remedies, 3rd edn, above n 40, 185–99. 56 57

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the proper approach is to assess the damages at the date of the hearing unless it can be said that the plaintiff ought reasonably to have mitigated by seeking an alternative performance at an earlier date.60

Yet for Stevens it would appear that there is never a good reason for assessing the value of the right infringed other than at the date of the infringement. It is therefore not surprising that the recent decision of the majority of the House of Lords (and even the reasoning of the minority) in Golden Strait Corpn v Nippon Yusen Kubishika Kaisha, The Golden Victory61 causes him difficulty. In that case, charterers had repudiated a seven-year charterparty with four years left to run. It was held that the shipowner’s damages should be reduced to take into account that, two years after the breach, a war had broken out that would have entitled the charterers to terminate the charterparty. That is, damages were to compensate for the owner’s loss taking into account events known about at the date of assessment and there was no rigid rule that the loss had to be assessed as at the date of the breach. Their Lordships all saw themselves as applying the compensatory principle, and the difference between the majority and the minority turned merely on the extent to which it was felt that one should adhere to a more certain (objective) approach or a more precise (subjective) approach. None thought that one should assess damages at the date of breach because one was concerned to value the contractual right rather than to compensate for loss. 4. Applying the Stevens approach, it is not clear to me how one avoids an unacceptable overlap between the damages for the value of the right infringed and the consequential compensatory damages. Say, for example, in a Ruxley-type situation, the claimant had actually rebuilt the swimming pool and that that ‘cost of cure’ was therefore awarded to compensate him for the expense incurred. It would seem wrong for this to be added to the so-called ‘loss of amenity’ award that, on the Stevens thesis, would appear to be justifiably awarded as damages for the value of the right infringed. Similarly, if my car is damaged beyond repair by your negligence, but the next day I spend £10,000 to replace it with a new car, one surely would not wish to award the market value of the right infringed—which is presumably the market value of the destroyed car—plus the £10,000 replacement cost. 5. It is not clear that there is any role for ‘nominal damages’ in the Stevens scheme. Every infringement of a right would seem to require a substantial sum of damages assessed according to the market value of the right infringed. The idea of a nominal sum for wrongs actionable per se, not reflecting any loss suffered, would appear to be redundant. This may be [1977] 1 WLR 1262 (Ch) 1286. [2007] UKHL 12, [2007] 2 WLR 691 (HL). As ever, his views on this case were forcibly expressed over the internet to members of the obligations discussion group. 60 61

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no bad thing because, arguably, nominal damages are unnecessary given that one can always seek a declaration that one’s rights have been infringed. However, my point here is that, under the present law, for better or worse, nominal damages do exist and Stevens’s thesis cannot account for them. Moreover, it raises the question of whether the Stevens approach is not ultimately better viewed as a call for the idea behind nominal damages to be given a significantly enhanced role. Instead of merely nominal damages, substantial damages should be given as a means of declaring that the claimant’s right has been infringed. 6. Underpinning several of the above difficulties is my view that the Stevens approach is flawed in imagining that we sensibly can, or would want to, put a value on the right that has been infringed without considering the consequential impact of that infringement. In principle I would argue that the value of a right infringed should be measured by the consequences of the infringement for the victim; and that is what the traditional compensatory approach does, albeit that there is room for argument over how subjective (that is, how finely tuned to the claimant’s own circumstances) that compensatory approach should be. The pockets of objectivity left in the law should not, in my view, be reinterpreted as revealing a novel ‘rights-based’ approach.

VI

CONCLUSION

‘Wrotham Park damages’ are far from straightforward to justify. They are, and should continue to be seen as, exceptional and not as representing the norm. In some cases in which they have been awarded, a compensatory analysis is plausible, but in most cases that compensatory analysis is strained or cannot apply. In those cases, it is a restitutionary analysis— based principally on the stripping of a fair proportion of the defendant’s profits—that provides the most satisfying and convincing rationale. But this is dependent on the defendant having actually benefited from its wrong, and is not applicable where the wrong has made the defendant’s own position worse. The novel ‘rights-based approach’ of Stevens, while of huge interest and brilliantly presented by him in his new book, in my view—and throwing back at him one of his favourite phrases62—causes more problems than it solves.

62

R Stevens, ‘Contracts (Rights of Third Parties) Act 1999’ (2004) 120 LQR 292, 322.

8 Gains Derived from Breach of Contract: Historical and Conceptual Perspectives GAI NS DERI VED FROM BREACH OF CONTRACT

STEPHEN WADDAMS * S TEPHEN WADDAMS

I

UN J U S T E N R I C H M E N T AN D G A I N S F RO M W RO N G S

The relation between unjust enrichment and profits derived from wrongs has been (to say the least) the subject of considerable differences of academic opinion. The topic was claimed as part of unjust enrichment (then called restitution) by the American Law Institute in 1937,1 and included in the subject by Goff and Jones (1966)2 and by other leading writers. Professor Peter Birks included it in his An Introduction to the Law of Restitution (1985),3 while pointing out that it was distinctive, in that the claimant was not required to prove a loss corresponding with the defendant’s gain. Later Birks called these cases ‘remedial restitution’ in contrast to ‘substantive restitution’,4 but later still Birks, followed by other writers, seemed to deny altogether the link between the two topics. In an article published in 2001, Birks wrote that: The . . . categories are exclusive of one another . . . [I]t is no more possible for the selected causative event to be both an unjust enrichment and a tort than it is for an animal to be both an insect and a mammal . . . Wrongful enrichment belongs in the law of wrongs. The law of unjust enrichment is concerned solely with enrichments which are unjust independently of wrongs and contracts. To * University Professor and holder of the Goodman/Schipper Chair in the Faculty of Law, University of Toronto. I am very grateful to Ralph Cunnington for helpful suggestions in the preparation and revision of this chapter. 1 American Law Institute (AW Scott and WA Seavey, reporters), Restatement of the Law of Restitution: Quasi-Contracts and Constructive Trusts (St Paul, MN, American law Institute Publishers, 1937). 2 R Goff and G Jones, The Law of Restitution, (London, Sweet & Maxwell 1st edn, 1966) chs 33–6. 3 P Birks, An Introduction to the Law of Restitution (Oxford University Press, 1985) ch 10. 4 P Birks, Restitution—The Future (Sydney, Federation Press, 1992) 1, 10.

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assert the contrary is to violate one of the basic principles of rationality, namely that a classified answer to a question must use categories which are perfectly distinct one from another.5

This is very forceful, but in his last book, Unjust Enrichment (2003), Birks modified his view on this question, as on other important questions of unjust enrichment, going so far as to say that ‘almost everything of mine now needs calling back for burning’.6 On the relation between unjust enrichment and profits derived from wrongs, he wrote that by assuming without proving, and in fact almost certainly incorrectly, that the claimant in unjust enrichment must have suffered a loss corresponding to the defendant’s gain, I adopted a much too narrow view of the extent to which cases of restitution for wrongs are susceptible of alternative analysis in unjust enrichment.7

In the text of the book, Birks wrote: Suppose that when I am taking my summer holidays you use my bicycle for a month without my permission, then put it back in perfect condition; or that you stow away on my ship intending to take a free ride across the Atlantic. In these cases you have gained a valuable benefit but I have suffered no loss. I am no worse off. As long ago as 1776 in Hambly v Trott Lord Mansfield indicated that a claim for the value of these benefits would lie. Such a claim might be explained as restitution for a wrong, but it is not obvious that it should be and it is very unlikely that Lord Mansfield was thinking on those lines. There is other evidence that a claimant in unjust enrichment need not have suffered a loss.8

In reference to the well-known Kentucky case of Edwards v Lee’s Administrator,9 where the defendant profited by allowing access to a cave that was under Lee’s land but only accessible from the defendant’s, Birks wrote, The result is easily explained as restitution for the trespass itself. In that light it is an instance of gain-based recovery for a wrong. Can it be understood, by alternative analysis, as restitution of unjust enrichment at [the claimant’s] expense? The language used by the court is equivocal, but the answer must be yes.10

This change of opinion was the subject of academic criticism at a conference held to discuss the book,11 and in the second edition (published 5 P Birks, ‘Unjust Enrichment and Wrongful Enrichment’ (2001) 79 Texas Law Review 1769, 1781, 1794. 6 P Birks, Unjust Enrichment (Oxford University Press, 2003) xiv. 7 Ibid. 8 Ibid, 64; 2nd edn (Oxford University Press, 2005) 79. 9 265 Ky 418 (1935). 10 Birks, Unjust Enrichment, 70; 2nd edn, 84 (words added strengthening the conclusion). 11 See [2004] Restitution Law Review 260.

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posthumously, 2005) Birks acknowledged the criticism. He said, on this point, that the new edition now bears the marks of a near knock-out blow landed in defence of the view that the gain-based recovery of a claimant in unjust enrichment must be capped by the amount of his own loss

and he said that ‘it is a difficult and doubtful question whether the claimant must have suffered a loss’.12 In his actual discussion of the question, however, he maintained, and indeed reinforced, the view expressed in the first edition.13 In the second edition, words were added that had the effect of strengthening the conclusion and emphasising what Birks saw as a break with his own former thinking: once we break away from the requirement of corresponding loss the answer must be that it can [i.e. the Kentucky cave case can be understood as restitution of unjust enrichment at Lee’s expense]. Jones14 and Foskett15 tell us that we have, unequivocally, made that break.16

A first reaction to this sequence of opinions is admiration for Birks’s intellectual courage and honesty. Few writers have ventured to say that ‘almost everything of mine now needs calling back for burning’, and for a writer as eminent, prolific and successful as Birks to say so must be practically unique. There have been sharp differences of academic opinion on this point, both as among leading writers and in the mind of single writers over time. This strongly suggests that there is likely to be truth on both sides of this debate. Opinions in legal controversy that appear at first sight implacably opposed may often be reconciled by the consideration that each is describing a different dimension of a complex phenomenon or by the consideration that each is addressing a slightly different question. Thus both, of seemingly opposite views, or several, of seemingly diverse views, may be correct. This possibility is well illustrated by the variety of views expressed in the present collection of essays. Andrew Burrows, Peter Jaffey, Daniel Friedmann, Ralph Cunnington and Anthony Ogus have all touched on the subject, and each suggests different criteria for resolving the question in issue. It is not possible to select one of these criteria exclusively as definitive: from a historical perspective all these writers are correct for, in the past, the courts have been influenced by all the factors they mention. In his article of 2001, Birks was addressing a conceptual question, and his conclusion necessarily followed from his premisses (which were that every legal question must be assigned exclusively to a single distinct category, one of which was unjust enrichment defined so as expressly to 12 13 14 15 16

Birks, Unjust Enrichment, 2nd edn, 75. Ibid, 79, 81–4. Jones Estate v Jones [1997] Ch 159 (CA). Foskett v McKeown [2001] AC 102 (HL). Birks, Unjust Enrichment, 2nd edn, 84.

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exclude wrongs and contracts). The whole tone of the passage shows that this was a conceptual conclusion demanded by inexorable logic, not an invitation to join in a historical judgment. In his discussion of Hambly v Trott,17 by contrast, Birks was addressing a historical question, and he drew the conclusion that ‘it was most unlikely that Lord Mansfield was thinking on those lines [ie that the claim might be explained as restitution for a wrong]’, and therefore that the case was ‘susceptible of alternative analysis in unjust enrichment’. As a matter of historical judgment this conclusion is entirely persuasive, because the question in issue in Hambly v Trott was whether a claim for conversion survived against the estate of a deceased wrongdoer so as to enable the plaintiff to avoid the effect of the common law rule that a personal action dies with the person. The question was perceived as difficult, and after consideration the court held that, although a tort action was admittedly precluded by the common law rule, the plaintiff might nevertheless bring an action against the estate in assumpsit. Lord Mansfield’s reasoning therefore depended entirely on the holding that the plaintiff was not compelled to categorise the claim as tortious. The conclusion in Hambly v Trott had much to do with unjust enrichment, in the general sense of that phrase: as many passages in the judgment make clear, the court considered it unjust that the estate should be enriched at the expense of the plaintiff. The case was not directly concerned with the measure of recovery for profits derived from wrongs, but, in the course of the judgment, Lord Mansfield used a hypothetical example that has often been quoted: if a man take a horse from another, and bring him back again; an action of trespass will not lie against the executor, though it would against him; but an action for the use and hire of the horse will lie against the executor. 18

From this passage it has often been inferred that Lord Mansfield would, if the question had arisen, have permitted the plaintiff to recover against a living defendant an amount measured by the defendant’s gain, even if this exceeded the plaintiff’s loss. Birks said, in the passage quoted above from Unjust Enrichment, that Lord Mansfield ‘indicated’ that such a claim would lie. This conclusion is less compelling than the conclusion that Mansfield did not think that the plaintiff was compelled to categorise his claim as tortious, because the amount of the award was not in issue. The inference that, had the question been in issue, Lord Mansfield would have favoured a gain-based award against a living defendant has persuasive force, but the mode of persuasion is by invitation to join in a historical judgment, rather than by a peremptory demand to submit to inexorable logic. Strict logic might seem to demand, as Birks said in 2001, that the 17 18

(1776) 1 Cowp 371. Ibid, 375.

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question be allocated exclusively to one only of two categories (wrongs and unjust enrichment), but, as his later writing shows, this conclusion must be accompanied by the observation that, in English law, both ideas have been influential. It is not a satisfactory account to say that the question has been classified exclusively as a matter of tort law and that therefore unjust enrichment is irrelevant if the evidence shows that the idea of unjust enrichment has, in the past, been influential.

II

G A I N - B A S E D M O N E Y AWAR D S

By a variety of means, and using a variety of concepts and terminology, courts have made money awards based, in whole or in part, on gains derived from wrongs. The means include, besides the so-called waiver of tort cases associated with Hambly v Trott, the award of damages in substitution for an injunction, the award of exemplary damages, accounting of profits and a group of cases, sometimes called the ‘wayleave’ cases, where the defendant has been required to pay a reasonable fee for the use of the plaintiff’s rights. To these may be added various concepts that have enabled the court to allow a claimant to assert proprietary rights in assets held by the defendant and not obviously owned by the plaintiff, including tracing and constructive trust. As we have seen, it is a controverted question whether these cases should or should not be classified as ‘unjust enrichment cases’. But what is reasonably clear is that many cases of the kind just mentioned have been influenced by the general idea of unjust enrichment. Though the form of words differs widely, and while the phrase ‘unjust enrichment’ does not occur in most of these cases, the court usually indicates that it is conscious of taking special steps, going beyond the award of compensatory damages, in order to deprive the defendant of a gain that the defendant ought, on considerations of justice, to surrender to the claimant. Thus it may fairly be concluded that the idea of unjust enrichment, in the general sense of the phrase, has been influential. But it does not follow that the results can be explained solely in terms of unjust enrichment. The court has evidently been influenced also in many of the cases by considerations of wrongdoing, property, and public policy. These considerations have not operated in isolation from each other. That is to say, justice requires the defendant to surrender the gain partly because the gain has been wrongfully acquired, and often it is adjudged to have been wrongfully acquired partly because it has been derived from the claimant’s property, and public policy in such cases requires surrender of the gain both because it has been wrongfully acquired and because it has been derived from something that, as between claimant and defendant, belongs to the claimant.

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One dimension of the question is the argument that in many of the cases the claimant has suffered a real loss, though one that is difficult to quantify, by being deprived of an opportunity to bargain with the wrongdoer for a rent, licence charge or fee.19 This consideration might in some cases, though not in all, support a substantial award on purely compensatory principles. But, even where it does not, it is not wholly irrelevant because of, as Sir Thomas Bingham put it, the obvious relationship between the profits earned by the defendants and the sum which the defendants would reasonably have been willing to pay to secure release from the covenant.20

This is not an alternative analysis that seeks to displace ideas of property, wrongdoing and unjust enrichment. On the contrary, it is another way of looking at the same question that incorporates those ideas and supplies an additional reason in many cases (not in all) in support of a substantial money award. Compensation cannot supply the sole explanation of the cases, but neither has the idea of compensation been wholly irrelevant. To put the point at its lowest, the idea that the claimant has suffered an actual loss, though one that is difficult to quantify, has tended to strengthen the claim to a substantial money award and, together with other considerations, has been influential in supporting awards based in some degree on gains derived by the defendant. Lord Lloyd said that ‘the principle [supporting a substantial award] need not be characterised as exclusively compensatory, or exclusively restitutionary; it combines elements of both’.21

III

T E R M I N O L O G Y AN D C L A S S I F I CAT I O N

There are certain difficulties here of terminology and classification. One is that legal terms such as contract, tort, equity and property have both a general and a specifically legal meaning. Thus, while tort means wrong, it also means ‘that conduct to which the law attaches liability’. The meanings are different, but, in an uncodified system, they cannot be entirely dissociated because, where a new question has arisen for decision, the perception of the defendant’s conduct as wrong, though not legally conclusive, has been influential. The same is true of the term ‘unjust enrichment’. The expression describes a branch of the law (sometimes called restitution), but, as new cases have arisen, the perception that it is unjust (in a general sense) 19

RJ Sharpe and SM Waddams, ‘Damages for Lost Opportunity to Bargain’ (1982) 2 OJLS

290. Jaggard v Sawyer [1995] 1 WLR 269 (CA) 282. Inverugie Investments Ltd v Hackett [1995] 1 WLR 713 (PC) 718. Lord Denning spoke to the same effect in Strand Electric Engineering Co Ltd v Brisford Entertainments Ltd [1952] 2 QB 246 (CA) 255. 20 21

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for the defendant to retain the benefit in question has been influential. In his An Introduction to the Law of Restitution (1985) Birks suggested that the word phrase ‘reversible enrichment’ might preferably, or just as well, be substituted for ‘unjust enrichment’.22 In Unjust Enrichment (2003), however, he accepted that the words ‘unjust’ and ‘unjustified’ carry a general, as well as a purely technical, meaning: The chosen adjective must serve as a peg on which to hang the reasons . . . why an enrichment should be given up, and it must be weakly normative.23

Like other legal terms, the phrase ‘unjust enrichment’ has both a general and a technical sense. Confusion is added by the variance in the meaning of the word ‘restitution’. Sometimes (as mentioned) it means the branch of the law concerned with reversing unjust enrichment; sometimes it means a judicial award of money based on the defendant’s gain; and sometimes the word means reversal of a transfer by the claimant to the defendant (as opposed to ‘disgorgement’ of gains derived by the defendant from other sources). The phrase ‘restitutionary damages’, though sometimes used as a synonym for money awards based on the defendant’s gain, has not been universally accepted, and was rejected by Lord Nicholls in Attorney General v Blake as an ‘unhappy expression’.24 The trouble with the phrase is that it is objectionable to different observers for different reasons: to some, gain-based awards are not ‘restitutionary’ because they are not based on unjust enrichment; to others they are not restitutionary because they involve a giving up rather than a giving back; and to others they are not properly called ‘damages’ because they do not constitute compensation for harm or loss. Other difficulties are caused by the assertion that a claim in unjust enrichment cannot exceed the amount of the claimant’s loss. The formulation that the defendant’s gain must be ‘at the expense of’ the claimant is also sometimes taken to imply a loss on the claimant’s side that corresponds precisely with the defendant’s gain, but is sometimes understood in a more general sense as meaning that the defendant’s gain is derived from something that belongs, in general terms, to the claimant. Again, it is not always clear whether a writer who asserts that there can be no claim in unjust enrichment exceeding the claimant’s loss is addressing the question of what result justice requires between the parties, the question of how, Birks, above n 3, 19. Birks, above n 6, 236. In the second edition, above n 12, 275, the words ‘in order to encourage fine-tuning’ are added, meaning, presumably, ‘in order to deal with new cases as they arise’. See also Birks, Unjust Enrichment, 2nd edn, 258: ‘The law of unjust enrichment would itself be stultified if the criteria which normally identify an unjust enrichment were allowed in an exceptional case to compel restitution of one which was not unjust.’ The last word in this sentence carries a general, not a technical, sense. 24 [2001] 1 AC 268 (HL) 284. 22 23

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accurately, to describe actual past decisions or the question of how the issue, or a legal result, in favour of a claimant who has recovered an amount exceeding apparent loss should be classified within a particular proposed scheme of classification. Some writers have emphasised the distinction between giving back (restitution) and giving up (disgorgement). The idea that the claimant may suffer a loss of opportunity to bargain tends to cut across all these lines of discussion, because it suggests that the courts have been influenced simultaneously, not only by considerations of compensation for loss, but also by considerations of avoidance of unjust enrichment and also again by considerations of depriving the defendant of gains improperly acquired. This concurrence of reasons tends to disturb the neat dichotomies between compensation and restitution, between restitution and disgorgement, and between wrong and unjust enrichment.

IV

G A I N S D E R I VE D F RO M B R E AC H O F C O N T R AC T

When we turn to gains derived from breach of contract, the element of unjust enrichment (in its general sense) is crucial, because retention of some gains derived from breach of contract is generally perceived as permissible. In many of his writings, Birks divided the events that give rise to civil obligations into four categories, namely, consent, wrongs, unjust enrichment and other events. This scheme would appear to distribute contract law between two categories (consent and wrongs) and, as Professor Burrows has pointed out, this division would have some strange consequences. He wrote that while Birks’ scheme may seem logically persuasive when one looks at unjust enrichment and restitution in isolation or along with only a part of private law, it causes difficulties when one widens the picture to include all private law. In other words, if one is following Birks’ map, one may ultimately find oneself being led into strange places!.25

The idea of dividing primary contractual obligation from the obligation to pay compensation for breach of contract had been suggested by Anson in 1879 in the first edition of his book on contract (the other four of six categories being quasi contract, delict, judgments and miscellaneous)26 but, though carried through 17 editions over a period of 50 years,27 Anson’s scheme gained no following, partly for the reasons suggested by Burrows. Birks never (so far as I know) developed in detail the consequences of his scheme for contract law, but one possible consequence would be that 25 A Burrows, ‘The New Birksian Approach to Unjust Enrichment’ [2004] Restitution Law Review 260, 261. 26 W Anson, Principles of the English Law of Contract (Oxford, 1879) 7–8. 27 JC Miles and JL Brierly (eds), Anson’s Law of Contract (Oxford University Press, 17th edn, 1929) 7–8.

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the wrong of breach of contract should be treated precisely like any other legal wrong, with precisely the same consequences. As a matter of past English law, this has not been the case. Non-contractual wrongs may often be restrained by judicial order (injunction); they may be abated where practicable by self-help; benefits derived from the threat of a wrong must be restored; persuading or assisting another to commit a wrong is itself a wrong; they may be punished by awards of exemplary damages; they generally attract moral disapprobation; and, most significantly for the present enquiry, gains derived from non-contractual wrongs must usually be given up. The law (past and present) has not attached all these consequences to all breaches of contract, and few would argue that it should do so. Let us consider the case of a contract for routine personal services followed by a breach because the employee finds a more profitable use for her time (for example, a contract by a student to paint a house during the whole of October, followed by breach because the student receives an unexpected opportunity to attend law school). Of course the contract breaker is liable for damages, but if the house-owner can find a professional painter for the contract price or less there will be no substantial damages. It is plain that in this instance the house-owner is not (as a matter of past or present law) entitled to a decree of specific performance, or to an injunction to prevent the student from attending law school, or to punitive damages or (it is safe to say) to an account of the gains derived by the student from pursuing a legal career. The reasons for this set of interrelated conclusions may be summarised by saying that the house-owner is amply compensated by damages, has no special interest (more than an economic interest) in the actual personal services of the student, ought not to have anything like a proprietary interest in the student or her services, and that there is a public as well as a private interest in freedom of action on the part of the defendant and on the part of potential defendants. The student is enriched in this example by the breach of contract, but by no means is the enrichment unjust, nor is it made ‘at the expense of’ the house-owner. On the contrary, if the law should compel the student to pay over to the house-owner the full present value of her future legal career most observers would say that the law would have exacted an unjust confiscation and would have conferred an undeserved windfall on the house-owner. As the example just discussed shows—and many others could readily be given28—there are circumstances in which we may all find ourselves from 28 D Friedmann, ‘Economic Aspects of Damages and Specific Performance Compared’, this volume, gives examples of losing contracts and wasteful performance, usefully suggesting the term ‘tolerated breach’ (rather than ‘efficient breach’) to signify the law’s unwillingness to award more than compensatory damages.

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time to time where it is reasonable to break a contract on payment of compensatory damages to the other party. The situation just discussed is where a more profitable opportunity arises for the plaintiff’s time or other resources. Another common situation is where the cost of performance greatly exceeds the economic benefit of it, as in the case of a promise to restore damaged land, where the cost of restoration may greatly exceed the economic benefit of doing the work.29 In these cases, unless the plaintiff has a not unreasonable non-economic interest and is likely actually to carry out the work, the courts have refused damages based on the cost of performance. These also are cases in which the defendant is permitted to benefit from the breach, because the defendant saves the cost of actual performance on payment of a lesser sum of compensatory damages. Another very simple and everyday example would be cancellation of a restaurant reservation because of the customer’s change of plans. The customer might (perhaps, and at the most) be liable for the restaurant’s loss of profit, but no one would seriously contemplate specific performance to compel the customer to dine at the restaurant, or an injunction to prevent the change of plans, or exemplary damages or requiring the giving up of gains made through the change of plans. Though there are close analogies between contractual and noncontractual obligations, there are also important differences.30 Contractual obligations are defined by the parties with practically no restrictions. Thus, a contractual obligation may turn out to be extremely onerous, even ruinous, to the defendant, and performance of contractual obligations may have the effect of very greatly enriching the promisee. The exchange of a few words, casually spoken or written, may easily create an obligation that exceeds the defendant’s total wealth. These features are absent from most non-contractual obligations. The reasonable person may usually avoid committing torts without suffering very heavy burdens, and the failure to commit torts does not usually in itself enrich others. Liability for breach of contract is strict, whereas tort liability often requires proof of fault. Another aspect of the matter is that there is usually a public interest in encouraging observance of tort law, but the acts or omissions that constitute breaches of contract are not in themselves inherently objectionable: usually they are, considered simply as actions, perfectly innocent. They are wrongful only in the sense that a private agreement has made them so. There are good reasons, therefore, for making a distinction between contractual and non-contractual obligations. The law may be said to treat the contractual promisee quite generously in allowing the full 29 Peevyhouse v Garland Coal & Mining Co 382 P2d 109 (Okla SC, 1962); Tito v Waddell [1977] Ch 106 (Ch); Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 (HL). 30 See S Waddams, ‘Breach of Contract and the Concept of Wrongdoing’ (2000) 12 Supreme Court Law Review (Second series) 1.

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measure of expectation damages;31 it is not very surprising that, where the claimant’s interest is only economic, this has been the limit of the defendant’s obligation.

V

E F F I C I E N T, O R TO L E R AT E D, B R E ACH

The economic idea of ‘efficient breach’, or ‘tolerated breach’ as Daniel Friedmann usefully calls it in his essay, is relevant in this context. Economists have pointed out that, where the defendant finds a more remunerative use of her resources, as in the house-painting example just discussed, it may enhance the welfare of the two contracting parties jointly for the contract to be broken on payment of damages: the promisee is no worse off (on receipt of full expectation damages) and the promisor, who puts her resources to better use, is better off. This is a useful insight that may be welcomed by lawyers, but it does not follow that all breaches of contract are efficient, or that the law has been or should be governed by economics. The idea of efficient breach may be described as a parallel insight that tends to support the legal conclusion, and which probably rests on similar underlying values, including the avoidance of an unjust windfall to the claimant and reasonable freedom of action on the part of the defendant. But the acceptance of such a parallel insight does not mean that the law has deferred, or should defer, to economics. If an ethicist, a philosopher or a civil lawyer should say that certain conclusions of English law had often conformed to principles of ethics, to certain systems of philosophy or to certain civil law systems, these comments might well be welcomed by lawyers (as tending in a general way to increase confidence in the legal conclusions) without, however, implying that ethics, or any particular system of philosophy or system of civil law, had in itself been, or should in the future become, the single, overriding or dominant reason for the legal conclusions. Thus, the idea of efficient breach, though it may be said to correspond to the approach of the law in many cases, is not in itself a binding legal principle or rule. There are cases in which supra-compensatory remedies have been available. These are cases, also, in which the claimant has had more than a purely economic interest in performance, where the breach deprives the claimant of an opportunity to bargain, where compensatory damages have been perceived as inadequate, where the claimant has something like a proprietary interest, where it is not in the public interest for the contract to be broken and where the defendant would be unjustly enriched by gains derived from the breach. It is in these cases that specific 31 LL Fuller and WR Perdue, ‘The Reliance Interest in Contract Damages’ (1936) 46 Yale Law Journal 52.

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performance is often available, where an injunction is often available to restrain breach, where exemplary damages might be appropriate (if they are appropriate anywhere), where breach of the contract is perceived as morally reprehensible and where the defendant is required to account for gains. The various considerations are interlinked: it is in just the kind of case where there is a right to specific enforcement that the claimant is perceived to have a proprietary right, or something like one, and it is in just such a case that the defendant is likely to be thought to be acting reprehensibly by taking something that belongs not to him but to the claimant, and where retention of a gain so made is perceived as an unjust enrichment. Attorney General v Blake32 (publication of memoirs by a former secret service agent) may be given as an instance where an accounting was required. The reasons that tended to support the result in that case are cumulative: the government had more than a purely economic interest in preventing the publication; the information, in a sense, belonged to the government; publication of it was closely akin to a breach of fiduciary duty; an injunction might have been obtained to restrain publication at an earlier date when the information was still confidential; the government had a legitimate interest in preventing publication of such memoirs independent of its interest in receiving Blake’s services; and Blake’s conduct was reprehensible and contrary to the public interest. The features just mentioned do not accompany every contract, but they do, in whole or in part, accompany some contracts. Therefore, no simple rule is available that treats all breaches of contract alike, and the search for a simple or single rule on the point, so far from representing an advance in clarity or precision, is likely to obscure important distinctions that are necessary to the attainment of justice.

VI

CAN A D E F I N I T I VE RUL E B E F O R M U L AT E D ?

Several possible rules have been suggested on the question of gains derived from breach of contract. The simplest, impliedly suggested by some writers though usually not made fully explicit, is that the plaintiff should have an unfettered right to recover all such gains from the contract breaker. The instances of the student painter and the case where the cost of performance is extravagant in relation to the economic benefit show that no such rule has been acceptable. The opposite view, that a contract-breaker is never accountable for gains made from breach of contract, is also unacceptable, and does not correspond, as we have seen, with past law. Therefore some additional factor, other than breach of contract, must be required. It has been suggested that recovery of gains should be available where there is an 32

[2001] 1 AC 268 (HL).

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‘abuse of contract’ or a ‘cynical’ breach, or where performance is ‘skimped’ or where the gain is derived from doing what the defendant promised not to do. All these raise difficulties, and none was accepted as definitive by the House of Lords in the Blake case. Lord Nicholls reaffirmed that the general rule was not to require an accounting of gains made by breach of contract, but he accepted that in exceptional circumstances an accounting would be appropriate. He was, in view of earlier unsuccessful attempts, including those of the Court of Appeal in the Blake case itself, understandably reluctant to lay down a precise rule as to what those exceptional circumstances were, suggesting ‘as a useful general guide, although not exhaustive’ the test of ‘whether the plaintiff had a legitimate interest in preventing the defendant’s profit-making activity and, hence, in depriving him of his profit’, adding immediately that ‘it would be difficult and unwise to attempt to be more specific’.33 This test has attracted some criticism on the ground that it lacks substance and leaves the matter too much in the discretion of the court, but, in my view, the test proposed has substance and is relevant, and Lord Nicholls was right in suggesting that there are real dangers in attempting to be overprecise. The concept of ‘legitimate interest in preventing the defendant’s profit-making activity’ signifies activities likely to cause damage to the government (memoir writing, for example) independent of what would have been caused by simple neglect of contractual duties (such as unauthorised absences to pursue landscape painting). Such independent damage is likely to occur in precisely those cases where the plaintiff suffers a loss of opportunity to bargain, where damages measured by the plaintiff’s loss will seem inadequate, where the obligation is likely to be, or to have been at some point in time, specifically enforceable, where the defendant can be said to have infringed a proprietary or quasi-proprietary interest, where the defendant is unjustly enriched and where there is a public policy in preventing the breach. Not all these factors have been present in every case, nor can they be considered in isolation from each other, for they tend to be mutually interdependent. Reference has been made in the preceding paragraphs to compensation for loss of opportunity to bargain, and it was suggested that this idea, though not an alternative analysis supplying the sole explanation for money awards based on gains derived from wrongs, has, together with considerations of property, wrongdoing and unjust enrichment, been relevant in some cases. Not all breaches of contract involve a loss of bargaining power, because, where the claimant has no property interest that the court will protect in advance and where the contract is not specifically enforceable (as in the example of the student painter), the claimant never had effective power to prevent the breach of contract in the first place. Thus, if the student painter announced in advance her intention to 33

Ibid, 285.

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break the contract in order to attend law school, the house-owner would not have been in any stronger position: the most he could effectively have said would have been that he would hold the defendant responsible for payment of any damages. No injunction or decree of specific performance would have been available. But where the contract breaker infringes a property right or a quasi-proprietary right that the court would have protected, or defeats a right to specific performance or an injunction, the claimant does suffer a real loss and the defendant, in a real sense, has taken something of value that belonged to the claimant. This is not a fiction: a person deprived of an opportunity to prevent a wrong or to grant a valuable licence may realistically be said to have lost something of value, even if in fact she would never herself have exploited the opportunity for money gain. Measuring the value of what the defendant has taken is not an easy task where, as is usual in such cases, no market price can be ascertained. Some cases have given an accounting of profits, and some have awarded the amount of the reasonable licence fee that the plaintiff might have demanded. These measures, though sometimes contrasted,34 are closely linked, as was said in Jaggard v Sawyer,35 because of the obvious relationship between the profits earned by the defendants and the sum which the defendants would reasonably have been willing to pay to secure release from the covenant.36

The full amount of the profit derived from the breach is the maximum that the defendant, foreseeing the future, would have paid. We cannot know the minimum that the claimant might have accepted, but that is because of the defendant’s wrong, and it is not unusual, in the law of damages, for presumptions to operate against a wrongdoer where the wrong itself impedes precise evaluation.37 It may be said that there is an element of artificiality involved, but this is no greater than that involved in the valuation of a unique chattel wrongfully taken by the defendant which the claimant would never in fact have sold. There is nothing fictitious in the observation that the net profit to be derived from doing something is closely related to, and often identical with, the price that a reasonable person would pay for permission to do it. The assessment of a reasonable licence fee and the accounting of profits are not therefore unrelated: they are alternative ways of doing justice between the parties by setting a value on what the defendant has taken. Sometimes the one method, and sometimes the other, will be the more convenient. In the Wrotham Park 34 35 36 37

Ibid, 280 (Lord Nicholls). [1995] 1 WLR 269 (CA). Ibid, 282. Armorie v Delamirie (1722) 1 Str 505.

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case,38 the court awarded only 5% of the sum calculated to be the defendant’s total anticipated profit. However, Brightman J stressed that there were peculiar factors, including delay on the part of the plaintiff, that justified ‘great moderation’. Where these factors are absent, and where the accounting process gives full credit for all factors favourable to the defendant (deduction of all expenses, including overheads, and insistence on proven causal link between wrongdoing and profit, with due allowance for the defendant’s time and skill),39 it is likely that in many cases the measures will converge. A conscientious accounting is often complex, and frequently less beneficial to a claimant than at first appears likely. It is perfectly legitimate for a court, in seeking to minimise the expense of litigation and to do practical justice to both parties, to adopt a somewhat rough-and-ready assessment of what, in the circumstances, would have been a reasonable licence fee in order to avoid a lengthy, expensive and possibly inconclusive accounting. As Dr Lushington said in another context, The true principle is, not to adopt that system which, in special cases, may best arrive at the truth, regardless of delay and expense, but to choose that course which, on the whole, will best administer justice with a due regard to the means of those who seek it. 40

Awards of gain-based damages have been linked by some writers with punitive and deterrent considerations. It is true that, in some cases, such as Blake, considerations of public policy have been prominent, but it should be remembered that breach of contract, infringement of property rights and unjust enrichment may all occur without any fault on the part of the defendant. It is not desirable, therefore, to subordinate gain-based awards to punitive considerations, as the reference in the last paragraph to credit for items favourable to the defendant was intended to suggest.41 It is understandable that, in a case like Blake, the court will not be inclined to be very diligent, in the process of accounting, to seek out items to enter to the credit of the defendant. In many other cases, though, the breach of contract, together with the concomitant infringement of proprietary right and the unjust enrichment, will be entirely without fault, and in such cases the defendant is in justice entitled to insist on satisfactory proof of the amount of the profit alleged to have been derived from the wrong.

Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798 (Ch). See Boardman v Phipps [1967] 2 AC 46 (HL). The Resultatet (1853) 17 Jur 353, 354. Ralph Cunnington has convincingly pointed out the danger of confusing exemplary with compensatory damages: R Cunnington, ‘The Border between Compensation, Restitution and Punishment’ (2006) 122 LQR 382, commenting on Borders (UK) Ltd v Commissioner of Police of the Metropolis [2005] EWCA Civ 197 (CA). 38 39 40 41

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T WO R E C E N T E N G L I S H CA S E S

Many of these considerations were in evidence in the decision of the English Court of Appeal in Experience Hendrix LLC v PPX Enterprises Inc,42 where the defendant, in breach of contract, had made commercial use of musical recordings. The plaintiff could not prove direct financial loss because it would not itself have exploited the recordings, but the Court of Appeal, reversing the trial judge, held that the defendant was obliged to pay a reasonable sum in respect of the wrongful use made of the recordings. Mance LJ said that ‘practical justice’ (not distinguishable in this context from ‘justice’) required the defendant to ‘make (at the least) reasonable payment for its use of [the recordings] in breach of the . . . agreement’.43 He recognised that the law of damages often includes ‘objective measures’ that do not correspond precisely with the claimant’s actual loss.44 He recognised also the link between compensation and accounting of profits: The law can in such cases act either by ordering payment over of a percentage of any profit or, in some cases, by taking the cost which the wrongdoer would have had to incur to obtain (if feasible) equivalent benefit from another source.45

He accepted that the supposition of a hypothetical bargain ‘involves an element of artificiality’ since no such bargain would in fact have been made, but he concluded that this method has the merit of directing the court’s attention to the commercial value of the right infringed and of enabling it to assess the sum payable by reference to the fees that might in other contexts be demanded and paid between willing parties.46

A full accounting of profits was not ordered, partly because it would have been an unduly complex and expensive process.47 Peter Gibson LJ agreed with the conclusion, saying that ‘to avoid injustice I would require PPX to make a reasonable payment in respect of the benefit it has gained’.48 These words show that considerations of justice, undue enrichment, restitution and compensation were all in operation and that they were intertwined, and linked also with considerations of practical convenience in the administration of justice. The difficulties of allocating this issue to a single category have more recently been illustrated by the decision of the Court of Appeal in 42 43 44 45 46 47 48

[2003] EWCA Civ 323 (CA). Ibid, [42]. Ibid, [26]. Ibid, [26]. Ibid, [45]. Ibid, [44]. Ibid, [58].

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WWF—World Wide Fund for Nature v World Wrestling Federation Entertainment Inc,49 which directly involved a question of characterisation. The claimant had originally sought leave to amend its pleadings to claim profits derived, in breach of contract, by the defendant from the use of the initials WWF, but leave was refused by Jacob J,50 and no appeal was taken from that order. The claimant subsequently sought to claim damages based on what the defendants would reasonably have had to pay as ‘quid pro quo’, in effect a licence fee, for the claimants to relax their rights under the agreement.

The question at issue was whether the latter claim was substantially distinct from the former or whether it was substantially similar, so that the attempt to pursue the latter claim, after the former had been denied, amounted to an abuse of process. The Court of Appeal held that the claims were substantially similar. Chadwick LJ expressly warned against overrigid categorisation, correctly, I think, though not every phrase in the judgment is easy to justify: The circumstances in which an award of damages on the Wrotham Park51 basis may be an appropriate response, and those in which the appropriate response is an account of profits, may differ in degree. But the underlying feature, in both cases, is that the court recognizes the need to compensate the claimant in circumstances where he cannot demonstrate identifiable financial loss. To label an award of damages on the Wrotham Park basis as a ‘compensatory’ remedy and an order for an account of profits as a ‘gains-based’ remedy does not assist an understanding of the principles on which the court acts. The two remedies should, I think, each be seen as a flexible response to the need to compensate the claimant for the wrong which has been done to him . . .52

He accepted the defendant’s argument that the remedy now sought by the Fund (an award of damages on the Wrotham Park basis) is a ‘juridically highly similar remedy to the relief [an account of profits] previously sought’.53

The court’s conclusion was that the claim to Wrotham Park damages (if it were to be raised at all) should have been raised before Mr Justice Jacob in conjunction with the claim to an account of profits.54 49 [2007] EWCA Civ 286 (CA). There was a long and inconclusive discussion in the lower court [2006] EWHC Ch 184, on which see Ralph Cunnington’s comment: R Cunnington, ‘A Lost Opportunity to Clarify’ (2007) 123 LQR 48. 50 WWF—World Wide Fund for Nature v World Wrestling Federation Entertainment Inc [2001] EWHC Ch 482. 51 See n 38. 52 WWF, above n 50, [59]. 53 [2007] EWCA Civ 286 (CA) [60]. 54 Ibid, [74].

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The case shows that the issue (of when an award based on profits derived from breach of contract is appropriate) cannot be allocated exclusively to a category designated ‘gain-based award’, nor exclusively to a category designated ‘compensation’. It combines elements of both. There are some difficulties of terminology here. Parts of Chadwick LJ’s judgment just quoted might seem to suggest that the claimant’s loss and the defendant’s gain are the same thing, or that all gain-based awards are compensatory, but, when the words are read in the context of the court’s actual decision, it is doubtful that this was their intended meaning. The concepts of ‘compensation’ and ‘gain-based award’ are distinct, and the distinction is essential for the sake of clarity: the claimant’s loss is one thing; the defendant’s profit may be quite another. The court’s decision does not deny this. What the case does show, however, is that the two concepts may in practice operate simultaneously and cumulatively in relation to a single legal question.55 If the question is whether the defendant must pay to the claimant a substantial sum of money, an affirmative answer may be influenced, and often in the past has been influenced, both by the consideration that the defendant has wrongfully derived a profit from acting as it did and also by the consideration that the claimant has lost the opportunity to demand a fee for giving permission. As we have seen, the two lines of thinking tend to converge in their result. WWF was not itself a case in which such an award was made. That dispute arose precisely because a claim for profit gained by the defendant had been expressly disallowed. Perhaps that conclusion might have been challenged,56 but no appeal was taken from the order of Jacob J. The holding of the Court of Appeal was that the effect of this final order could not be evaded by making what was, in the context of the particular case, substantially the same claim in a different guise. The court’s decision might be summarised by saying that the claim for a money award related to the defendant’s profits had two aspects, but it was, in substance, one claim.

VIII

CUMULAT IVE REASONS

The Hendrix case has been the subject of some critical comment on the ground that it opens the door to arbitrary and unpredictable awards.57 In my opinion this criticism is overstated. The decision recognises and maintains the general rule, which will be determinative in the vast majority 55 Other such instances are discussed in SM Waddams, Dimensions of Private Law: Categories and Concepts in Anglo-American Legal Reasoning (Cambridge University Press, 2003). 56 See n 58. 57 D Campbell and P Wylie, ‘Ain’t No Telling (Which Circumstances Are Exceptional)’ [2003] CLJ 605; D Campbell and J Devenney, ‘Damages at the Borders of Legal Reasoning’ [2006] CLJ 208.

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of ordinary commercial contracts, that damages for breach of contract are only compensatory. In exceptional cases an award may be made based on the defendant’s gain, but, as earlier suggested in this chapter, we are not left at sea in identifying such cases. Relevant factors include whether specific enforcement would have been available, whether the defendant has infringed a proprietary or quasi-proprietary interest,58 whether the defendant has deprived the claimant of a valuable opportunity to bargain, whether the claimant has a legitimate non-economic interest that is not adequately compensated by the ordinary measure of damages,59 whether the defendant is unjustly enriched by retention of the gain, whether the claimant would be perceived as receiving a windfall if the gain were transferred, whether the breach of contract is reprehensible and whether there was a public interest in deterring it. These factors are mutually interdependent: not all have been present in every case, but often several have operated simultaneously and with cumulative effect. It is very common in judicial reasoning for a matter to be determined by a number of factors, all relevant, but none on its own conclusive. An example, very closely related to the present subject, is the power of the court to decree specific performance of contracts. In Co-operative Insurance Society Ltd v Argyll Stores (Holdings) Ltd, Lord Hoffmann, having mentioned various factors that tended to make courts reluctant to decree specific performance, said: The cumulative effect of these various reasons, none of which would necessarily be sufficient on its own, seems to me to show that the settled practice [ie of refusing specific performance] is based upon sound sense.60

One of the main reasons given by Lord Hoffmann for refusing specific performance in that case was that a decree would give the claimant power to extract from the defendant the gains to be derived from breach; in other words, to obtain the equivalent of a gain-based award.61 It was, in large part, because Lord Hoffmann judged that result to be unjust that he refused specific performance. The ideas are interrelated and interdependent: where specific performance is appropriate, a gain-based award is likely also to be 58 Reference was made in Hendrix to the proceedings before Jacob J in the WWF case, above n 50, [62], in which an account of profits had been refused and where Jacob J had said that he did not think that the claim was assisted by the fact that it was ‘a bit trademarkish, or IP-ish’. Mance LJ, however, indicated at [32] of Hendrix that he considered that the analogy with property was relevant, even though the claimant did not have a property interest in the strict sense, mentioning the reliance by the House of Lords in Blake on the analogy between Blake’s position and that of a fiduciary. 59 In Esso Petroleum Co Ltd v Niad Ltd [2001] EWHC Ch 458 (Ch), where an account of profits was ordered against a motor fuel dealer for violating its price agreement with the supplier, there was the significant feature, mentioned by Mance LJ in Hendrix at [31], that the defendant’s conduct undermined a key component of the claimant’s legitimate business and advertising policy. 60 [1998] AC 1 (HL) 16 (emphasis added). 61 [1998] AC 1 (HL) 15.

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appropriate; looking at the matter from the other direction, if it is first judged that a gain-based award would not be appropriate, this is itself a reason for refusing specific performance. This line of thinking shows also the significance in this context of the idea of lost opportunity to bargain: where specific enforcement is available, the claimant has a very valuable bargaining power and suffers a real loss if deprived of it, but where specific enforcement would never have been contemplated (as in a routine contract for personal services), the claimant had no bargaining power and has no legitimate claim to profits made by the defendant. The availability of specific performance and the recovery of profits made in breach of contract are closely connected62 because the availability of specific performance is interrelated with the question of whether the defendant has infringed a proprietary right, and this in turn is interrelated with the question of whether the defendant’s gain has been made at the claimant’s expense. As Lord Hoffmann’s comment shows, the availability of specific performance itself depends on multiple cumulative factors, and many of the same factors, particularly those just mentioned in the last paragraph, are likely to be relevant also to the determination of when a gain-based award is appropriate. The application of these tests necessarily involves some uncertainty, but they are not for that reason to be rejected as unprincipled. Principle, in legal discourse, is an elusive concept, but it does not always imply the exclusion of a general judgment resting on multiple considerations;63 on the contrary, too great an insistence on formulating a single precise rule or on allocating an issue to a single category has sometimes led to the assertion of propositions that have proved to be oversimplified, unsustainable and therefore ultimately self-defeating. Precision and elegance, though good in themselves when attainable, are not overriding objectives and have yielded, here as elsewhere, where they have come into conflict with the court’s perception of justice and with considerations of practical convenience in administering it.

62 As Ralph Cunnington emphasises in ‘The Measure and Availability of Gain-based Damages for Breach of Contract’, this volume. 63 Whether this should be called ‘discretion’ is another question.

9 The Measure and Availability of Gain-based Damages for Breach of Contract GAI N- BAS ED DAMAGES FOR BREACH OF CONTRACT

RALPH CUNNINGTON * RALPH CUNNI NGTON

I

I NTRO DUCTION

In Attorney-General v Blake,1 the House of Lords recognised for the first time the availability of gain-based damages for breach of contract. Lord Nicholls insisted that there was ‘no reason, in principle, why the court must in all circumstances rule out an account of profits2 for breach of contract’.3 Subsequent cases have confirmed the gain-based nature of the award,4 and have proceeded on the assumption that Blake represented ‘a new start’5 in * Lecturer in Law, University of Birmingham. I am most grateful to Tanya Corrigan, James Edelman, Craig Rotherham and Djakhongir Saidov for their comments on earlier drafts of this chapter. 1 [2001] AC 268 (HL). 2 Lord Nicholls said that he preferred the label ‘account of profits’ to the ‘unhappy expression “restitutionary damages”’ (ibid, 284). He gave no reason for this preference. Possibly the use of the term reflects Lord Nicholls’s view that the remedy awarded in Blake was really only an extension of the availability of account of profits for breach of fiduciary duty: see S Doyle and D Wright, ‘Restitutionary Damages—The Unnecessary Remedy?’ (2001) 25 Melbourne University Law Review 1, 7. Alternatively, the label ‘restitutionary damages’ may have been rejected on the grounds that it was inappropriate to cover a situation which involved the disgorgement of the defendant’s profits: J Edelman, ‘Restitutionary Damages and Disgorgement Damages for Breach of Contract’ [2000] Restitution Law Review 129, 132; cf P Birks, ‘Equity in the Modern Law’ (1996) 26 University of Western Australia Law Review 1, 28. In this chapter, the label ‘gain-based damages’ will be preferred in the belief that it provides the most appropriate descriptive label for remedies that focus on the defendant’s gain. Cf Sempra Metals Ltd (formerly Metallgesellschaft Ltd) v Inland Revenue Commissioners [2007] UKHL 34, [2007] 3 WLR 354 (HL) [230] (Lord Mance). 3 Blake, above n 1, 284. 4 See, eg Esso Petroleum Company Ltd v Niad Ltd [2001] EWHC Ch 458 (Ch) [57] (Morritt VC); World Wide Fund for Nature (Formerly World Wildlife Fund) and World Wildlife Fund Incorporated v World Wrestling Federation Entertainment Inc [2002] FSR 32 (Ch), [62]–[63] (Jacob J). 5 Experience Hendrix LLC v PPX Enterprises Inc, Edward Chalpin [2003] EWCA Civ 323, [2003] EMLR 25 (CA) [16]. This sentiment was echoed by Peter Smith J in WWF—World Wide

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the area of the law, freeing the courts from the ‘constraints that prior authority . . . imposed’.6 This interpretation was, however, rejected last year by the Court of Appeal in WWF—World Wide Fund for Nature v World Wrestling Federation Entertainment Inc.7 Chadwick LJ, delivering the leading judgment of the court, insisted that neither Wrotham Park damages8 nor Blake damages9 are examples of ‘gains-based’10 relief but are instead nothing more than ‘a flexible response to the need to compensate the claimant’.11 This chapter seeks to challenge that view. The chapter is divided into four parts. In the first part, we will trace the origins of gain-based damages, examining both the decision in Blake and the cases that preceded and followed it. In the second part, we will consider the juridical basis of the damages awarded in Blake and Wrotham Park. It will be shown that Blake damages are incontrovertibly gain-based and that Wrotham Park damages, although susceptible to a compensatory analysis, are best viewed as being based on gain rather than loss. The third part will discuss the availability of gain-based damages and show that they are inextricably tied to the availability of specific relief. This will be justified in the final part of the chapter, where it will be shown that this framework provides the necessary protection to the performance interest of contracts.

II

T H E O R I G I N S O F G A I N - B A S E D DAM AG E S F O R B R E AC H O F CONTRACT

Professor Hedley has argued that the acceptance of gain-based damages in Blake cannot be severed from the case’s cold war roots and for that reason it is of little value as a precedent.12 This argument is undoubtedly Fund for Nature v World Wrestling Federation Entertainment Inc [2006] EWHC 184 (Ch) [162]: ‘It seems to me that the House of Lords in Blake was intending to create a remedy of a new model’. Hendrix, above n 5, [16]. [2007] EWCA Civ 286 (CA). Damages assessed by reference to the sum that the claimant might reasonably have demanded from the defendant in return for relaxing her rights under the contract. 9 Account of profits. 10 Chadwick LJ rather confusingly adopted the label ‘gains-based’ award. This label was hitherto unheard of, although it does resemble the more common label ‘gain-based damages’: see J Edelman, Gain-based Damages (Oxford, Hart Publishing, 2002); F Giglio, The Foundations of Restitution for Wrongs (Oxford, Hart Publishing, 2007); S Watterson, ‘The Law of Damages in the 21st Century’ [2004] Lloyd’s Maritime and Commercial Law Quarterly 513; E Weinrib, ‘Restitutionary Damages as Corrective Justice’ (2000) Theoretical Inquiries in Law 1. 11 Ibid, [59]. 12 S Hedley, ‘“Very Much the Wrong People”: the House of Lords and Publication of Spy Memoirs’ (2000) 2 Web Journal of Current Legal Issues. See also the comments of Lord Hobhouse, who in Blake warned his fellow Law Lords against ‘being drawn into making bad law in order to enable an intuitively just decision to be given against a traitor’: Blake, above n 1, 293. 6 7 8

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overstated as it is clear from what their lordships actually said13 that they intended the case to have a much more far-reaching effect.14 George Blake was a Soviet informant who worked as a member of the British Secret Intelligence Service. On discovery of his treason he was tried and imprisoned for 42 years. In 1966, Blake escaped from Wormwood Scrubs prison and fled to Moscow. In 1989, he entered into a contract with Jonathan Cape Ltd for the publication of his autobiography entitled No Other Choice. Jonathan Cape agreed to pay him advances against royalties totalling £150,000, £60,000 of which was to be paid prior to publication of the book. Following publication, the Crown commenced proceedings against Blake to stop him from receiving the remaining £90,000. At first instance, the Crown argued that Blake was a fiduciary and was therefore under a duty to account for the royalties he received from publication of the book. Sir Richard Scott VC rejected this argument, holding that the fiduciary duty did not extend to prohibit profiting from the disclosure of information which was no longer confidential. The Court of Appeal upheld this finding but allowed the Crown’s appeal on an alternative public law ground, holding that an injunction should be granted to prevent Blake from receiving the proceeds of his crime. The Court of Appeal also suggested that the Crown might have been successful had it sought to recover Blake’s profits in a claim for breach of contract, Blake having signed an Official Secrets declaration on 16 August 1944. The Crown declined to argue this point before the Court of Appeal but did raise it once Blake appealed to the House of Lords. The Lords held (by a majority)15 that, whilst the injunction should not have been ordered, the Crown was entitled to recover Blake’s profits in an action for breach of contract. Lord Nicholls, who delivered the leading speech, came to this conclusion after a comprehensive review of the authorities. He concluded: [T]here seems to be no reason, in principle, why the court must in all circumstances rule out an account of profits as a remedy for breach of contract . . . When, exceptionally, a just response to a breach of contract so requires, the court should be able to grant the discretionary remedy of requiring a defendant to account to the plaintiff for the benefits he has received from his breach of contract. 16

Blake, ibid, 284–5 (Lord Nicholls), 291 (Lord Steyn). The facts were exceptional but not unique. The US Supreme Court had to consider a very similar case several years earlier: Snepp v United States (1980) 444 US 507 (SC). The Supreme Court reached the same conclusion as the House of Lords but by a rather different route. 15 Lord Hobhouse dissented and would have denied the claim for the profits arising from Blake’s breach of contract. 16 Blake, above n 1, 284–5. 13 14

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In relation to when this exceptional remedy should be available, Lord Nicholls insisted that ‘no fixed rules can be prescribed’.17 He did, however, proffer two criteria that must be met if a claim is to succeed: first, the claimant must show that alternative remedies18 are inadequate; and secondly, she must show that she had ‘a legitimate interest in preventing the defendant’s profit-making activity and hence, in depriving him of his profit’.19 This legitimate interest test is rather problematic, and will be examined in greater detail in part IV of this chapter. Lord Nicholls relied on two lines of authority in support of his conclusion. The first, which shall be referred to as the ‘reasonable fee’ cases, mostly concern the infringement of property rights, and include cases of trespass by the wrongful use of land,20 trespass by the wrongful occupation of land21 and wrongful detention of goods.22 In each of the cases, the court ordered the defendant to pay a ‘reasonable fee’ or a ‘licence fee’ for the use of the claimant’s property. Some commentators have argued that these damages were compensatory; others that they were gain-based. The latter view is preferable, as will be explained below. The second line of authority might be described as the ‘fiduciary duty’ cases. These concern situations in which equity has required the defendant to account for the profits he has received from the breach of his fiduciary obligations. Lord Nicholls cited the well-known case of Reading v Attorney-General,23 as well as a number of more controversial cases in which the courts have used the label of ‘trust’ to justify the disgorgement of profits in an action for breach of contract.24 Despite the abundance of authority for the availability of gain-based damages in both equity and tort, Lord Nicholls conceded that there was ‘a significant dearth of judicial decision’ on the availability of gain-based 17 Ibid. Lord Steyn reached a similar conclusion in holding that ‘exceptions to the general principle that there is no remedy of disgorgement of profits against a contract breaker are best hammered out on the anvil of concrete cases’: ibid, 291. 18 His lordship had just listed the remedies of damages, specific performance and injunction. 19 Blake, above n 1, 285. 20 Ibid, 278 and 281. The following examples were given: Whitwham v Westminster Brymbo Coal Co [1892] 2 Ch 538 (CA); Martin v Porter (1839) 5 M & W 351 (Exch); Jegon v Vivian (1871) LR 6 Ch App 742 (CA); Bracewell v Appleby [1975] Ch 408 (Ch); Jaggard v Sawyer [1995] 1 WLR 269 (CA). 21 Ibid, 278–9. The following examples were given: Penarth Dock Engineering Co Ltd v Pounds [1963] 1 Lloyd’s Rep 359 (QB); Ministry of Defence v Ashman [1993] 2 EGLR 102 (CA); Ministry of Defence v Thompson [1993] 2 EGLR 107 (CA). 22 Ibid, 278–9. The following examples were given: Strand Electric Co Ltd v Brisford Entertainments Ltd [1952] 2 QB 246 (CA); The Mediana [1900] AC 113 (HL), 117 (Earl of Halsbury LC); Watson, Laidlaw & Co Ltd v Pott, Cassels and Williamson (1914) 1 SLT 130 (HL) 139 (Lord Shaw). 23 [1951] AC 507 (HL). 24 Lake v Bayliss [1974] 1 WLR 1073 (Ch); Reid-Newfoundland Co v Anglo-American Telegraph Co Ltd [1912] AC 555 (PC); British Motor Trade Association v Gilbert [1951] 2 All ER 641 (Ch).

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damages for breach of contract.25 Undeterred by this, his lordship claimed that one case stood out as a ‘solitary beacon, showing that in contract as well as tort damages are not narrowly confined to recoupment of financial loss’.26 That case was Wrotham Park v Parkside Homes.27 The defendant, Parkside Homes, had erected homes on its land in breach of a restrictive covenant requiring it to obtain prior approval from Wrotham Park Estate before commencing building. On 14 February 1972, Wrotham Park issued a writ seeking an injunction to restrain building on the land and a mandatory injunction for the demolition of any buildings erected in breach of the covenant. Brightman J refused to order the mandatory injunction, holding that it would have constituted an unpardonable waste of much needed houses.28 Instead, he awarded the plaintiff damages in lieu of an injunction under Lord Cairns’s Act. On the issue of quantum, Brightman J recognised that damages measured on the diminution of value basis would have been nominal because the value of the plaintiff’s land had been unaffected by the construction of the new houses. Such a result would have been unsatisfactory, and ‘justice would manifestly not have been done’.29 For that reason, Brightman J, in reliance on the ‘reasonable fee’ cases,30 ordered the defendant to pay the plaintiff 5% of its anticipated profit.31 He held that this was the sum that the plaintiff might reasonably have demanded ‘from Parkside as a quid pro quo for relaxing the covenant’.32 In Blake, Lord Nicholls acknowledged that Wrotham Park was hard to reconcile with the later decision of the Court of Appeal in Surrey County Council v Bredero Homes,33 but indicated that, insofar as it was inconsistent with Wrotham Park, he preferred the approach adopted in the earlier case.34 For Lord Nicholls, Wrotham Park provided crucial support for the view that ‘damages for breach of contract can be measured by the benefit gained by the wrongdoer from the breach’. That is not to say, however, that his lordship believed that the damages awarded in Wrotham Park were of exactly the same nature as those being claimed in Blake. He acknowledged that the Crown sought to go further in the case before him

Blake, above n 1, 277. Ibid, 283. [1974] 1 WLR 798 (Ch). Ibid, 811. Ibid, 815. Brightman J relied on Whitwham v Westminster Brymbo Coal Co [1892] 2 Ch 538 (CA); Watson, above n 22; Strand Electric, above n 22; Penarth Dock Engineering, above n 21. 31 Wrotham Park, above n 27, 816. 32 Ibid, 815. 33 [1993] 1 WLR 1361 (CA). 34 Blake, above n 1, 283. Lord Steyn, who sat in the Court of Appeal in Bredero, acknowledged that the academic comment on the decision had been critical: Blake, above n 1, 291. 25 26 27 28 29 30

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by claiming a full account of the defendant’s profits. This more exacting measure was, in his view, justified on the exceptional facts of the case.35 This distinction between the damages awarded in Wrotham Park and those awarded in Blake was subsequently developed and explained by both the commentators36 and the courts. Just one year after Blake, Morritt VC said that there were two alternative gain-based remedies available for breach of contract: an account of profits (as awarded in Blake) and a separate ‘restitutionary remedy’.37 Even more explicitly, in Experience Hendrix,38 Mance LJ distinguished between the Wrotham Park measure of damages and the Blake measure, holding that only the former was available on the facts of the case. In WWF—World Wide Fund for Nature v World Wrestling Federation Entertainment Inc,39 the distinction arose once again. The case concerned a long running dispute between the World Wide Fund for Nature (the ‘Fund’) and the World Wrestling Federation (the ‘Federation’) about the use of the initials ‘WWF’. In 1994, the two parties entered into a settlement agreement whereby the Federation agreed to limit significantly its use of the initials. The Federation subsequently broke this agreement and the Fund sought damages. In 2002, the Fund applied for leave to amend its claim to include an account of profits (following the decision of the House of Lords in Blake). This application was refused by Jacob J on the ground that there was nothing in the case that made it ‘of the exceptional character called for by the decision in Blake’.40 After a significant period of delay (largely due to an appeal lodged by the Federation), the Fund brought a claim for damages measured on the Wrotham Park basis.41 On the preliminary issue of whether damages measured on this basis were available, Peter Smith J answered in the affirmative. This finding was appealed by the Federation. One of the grounds for the Federation’s appeal Ibid, 287. What these exceptional facts were will be considered in part IV. The seminal work on these two measures of damages is: Edelman, above n 10. See also R Cunnington, ‘Rock, Restitution and Disgorgement’ [2004] Journal of Obligations & Remedies 46; P Jaffey, ‘Disgorgement and “Licence Fee Damages” in Contract’ (2004) 20 Journal of Contract Law 57; H Dagan, The Law and Ethics of Restitution (Cambridge University Press, 2004) 214; D Friedmann, ‘Restitution for Wrongs: The Measure of Recovery’ (2001) Texas Law Review 1879, 1880–3; P-W Lee, ‘Responses to a Breach of Contract’ [2003] Lloyd’s Maritime and Commercial Law Quarterly 301. 37 Niad, above n 4, [57]–[58]. Morritt VC said that the restitutionary remedy was based on unjust enrichment. For a convincing explanation as to why this is not the case, see P Birks, ‘Misnomer’ in WR Cornish et al, Restitution: Past, Present & Future (Oxford, Hart Publishing, 1998). 38 Hendrix, above n 5, [43]–[45]. The distinction between the user principle (Wrotham Park) and an account of profits (Blake) was also recognised by Creswell J in Kuwait Airways Corp v Iraqi Airways Co [2004] EWHC 2603 (Comm) [462]. For a similar recognition in Australia, see Hospitality Group Pty Ltd v Australian Rugby Union Ltd (2001) 110 FCR 157 (FCA) [160]–[162] (Hill and Finkelstein JJ). 39 WWF, above n 7. 40 [2002] FSR 32 (Ch) 63. 41 See n 8. 35 36

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was that the remedy sought by the Fund was the same as, or a juridically highly similar remedy to, the relief previously sought. The Federation argued that both remedies are gain-based and, since the Fund’s disentitlement to claim such relief had already been finally determined, the Fund was not entitled to raise the matter again. The Court of Appeal allowed the Federation’s appeal on the alternative ground that the Fund’s attempt to raise a claim for Wrotham Park damages was an abuse of process. In Chadwick LJ’s view, such a claim could and should have been raised by the Fund in October 2001, when it sought to amend its claim to include an account of profits. The Court of Appeal’s conclusion on this point is somewhat doubtful.42 Even more suspect was the court’s conclusion on the other point of appeal—the Federation’s claim that Jacob J had already determined that the Fund was not entitled to claim Wrotham Park damages. Chadwick LJ rejected this argument, holding that Jacob J had only determined that this was not one of those exceptional cases in which an order for an account of profits would have been appropriate. He did not make any final decision on whether the ‘claimant’s inability to quantify identifiable financial loss justified the award of Wrotham Park damages’.43 This conclusion was founded on his lordship’s prior rejection of the view that Blake damages and Wrotham Park damages are assessed by reference to gain. Instead, in a rather baffling paragraph, Chadwick LJ insisted that both measures are compensatory: When the court makes an award of damages on the Wrotham Park basis it does so because it is satisfied that that is a just response to circumstances in which the compensation which is the claimant’s due cannot be measured (or cannot be measured solely) by reference to identifiable financial loss. Lord Nicholls’s analysis in Attorney General v Blake demonstrates that there are exceptional cases in which the just response to circumstances in which the compensation which is the claimant’s due cannot be measured by reference to identifiable financial loss is an order which deprives the wrongdoer of all the fruits of his wrong. The circumstances in which an award of damages on the Wrotham Park basis may be an appropriate response, and those in which the appropriate response is an account of profits, may differ in degree. But the underlying feature, in both cases, is that the court recognises the need to compensate the claimant in circumstances where he cannot demonstrate identifiable financial loss. To label an award of damages on the Wrotham Park basis as a ‘compensatory’ remedy and 42 One might disagree with Chadwick LJ’s conclusion (at [67]) that the Fund must have decided upon whether to pursue a claim for Wrotham Park damages at the time it sought to amend its claim to include an account of profits. This conclusion is highly questionable, given the general confusion surrounding the nature of Wrotham Park damages throughout the WWF litigation and the fact that the distinction between Blake damages and Wrotham Park damages had not been clearly drawn at this time (Hendrix was decided some 18 months later). See R Cunnington, ‘Changing Conceptions of Compensation’ [2007] CLJ 507, 508–9. 43 WWF, above n 7, [69].

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an order for an account of profits as a ‘gains-based’ remedy does not assist an understanding of the principles on which the court acts. The two remedies should, I think, each be seen as a flexible response to the need to compensate the claimant for the wrong which has been done to him.44

This paragraph requires careful consideration since it appears to be irreconcilable with the position adopted by the House of Lords in Blake. It is to this that we now turn.

III

T HE JURI D I CAL B ASI S O F T HE DAMAG E S AWARD E D I N AND

Before analysing Chadwick LJ’s comments in WWF, it is necessary to clear the ground by defining some terms and explaining the means by which we identify remedies.

A

Defining Remedies

Dr Zakrzewski, in his excellent taxonomy of remedies,45 has distinguished between remedies which restate or replicate substantive rights (replicative remedies),46 and those that generate something that is quite different from the original rights and duties that existed between the parties (transformative remedies)47. At a lower level, he divides replicative remedies into specific remedies (which replicate primary rights) and substitutionary remedies (which replicate secondary rights).48 In this chapter, we are concerned with substitutionary remedies—awards of damages that replicate the claimant’s secondary rights, ie the rights arising from the defendant’s breach of contract.49 The term ‘damages’ has a natural association with the occurrence of injury and, for that reason, is often assumed to be synonymous with Ibid, [59]. R Zakrzewski, Remedies Reclassified (Oxford University Press, 2005). Examples of replicative remedies include damages, specific performance, an injunction and restitution for an unjust enrichment. 47 Examples of transformative remedies include a family provision order under the Inheritance (Provision for Family and Dependants) Act 1975 and a remedial constructive trust. 48 R Zakrzewski, ‘The Classification of Judicial Remedies’ [2003] Lloyd’s Maritime and Commercial Law Quarterly 477; Zakrzewski, above n 45, 103–202. See also D Friedmann, ‘The Performance Interest in Contract Damages (1995) 111 LQR 628, 629–630. 49 For the distinction between primary rights and secondary rights, see J Austin, Lectures in Jurisprudence, edited by R Campbell (London, J Murray, 3rd edn, 1869), Lecture XLV; Photo-Production v Securicor [1980] AC 827 (HL) 848–51 (Lord Diplock); P Birks, ‘Rights, Wrongs and Remedies’ (2000) 20 OJLS 1; C Webb, ‘Performance and Compensation: An Analysis of Contract Damages and Contractual Obligation’ (2006) 26 OJLS 41. 44 45 46

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‘compensation’.50 In the twelfth edition of his magisterial work, Dr McGregor defined damages as ‘the pecuniary satisfaction, obtainable by success in an action, for a wrong’.51 However, as Dr McGregor later conceded,52 this definition is inadequate because it fails to take into account non-consequential measures of damages (such as nominal damages and punitive damages), or damages measured by reference to the defendant’s gain. A more comprehensive and appropriate definition might be ‘a monetary award given for a wrong’.53 Consequential measures of damages fall into two categories: compensatory damages and gain-based damages. Unsurprisingly, controversy surrounds the definition of both. (i)

Compensatory Damages

The Oxford English Dictionary provides the following definition of compensation: 2a. That which is given in recompense, an equivalent rendered, remuneration, amends; 2b. Amends or recompense for loss or damage.54

It is clear from this definition that, etymologically, the word ‘compensation’ can carry two different meanings: it can mean a monetary equivalent to a right of which a person has been deprived or denied (definition 2a), which might be labelled ‘substitutive compensation’55; or it can mean a monetary recompense for loss or damage suffered (definition 2b). This is the much more familiar sense of ‘reparative compensation’ or ‘compensation for loss’.56 Whilst compensation for loss is subjective and corresponds to the actual loss or injury suffered by the claimant, substitutive compensation is objective, calculated by reference to the objective value of the right of which the claimant has been deprived.57 In calculating substitutive compen50 See Stoke-on-Trent City Council v W & J Wass Ltd [1988] 1 WLR 1406 (CA) 1415 (Nourse LJ). 51 H McGregor, Mayne and McGregor on Damages (London, Sweet & Maxwell, 12th edn, 1961) 3. 52 The definition was abandoned in the seventeenth edition: McGregor on Damages (London, Sweet & Maxwell, 17th edn, 2003) [1-001]. 53 This definition has now been adopted by a number of commentators: J Stapleton, ‘A New “Seascape” for Obligations: Reclassification on the Basis of Measure of Damages’ in P Birks (ed), The Classification of Obligations (Oxford, Clarendon Press, 1997) 193; Edelman, above n 10, 5; Watterson, above n 10, 516–17. 54 JA Simpson and ESC Weiner (eds), Oxford English Dictionary (Oxford University Press, 2nd edn, 1989). 55 See S Elliott and C Mitchell, ‘Remedies for Dishonest Assistance’ (2004) 57 MLR 16, 24. 56 Robinson v Harman (1848) 1 Ex 850 (Exch) 855 (Parke B); Livingston v Raywards Coal Company (1880) 5 App Cas 25 (HL) 39 (Lord Blackburn). 57 On the distinction between objective and subjective assessment, see G Treitel, Remedies for Breach of Contract—A Comparative Account (Oxford, Clarendon Press, 1991) 111. Treitel uses the terms ‘abstract’ (objective) and ‘concrete’ (subjective). This terminology may indeed be preferable, given that objective methods of assessment are sometimes used to value subjective losses: Ruxley Electronics & Construction Ltd v Forsyth [1996] AC 344 (HL) 360–1 (Lord

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sation, it is irrelevant whether the claimant has suffered any financial loss or harm. Elsewhere in this volume, Professor Burrows has criticised attempts to explain the ‘reasonable fee’ cases as examples of compensation for the value of the claimant’s lost right.58 He objects to the use of the word ‘lost’ in this context, arguing that it is inaccurate to describe the claimant as having lost her right. This objection is perhaps overstated. Whilst it is true that the claimant retains her secondary right to damages, it is very often the case that she has lost her primary right to performance of the defendant’s obligations.59 Thus, it is not entirely inappropriate to speak about ‘lost rights’. Nevertheless, in order to avoid confusion, I have deliberately eschewed the use of the word ‘loss’ in relation to rights-based compensation and have instead chosen to distinguish between compensation for loss and substitutive compensation (the infringement of a right belonging to the claimant). The courts have used the word ‘compensation’ in both of these senses. Lord Blackburn famously used the word to describe compensation for loss in Livingston v Raywards Coal Company.60 But the word has also been used to describe substitutive compensation. In The Mediana, Lord Halsbury spoke of ‘compensation for the use of something’ that belongs to the claimant.61 His lordship noted that the actual use to which the property was put is irrelevant to the task of assessing damages on this basis.62 Similarly, in Watson, Laidlaw & Co Ltd v Pott, Cassels and Williamson, Lord Shaw said that damages could be awarded to provide ‘recompense’ for the infringement of a proprietary right, even in the absence of an identifiable financial loss.63 Subsequent cases have described this award as compensatory.64 More recently, the courts have shown an Mustill). This chapter will, however, continue to use the terms ‘objective’ and ‘subjective’ since this is the more commonly used terminology and ‘abstract’ is a rather unilluminating term, see Hendrix, above n 5, [26] (Mance LJ); Sempra Metals, above n 2, [45] (Lord Hope), [117] (Lord Nicholls), [145] (Lord Scott), [233] (Lord Mance). 58 A Burrows, ‘Are “Damages on the Wrotham Park Basis” Compensatory, Restitutionary or Neither?’, this volume. 59 On the division between primary and secondary obligations, see n 49. 60 (1880) 5 App Cas 25 (HL) 39 (Lord Blackburn). See also Robinson v Harman (1848) 1 Ex 850 (Exch) 855 (Parke B); Alfred McAlpine Constructions v Panatown Ltd [2001] 1 AC 518 (HL) 534 (Lord Clyde). 61 [1900] AC 113 (HL) 116. Lord Halsbury made it clear (at 118) that, although the damages may be trifling in amount, they will not be nominal. See also The Greta Holme [1897] AC 596 (HL); Admiralty Commissioners v SS Chekiang [1926] AC 637 (HL); Ruxley, above n 57, 361 (Lord Mustill). 62 [1900] AC 113 (HL) 117. 63 (1914) 1 SLT 130 (HL) 139. Lord Shaw provided the hypothetical example of a defendant who rode the claimant’s horse without permission and then returned it to him unharmed. He said that it would be no answer for the defendant to respond: ‘Against what loss do you want to be restored? I restore the horse. There is no loss. The horse is none the worse; it is the better for the exercise.’ 64 Wrotham Park, above n 27, 813 (Brightman J).

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increasing willingness to use the word ‘loss’ to describe the value of a right infringed rather than the financial loss suffered by the claimant.65 Accordingly, it is clear that a monetary award can be described as ‘compensation’ if it conforms to either of the two definitions stated above. Nevertheless, in order to avoid taxonomical confusion the distinction between compensation for loss and substitutive compensation will be retained here.66 (ii) Gain-based Damages Gain-based damages focus on the defendant’s gain rather than on the claimant’s loss. Whereas compensatory damages seek to reverse the effect that the wrong has had on the claimant, gain-based damages seek to reverse the effect that the wrong has had on the defendant by removing the gains he has acquired by virtue of the wrong. These gains may consist of either benefits received or expenses saved. There are two distinct measures of gain-based damages. One measure requires the defendant to ‘give up’ the gain he has acquired by virtue of a wrong. This is commonly called ‘disgorgement’.67 Disgorgement is calculated by reference to the actual profit accruing to the defendant from the commission of a wrong. Whether the profits are derived from the claimant or not is irrelevant. There need be no transfer of value and there need be no loss sustained by the claimant. The second measure requires the defendant to ‘give back’ the gains he has acquired by virtue of a wrong. This is restitution in its truest sense68—the defendant is required to restore a gain that he received from the claimant.69 In cases of gain-based damages measured on this basis, there is a correlation between the defendant’s gain and the claimant’s loss.70 Indeed, the award may resemble an award of 65 Tito v Waddell (No 2) [1977] Ch 106 (Ch) 335 (Megarry VC); Jaggard, above n 20, 282 (Bingham MR); Alfred McAlpine, above n 60, 552–7 (Lord Goff), 585–92 (Lord Millett). 66 If we wish to avoid taxonomical confusion it is important to ensure that a single word is not made to do too much work. For the same reason, it is important to distinguish between the two measures of gain-based damages (see below). 67 See Blake, above n 1, 291 (Lord Steyn); L Smith, ‘Disgorgement of the Profits of Breach of Contract: Property Contract and “Efficient Breach”’ (1994–5) 24 Canadian Business Law Journal 121; Edelman, above n 10, 65. 68 Birks, however, has argued that the term ‘restitution’ encompasses both ‘giving up’ and ‘giving back’. He notes that the underlying Latin ‘restituere/restitutio’ indicates that the word ‘restitutionary’ can include both concepts (See P Birks ‘Equity in the Modern Law’ (1996) 26 University of Western Australia Law Review 1, 28; H Heumann and E Seckel, Handlexikon zu Romischen Rechts (1971) 515). 69 See Edelman, above n 10, 66. For a recent critique of this analysis of the reasonable fee cases, see C Rotherham, ‘The Conceptual Structure of Restitution for Wrongs’ [2007] CLJ 172. 70 Whether the correlation has to be exact is a matter of debate in the unjust enrichment literature. Some commentators argue that there must be an exact correlation between the defendant’s gain and the claimant’s loss. This means that the restitutionary claim is limited to the highest amount common to the defendant’s ultimate gain and the claimant’s ultimate loss. See M McInnes, ‘“At the Plaintiff’s Expense”: Quantifying Restitutionary Relief’ [1998] CLJ 472;

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compensatory damages in that the sum awarded (the gain received by the defendant) is sometimes identical to the loss sustained by the claimant.71 This correlation raises difficult questions concerning how we go about identifying and labelling remedies. If the award matches exactly both the gain acquired by the defendant and the loss sustained by the claimant, should we label the award ‘gain-based’ or ‘compensatory’?

B Labelling Remedies Awards of damages often have multiple effects.72 For example, damages awarded for the tort of battery will always have the effect of compensating the victim for her loss but might also have the effect of punishing the defendant for his wrongdoing if the award causes him significant financial hardship. Similarly, an award of compensatory damages will often operate to strip the defendant of his gain as well as compensating the claimant for her loss. Consider the common situation of a seller who breaches his contract in order to obtain a better price for his goods on a rising market. The claimant’s loss (the difference between the contract price and the market rate) will be identical to the defendant’s gain (the price which the defendant received for the goods in a rising market less the contract price) assuming that the claimant has not suffered any consequential loss. In such situations, does it really matter whether we label the award as ‘compensatory’ or ‘gain-based’? The contention of this chapter is that it does matter because different functions of the law of damages have different rationales and a court cannot determine whether damages ought to be awarded unless it first knows what function those damages are performing.73 For this reason, damages and other legal responses must be identified on the basis of their R Grantham and C Rickett, ‘Disgorgement for Unjust Enrichment’ [2003] CLJ 159; and the acceptance of the ‘passing on’ defence in Canada in Air Canada v British Columbia (1989) 59 DLR (4th) 161 (SCC). Other commentators argue that there does not need to be such precise correlation, and that the restitutionary claim is not limited to the claimant’s ultimate loss, see A Burrows, The Law of Restitution (Oxford University Press, 2nd edn, 2002) 28; P Birks, Unjust Enrichment (Oxford, Clarendon Press, 2nd edn, 2005) 78–86; P Birks, ‘“At the Expense of the Claimant”: Direct and Indirect Enrichment un English Law’ in D Johnson and R Zimmermann (eds), Unjustified Enrichment: Key Issues in Comparative Perspective (Cambridge University Press, 2002); and the rejection of the ‘passing on’ defence in England and Australia: Kleinwort Benson v Birmingham City Council [1996] 4 All ER 733 (CA); Roxborough v Rothmans of Pall Mall Australia Ltd (2001) 208 CLR 516 (HCA). 71 An example of such a case is O’Brien Homes Ltd v Joan Eileen Lane [2004] EWHC 303 (QB). 72 See S Watterson, ‘An Account of Profits or Damages? The History of Orthodoxy’ (2004) 24 OJLS 471, 473. Cf Giglio, above n 10, 76. 73 See R Cunnington, ‘The Border between Compensation, Restitution and Punishment’ (2006) 122 LQR 382.

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‘function’ instead of their ‘effect’.74 The importance of this distinction can be illustrated using the example of the legal response to an unjust enrichment arising from a mistaken payment.75 The defendant is required to repay the value of the mistaken payment to the claimant. This response could be analysed in three different ways. First, it could be viewed as a form of compensation, since the claimant has her loss restored. Secondly, it could be analysed as a form of disgorgement, since the defendant has his gains removed. Thirdly, it could be construed as a restitutionary response, since it involves the reversal of a transfer of value. The response has three effects but it only has one function—‘restitution’—and it must be identified by that label in order to avoid confusion and error. If, for instance, the response were labelled ‘compensation’ it would lead to the mistaken belief that the strict liability action in unjust enrichment could give rise to loss-based relief in the absence of a corresponding gain to the defendant. Alternatively, if the response were labelled ‘disgorgement’ it would lead to the mistaken belief that the action could give rise to gain-based relief in the absence of a corresponding subtraction from the wealth of the claimant. It is only when the response is correctly labelled by its function, rather than its effect, that such category errors are avoided.76

C

The Juridical Basis of Wrotham Park Damages

In WWF, Chadwick LJ insisted that the function of Wrotham Park damages is to provide compensation for the claimant’s loss: It is, I think, reasonably clear . . . that, in the Wrotham Park case, Mr Justice Brightman took the view that he was making an award of compensatory damages. The plaintiff’s loss was to be seen as that sum which it might reasonably have demanded as the quid pro quo for relaxing the covenant. The question, then, was what sum would it have been reasonable for the covenantee to demand: it being assumed (I think) that, if the demand were reasonable, the developer would have been willing to meet it . . . In the result, the sum awarded was a percentage of actual profit. In that sense the award was ‘gains-based’: that is to say, based on the actual gain to the developer as a result of his breach. But there is little or no support in the reasoning for the view that Mr Justice Brightman saw himself as making a gains-based award. 77 74 The distinction between ‘purpose’ and ‘effect’ is a hallmark of Professor McInnes’s analysis. See M McInnes, ‘Restitution, Unjust Enrichment and the Perfect Quadration Thesis’ (1999) 7 Restitution Law Review 118, 121; M McInnes, ‘Misnomer: A Classic’ (2004) 12 Restitution Law Review 79, 88–9; M McInnes, ‘Gain, Loss and the User Principle’ (2006) 14 Restitution Law Review 76, 78–9. 75 This example was originally developed in McInnes (2006), ibid, 78. 76 Ibid, 79. 77 WWF, above n 7, [29].

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Chadwick LJ considered that this conclusion was supported by a number of previous decisions, including Bracewell v Appleby,78 Jaggard v Sawyer79 and Gafford v Graham.80 His lordship’s approach was, in essence, a re-statement of Sharpe and Waddams’s ‘Damages for Lost Opportunity to Bargain’ theory.81 (i)

Damages for a Lost Opportunity to Bargain

In their seminal article, Professors Sharpe and Waddams argued that, in cases where a defendant has profited from his violation of the claimant’s property rights, damages can be assessed by reference to the defendant’s gain in order to compensate the claimant for her lost opportunity to bargain. In other words, the damages awarded in Wrotham Park and in the other ‘reasonable fee’ cases82 were just examples of monetary recompense for the loss of an opportunity to bargain release from the contract (the second definition of compensation above). This approach rests on the assumption that the hypothetical bargain would have resulted in the defendant agreeing to pay the claimant a reasonable sum for release from the contract and, therefore, that such a sum constitutes the financial loss suffered by the claimant. The ‘lost opportunity to bargain’ theory has proven rather popular with the courts, being adopted (though not explicitly) by the Court of Appeal in both Jaggard and Gafford. In the former case, Millett LJ insisted that Brightman J’s approach in Wrotham Park was compensatory, not gain-based.83 In the latter, Nourse LJ agreed insisting that, the compensatory analysis, if accompanied by a recognition that it was not a diminution in value of the dominant tenement that was compensated, is perfectly acceptable.84

Despite the popularity of the ‘lost opportunity to bargain’ theory, it is submitted that it is fictitious and ought to be rejected.85 This is because it Above n 20. Ibid. (1998) 77 P & CR 73 (CA). R Sharpe and S Waddams, ‘Damages for Lost Opportunity to Bargain’ (1982) 2 OJLS 290. As well as citing Wrotham Park in support of their thesis, Sharpe and Waddams also cited Bracewell, above n 20; Strand Electric and Engineering Co Ltd v Brisford Entertainments [1952] 2 QB 246 (CA); Lever v Goodwin (1887) 36 Ch D 1 (CA); Whitwham v Westminster Coal and Coke Co [1896] 2 Ch 538 (CA); Livingstone v Raywards Coal Co (1880) 5 App Cas 25 (HL). 83 [1995] 1 WLR 269 (CA) 291. 84 (1999) 77 P & CR 73 (CA) 86. 85 See the criticisms of the theory in Surrey County Council v Bredero Homes Ltd [1993] 1 WLR 1361 (CA) 1369–70 (Lord Steyn); P Birks, ‘Profits of Breach of Contract’ (1993) 109 LQR 518; J Edelman, ‘The Compensation Straight-jacket and the Lost Opportunity to Bargain’ [2001] Restitution Law Review 104; Burrows, above n 70, 477; G Virgo, Principles of the Law of Restitution (Oxford University Press, 2nd edn, 2006) 439–40; R Cunnington, ‘A Lost Opportunity to Clarify’ (2007) 122 LQR 47. 78 79 80 81 82

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fails to explain the availability of gain-based damages in two important categories of case: (i) cases where the claimant would never have agreed to release the defendant from his obligations; and (ii) cases where there never had been an opportunity for the claimant to bargain for release with the defendant. Interestingly, both these problems arose on the facts of Wrotham Park. In his judgment, Brightman J recognised that the claimants, ‘rightly conscious of their obligations towards existing residents’, would clearly not have granted any relaxation of the restrictive covenant.86 Furthermore, a careful reading of the facts shows that the claimants never had an opportunity to bargain release from the covenant with the second defendants. The second defendants were the purchasers of the properties from Parkside Homes and did not complete their purchases until after the building work had been completed. By this time the covenant was unenforceable because a mandatory injunction would, in the words of Brightman J, constitute ‘an unpardonable waste of much needed houses’.87 Therefore, there was no historical point at which the claimant would have been able to enforce the covenant against the second defendants. It had been thought that the ‘lost opportunity to bargain’ theory was falling out of favour with the courts.88 In Blake, Millett LJ appeared to retract the comments he had made in Jaggard. As a party to the joint judgment of the Court of Appeal, he expressed the view that it would be ‘simpler and more open’ to award gain-based damages than to rely on presumptions and fictions of loss.89 Lord Nicholls, delivering the leading speech in the House of Lords, agreed, insisting that, these awards cannot be regarded as conforming to the strictly compensatory measure of damage for the injured person’s loss unless loss is given a strained and artificial meaning.90

Similar views were expressed by the Court of Appeal in Experience Hendrix.91 Peter Gibson LJ referred to the ‘lost opportunity to bargain’ theory as ‘wholly fictional’,92 and Mance LJ described it as artificial, noting [1974] 1 WLR 789 (Ch) 815. Ibid, 811. For notable recent affirmations of the theory, see O’Brien Homes, above n 71, [22]–[25] (David Clarke J); Harris v Williams-Wynne [2005] EWHC 151 (Ch) [27]–[34] (Bernard Livesey QC) (affirmed on appeal: Harris v Williams-Wynne [2006] EWCA Civ 104 (CA) [18] (Chadwick LJ)); WWF, above n 5, [137] (Peter Smith J). 89 [1998] Ch 439 (CA) 458. 90 Blake, above n 1, 279. Comments later in his speech (at 281) suggest that Lord Nicholls approved of the lost opportunity to bargain analysis. However, it is apparent from views expressed extra-judicially that Lord Nicholls considers Wrotham Park damages to be gain-based: see A Burrows and E Peel (eds), Commercial Remedies (Oxford University Press, 2003) 129. 91 Hendrix, above n 5. 92 Ibid, [57]. In the context, Peter Gibson LJ was reporting the words of Buckley J at first instance: [2002] EWHC 1353 (QB) [50]. It seems, however, that Peter Gibson LJ was in agreement with the first instance judge. This is certainly the implication of the following 86 87 88

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that the sum awarded in Wrotham Park was ‘the value which the court puts on the right infringed’.93 Given the fundamental and well-documented flaws in the ‘lost opportunity to bargain’ theory, it was rather surprising to find Chadwick LJ relying on it in WWF.94 (ii) Substitutive Compensation Even more surprising was Chadwick LJ’s reliance on Blake, a case which he claimed provided support for the view that Wrotham Park damages are ‘essentially compensatory’.95 With respect, it is extremely doubtful that this was the view of the majority. As we have seen, Lord Nicholls (with whom the majority concurred) criticised approaches that adopt a ‘strained and artificial’ meaning of loss. Moreover, he insisted that Wrotham Park was the seminal example of an award of gain-based damages for breach of contract.96 Such a claim would have been very odd indeed had Lord Nicholls adopted a compensatory analysis of Wrotham Park. Indeed, it is quite clear that the only speech in Blake that supported a compensatory analysis was the dissenting speech of Lord Hobhouse. It was from this speech that Chadwick LJ quoted in WWF: The view that Wrotham Park damages are essentially compensatory was endorsed by the House of Lords in Attorney-General v Blake. That appears most clearly, I think, in a passage in the speech of Lord Hobhouse of Woodborough ([2001] 1 AC 268, 298f–g): Where the plaintiff has failed to obtain or failed to apply for an injunction, he has to be content with a remedy in damages. What has happened in such cases is that there has either actually or in effect been a compulsory purchase of the plaintiff’s right of refusal . . . What the plaintiff has lost is the sum which he could have exacted from the defendant as the price of his consent to the development. This is an example of compensatory damages. They are damages for breach. They do not involve any concept of restitution and so to describe them is an error. The error comes about because of the assumption that the only loss which the plaintiff can have suffered is a reduction in the value of the dominant tenement.97

sentence, in which his lordship indicated that the fiction could be ignored because it was accepted by Brightman J in Wrotham Park. Ibid, [45]. The theory has also seen a resurgence in a recent case concerning the right to light: Tamares (Vincent Square) Ltd v Fairpoint Properties (Vincent Square) Ltd [2007] EWHC (Ch) 212. See Professor Burrows’s criticisms of the case in ‘Are “Damages on the Wrotham Park Basis” Compensatory, Restitutionary or Neither?’, this volume. Cf D Fox, ‘Remedies for Interference with a Prescriptive Right to Light’ [2007] CLJ 267. 95 WWF, above n 7, [47] (Chadwick LJ). 96 Blake, above n 1, 283. 97 WWF, above n 7, [47]. 93 94

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Whilst we would wish to respectfully disagree with Chadwick LJ’s claim that Lord Hobhouse’s speech represents the view of the majority (he was in dissent), the extract does serve to identify two alternative arguments for a compensatory analysis of Wrotham Park damages. The ‘lost opportunity to bargain’ theory lies behind Lord Hobhouse’s claim that the damages should be assessed by reference to the sum which the claimant ‘could have exacted from the defendant as the price of his consent to the development’. This is reparative compensation, or compensation for loss. But before mentioning the need for reparative compensation, Lord Hobhouse identified a fact situation that calls for substitutive compensation: there has either actually or in effect been a ‘compulsory purchase of the plaintiff’s right’.98 The claimant has been deprived of a right and there is a need for compensation. The possibility of analysing Wrotham Park damages as an example of ‘substitutive’ compensation was recognised by Mance LJ in Hendrix as well. His lordship acknowledged that the law frequently introduces objective measures to quantify loss, citing the example of the law of conversion. In his view, whether such measures represent a departure from a compensatory approach depends upon whether ‘compensation’ is ‘only apt to cover circumstances where an injured party’s financial position, viewed subjectively, is being precisely restored’.99 A substitutive rights-based analysis has also been advanced by a number of academic commentators, most notably Professor Mitchell McInnes.100 McInnes notes that, when a person’s rights are infringed, this necessarily entails a loss because it constitutes a subtraction from the claimant’s dominium (that is, the right to control access and use).101 Compensation is available, even in the absence of identifiable financial loss, as a substitute for the right infringed. The compensation is calculated by reference to the market value of the right, ie the price that reasonable and willing parties would have agreed to in the circumstances prevailing immediately before 98 See also Blake, above n 1, 281 (Lord Nicholls). 99 Hendrix, above n 5, [26]. 100 See M McInnes, ‘Account of Profits for Common

Law Wrongs’ in S Degeling and J Edelman, Equity in Commercial Law (Sydney, Thomson, 2004) 416–18; M McInnes, ‘Gain, Loss and the User Principle’ (2006) 14 Restitution Law Review 76, 84–6. See also A Tettenborn, ‘Gain, Loss and Damages for Breach of Contract: What’s in an Acronym?’ (2006) 14 Restitution Law Review 112, 113; Giglio, above n 10, 207; C Smith, ‘Recognising a Valuable Lost Opportunity to Bargain when a Contract is Breached’ (2005) 21 Journal of Contract Law 250, 259; J O’Sullivan, ‘Reflections on the Role of Restitutionary Damages to Protect Contractual Expectations’ in D Johnston and R Zimmermann (eds), Unjustified Enrichment (Cambridge University Press, 2002) 343; R Nolan, ‘Remedies for Breach of Contract: Specific Enforcement and Restitution’ in F Rose (ed), Failure of Contracts (Oxford, Hart Publishing 1997) 47. Virgo has subsequently retreated from his position (see n 85) and recognised that the ‘reasonable fee’ cases could be analysed as examples of substitutive compensation: G Virgo, ‘Restitutionary Remedies for Wrongs: Causation and Remoteness’ in C Rickett, Justifying Private Law Remedies (Oxford, Hart Publishing, 2008). 101 For a criticism of the view that these cases concern a subtraction from the claimant, see Burrows, above n 58; C Rotherham, ‘The Conceptual Structure of Restitution for Wrongs’ [2007] CLJ 172, 176–81.

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the breach.102 According to McInnes, since the reasonable vendor would take into account the purchaser’s anticipated profits in setting the price, it is appropriate to take the defendant’s gain into account when assessing the objective value of the claimant’s right of dominium. Thus the awards of damages in the ‘reasonable fee’ cases are based on compensatory principles even though they are calculated by reference to the defendant’s gains.103 McInnes explains the difference between his rights-based approach and the ‘lost opportunity to bargain’ theory in the following terms: The focus is not on the hypothetical bargain that the parties might have reached but rather on the reason why the claimant could have demanded a bargain in the first place.104

(iii) Transfer Reversing Gain-based Damages A third explanation of the damages awarded in Wrotham Park is that they were transfer reversing gain-based damages (the second measure of gain-based damages described above). They were a gain-based award calculated by reference to the objective value of the benefit received by the defendant as a consequence of his breach. It is important to point out that this does not mean that the damages awarded in Wrotham Park were a form of partial disgorgement (the first measure of gain-based damages described above). Such a view was expressed, extra-judicially, by Lord Nicholls,105 and has been subsequently endorsed by a number of commentators.106 However, it overlooks the important fact that the damages awarded in Wrotham Park were calculated by reference to Parkside’s anticipated profit, not Parkside’s actual profit.107 The award had nothing to do with Parkside’s actual profits and was calculated on the basis of the sum which, ‘might reasonably have been demanded by the plaintiffs from Parkside as a quid pro quo for relaxing the covenant’.108 If Wrotham Park damages are to be described as gain-based, then this can only be on the ground that they are an example of transfer reversing damages. The award was a judicially determined value placed on the objective benefit

McInnes (2006), above n 74, 86. McInnes thesis, although persuasive, is ultimately unconvincing. See text following n 109. McInnes (2006), above n 74, 85. A Burrows and E Peel (eds), Commercial Remedies (Oxford University Press, 2003) 129. D Campbell and P Wylie, ‘Ain’t No Telling (Which Circumstances are Exceptional)’ (2003) 62 CLJ 605, 608; M Graham, ‘Restitutionary Damages: The Anvil Struck’ (2004) 120 LQR 26, 28; Burrows, above n 58, 176–81. 107 Some commentators note that the sum awarded in Wrotham Park was 5% of the defendant’s actual profit. This is true, but the sum was used as an estimation of ‘what profit [the defendant] expected to make from his operations’ at the time of the breach: Wrotham Park, above n 27, 815. The emphasis throughout was on the defendant’s ‘anticipated profit’. 108 Wrotham Park, above n 27, 815. 102 103 104 105 106

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transferred from the claimant to the defendant. The arguments in favour of this view are persuasive.109 (iv)

What are Wrotham Park Damages?

In Wrotham Park and the majority of the ‘reasonable fee’ cases there was an exact correspondence between the objective gain acquired by the defendant and the value subtracted from the claimant’s dominium. Accordingly, the damages awarded could be described as either transfer reversing gain-based damages or substitutive compensation.110 It is submitted that there are two convincing reasons why the gain-based interpretation is to be preferred. First, the gain-based interpretation explains why Wrotham Park damages are only available where compensatory damages are shown to be inadequate.111 This inadequacy requirement is entirely compatible with a gain-based rationale, gain-based damages being available as a tertiary remedy for breach of contract in circumstances where specific relief is unavailable and compensatory damages are inadequate.112 The requirement is much harder to reconcile with a compensatory rationale because, if Wrotham Park damages are compensatory, it follows that compensation is adequate and the crucial prerequisite for an award is not established. It could be argued that the inadequacy requirement only concerns the inadequacy of compensation for loss. In other words, the requirement simply means that substitutive compensation will only be available where compensation for loss is inadequate. However, none of the cases on substitutive compensation recognise such a requirement.113 A second reason to favour the gain-based interpretation is the fact that reversal of gains is the most commonly described function of the awards. As was noted above, remedies should be identified according to their function rather than their effect. Whilst several of the cases support a compensatory understanding of Wrotham Park damages, this view has usually been predicated on the unsound foundations of the ‘lost opportunity to bargain’ theory.114 The vast majority of the remaining cases See Edelman, above n 10, 178–81; Cunnington, above n 36, 49. See Inverugie Investments Ltd v Hackett [1995] 1 WLR 713 (PC) 718, where the Privy Council suggested that the measure of relief ‘need not be characterised as exclusively compensatory, or exclusively restitutionary; it combines elements of both’. See also S Waddams, ‘Gains Derived from Breach of Contract: Historical and Conceptual Perspectives’, this volume. 111 The inadequacy requirement was affirmed in Blake, above n 1, 285–6 (Lord Nicholls); Hendrix, above n 5, [38] (Mance LJ); WWF, above n 5, [174] (Peter Smith J); Jaggard, above n 20, 284 (Millett LJ). 112 See part IV on the availability of gain-based damages. 113 Clydebank Engineering and Shipbuilding Co Ltd v Don Jose Ramos Yxquierdo Y Castaneda [1905] AC 6 (HL); The Mediana, above n 22; Ruxley, above n 57; Alfred McAlpine, above n 60, 547–54 (Lord Goff), 585–92 (Lord Millett) (both dissenting). 114 Jaggard, above n 20, 281 (Lord Bingham MR), 291 (Millett LJ); Gafford, above n 80, 86 (Nourse LJ); WWF, above n 5, [137] (Peter Smith J). 109 110

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support a gain-based function. In Surrey County Council, Steyn LJ insisted that Wrotham Park was only defensible on the basis of the ‘restitutionary principle’.115 Likewise, in Blake, Lord Nicholls said that the function of the award was to compel the defendant to ‘make a reasonable payment in respect of the benefit he had gained’.116 Further support is to be found in the tort cases in which a ‘reasonable fee’ has been awarded.117 Simon Brown LJ described the damages awarded in Gondal v Dillon as ‘a restitutionary award, ie damages calculated according to the value of the benefit received by the [defendant]’.118 Similarly, in Horsford v Bird, the Privy Council purported to award a ‘form of mesne profits for the use made of [the] land by the respondent’.119 More recently still, Lord Mance has expressed the view that the ‘reasonable fee’ cases should be regarded as examples of ‘restitutionary damages’.120 Even those cases that seemingly support a compensatory rationale undermine that position by repeatedly referring to the benefits acquired by the defendant.121 Such benefits are largely irrelevant to an award of substitutive compensation, which should be measured by reference to the value subtracted from the claimant’s dominium. Proponents of the compensatory analysis might object that the defendant’s gain is relevant to the assessment of the price that the reasonable vendor would be willing to accept for the relaxation of his rights. This may be true; but also relevant to such a calculation is the price that other potential purchasers would be willing to pay for the relaxation of the claimant’s rights. The fact that such factors are not taken into account strongly suggests that the award focuses on the objective gain acquired by the defendant rather than the objective subtraction from the claimant’s dominium. In summary, although the Wrotham Park measure of damages may be susceptible to a compensatory analysis,122 a gain-based analysis is much to be preferred as it more accurately describes the function of the award (as

[1993] 1 WLR 1361 (CA) 1369. Blake, above n 1, 284. See, eg Ministry of Defence v Ashman, above n 21, 519 (Hoffmann LJ); Ministry of Defence v Thompson, above n 21, 554 (Hoffmann LJ); Penarth Dock Engineering, above n 21, 362 (Lord Denning MR). 118 [2001] RLR 221 (CA) 228. 119 [2006] UKPC 3 (PC) [15]. 120 Sempra Metals, above n 2, [230]. Lord Mance did add the caveat that he did not intend to enter into the ‘analytical controversy’. 121 See, eg, WWF, above n 5, [119] (Peter Smith J). In the Court of Appeal, Chadwick LJ even recognised that the award in Wrotham could have been labelled ‘gains-based’ since it was ‘based on the actual gain to the developer as a result of his breach’: WWF, above n 7, [29]. 122 See Dr Edelman’s recent acceptance of the ‘rights-based thesis of compensation’ in relation to the infringement of rights held for non-commercial purposes: J Edelman, ‘Gain-based Damages and Compensation’ in A Burrows and Lord Rodger (eds), Mapping the Law (Oxford University Press, 2006) 153–8. This marks a retreat from the position adopted in Edelman, above n 10. 115 116 117

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stated by the courts) and provides a coherent explanation for the existence of the inadequacy requirement.

D

The Juridical Basis of Blake Damages

Chadwick LJ’s suggestion that Blake damages are based on loss rather than gain was even more startling than his interpretation of Wrotham Park. Before considering the substance of his view, it is sensible to reflect on the nature of the remedy awarded in Blake—account of profits. (i)

The Nature of Account

Account has its roots in the thirteenth-century common law writ of praecipe quod reddat.123 Due to the unnecessary technicality of the action and the cumbersome associated procedure,124 the common law account fell into disuse and was eventually superseded by the more flexible equitable account in the mid-eighteenth century.125 Although account is often thought of as a remedy, it is actually more like a process, similar to tracing, by which the claimant is able to make a detailed inquiry into the financial liability of the defendant. An account is not necessarily tied to gain-based relief and can be used to establish a claim for compensatory relief as well.126 Once the inquiry has been made, the court can order the defendant to account to the claimant for the profits he has received. This is the sense in which the term ‘account of profits’ was used by Lord Nicholls in Blake and it the sense in which it is used in cases of breach of fiduciary duty.127 (ii) The Operation of Blake Damages In Blake itself, the House of Lords ordered Jonathan Cape to pay to the Crown all the profits of Blake’s book which it had not yet paid to him.128 This was unmistakably a gain-based remedy. Blake was required to ‘give up’ the gain he had acquired by virtue of his breach of contract (the first measure of gain-based damages described above). He was ordered to give a full account of his gross profit without any allowance being made for the S Stoljar, ‘The Transformations of Account (1964) 80 LQR 208. See McInnes (2004), above n 100, 407; R Meagher, JD Heydon, M Leeming, Meagher Gummow and Lehane’s Equity: Doctrines and Remedies (Sydney, Butterworths, 4th edn, 2002) 869–83. 125 Stoljar, above n 123, 223–4. 126 Pitt v Cholmondeley (1754) 2 Ves Sen 565; 28 ER 3601 (Ch); Knott v Cottee (1852) 16 Beav 77; 51 ER 705 (Rolls); Re Wrightson [1908] 1 Ch 789 (Ch); Gordon v Gonda [1955] 1 WLR 885 (CA). 127 Blake, above n 1, 284. 128 Ibid, 284 and 288. 123 124

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time, effort and skill which he had put into writing the book.129 It is clear that the Crown did not need to show that it had suffered any loss.130 Nor did it need to demonstrate that the profits received by Blake had been derived directly from the Crown. To this extent, the remedy was not restitution in its truest sense, as it did not require a transfer of value.131 Indeed, it is clear that the Crown would still have been entitled to claim even if Blake had been able to demonstrate that all of his profits had been generated by his own work and skill.132 The damages were a form of disgorgement of profits.133 They were incontrovertibly gain-based. So why did Chadwick LJ describe them as compensatory? (iii) A Compensatory Rationale for an Account of Profits It is rather difficult to provide an answer to that question because Chadwick LJ did not elaborate upon his position. Instead, in a rather enigmatic passage, his lordship quoted from Lord Nicholls’s judgment in Blake, claiming that it supported his own conclusion.134 As we have seen already, the remedy awarded in Blake was incontrovertibly gain-based, which makes the argument a little peculiar. It becomes even more curious when one examines the actual content of the passage cited from Blake. In it, Lord Nicholls plainly distinguishes between gain-based and compensatory remedies, noting at one point that ‘sometimes the injured party is given a choice: either compensatory damages or an account of the wrongdoer’s profits’.135 Nothing in these words suggests that Lord Nicholls endorsed Chadwick LJ’s view that account of profits is a compensatory remedy.136 Indeed, Lord Nicholls’s subsequent extra-judicial comments unequivocally confirm that his lordship considered Blake damages to be a form of gain-based relief.137 If we are looking for support for Chadwick LJ’s position we are not going to find it in Lord Nicholls’s comments in Blake or elsewhere. It is to other sources that we must turn, and out of those sources two main theories emerge. 129 For a detailed discussion of the Blake award, see E McKendrick, ‘Breach of Contract, Restitution for Wrongs, and Punishment’ in A Burrows and E Peel (eds), Commercial Remedies (Oxford University Press, 2003) 112–14. 130 In fact, an account of profits will even be awarded when the defendant’s wrong has enhanced the claimant’s financial position, see Boardman v Phipps [1967] 2 AC 46 (HL). 131 Murad v Al-Saraj [2005] EWCA Civ 959 (CA) [108] (Jonathan Parker LJ). 132 For examples of this, see Boardman, above n 130; Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 (HL). But see recent calls for a softening of the strict approach in Murad, ibid, [83] (Arden LJ), [121] (Jonathan Parker LJ), [158] (Clarke LJ); M Conaglen, ‘The Nature and Function of Fiduciary Loyalty’ (2005) 121 LQR 452. 133 ‘Disgorgement of profits’ was the label preferred by Lord Steyn in Blake, above n 1, 291. See also the description of the Blake award in Hendrix, above n 5, [44]. 134 WWF, above n 7, [58]. Quoting from Blake, above n 1, 284–5. 135 Blake, above n 1, 285. This part of the passage is omitted from Chadwick LJ’s extract. 136 Chadwick LJ’s conclusion at [59]. 137 A Burrows and E Peel (eds), Commercial Remedies (Oxford University Press, 2003) 129.

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(a) Account of Profits as a Proxy for Compensation. The first theory is that the remedy of account of profits was simply equity’s method of compensating the claimant in cases where loss was difficult to measure. A number of nineteenth-century intellectual property cases seem to support this view. In Hogg v Kirby, for example, Lord Eldon LC suggested that, a Court of Equity in these cases is not content with an action for damages; for it is nearly impossible to know the extent of the damage.138

Although there is some support for this view,139 there are a number of reasons why it should be rejected. First, the view is incompatible with the subjective nature of account of profits. As we have seen, substitutive compensation is measured by reference to the value of the subtraction from the claimant’s dominium. This is an objective measure, unaffected by the claimant’s financial loss or the defendant’s actual gain. Thus, on a compensatory approach the defendant will be required to compensate the claimant for the infringement of his rights even if the defendant has, due to his own incompetence, failed to make any profit. An account of profits is not calculated in this way. It is subjective and corresponds to the actual profit received by the defendant. This may be greater or less than the loss of dominium suffered by the claimant, depending on whether the defendant was successful in exploiting the claimant’s rights.140 Secondly, although it is possible that a claimant’s losses might be incidentally compensated by an account of the defendant’s profits, this will not always be so. Such a point was acknowledged by Lord Eldon LC in Mawman v Tegg: [O]ne difficulty in all these cases is that, though keeping an account of the profits may prevent the defendant from deriving any profit . . . if the work, which the defendant is publishing in the meantime, really affects the sale of the work which the plaintiff seeks to protect, the consequence is, that the rendering the profits of the former work to the complaining party may not be a satisfaction to him for what he might have been enabled to have made of his own work, if it had been the only one published.141

Thirdly, the view cannot explain the availability of an account of profits in those cases where it was apparent that no loss had been suffered by the claimant. As we have seen, an account of profits has been held to be 138 (1803) 8 Ves 215, 223; 32 ER 336 (Ch) 339. See also Lever v Goodwin (1887) 36 Ch D 1 (CA) 7 (Cotton LJ). 139 See, in the contractual context, Nolan, above n 100, 57; S Stoljar, ‘Restitutionary Relief for Breach of Contract’ (1989) 2 Journal of Contract Law 1, 3–4; JP Dawson, ‘Restitution or Damages?’ (1957) 20 Ohio State Law Journal 175, 179. 140 Hendrix, above n 5, [26] (Mance LJ); Sempra Metals, above n 2, [230] (Lord Mance). 141 (1826) 2 Russ 385, 400; 38 ER 380 (Ch) 386. See also Colburn v Simms (1843) 2 Hare 543 (Ch) 560 (Sir James Wigram VC).

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available even in cases where the defendant’s wrong has actually benefited the claimant.142 As Dr Edelman has noted, ‘it is entirely fictitious to irrebuttably presume that a loss has been suffered in order to justify an account of profits’.143 Fourthly, it cannot account for the cases in which an account of profits has been ordered even though the claimant’s loss was easy to measure. In Tang Man Sit v Capacious Investments Ltd,144 the defendant committed a breach of trust by agreeing to assign 16 houses to the plaintiff and then letting them, without the plaintiff’s knowledge, to be used as accommodation for the elderly. The loss caused by the secret letting was easy to measure, and the Privy Council held that the plaintiff was entitled to elect between equitable compensation and an account of the defendant’s profits. Finally, the view expressed by Lord Eldon has been expressly doubted by the House of Lords in Blake. After quoting from Lord Eldon’s judgment in Hogg v Kirby, Lord Nicholls continued, ‘whether this justification for ordering an account of profits holds good factually in every case must be doubtful’.145 (b) Account of Profits as Damages for a Lost Opportunity to Bargain. A second theory advanced in support of a compensatory analysis of Blake is that account of profits is awarded as compensation for the claimant’s lost opportunity to bargain. This position has been adopted by a number of commentators,146 and has recently been advocated extra-judicially by Lord Scott: In Blake the Crown had been deprived by Blake’s breach of contract of the ability to forbid or to licence on its own terms the publication of the book. This was a loss created by the breach of contract. It was a loss capable of being attributed a monetary value. The correct analysis of the case, in my opinion, is that the royalties due from the publisher to Blake constituted, in the majority’s view, the due measure of compensation to the Crown for being deprived of the ability to control the publication by Blake of his experiences as an MI6 officer.147

We have already noted the persuasive objections to the ‘lost opportunity bargain’ theory in our discussion of Wrotham Park damages. Those objections apply with equal (if not more) force to any application of the See n 130. Edelman, above n 10, 82. [1996] AC 514 (PC). Blake, above n 1, 280. A Phang and P-W Lee, ‘Rationalising Restitutionary Damages in Contract Law’ (2001) 17 Journal of Contract Law 240, 258–61; J O’Sullivan, ‘Reflections on the Role of Restitutionary Damages to Protect Contractual Expectations’ in D Johnston and R Zimmermann (eds), Unjustified Enrichment (Cambridge University Press, 2002) 344–5. 147 R Scott, ‘Damages’ [2007] LMCLQ 465, 468. 142 143 144 145 146

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theory to Blake damages. It cannot be argued that the Crown had an interest in granting permission for Blake to disclose information because, as Margaret Halliwell noted, ‘had Blake sought permission for publication it would not, at any price, have been granted’.148 Interestingly, exactly the same point was made by Chadwick LJ in WWF: The concept of a notional bargain between the Crown (as employer) and a double agent—under which the Crown was to be taken as having agreed (for a suitable sum) to release the agent from an undertaking not to publish official secrets—was, perhaps, too bizarre to contemplate.149

Indeed. It is clear that the Crown would never have agreed to release Blake from his contractual obligations. The same is true of the claimant in the only other reported case to have awarded Blake damages for a breach of contract. In Esso Petroleum v Niad,150 the defendant petrol dealer failed to implement and maintain petrol prices in accordance with the claimant’s ‘Pricewatch’ scheme. Esso would never have agreed to release the defendant from this obligation because maintaining the recommended petrol prices was ‘fundamental to the whole Pricewatch scheme’.151 Accordingly, any argument that an account of profits was awarded in this case as compensation for a lost opportunity to bargain is pure fiction. It has been shown that Wrotham Park damages and Blake damages are both gain-based measures of relief. The former is calculated by reference to the objective gain acquired by the defendant. The latter is a subjective measure requiring the defendant to ‘give up’ the gain he has acquired. As Jonathan Parker LJ recently noted, an account of profits is ‘neither compensatory nor restitutionary: rather, it is designed to strip the [defendant] of the unauthorised profits he has made’.152

IV

T H E AVAI L A B I L I T Y O F G A I N - B A S E D DAM AG E S F O R BREACH OF CONTRACT

Having shown that Wrotham Park damages and Blake damages are forms of gain-based relief, we turn to consider the availability of these damages, bearing in mind that questions of availability should never be severed from a consideration of the reasons why such damages are available. We will begin by considering the tests set out in Blake and in the cases that followed that landmark decision. It will be shown that these tests lack precision and 148 M Halliwell, ‘Profits from Wrongdoing: Private and Public Law Perspectives’ (1999) 62 MLR 271, 278. 149 WWF, above n 7, [46]. 150 Niad, above n 4. 151 Ibid, [60] (Morritt VC). 152 Murad, above n 131, [108] (Jonathan Parker LJ).

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clarity, and leave the law in a state of profound uncertainty. The chapter will then argue that a preferable alternative would be to tie the availability of gain-based damages to the jurisdictional availability of specific relief. It will be shown that this proposal finds support in the cases and in the underlying rationale of gain-based damages. This will be explored further in the final part of the chapter.

A

Damages Must Be Inadequate

In Blake, Lord Nicholls insisted that gain-based damages should only be available in exceptional cases where damages and other contract remedies are shown to be inadequate.153 This conclusion naturally followed from his lordship’s reliance on a number of cases decided under Lord Cairns’s Act,154 most notably Wrotham Park itself. Damages under Lord Cairns’s Act are only available when the court has jurisdiction to entertain an application for specific performance or an injunction.155 Such jurisdiction is only present when damages are shown to be inadequate.156 It follows from this that equitable damages, and by implication gain-based damages, are only available when compensatory damages are deemed to be inadequate. I have explored elsewhere the circumstances in which damages are deemed to be an inadequate response to a breach of contract.157 Five situations were identified: (i) cases in which no market substitute for performance is available;158 (ii) cases in which compensatory damages are difficult to quantify;159 (iii) cases in which the defendant is insolvent by the time the action reaches court;160 (iv) cases in which only nominal damages are available;161 and (v) cases in which damages are deemed to be Blake, above n 1, 285. His lordship’s judgment even contained a heading titled ‘Damages under Lord Cairns’s Act’: ibid, 281. 155 See s 50 Supreme Court Act 1981. 156 Adderley v Dixon (1824) 1 Sim & St 607, 610; 57 ER 239 (Ch) 240 (Leach VC); Wilson v Northampton and Banbury Junction Rly Co (1874) 9 Ch App 279 (CA) 284 (Lord Selbourne); Ranelaugh Earl v Hayes (1683) 1 Vern 189, 190; 23 ER 405, 406; Beswick v Beswick [1968] AC 58 (HL) 102 (Lord Upjohn). 157 R Cunnington, ‘The Inadequacy of Damages as a Remedy for Breach of Contract’ in C Rickett, Justifying Private Law Remedies (Oxford, Hart Publishing, 2008). 158 Falcke v Gray (1859) 4 Drew 651; 62 ER 250 (Ch); Sky Petroleum Ltd v VIP Petroleum [1974] 1 WLR 576 (Ch); Blake, above n 1. 159 Adderley, above n 156; Evans Marshall & Co Ltd v Bertola SA [1973] 1 WLR 349 (CA); Decro-Wall International SA v Practitioners in Marketing Ltd [1971] 1 WLR 361 (CA); Niad, above n 4. 160 This is a rather controversial ground for the inadequacy of damages, but see Evans Marshall & Co Ltd v Bertola SA [1973] 1 WLR 349 (CA) 380 (Sachs LJ). 161 Beswick, above n 156; Blake, above n 1; Wrotham Park, above n 27; O’Brien Homes, above n 71. 153 154

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insufficient to accomplish the objective of deterrence.162 Underlying each of these five situations is a judicial concern to ensure that the promisee’s bargained-for interest in performance is protected. We will consider this point further when we examine the rationale of gain-based damages in part V.

B The Legitimate Interest Test The test advocated by Lord Nicholls in Blake involved two stages. In addition to demonstrating that a compensatory award would be inadequate, the claimant must also show that she had a legitimate interest in preventing the defendant’s profit making activity.163 This test is notoriously vague. It has been described as ‘a broad and fluid conception’, which ‘renders the task of distilling useful and practical guidance therefrom formidable at best and futile at worst’.164 The problem lies in the difficulty of ascertaining precisely what his lordship meant by a ‘legitimate interest in preventing the defendant’s profit making activity’.165 The difficulty is highlighted by a consideration of the application of the test to the facts of Blake itself. Lord Nicholls insisted that, the Crown had and has a legitimate interest in preventing Blake profiting from the disclosure of official information, whether classified or not, while a member of the service and thereafter.166

Whilst it is uncontroversial that the Crown had a legitimate interest in preventing Blake’s profit-making breach while he remained in the employment of the Crown, it is far from clear why this interest remained following Blake’s treachery and escape to the Soviet Union. Blake was no longer employed by the Crown and the information was now in the public domain. What ‘legitimate interest’ remained except for the interest that the contract should be performed according to its full tenor? Of course, it is possible that the ‘legitimate interest’ test can be reduced to this, but that was surely not the intention of Lord Nicholls, who earlier in his speech insisted that an account of profits should only be exceptionally available.167 Ultimately, it has been left to subsequent courts to determine the width of the ‘legitimate interest’ test. A very narrow approach was advocated by 162 Whiten v Pilot Insurance Company (2002) 209 DLR (4th) 257 (SCC) 303 (Binnie J); Royal Bank of Canada v W Got & Associate Electric Ltd (2000) 178 DLR (4th) 385 (SCC) 395 (McLachlin and Bastarache JJ). 163 Blake, above n 1, 285. 164 Phang and Lee, above n 146, 248–9. 165 It is possible that this ambiguity was intentional, it giving the courts a broad discretion to hammer out the rules for availability ‘on the anvil of concrete cases’: Blake, above n 1, 291 (Lord Steyn). 166 Blake, above n 1, 287. See also Lord Steyn at 292. 167 Ibid, 285.

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Jacob J in WWF.168 The judge concluded that there was nothing in the case to make it of the exceptional character called for by the decision in Blake. The mere fact that the covenant related to the use of initials and was, in his words, a ‘bit “trademarkish” or “IPish”’ was, in his view, insufficient to justify an award of Blake damages.169 The decision has subsequently been criticised by Mance LJ,170 who suggested that Jacob J’s terse dismissal both of the relevance of analogy171 and of any possibility of an account of profits in a restraint of trade case may require reconsideration in a future case. Undoubtedly, the judgment can be criticised for failing to provide a workable definition of the legitimate interest test that it was purporting to apply. A much more liberal approach was taken by Morritt VC in Niad. The Vice Chancellor ordered an account of the defendant’s profits on the ground that: (i) damages were inadequate; (ii) the obligation to implement and maintain the recommended pump prices was fundamental to the contract; (iii) the claimant had complained about the breach on four occasions; and (iv) the claimant undoubtedly had a legitimate interest in preventing the defendant from profiting from its breach.172 A similar set of criteria was applied by the Court of Appeal in Hendrix, a case concerning the breach of a settlement agreement for the use of various Jimi Hendrix recordings. Mance LJ noted the two-stage test advocated by Lord Nicholls in Blake and added two further criteria: (i) the breach must go to the root of the contract or ‘give lie to its integrity’; and (ii) the defendant must have profited directly from the breach of contract.173 At first glance, these two requirements appear to be additional criteria, but on a closer examination it is clear that they are merely refinements of the pre-existing two-stage test. The first requirement clearly relates to the legitimate interest criterion—the claimant only has a legitimate interest in preventing the profit-making breach if the breach goes to the root of the contract. The second relates to the test of causation, a test that Lord Nicholls appeared to endorse as a necessary limitation on the availability of gain-based damages.174

[2001] EWHC Ch 482, [2002] FSR 32. Ibid, [62]. Hendrix, above n 5, [32]. Which was accorded considerable significance by Lord Nicholls and Lord Steyn in Blake, above n 1, 287 and 292 respectively. 172 Niad, above n 4, [63]. 173 Hendrix, above n 5, [38]. 174 Lord Nicholls appeared to adopt the ‘but for’ test of causation: Blake, above n 1, 287. For a discussion of the issues of causation and remoteness in relation to gain-based damages, see McKendrick, above n 129, 116–17; Virgo, above n 100; EA Farnsworth, ‘Your Loss or My Gain? The Dilemma of the Disgorgement Principle in Breach of Contract’ (1985) 94 Yale Law Journal 1339, 1343–50. 168 169 170 171

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Somewhat surprisingly, the Court of Appeal held that Blake damages were not available on the facts of Hendrix. Mance LJ said that Experience Hendrix had failed to demonstrate that the defendant’s breaches went to the root of the contract or that the defendant had profited directly from its breach. With respect, both these conclusions are rather doubtful. PPX’s wrongful exploitation of the master recordings clearly went to the root of the settlement agreement, giving lie to its integrity and generating significant profit for PPX.175 Even more difficult to understand is why the claim was denied when Mance LJ accepted both that damages were inadequate176 and that the claimant had a legitimate interest in performance.177 His lordship distinguished the facts of the case before him from those pertaining in Blake on three grounds: (i) the facts were not as special or sensitive as national security; (ii) the notoriety of the breach accounted for Blake’s royalty-earning capacity and there was no parallel in the present case; and (iii) there was no direct analogy between PPX’s position and that of a fiduciary.178 All these distinctions were matters of historical particularity which did not directly relate to the two-stage test set out by Lord Nicholls in Blake. As Professor Campbell and Mr Wylie have noted, ‘almost every case that will ever be heard will be distinguishable from Blake on this basis’.179 It may be that the Court of Appeal was attempting to restrict the availability of account of profits to the exceptional facts of Blake,180 but this approach is very hard to square with their lordships acceptance of Niad (a commercial case) and criticism of the outcome reached by Jacob J in WWF. The only conclusion that we can make with any degree of certainty is that the legitimate interest test remains hopelessly ill-defined and difficult to apply.181

C

The Distinction between Wrotham Park Damages and Blake Damages

A further problem that has emerged from the post-Blake case law concerns the difficulty of articulating when each measure of damages ought to be available. It is apparent from what Lord Nicholls said in Blake that the two-stage test was only ever intended to apply to the availability of account of profits (disgorgement). Nevertheless in Hendrix, Mance LJ insisted that 175 For more detailed criticisms, see Cunnington, above n 36, 52; J Edelman, ‘AttorneyGeneral v Blake Revisited’ [2003] Restitution Law Review 101, 105. 176 Hendrix, above n 5, [38]. 177 Ibid, [36]. 178 Ibid, [37]. 179 Campbell and Wylie, above n 106, 618. 180 This is a position supported by Professor Hedley, above n 12, 8. 181 Of course some commentators argue that the pursuit of certainty in this area is futile: see Waddams, above n 110.

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the same test should provide the starting point in relation to Wrotham Park damages as well.182 With respect, it is rather difficult to understand why the same criteria should be applied if the two awards are distinct. Fortunately, some light was shed on this apparent paradox by his lordship’s subsequent reasoning. In Mance LJ’s view, the grant of an injunction for the future show[ed] that the appellants had a legitimate interest in preventing PPX’s profit-making activity.183

This comment is revealing. Specific relief, in the form of specific performance or an injunction, is only available where compensatory damages are inadequate. Thus the availability of an injunction is evidence that compensatory damages are an inadequate response to the breach of contract: the first of Lord Nicholls’s criteria in Blake. It would therefore seem that the crucial criterion for the availability of Wrotham Park damages, according to Mance LJ, is not evidence of a legitimate interest but evidence that compensatory damages would be an inadequate remedy. Support for this view is to be found in other cases as well. In Wrotham Park itself, there was no suggestion that the claimant needed to demonstrate a legitimate interest in preventing the defendant’s profit-making activity; it was enough simply to show that compensatory damages would have been inadequate and that the court had jurisdiction to order an injunction. A similar approach was adopted in Harris v WilliamsWynne,184 where the court emphasised the importance of demonstrating that the court had jurisdiction to order specific relief.185 In WWF, Peter Smith J offered a set of principles to be applied when assessing Wrotham Park damages.186 These included the inadequacy of damages requirement but contained no mention of the legitimate interest test. It seems clear that Wrotham Park damages will be available whenever compensatory damages are shown to be an inadequate remedy—nothing more is required. The more exacting measure of Blake damages will only be available where the claimant is able to demonstrate that she had a legitimate interest in the preventing the defendant’s profit-making activity. The precise width of this requirement remains unclear, as does its relationship with the additional criteria set out by the Court of Appeal in Hendrix.

Hendrix, above n 5, [35]. Ibid, [36]. [2005] EWHC 151 (Ch). Upheld by the Court of Appeal in [2006] EWCA Civ 104 (CA). See also O’Brien Homes, above n 71. 185 Ibid, [29]–[30] (Bernard Livesey QC). 186 [2006] EWHC 184 (Ch) [174]. 182 183 184

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The Relationship between Gain-based Damages and Specific Relief

An often overlooked element of the case law on gain-based damages is the relationship between gain-based damages and specific relief.187 It is unfortunate that this relationship has been ignored since it is therein that the key to understanding the availability of gain-based damages is to be found. Consider the following extract from Lord Nicholls’s speech in Blake: In practice . . . specific remedies go a long way towards providing suitable protection for innocent parties who will suffer loss from breaches of contract which are not adequately remediable by an award of damages. But these remedies are not always available. For instance, confidential information may be published in breach of a non-disclosure agreement before the innocent party has time to apply to the court for urgent relief. Then the breach is irreversible. Further, these specific remedies are discretionary. Contractual obligations vary infinitely. So do the circumstances in which breaches occur, and the circumstances in which remedies are sought. The court may, for instance, decline to grant specific relief on the ground that this would be oppressive.188

Lord Nicholls recognised that specific relief is a secondary remedy for breach of contract, available in circumstances where the breach is ‘not adequately remediable by an award of damages’. But specific relief will not always be available. The reasons given by the courts fall into two categories: (i) reasons why the court ‘will not’ order specific relief, such as delay, hardship and public policy; and (ii) reasons why the court ‘cannot’ order specific relief, such as impossibility or the need for constant supervision. Wrotham Park and Harris v Williams-Wynne fall into the first category. In both cases, the building work had already commenced and an injunction was either refused or not sought by the claimant on the ground of delay189 or waste.190 Blake, Hendrix, Esso and WWF fall into the second category. Each case concerned a situation where the court was no longer able to order specific relief because the date for performance had already passed. The defendants had failed to fulfil their contractual obligations and there was no specific remedy that could be ordered to undo the consequences of the breach.

187 Commentators who have considered this relationship in detail include Nolan, above n 100; J Beatson, The Use and Abuse of Unjust Enrichment (Oxford University Press, 1991) 15–17; Law Commission, ‘Aggravated, Exemplary and Restitutionary Damages’, Consultation Paper No 132, para 7.21. 188 Blake, above n 1, 282 (Lord Nicholls). See also WWF, above n 5, [137] (Peter Smith J). 189 Harris (2005), above n 88. Bernard Livesey QC was of the view that delay deprived the defendant of any possibility of obtaining injunctive relief and he had realistically not sought it [42]. See also Amec Developments Limited v Jury’s Hotel Management (UK) (2001) 82 P & CR 22 (Ch). 190 Wrotham Park, above n 27, 811 (Brightman J).

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When damages are inadequate and specific relief is unavailable (either because the court ‘will not’ or ‘cannot’ order it), gain-based damages will be awarded. Later in his speech, Lord Nicholls said the following: In the same way as a plaintiff’s interest in performance of a contract may render it just and equitable for the court to make an order for specific performance or grant an injunction, so the plaintiff’s interest in performance may make it just and equitable that the defendant should retain no benefit from his contract.191

Gain-based damages are available as a tertiary remedy for breach of contract in situations where compensatory damages are inadequate and specific relief is unavailable. In this role, gain-based damages may be said to act as an alternative to specific relief or even as ‘a monetised form of specific performance’.192 Two functions of gain-based damages seem to support this formulation. First, there is the ‘deterrence function’: both specific relief and gain-based damages operate to deter the defendant from breaking his contract. While specific relief performs this function through the threat of contempt-backed sanctions, gain-based damages perform the same function by removing any incentive to breach. The second function might be described as the ‘value function’: gain-based damages require the defendant to return the value of his breach. The sum awarded is equivalent to the value of specific relief; or, conversely, it is equivalent to the value to the defendant of non-performance. A closer examination of the two measures of gain-based damages reveals that Wrotham Park damages fulfil the ‘value function’ but rarely the ‘deterrence function’, whilst Blake damages fulfil the ‘deterrence function’ but rarely the ‘value function’. Consider the sum of damages awarded in Wrotham Park. It was assessed at such a value as to require the defendant to pay a just price for the value of its non-performance. It was an assessment of the objective value of release from Parkside’s obligations. This fulfilled the ‘value function’, in that it required the defendant to give back the value of non-performance. It did not, however, amount to an absolute deterrent to breach since the defendant was entitled to retain some of the profit that it had made. Consequently, the Wrotham Park measure of damages can be said to be a monetised form of specific performance only in a very weak sense. Blake damages, on the other hand, are a monetised form of specific performance in a much stronger sense. By requiring the defendant to disgorge all of his profit, the measure operates as an absolute deterrent to breach. The measure may not, however, fulfil the ‘value function’ since the subjective assessment of the defendant’s Blake, above n 1, 285. Beatson, above n 187, 17. See also P Maddaugh and J McCamus, The Law of Restitution (Toronto, Canada Law Book, 1990) 432–8; Adras Building Material Ltd v Harlow and Jones Gmbh [1995] RLR 235 (SC of Israel) 241 (S Levin J), 272 (Barak J). 191 192

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profit may produce a lower figure than the objective value of the defendant’s non-performance.193 Given the functions that the two measures of gain-based damages perform, when should they be available? Wrotham Park damages should be available in all situations where specific relief is refused, whether this refusal be because the court ‘cannot’ make such an order or because the court ‘will not’ make such an order. Blake damages, on the other hand, should be reserved for those situations where the court ‘cannot’ order specific relief. Significantly, Blake damages should be available in all such situations, including those that arose in WWF and Hendrix. Some cases, of course, will involve a situation where the court ‘will not’ order specific relief because of waste or delay but also ‘cannot’ order specific relief because the time for performance has passed. In such cases, only Wrotham Park damages should be available. These criteria provide a workable test for the availability of gain-based damages which is supported by the underlying purpose of gain-based damages (see part V) and preferable to the vague and ill-defined legitimate interest test proposed in Blake.

V

T H E P U R P O S E O F G A I N - B A S E D DAM AG E S F O R B R E AC H O F CONTRACT

In Blake, Lord Nicholls recognised that contract remedies are awarded to protect the claimant’s interest in performance of the contract. Compensatory damages are the ‘basic [or primary] remedy’,194 because in most situations a market substitute for performance can be found and thus damages will place the claimant in a ‘situation as beneficial to him as if the agreement were specifically performed’.195 In some situations, however, a party to a contract may have an interest in performance which is not readily measurable in terms of money.196

In such situations, [the] plaintiff’s interest in performance . . . may render it just and equitable for the court to make an order for specific performance or grant an injunction.197

In the same way, 193 This would be the case if the defendant, through his own incompetence, failed to make a profit. See the comments of Mance LJ in Hendrix, above n 5, [26]. Lord Mance repeated these comments but recognised that not all commentators would agree with him in: Sempra Metals, above n 2, [230]. 194 Blake, above n 1, 282 (Lord Nicholls). 195 Harnett v Yielding (1805) 2 Sch & Lef 549, 553 (Lord Redesdale). Robinson v Harman (1848) 1 Exch 850 (Exch) 855. 196 Blake, above n 1, 282 (Lord Nicholls). 197 Ibid, 285.

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the plaintiff’s interest in performance may make it just and equitable that the defendant should retain no benefit from his breach of contract.198

According to Lord Nicholls, compensatory damages, specific relief and gain-based damages all serve the same purpose: they operate to ‘protect the claimant’s interest in performance’. This is unsurprising. As Roskill LJ famously said in The Hansa Nord, ‘contracts are made to be performed and not to be avoided’.199 Pacta sunt servanda—agreements must be kept. A party enters into a contract, not because she wants to obtain an insurance policy against non-performance,200 but because she desires to receive the performance which the other party has promised to deliver.201 As Professor Coote explained, what distinguishes an effective contractual promise from any other is that it is intended to, and does in fact, confer on the promisee an enforceable legal right to have the promise performed.202

The courts are committed to protecting this right to performance. Failure to perform results in two forms of harm.203 First, the promisee does not receive the performance to which she was entitled under the contract. This is a tangible harm—resources are not transferred in accordance with the terms of the contract. Secondly, society’s confidence in the institution of contracting is undermined.204 This is of concern to the law because contracts provide a means for individuals to submit their own will to the will of others, thus allowing them to benefit from coordination and constructive action.205 Unless the parties are confident that their bargained-for interests will be protected by the law, they will be reluctant to contract at all and commercial activity will be stifled.206 To prevent this from happening, the courts have developed an armoury of remedies for

Ibid. Cehave NV v Bremer Handelsgesellschaft mbH [1976] QB 44 (CA) 71. See also George Mitchell v Finney Lock (Seeds) Ltd [1983] QB 284 (CA) 304 (Oliver LJ). 200 F Buckland, ‘The Nature of Contractual Obligation’ [1944] CLJ 247, 249–51. 201 D Friedmann, ‘The Performance Interest in Contract Damages (1995) 111 LQR 628, 629. 202 B Coote, ‘The Performance Interest, Panatown, and the Problem of Loss’ (2001) 117 LQR 81, 82. See also B Coote, ‘Contract Damages, Ruxley, and the Performance Interest’ [1997] CLJ 537, 540–3. 203 See S Smith, ‘Performance, Punishment and Contractual Obligations’ (1997) 60 MLR 360, 367. 204 See J Raz ‘Promises in Morality and Law’ (1981–2) 95 Harvard Law Review 916, 933; C Fried, Contract as Promise (Cambridge, MA, Harvard University Press, 1981) 16. I discuss this in greater detail in Cunnington, above n 157. 205 Raz, above n 204, 933; J Danforth, ‘Tortious Interference with Contract: A Reassertion of Society’s Interest in Commercial Stability and Contractual Integrity’ (1981) 81 Columbia Law Review 1491, 1509 and 1511–14. 206 J Finnis, Natural Law and Natural Rights (Oxford, Clarendon Press, 1980) 325; P Jaffey, ‘Efficiency, disgorgement and reliance in contract: a comment on Campbell and Harris’ (2002) 22 Legal Studies 570, 573. 198 199

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breach of contract that vindicate the claimant’s bargained-for interest in performance.207 As we have seen, the primary remedy is compensatory damages. Such damages will usually be adequate as long as substitute performance is available. If damages are inadequate,208 however, specific relief will be available. Due to the nature of specific relief as a contempt-backed equitable remedy, it will often be denied for discretionary reasons. There is no reason why these restrictions209 should apply with equal force to the availability of gain-based damages (which is a monetary remedy),210 but the reasons are of relevance to the extent that they reveal the nature of the bargained-for interest that requires protection. This, in turn, determines the measure of gain-based damages that is required to protect the claimant’s interest in performance. If specific relief has been denied because the court is unwilling to order it, this indicates that the bargained-for interest does not merit the full protection of specific enforcement. In other words, it can be expropriated at a price. As Millett LJ noted in Jaggard, the denial of specific relief has ‘the practical effect of licensing the defendant to commit the wrong’.211 For this reason, it is quite inappropriate to award Blake damages. The claimant was never entitled to specific relief and would have been denied it had she sought it. Thus absolute deterrence is not required. Instead, damages are to be calculated by reference to the objective value of the benefit received by the defendant—the Wrotham Park measure. This is the price of the expropriation of the claimant’s rights and, indeed, it is the sum that would have been awarded in lieu of specific relief had the claimant sought it from the court.212 The situation is quite different, however, where specific relief has been denied because the court ‘cannot’ order it. Here absolute deterrence is required. Such deterrence would have been achieved by specific relief had it been available, but in its absence, Blake damages perform the same function by disgorging the defendant’s profits. Blake, Esso, Hendrix and WWF all concerned such a situation. Had specific relief been sought it undoubtedly would have been ordered, but by the time the cases reached the court the time for performance had passed and specific relief was incapable of undoing the wrong. Disgorgement was appropriate in all four See Coote, ‘Performance Interest’, above n 202, 83; Webb, above n 49. See the discussion of the inadequacy of damages at text following n 157. See text following n 188. See the arguments against tying the availability of gain-based damages to the availability of specific relief in W Goodhart, ‘Restitutionary Damages for Breach of Contract’ [1995] Restitution Law Review 3, 11–12; Smith, above n 67, 137; D Friedmann, ‘Restitution of Benefits Obtained through the Appropriation of Property or the Commission of a Wrong’ (1980) 80 Columbia Law Review 504, 514. 211 [1995] 1 WLR 269 (CA) 286. 212 See Wrotham Park, above n 27; Jaggard, above n 20; Gafford, above n 80. 207 208 209 210

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cases (although it was only awarded in Blake and Niad213), since it fulfilled the function of specific relief by removing the benefits of breach. In circumstances such as these, Blake damages provide essential protection to the performance interest. Without such a remedy, the bargained-for interest in performance would be left hopelessly unprotected and society’s confidence in the institution of contracting would be severely undermined. Lord Nicholls was of the view that gain-based damages are awarded to protect the claimant’s interest in performance. This perspective on the purpose of gain-based awards provides the necessary theoretical foundations for the framework articulated above concerning the availability of such awards.

VI

CONCLUSION

The decision of the Court of Appeal in WWF was eagerly awaited but ultimately disappointing.214 It had been hoped that their lordships would grasp the nettle and provide much-needed guidance about the measure, availability and assessment of Wrotham Park damages. Instead, the court took a gigantic step backwards, denying the very existence of gain-based damages and concluding that both Wrotham Park and Blake damages are forms of compensatory relief. This chapter has sought to challenge that conclusion. It has been shown that Blake damages are incontrovertibly gain-based and that Wrotham Park damages are best viewed as being based on gain rather than loss. In part IV, a workable set of criteria has been set out for determining the availability of gain-based damages. By tying gain-based damages to the availability of specific relief, the framework remains consistent with the approach outlined by Lord Nicholls in Blake but avoids the needless ambiguity of the legitimate interest test. The framework is consistent with the underlying purpose of gain-based damages in that it provides a structured approach to protecting the claimant’s interest in performance. Inevitably, the issue of gain-based damages will once more arise before the higher appellate courts of this country. It is to be hoped that, when it does, the court will have the courage and determination to make real advances in this ‘devilishly difficult’215 area of the law.

See the criticisms of WWF and Hendrix at text following n 167. See the comments on the Restitution Discussion Group, 2–3 April 2007, available at http://www.ucc.ie/law/restitution/rdg_admin/2007lis.htm (accessed 27 June 2007). 215 A Burrows, ‘No Restitutionary Damages for Breach of Contract’ [1993] Lloyd’s Maritime and Commercial Law Quarterly 453. 213 214

10 The Limitation of Contract Damages in Domestic Legal Systems and International Instruments LI MI TATI ON OF DOMES TI C AND I NTERNATI ONAL CONTRACT DAMAGES

ALEXANDER K OMAROV * ALEXANDER KOMAROV

I

I NTRO DUCTION

The subject of contract damages, including the issue of the limitation of damages, generally has an enormous practical impact on the functioning of any domestic or international legal system which aims to regulate the turnover of material values. This is especially important in the context of the market economy, where the law of damages plays the role of an instrument of self-regulation.1 It is suggested that the more market relationships are developed in a particular legal system, the more attention is paid, by positive law and doctrine, to different aspects of contract damages.2 It seems that lawyers have, by and large, taken a practical attitude to this subject and the problems surrounding it. This seems to be the case particularly in common law systems, where lawyers appear to concentrate more on the pragmatic side of law by preferring to achieve practical goals using legal techniques available to them rather than being too concerned * Chairman of the International Commercial Arbitration Court at the Russian Federation Chamber of Commerce and Industry and Professor at the Russian Academy of Foreign Trade. The author is grateful to Djakhongir Saidov for his comments and help in preparing this presentation for publication. 1 For example, in the socialist civil law, the role of the institution of damages, as well as of the contract as a whole, was minimal. By contrast, in the conditions of market economy the relations between the parties are constructed independently by the parties and largely on the basis of default rules. In other words, the parties themselves can be said to regulate their relations and consequently, in such an environment, damages play a decisive role by directly influencing the parties’ material and financial position where a breach occurs. 2 This thesis derives from the author’s extensive comparative work carried out in the process of developing new Russian civil legislation. The thesis that the law of damages becomes more complex as contractual relations deepen and diversity seems quite obvious, particularly where the law of countries with well-developed market economies are compared with the law of the countries in transition to market economy.

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with details of a theoretical analysis. It is submitted that the necessity of enquiring into a theoretical background of rules on contract damages will inevitably arise in the context of international commerce due to the existence of various alternative approaches to resolving a particular issue and because of an important aim, in international trade, of achieving uniformity in legal regimes. In order to come to a satisfactory solution for a particular problem in an international setting, it is inevitable that a court or tribunal will attempt to understand not only the substance of existing alternative rules, but also their underpinnings. It is submitted that rules of an unfamiliar legal system can only be successfully applied if a judge is certain about the extent to which they are similar to, or different from, his or her own legal system. This certainty, in turn, is only achievable where the rationale underlying those rules is fully understood. Modern developments in trade make it necessary for the law to react to an increasing significance, in commercial practice, of economic analysis of legal problems, including the recovery of damages. This seems vital, especially in international investment disputes involving substantial sums of money and material resources. However, the diversity of circumstances and conditions, arising from modern commercial practices and sophisticated business transactions, has traditionally been considered primarily from the standpoint of legal standards established in a particular domestic legal system a long time ago. It is difficult to avoid the impression that these standards are inadequate against the background of complex mathematical formulae used by economists in providing their calculation of damages. Although the main focus of this presentation relates to the so-called methods of limiting damages, the general considerations set out above are directly relevant to our understanding of the subject-matter of this presentation and they will be elaborated upon in the course of the discussion. The presentation will begin by exploring the essence and evolution of the idea of limiting damages. The remaining part will examine various specific methods of limiting damages in domestic legal systems as well as under the relevant international instruments.

II

B A S I C I D E A S O F L I M I TAT I N G DAM AG E S

Along with the principles of full compensation and the protection of the innocent party’s interest in the performance of the contract, contemporary domestic legal systems also recognise the limitation of damages as one of the main principles underlying the award of damages. In modern economic relationships, the availability of clear and transparent rules of measuring contract damages could serve as an effective instrument in providing stability to a very rapidly changing world. This will also make commercial

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relations, which are exposed to a variety of risks, more predictable. Adequate solutions in the area of limiting damages would be vital to enable contracts to be treated as nearly perfect instruments in the allocation of risks which the parties are expected to take into account in the process of exchanging economic values. In the first version of his well-known comparative study on damages, Professor Treitel noted that the idea of setting certain limitations on the recoverability of damages for breach of contract has always been so clear that there had hardly been any serious and substantial discussions of the reasons why such limitations exist.3 Although he dropped this statement in the later edition, he retained his reference to Corbin where the latter stated that one fundamental aim of awarding damages for breach of contract was ‘the prevention of similar breaches in the future and the avoidance of private war’.4 It was also stressed that the more probable view was simply that the full protection of the expectation and reliance interests would either operate as too strong a disincentive to the assumption of contractual obligations or lead to an undue increase in charges to cover such unlimited liability.5 There is, in particular, a reluctance to hold a party liable for heavy losses if they are disproportionate to the amount of the benefit he receives under the contract. A modern day economic environment directly influences the role and effectiveness of the existing rules of limiting damages if one looks at a rapidly developing commercial life consisting of an enormous variety of large-scale business practices. These practices seem to resemble very little the economic situation existing at the time when the main fundamental concepts about contract damages had emerged in domestic legal systems in the form of either positive or case law. Nevertheless, essentially the same legal tools are used, with some necessary adjustments, in legal practice today. As noted, all national jurisdictions set limits on the amount of recoverable damages. They do so in different ways by using different legal techniques, which often means the use not only of different legal terminology but also of different theoretical concepts. Even domestic systems within the same legal family deal with the issue of limiting damages in different ways.6 It is further submitted that, in a well-established legal system, the parameters relating to the criteria of limiting damages and their implication in practice are more detailed than in those jurisdictions where the law of damages and its practical application have not been so 3 GH Treitel, ‘Remedies for Breach of Contract (Courses of Action Open to a Party Aggrieved)’ in International Encyclopedia of Comparative Law, Vol VII (Tübingen, JCB Mohr (Paul Siebeck), 1976) ch 16, 55. 4 GH Treitel, Remedies for Breach of Contract (Oxford, Clarendon Press, 1989) 143. 5 Ibid. 6 See the discussion below.

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well developed due to the peculiarities of the economic environment. As a rule, less developed legal techniques are to be found in countries with a lower degree of industrialisation and an insufficient diversity of commercial turnover, as well as where private legal relationships are underdeveloped.7 In many respects, the process of setting limits on damages sometimes overlaps with the process of establishing the contractual liability itself. While methods of limiting damages pre-determine the extent of responsibility of the defaulting party for the breach of contract, they cannot be separated from the definition of contract damages. By contrast, modern commercial practices reflect the tendency of dealing with the problem of damages by, first of all, resolving the issue of the measure of damages (quantum). As a consequence, the question of the amount of damages, including their limitation aspects, is dealt with in light of additional criteria which are not always employed in analysing the basis of liability for breach of contract. This trend is particularly characteristic of international commercial and investment arbitration, where a tribunal, facing the need to find a solution in a dispute that could involve billions of dollars in damages, does not generally feel overly bound by formal stipulations of any domestic system but instead guides itself by less formal rules of law (found in international practice or recognised in the majority of national legal orders).8 This approach gives the arbitral tribunal an opportunity to find more pragmatic and more flexible solutions, and is likely to be more suitable to international transactions (when compared with the position resulting from domestic rules which often do not take account of peculiarities in international trade).9

III

T H E E VO L U T I O N O F T H E CO N C E P T O F L I M I T I N G DAMAG E S

The methods of limiting damages used by various legal systems do not present much diversity. In most modern jurisdictions, the rules of limiting damages were formulated a long time ago, when legal concepts began to evolve to help promote industrial development. At that time,10 the law was See nn 1 and 2. What is meant here is the rather widely spread practice of relying on ‘soft law’ (eg the UNIDROIT Principles of International Commercial Contracts). The UNCITRAL Model Law on International Commercial Arbitration (Art 28(1)) and laws of countries which followed the Model Law refer to the application of the ‘rules of law’, which mean not only domestic law but also what is known as lex mercatoria, that is, widely recognised rules and principles of law. 9 See generally Y Derains and R Kreindler (eds) Evaluation of Damages in International Arbitration (Paris, ICC—Dossiers, 2006). 10 The eighteenth and nineteenth centuries (the period at the beginning of the industrial revolution and the formation of stable financial and trade relations). 7 8

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undergoing an initial stage of formation and adaptation to economic and social conditions in a market environment. What could seen as rather astonishing is that, in most domestic legal systems, these rules have not changed dramatically throughout this long period. This indicates that the development of the concepts relating to damages were primarily aimed at resolving practical problems, without much concern for theoretical explanation. The apparent suitability of, and preference for, the rules of limiting damages, as they were initially formulated, is illustrated by recent developments in some countries of the continental legal tradition, in particular, the Netherlands11 and Québec.12 This development is of substantial systematic importance since the codification of civil law in the said jurisdictions may be considered as indicating general trends in the modern development of continental legal systems. In analysing the relevant rules of limiting damages in domestic legal systems, it is necessary to bear in mind that, in many jurisdictions, especially those belonging to the Roman law tradition, the rules on damages were developed with respect to both contractual and noncontractual liability, or, in other words, as part of the general law of obligations. Moreover, it has often been the case that the practice of non-contractual liability has supplied much more factual material on the recovery of damages than that of the field of contractual obligations. However, not all of the practice relating to tort is relevant to contractual relationships and should not therefore have an equal impact on the law of contract damages. Finally, it is not surprising that the approach to the law of contract damages taken by the developed legal systems over the last two centuries has been adopted by the new civil law systems in the so-called ‘countries in transition’, where private law has recently begun a process of rebirth. The Russian Federation and other countries of the Commonwealth of Independent States (CIS), which includes former Soviet republics, provide a good example. The new Russian Civil Code13 follows the continental legal tradition and contains rules formulated in accordance with modern developments in private law in different legal traditions.14 All CIS jurisdictions have similar rules on damages because they have all been drafted in accordance with the CIS Model Civil Code. As a result, so far as the law of damages is concerned, nothing fundamentally different, in comparison 11 See PPC Haanappel and E Mackaay, New Netherlands Civil Code. Patrimonial Law (Boston, Kluwer Law and Taxation Publishers, 1990) 12 See JM Brisson and N Kasirer, Code Civil du Québec.Édition critique/Civil Code of Québec. A Critical Edition, 2006–2007 (Québec, Y Blais, 14th edn, 2006). 13 Civil Code of Russian Federation (2003), Parallel Russian and English Texts (Moscow). 14 Thus, the Civil Code of the Russian Federation (RF) is largely based on the German Civil Code. The most apparent examples of the adherence to German legal concepts include the RF Civil Code’s provisions on persons, transactions, general provisions on obligations and contracts, and specific types of contracts.

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with the well-known concepts in major modern civil law codes, has been included in the new Code. It is important to point out, however, that this reception of ‘classical’ private law rules on damages took place in jurisdictions where private law had not been practiced for many decades. Contract damages were claimed in exceptional cases because in a planned economy compensation for breach of economic contracts was based on a centralised regulation usually providing for penalties. Currently, because of the lack of court practice and experience, the law of damages in ‘transition economies’ is rather unstable and, to some extent, unpredictable.

IV

A

S P E C I F I C M E T H O D S O F L I M I TAT I O N US E D I N D O M E S T I C L E G A L SYS T E M S

Foreseeability of Damages

It is submitted that nowadays the so-called ’foreseeability’ test represents the prevailing legal method of limiting contract damages in domestic legal systems. In its most explicit form, it was expressed in French law at the beginning of the industrial revolution in Europe. In Article 1150 of the French Civil Code of 1804, it was laid down that the debtor was only liable for damage which he foresaw or which he could, at the time of contracting, have foreseen. It seems that the main reason for introducing this test was to ensure a balanced treatment of the situation whereby objective (the extent of the harm) and subjective (the defaulting party’s attitude) factors would have to be taken into account. This explanation may find its confirmation in the fact that the above-mentioned rule of the French Civil Code is subject to an important qualification: it will not apply if a defaulting party has acted in bad faith.15 The methods of limiting damages in French law, which constitute an element of the codified system of rules on contract obligations, demonstrated their pragmatic character and played an important role in creating an adequate legal environment where economic incentives played the leading role. The growing commercial activities required more predictability with regard to its economic consequences, which could be achieved only when businesses were able to rely on a legal environment which protected their expectations in cases of breach of contract. At the same time, the limitation of damages for breach of contract protected and stimulated the expansion of business. An introduction of the ‘forseeability’ test led to the creation of a balanced system of rules which turned the contract into the most effective instrument for developing economic relations where 15

Art 1150 of the French Civil Code.

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the parties themselves were expected to bear the risks of their activity in the market. In countries adopting the ‘foreseeability’ rule, as expressed in the French Civil Code, this rule is often associated with the requirement of ‘directness’ of damages. This follows from the fact that Article 1151 of the French Civil Code stipulates another test for the purpose of defining the measure of damages which provides that damages must be an immediate and direct consequence of the non-performance of the contract. This confusion in legal practice has arisen despite both requirements being dealt with in the Code separately and it is largely due to the fact that the ‘foreseeability’ test has sometimes been applied to determine whether the requirement of directness has been met.16 To appreciate correctly the role of the ‘foreseeability’ test, it is necessary to bear in mind that the rule on ‘directness’ forms just one of two parts of the concept of the French law which defines and limits the extent of the debtor’s liability. Confining liability to direct damages is not a replacement for the ‘foreseeability’ test. Both tests are applicable cumulatively. For example, a debtor who is guilty of fraud and is thus liable for unforeseeable damage will not be liable for ‘indirect’ damages. Generally, where the debtor is not guilty of fraud, both the requirements of ‘foreseeability’ and ‘directness’ must be satisfied. The ‘directness’ test also imports the requirement of causation, which will be discussed below. A recent codification of civil law in Québec has not changed its position which originated in French law. The new Civil Code almost repeated (at least, in substance if not literally) the rule of limiting damages for breach of contract that had been formulated in the French Civil Code almost two hundred years earlier. Article 1613 of the Québec Civil Code has combined the ‘foreseeability’ and ‘directness’ tests (which are expressed in two separate provisions of the French Civil Code) into a single provision which provides that, in contractual matters, the debtor is liable only for damages that were foreseen or foreseeable at the time when the obligation was contracted or where the failure to perform the obligation does not result from intentional or gross fault on his part. Even where the failure does so result, damages only include losses which are an immediate and direct consequence of non-performance.

B Foreseeability in Common Law The requirement of ‘foreseeability’ was widely adopted in legal systems based on the principles of the French Civil Code17 and this development 16 Thus, it is often the case that direct losses are thought to be those which could have been foreseen in the normal course of things. 17 Belgium, Spain, Italy and Luxembourg.

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seems quite natural. At the same time, however, the idea of limiting damages was also welcomed in other legal systems. Despite the fact that it was formulated in an abstract manner as a part of written, codified law, the concept turned out to be appealing enough to find its recognition in jurisdictions belonging to a legal tradition that developed contract law rules not a priori as abstract formulae but in the course of long-standing judicial practice. Now, it could hardly be disputed that the ‘foreseeability’ test entered into the English common law through the leading case of Hadley v Baxendale,18 yet not without the influence of the rule stated in Article 1150 of the French Civil Code. In the years following its introduction, thanks to a predominantly empiric way of developing legal rules, the English common law produced a substantial amount of case law on numerous aspects of the ‘foreseeability’ test. In fact, it now appears that the common law has been much more successful than continental legal systems in developing this concept, and this is largely due to the existence of an extensive body of case law on commercial matters. The rule in Hadley v Baxendale provides, in essence, that damages may be recovered when a loss is one that arises naturally, that is, in the usual course of things, or, otherwise, if this loss has been in the contemplation of the parties. In common law systems, the former category refers to the loss which any reasonable person in the defendant’s position could have foreseen. The latter category refers to the loss which could have been foreseen by a reasonable person with the same knowledge of special circumstances as the defendant had (for example, knowledge of the purpose for which the aggrieved party wanted the subject matter of the contract). The ‘foreseeability’ test is methodologically based on the so-called objective or abstract approach to the assessment of damages. The main point of the rule is that the defendant cannot reduce his liability by showing that, in particular circumstances, he foresaw less than the aggrieved party actually suffered as a consequence of the breach. It is not necessary to show that the defendant actually foresaw the loss, although proving this fact would normally be sufficient to satisfy the test. The time when the contract was made is considered generally to be the relevant time for identifying losses as arising ‘naturally’.

C

Causation as a Test of Limiting Damages

Despite a positive attitude to the ‘foreseeability’ test in national codifications in the years following the enactment of the French Civil Code and its introduction in the English common law, the concept of limiting damages was rejected in an important segment of continental legal 18

(1854) 9 Ex 341.

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tradition—German law. The German Civil Code, adopted almost 100 years after the Code Napoleon, opted for a different standard—‘causation’. This method of limiting damages is used in domestic legal systems that have been developing under the influence of the German Civil Code.19 Its starting point is the initial assumption that a debtor is liable for loss caused by his default. Whilst, in theory, causation has been explained by a variety of rather sophisticated philosophical doctrines, legal practice has mostly concentrated on the theory of ‘adequate’ causation. Questions of causal connection in breach of contract cases arise primarily as questions of fact. Therefore, a final conclusion would depend, to a great extent, upon the discretion vested in the judge. At the same time, in most situations this would involve the application of techniques which largely reflect the idea of foreseeability. In legal theory as well as in practice, the requirement of causation is often dealt with from the standpoint that events connecting the breach and its consequences should occur in the ordinary course of things. The practical effect of the theory of ‘adequate causation’ and of a formal rejection of the principle of foreseeability may give one reason to think that such an approach creates insufficient protection for the defendant. As a means of improving this position, a general provision on good faith in section 242 of the German Civil Code has sometimes been used to limit the defendant’s liability. Obviously, this method is by no means perfect since it creates too much uncertainty, as is often the case insofar as general standards are concerned. Causation as the principal method of limiting damages is consistently used not only in German law and doctrine, but also in legal systems based on Germanic legal techniques. This was true for the period when the German Civil Code was considered to be the most modern and influential codification in the world. The present time also gives examples of this kind. Thus, the new Russian Civil Code, adopted in 1994, which includes rules on measuring damages in its general provisions on damages,20 relies on the notion of causation in defining damages. Article 15 provides that a person whose right has been violated may demand full compensation for losses inflicted upon him unless a statute or a contract provides for compensation for losses of a lesser amount.21 The same is the case in civil codes of other CIS countries.22

Those of Austria, Sweden and Switzerland. Art 15, para 1 of the Russian Civil Code. Ibid. See, eg Art 21 of the Civil Code of Azerbaijan; Art 9(4) of the Civil Code of Kazakhstan; Art 14 of the Civil Code of the Republic of Moldova; and Art 14 of the Republic of Uzbekistan. 19 20 21 22

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Alexander Komarov Certainty of Damages

Some civil law systems impose the requirement of ‘certainty’ of damages, although it is often not formulated expressly.23 A general approach is that the degree of uncertainty of the loss sustained by the aggrieved party may be a valid ground for reducing the amount of damages. In commercial practice, however, only uncertainty of a very high degree would substantially affect the amount of damages. The application of this test is usually connected with specific losses, such as those which have not materialised at the time of the breach (so-called future losses) or loss of a chance. Strictly speaking, this problem relates more to the general idea of damages to be compensated rather than to the particular problem of their limitation. It has been suggested that, in European systems, certainty as a test for the measure of damages is not taken literally,24 and this may be one reason why this standard was not included in the Principles of European Contract Law. Such notwithstanding, it seems that the significance of this notion in the context of damages has been undeservedly underestimated for practical reasons, and it is suggested that it is premature to regard the ‘certainty of loss’ as a fading test. This suggestion is supported by the fact that, in the preparation of the reform of the law of obligations in France, the suggested new rule on damages takes advantage of employing the idea of certainty of damages.25 Thus, draft Article 1343 provides that any certain loss is recoverable where it causes prejudice to a legitimate interest, whether or not relating to assets and whether individual or collective. The notion of ‘certainty’ is also used in draft Article 1367, which stipulates that the right to recovery accrues as of the date when the harm takes place or, in the case of future harm, as of the date when its occurrence has become certain.

E Fault as a Factor Limiting Damages In some instances, damages could be also limited by reference to the degree of fault (culpa) of the breaching party. A seemingly prominent role allocated to the notion of fault in the continental legal tradition may be explained by the fact that, in these systems, fault represents the main element in formulating the basis of contractual liability. As a method of limiting the extent of contractual liability, fault does not play a decisive role except where it acquires an extreme form of fraud or gross negligence. In See Treitel, above n 4, 193–4; Comment on Art 7.4.3 of the UNIDROIT Principles. See O Lando and H Beale (eds), Principles of European Contract Law: Parts I and II (The Hague, Kluwer Law International, 2000) 443. 25 P Catala (English translation by J Cartwright and S Whittaker), Proposals for Reform of the Law of Obligations and the Law of Prescription (Oxford, 2007) 186. 23 24

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fact, in such cases the presence of the breaching party’s fault rules out the limitation of liability as it would follow from standard rules. In most relevant cases, a breach of contract accompanied by fault will mean that a breach has been committed either deliberately or in bad faith. As indicated earlier, in French law the principle of foreseeability in Article 1150 of the French Civil Code does not apply where the default is due to the fraud of the debtor. It is also accepted that, for this purpose, fraud includes gross negligence. In common law systems, fault is not considered to be an element of contractual liability. The general position is that, once a breach is established, it makes no difference whether the breach was committed deliberately, negligently or innocently, or whether the party in default acted in good faith or in bad.26

F

Modern Developments

An interesting approach to determining the extent of recoverable can be found in Dutch law. Historically, civil law in the Netherlands has been formulated and developed under the influence of French law and jurisprudence. Nevertheless, in the process of recent law reform it has abandoned the approach based on any concrete tests or standards in the assessment of damages. Instead, it has opted for providing a court with a great extent of flexibility. The new Dutch Civil Code contains no fixed or any other formal criteria for limiting damages and only provides for general principles for guidance. Thus, Article 97 simply gives the authority to a court to assess damages in a manner most appropriate to their nature.27 Another point which is noteworthy from the standpoint of the definition of damages, including their limitation aspect, relates to recent developments in French legal doctrine. In the course of preparing the reform of the French law of obligations, a rule relating to liability for breach of contract, which departs from the current position, has been proposed for inclusion in the French Civil Code. The idea of using, in measuring damages, the ‘causation’ test instead of ‘foreseeability’ has found its place into the draft, despite a long-standing tradition and extensive court practice to the contrary. The new rule has the following formulation: ‘any non-performance of a contractual obligation which has caused harm to its creditor obliges the debtor to answer for it’.28 Work on the reform of the French Civil Code is now in progress. Future developments will show whether French law on damages will substantially deviate See Treitel, above n 4, 148. A Hartkamp, Civil Code: Revision in the Netherlands 1947–1992. New Netherlands Civil Code. Patrimonial Law (Boston, Kluwer Law and Taxation Publishers, 1990). 28 Ibid, 184, Art 1340, para 2. 26 27

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from the traditional approach primarily based on the ‘foreseeability’ test. The fact that such a possibility has been considered in the process of the legal reform demonstrates that the time has come to reconsider the existing criteria. It should be noted that a dominating position of the ‘foreseeability’ test among different methods of limiting damages has been confirmed by the authoritative private codification of European contract law, where it was adopted as the test most widely used in domestic systems.29 Article 9.503 of the Principles of European Contract law, albeit in a rather laconic form, fixed this approach by providing that the non-performing party is liable only for loss which it foresaw or could reasonably have foreseen at the time of conclusion of the contract as a likely result of its non-performance, unless the performance was intentional or grossly negligent.

V

T H E R E DU C T I O N O F DA M AG E S

The amount of recoverable damages, after being defined on the basis of the limitation criteria, may be subject to further reduction. The most well known and widely used rule is that of ‘mitigation of damages’. Generally, mitigation means that the aggrieved party cannot recover damages in respect of the loss which ought to have been avoided. This rule may appear to impose a ‘duty’ to mitigate damages, but this is not the case, at least formally, because there is no sanction for the breach of this ‘duty’—the only consequence of a failure to mitigate damages is the reduction of the amount of damages. Mitigation also means that if the aggrieved party actually gains some benefit as a consequence of the breach, he may have to take that benefit into account. The notion of mitigation is not well known in continental law, but it is used in international commercial practice. The equivalent of the mitigation rule which prevents compensation for loss that could have been avoided is formulated with the help of the notion of ‘creditor’s fault’. In fact, in relevant situations one could speak of the fault of both parties. This approach is fairly well developed in French law, although it was predominantly developed and used in tort cases.30 In countries of the continental legal tradition the possibility of the application of the approach known as mitigation in the common law is either expressly stated in the positive law or established in case law. The new Russian Civil Code includes the provision which reflects the idea of mitigation under the heading ‘fault of the creditor’. It provides that 29 30

Lando and Beale, above n 24, 441. See Treitel, above n 4, 189.

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the court shall have the right to reduce the amount of the debtor’s liability if the creditor intentionally or by negligence facilitated an increase in the amount of damages caused by the non-performance or improper performance, or did not take reasonable measures to reduce them.31 At least the last part of the provision clearly points to the concept of mitigation of damages as it has evolved in modern practice. It should also be mentioned that, in the practice of the International Commercial Arbitration Court at the Russian Federation Chamber of Commerce and Industry, which at present is the principal arbitration institution dealing with international commercial disputes in the post-Soviet area, the requirement of mitigation of damages is frequently imposed. The idea of the reduction of damages seems to be recognised by all European countries, as demonstrated by the inclusion in the Principles of European Contract Law of provisions which attempt to combine the corresponding concepts used in the common law (mitigation) and in the continental law (contributory acts of the creditor). Article 9.504 (Loss attributable to the aggrieved party) provides that the non-performing party is not liable for loss suffered by the aggrieved party if the latter contributed to the non-performance or its effects. At the same time, Article 9.505 (Reduction of loss) stipulates that the non-performing party is not liable for loss suffered by the aggrieved party to the extent that the aggrieved party could have reduced the loss by taking reasonable steps and that the aggrieved party is entitled to recover any expenses reasonably incurred in attempting to reduce the loss.

VI

T H E L I M I TAT I O N O F DA M AG E S B Y AG R E E M E N T

In principle, all domestic legal systems give the parties to the contract the freedom to agree to a special legal regime governing the measure of damages. The parties usually take advantage of this position by including in their contract stipulations for the payment of a fixed sum of money by the breaching party in the case of the non-fulfilment of the contract. They may take a form of an obligation to pay a lump sum or a penalty which may be set in proportion to the seriousness of the breach: for example, a sum may be fixed by reference to the length of the delay in delivering the goods, or a fixed percentage rate could be calculated on the basis of the value of non-delivered goods or quality defects. In a continental legal tradition such stipulations are often referred to as ‘penalty clauses’.32 An important feature of continental law, which makes the regulation of penalty clauses less severe, is the right of the court to 31 32

Art 404. Known as Konventionalstrafe in German law and as clause penal in French law.

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reduce the amount fixed in such clauses. The defaulting party has no duty to pay the penalty if it is largely incomparable with the harm actually sustained by the aggrieved party. Liquidated damages and penalty clauses are widely used in international trade transactions. However, there are major differences in the way different legal systems resolve certain issues arising from such clauses. As a result, considerable uncertainty exists as to the rights of the parties under a clause until the applicable law is determined. Although many legal systems allow the use of penalty clauses to secure the fulfilment of contractual obligations, they nevertheless contain special rules which prevent the reliance on such clauses when they oppress a weaker party in certain transactions: for example, an employee in employment contracts, a debtor in contracts of loan, or a tenant in leases of lands and dwellings.33 In the common law, liquidated damages clauses whereby parties, at the time of contracting, attempt to fix the amount of compensation payable upon a breach of contract, are valid if they satisfy one or more of the following criteria: that the parties genuinely intended to provide for compensation and not to punish the breaching party; that the sum stipulated was a reasonable pre-estimate of the probable loss; and that the loss caused by the breach is impossible or difficult to quantify. Different common law jurisdictions attach differing degrees of importance to a failure to satisfy one or more of these criteria. Courts have no power to vary the amount stipulated in such clauses. In contrast, a clause which, contrary to the compensatory purpose, seeks to coerce a party into performing his obligation by a threat of a sum payable on breach, is considered in the common law not to be enforceable, and the party in breach is only liable for losses recoverable under the general rules on damages. In civil law, however, clauses pre-estimating damages or seeking to coerce a party into performing his obligation, or pursuing both of these objectives, are in principle valid and enforceable.34 However, the law usually provides that courts have the power to reduce the amount stipulated in such a clause in specified circumstances, such as where the amount is excessive or performance has been partial. Thus the new Russian Civil Code provides that if a penalty due for payment is clearly disproportionate to the consequences of the breach of an obligation, the court has the right to reduce the penalty.35 It should also be remembered that, in continental law, any contractual limitation of liability is not valid if a breach was committed intentionally or due to gross negligence. For example, the new 33 See Report of the Secretary-General: Liquidated Damages and Penalty Clauses (A/CN.9/161), UNCITRAL Yearbook, vol X (1979) 42. 34 See Art 1152 of the French Civil Code and §§ 339–45 of the German Civil Code. 35 See Art 333.

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Russian Civil Code provides that an agreement concluded in advance to eliminate or limit liability for an intentional breach of an obligation is void.36 The problem, which has a significant practical aspect, is the effect of a penalty clause on the right of the aggrieved party to recover more than the sum stipulated by the clause. In continental legal systems, it is generally recognised that, unless otherwise agreed between the parties, the aggrieved party may claim damages if it proves that its actual loss is in excess of the sum provided by the clause. In common law, the legal nature of liquidated damages clauses is such that, if they are valid, they exclude compensation of actual loss sustained by the aggrieved party.37

VII

A

T H E L I M I TAT I O N O F DAM AG E S I N I N T E R N AT I O N A L I N S T RUM E N T S AN D T E X T S

Criteria for Limiting Damages

Amongst international instruments, the dominant position is enjoyed by the ‘foreseeability’ test. One of the most important commercial law instruments—the Vienna Convention on Contracts for the International Sale of Goods (CISG)—expressly gives preference to this method. Article 74 CISG provides that damages for breach of contract comprise all losses, including loss of profits, suffered by the other party as a consequence of the breach, to the extent that these losses were foreseeable by the breaching party at the time of the conclusion of the contract. Naturally, this provision, being a result of an international compromise, is formulated in an attempt to produce a unified solution based on a pragmatic approach. The solution adopted by the CISG appears to be based on the drafters’ view that the foreseeability test is the most popular method of limiting damages as well as the most suitable one so far as the needs of international commerce are concerned. It should also be noted that the CISG damages formulae apply equally to the claims by both sellers and buyers. There is now a growing body of case law on Article 74, which shows that courts effectively apply the rule on foreseeability even in jurisdictions which use other tests, such as Germany, and, by and large, treat the CISG provisions on damages as exhaustive and exclusive of the recourse to domestic law.38 See Art 401, para 4. See § 340 of the German Civil Code; Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79. 38 UNCITRAL Digest of Case Law on CISG, ch V, s II. 36 37

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It is interesting to mention that the CISG Advisory Council (CISG-AC)39 in its Opinion No 6 on damages under Article 7440 has not addressed the application of the foreseeability test. Nevertheless, in the part of the Opinion which relates most closely to the issue of limiting damages, the CISG-AC has made a general reference to the ‘certainty’ test expressly stating that the aggrieved party bears the burden of proof, with reasonable certainty, that it has suffered loss. It is further explained that the party has to prove the extent of the loss, but need not do so with mathematical precision. We turng now to an instrument of a different legal nature, the UNIDROIT Principles on International Commercial Contracts, which also deal with the issue of limiting damages.41 Their position regarding methods of determining the extent of damages is different from the CISG in some respects. For instance, Article 7.4.3 provides that compensation is due only for harm that is established with a reasonable degree of certainty, and that certainty relates not only to the existence of the harm but also to its extent.42 The UNIDROIT Principles also provide that, where the amount of damages cannot be established with a sufficient degree of certainty, the assessment is at the discretion of the court.43 This means that the court is empowered to make an equitable quantification of the harm sustained by the aggrieved party, rather than refuse any compensation whatsoever or award only nominal damages. Although the requirement of directness is not expressly referred to by the Principles, Official Comment indicates that it is implicit in Article 7.4.2(1), which contains a general provision on damages. The Principles take account of the test of causation between the breach and the harm which is used for determining the extent of damages in jurisdictions following the German Civil Code. Highlighting that the language of Article 7.4.2(1) refers to the harm sustained ‘as a result of non-performance’, Official Comment stresses that the use of the ‘directness’ standard presupposes a sufficient causal link between the non-performance and the harm. Harm which is too indirect will usually be uncertain as well as unforeseeable.

39 The CISG Advisory Council is a private initiative by the Institute of International Commercial law at Pace University School of Law and the Central for Commercial Law Studies, Queen Mary, University of London, which has as its goal supporting an understanding of the CISG and promoting its uniform application. 40 CISG Advisory Council Opinion No 6 ‘Calculation of Damages under CISG Article 74’, rapporteur Professor JY Gotanda, available at http://www.cisg.law.pace.edu/cisg/ CISG-AC-op6.html (accessed 27 June 2007). 41 International Institute for the Unification of Private Law, UNIDROIT Principles of International Commercial Contracts 2004 (Rome, 2004), ch 7, s 4. 42 See Official Comment on Art 7.4.3. 43 See Art 7.4.3(3).

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B Mitigation of Damages The CISG provides that a party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach.44 If he fails to take such measures, the party in breach may claim a reduction in damages in the amount of which the loss should have been mitigated.45 It should also be noted that the idea of contributory negligence of the aggrieved party, which reflects the traditional approach of continental civil law to the problem of mitigating damages, is also included in Article 80 CISG, which provides that a party may not rely on a failure of the other party to perform to the extent that such failure was caused by the first party’s act or omission. The UNIDROIT Principles also contain a separate provision dealing with mitigation of harm which states that a non-performing party is not liable for harm suffered by the aggrieved party to the extent that the harm could have been reduced by the latter party’s taking reasonable steps. Also, the aggrieved party is entitled to recover any expenses reasonably incurred in attempting to reduce the harm.46 So far as the rationale of this provision is concerned, it can be said that, on the one hand, a party who has already suffered from the consequences of non-performance cannot be required to take time-consuming and costly measures. On the other hand, it would be unreasonable, from the economic standpoint, to permit an increase in harm which could have been reduced by the taking of reasonable steps. The steps to be taken by the aggrieved party may be directed either at limiting the extent of the harm, particularly where there is a risk of it lasting for a long time if such steps are not taken,47 or at avoiding any increase in the initial harm. The mitigation of harm must not, however, cause loss to that party, and it may therefore recover from the non-performing party the expenses incurred in mitigating the harm provided that they were reasonable in the circumstances. The UNIDROIT Principles also contain a rule originating from civil law which provides that, where the harm is due in part to an act or omission of the aggrieved party or to another event for which that party bears the risk, the amount of damages shall be reduced to the extent that these factors have contributed to the harm, having regard to the conduct of each of the parties.48

Art 77. Ibid. Art 7.4.8. Often such measures will consist in making a replacement transaction (see Art 7.4.5 of the UNIDROIT Principles). 48 Art 7.4.7. 44 45 46 47

262 C

Alexander Komarov Efforts in International Unification of Penalty Clauses

Two attempts of unification have been made in this field and both were at a regional level by Western European countries. The first attempt was made within the framework of the Council of Europe which culminated in the formulation of a set of principles set out in an Appendix to Resolution (78)3 on Penal Clauses in Civil Law adopted by the Committee of Ministers on 20 January 1978. The resolution recommended to member governments that they should take the principles into consideration when preparing new legislation and consider the extent to which the said principles could be applied, subject to any necessary modifications, to other clauses that have the same aim or effect as penalty clauses. Another attempt was made within the Benelux Economic Union and culminated in the adoption, on 26 November 1973, of the Benelux Convention relating to Penalty Clauses. Under Article 1, the contracting states agree that they will bring their national legislation on penalty clauses into conformity with certain common provisions set forth in an annex to the Convention by the date of entry into force of the Convention.49 While these attempts are directed at unifying domestic law, the scope of the application of the uniform provisions is not restricted to domestic transactions and, for this reason, the relevant provisions formulated in these two attempts are referred to, where appropriate, below. At its eleventh session in 1979, the UN Commission on International Trade Law (UNCITRAL) included in its programme of work the subject of liquidated damages and penalty clauses as part of the study of international contract practices. Upon considering the report presented by the Secretary-General, the Commission requested its Working Group on International Contract Practices to consider the feasibility of formulating uniform rules on liquidated damages and penalty clauses applicable to a wide range of international trade contracts. The analysis of the feasibility of drafting uniform rules for penalty or similar clauses undertaken by the UNCITRAL in the late seventies showed that the sharpness of the distinction between the invalidity of clauses seeking to coerce performance in the common law and their validity in the civil law was somewhat diminished by the following factors.50 In civil law systems, penal clauses seeking to coerce performance are sometimes invalidated for reasons of public policy, such as offending good morals, contrary to good faith or giving rise to unjust enrichment. Hence, all penal clauses which are purely coercive and which provide for private 49 Report of the Secretary-General: Text of Draft Uniform Rules on Liquidated Damages and Penalty Clauses, Together with Commentary Thereon (A/CN.9/218), UNCITRAL Yearbook, vol XII (1982) 28. 50 Report of the Secretary-General: Liquidated Damages and Penalty Clauses’ (A/CN.9/161), UNCITRAL Yearbook, vol X (1979) 42.

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penalties are invalid as being against public policy. In the common law, liquidated damages validly agreed upon might exceed ordinary damages payable upon breach.51 Where a debtor realises this before the breach, a liquidated damages clause is likely to coerce performance. This may also be the case where the amount of damages likely to be awarded is uncertain and, in the absence of a liquidated damages clause, a party might be tempted to breach the contract speculating on a low damages award. Where the primary object of a clause is to limit liability by fixing the sum payable on a breach at an amount below that of recoverable damages, both the common law and civil law systems give effect to the clause.52 At its second session, the UNCITRAL Working Group adopted draft uniform rules on liquidated damages and penalty clauses. At its fourteenth session, the Commission considered these draft rules and, inter alia, requested the Secretary General to incorporate, in the draft uniform rules, such supplementary provisions as might be required if the rules were to take the form of a convention or a model law, and to prepare a commentary on the uniform rules. In 1981, the UN General Assembly adopted the Resolution on Uniform Rules on Contract Clauses for an Agreed Sum Due upon Failure of Performance (38/135). The Resolution recognised that a wide range of international trade contracts contained clauses requiring a breaching party to pay an agreed sum to the other party, and pointed out that the effect and validity of such clauses were often uncertain owing to disparities in the treatment of such clauses in various legal systems. Based on the belief that this uncertainty constitutes an obstacle to the flow of international trade, it expressed an opinion that it would be desirable for legal rules governing such clauses to be harmonised in order to reduce or eliminate the uncertainty. Having in mind the adoption by UNCITRAL of the Uniform Rules on Contract Clauses for an Agreed Sum Due upon Failure of Performance, the UN General Assembly recognised that there were various ways in which these Uniform Rules could be implemented by states and recommended that states should give serious consideration to the Uniform Rules and, where appropriate, implement them in the form of either a model law or a convention. The Resolution also stressed that a recommendation that states implement the adopted Uniform Rules in an appropriate manner would not prejudice the Assembly from making further recommendations or taking a further action with respect to the Uniform Rules—no successful efforts have been made within the UN since that time. This problem is not addressed in the CISG, although some attempts were made during the drafting of its text. Thus, national rules still play a decisive role in this matter.

51 52

Ibid. Ibid.

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The UNIDROIT Principles is a positive example of successful efforts to unify the law governing penal clauses. Article 7.4.13 provides as follows: (1) where the contract provides that a party who does not perform is to pay a specified sum to the aggrieved party for such non-performance, the aggrieved party is entitled to that sum irrespective of its actual harm; but (2) notwithstanding any agreement to the contrary, the specified sum may be reduced to a reasonable amount where it is grossly excessive in relation to the harm resulting from the non-performance and to the other circumstances. Official Comment to this article indicates that this rule gives an intentionally broad definition of agreements to pay a specified sum in cases of non-performance, whether such agreements are intended to facilitate the recovery of damages (liquidated damages in common law) or to operate as a deterrent against non-performance (penalty clauses proper), or both.

VIII

CONCLUSION

This overview highlights the great similarity in the existing legal techniques used by different legal systems to limit contract damages. This is understandable as legal systems aim at achieving the same goals, one of which, in the context of limiting damages, is to provide predictability where a normal course of relations is disturbed by a breach of contract. Legal rules also pursue the same purpose of making the conduct of the parties capable of minimising the influence of negative events on the stability of turnover in general. It also needs to be remembered that the use of similar terminology by different domestic systems in respect of methods for limiting damages does not necessarily mean that the content of the concepts will be the same. At the same time, the use of different methods for limiting damages (foreseeability as opposed to causation, or vice versa) by legal systems does not mean that such usage leads to different results. Every legal system achieves, by means of different tools, the goal of creating a legal regime which is adequate for the normal function of the economy. All of this points to the existence of good reasons for creating an efficient and unified regulation of international trade.

11 No Need to Limit Where There is No Promise? NO NEED TO LI MI T WHERE THERE I S NO PROMI S E?

JAN R AMBERG * J AN RAMBERG

I

I NTRO DUCTION

Non haec in foedera veni—this is not what I promised! Therefore, there is no need for me to limit my liability. Does this not go without saying? Why take up your time by trying to explain what is self-evident? Well, if contracts and their inherent risk distribution were always crystal clear and reasonable, I could stop right here. But, as we all know, this is frequently not the case. A number of difficulties present themselves when the contractual risk distribution is to be analysed and assessed. Exemption and limitation of liability clauses are frequently discredited as a means of eroding contractual promises. However, this attitude is often too simplistic. At first, it is necessary to analyse the clause in order to find out whether it is an ordinary contract clause or a clause limiting a party’s liability. This is particularly needed where the contract is a ‘one-off’ deal which is tailored to the particular needs of the parties. If so, they would simply have to define their rights and obligations, and the validity of the contract terms would have to be determined without resort to the principles of assessing the reasonableness of the limitation and exemption clauses. If, however, the contract falls into a standard type, such as contracts of sale, transport, repair, storage and services based on well-known standard terms, one would have the possibility to compare the situation as it would have been in the absence of a clause limiting liability. The purpose of a clause could then simply be to achieve an appropriate division of risk between the parties. To take one important example, a seller having sold goods to a buyer in a foreign country could avoid the risk of loss of, or damage to, the goods in transit by choosing an appropriate trade term referring to the so-called E-, F- or C-terms of *

Professor Emeritus, University of Stockholm.

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INCOTERMS 2000.1 Alternatively, he could assume this risk by a contract on the so-called ‘delivered’ terms. But even so, he could limit his exposure by avoiding his obligation to tender substitute goods in the event the goods are lost in transit (‘no arrival, no sale’). Traditionally, exemptions and limitations of liability clauses were scrutinised and frequently set aside by adverse interpretation. An example could be mentioned where clauses exempting a party from liability for some type of loss were held inapplicable in the event the loss had been caused by negligence.2 This explains why many limitation clauses explicitly stipulate that they also apply in case of a party’s negligence (the so-called ‘negligence clauses’).

II

S E T T I N G A S I D E L I M I TAT I O N CL AU S E S

It is frequently stated that the clauses do not apply in case of loss or damage caused by a party intentionally or by his gross negligence. It has been assumed that a contracting party cannot reserve to himself the right to inflict loss or damage on his contracting party in such a manner, eg by setting fire to goods in his custody or intentionally failing to perform his contractual obligations. This assumption is frequently made by legal scholars but, as it seems, without much reflection. Indeed, such statements are too simplistic as it is necessary to distinguish between intentional or grossly negligent misbehaviour by the party himself and such behaviour which can only be imputed to persons for whom he has to accept a vicarious liability. The mere fact that he may become responsible for their acts or omissions does not imply that he must also lose any right to limit his liability. This matter is still vividly debated. In particular, I remember the discussions in May 1996 in the Commission on the Principles of European Contract Law (PECL). The Commission had, before that meeting, agreed that a clause limiting or excluding remedies was ineffective in case of intent or gross negligence. After a very close vote, the Commission decided to delete the words ‘intent or gross negligence’ and replace them with the following text in Article 8.109: Remedies for non-performance may be excluded or restricted unless it would be contrary to good faith and fair dealing to invoke the exclusion or restriction.

The present text invites an overall assessment of the reasonableness of the clause rather than solely expressing the subjective criteria of intent and gross negligence. Thus, it may be the case that the seller has no duty to 1 See J Ramberg, International Commercial Transactions (Stockholm, ICC Publication 691, 3rd edn, 2004) 95. 2 See AN Yiannopoulos, Negligence Clauses in Ocean Bills of Lading (Baton Rouge, LA, Louisiana State University Press, 1962).

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perform a contract where deliveries from its subcontractors are not sufficient to fulfil deliveries to all purchasers. The seller would then have to prorate his supply fairly between his customers and perform the contract with some customers to the detriment of others.

III

L I M I TAT I O N C L AUS E S AN D I N S U R A N C E

The validity of clauses limiting liability is intimately related to insurance. As between the contracting parties, there seems to be no particular reason why a party, having insured himself against a particular loss, should have a dual remedy giving him the right to recover compensation for the loss from the insurer as well as, alternatively, from his own contracting party.3 Nevertheless, it is frequently suggested that relieving a contracting party from liability would reduce his incentive to take measures for the avoidance of the loss. However, there are no convincing studies which could support such an assumption. In any event, a contracting party faced with the risk of having to pay damages to the other party could protect himself not merely by a liability insurance but also by offering his contracting party to take out insurance for his benefit giving him the right to proceed with his claim directly to the insurer in case of loss or damage. Basically, the required standard of behaviour could be ensured by stipulations in the respective insurance policies without any further incentive for loss prevention by setting aside limitation clauses. Although insurers are generally anxious to preserve their right of recourse against a party having caused the insured loss, this is normally not a sufficient reason for the invalidation of limitation of liability clauses. The insurers have ample opportunity to consider the absence or limitation of recourse possibilities when determining the premiums.

IV

B R E A K A B I L I T Y O F M O N E TARY L I M I TAT I O N S O F LIABILITY

When considering the breakability of monetary limitations of liability it is necessary to bear in mind the very purpose of the limitation.4 The objective here differs fundamentally from exemptions of liability. Take monetary limitations in transport law as an example. They are only intended as an assessment of the average value of the goods and as a method of facilitating See Ramberg, above n 1, 63. With respect to the purpose of the monetary limitation of liability, see J Ramberg, Ansvarsbegränsning—en fråga om skälighet eller praktikabilitet? Festskrift Nordenson (Stockholm, Norstedts Juridik, 1999) (also in J Ramberg, Studier i avtalsrätt, köprätt och transporträtt (Stockholm, Norstedts Juridik, 2007) 81–6, criticising the Swedish Supreme Court case NJA 1998, 390). 3 4

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the settlement of claims. Further, a higher value is available to the consignor by a declaration of value. In the absence of a monetary limit, it would be necessary to apply general principles of law on the limitation of recoverable damages which may differ in various jurisdictions. A settlement of claims based upon such principles would therefore tend to diminish the effect of any applicable convention attempting to unify the law in this area. It is to be expected that courts, and perhaps arbitrators as well, would follow the ‘homeward trend’ by applying the law governing the contract rather than, for example, the 2004 UNIDROIT Principles of International Commercial Contracts which, in Article 7.4.4 on foreseeability of harm, limit compensation to what the liable party ‘foresaw or could reasonably have foreseen at the time for the conclusion of the contract as being likely to result from its non-performance’ (emphasis added). Arguably, an application of this formula may well reintroduce the monetary limit if defeated by the blameworthy behaviour of the carrier!5 Monetary limits are practical alternatives to the use of various foreseeability formulae in determining recoverable damages. Without a monetary limit one is forced to cope with the problem in a different and more cumbersome manner. In transport law, the question of whose misconduct should be imputed to the carrier is answered differently depending upon the mode of transport. The mere fact that the carrier’s performance includes liability for servants and agents when acting in the course of their employment does not necessarily mean that their acts or omissions should be imputed to the carrier when his right to limit liability is considered. True, when the carrier is a legal entity, which is normally the case, it would be necessary to decide which acts or omissions should be attributed to the legal entity rather than to its servants or agents. However, the distinction is well known in general contract and corporate law and, indeed, particularly in maritime law with respect to a shipowner’s defence of error in the navigation and management of the vessel. In the latter case, the Hague and Hague-Visby Rules reference, in their Article 4.2(b), refers to ‘actual fault or privity of the carrier’, which signifies that the defence applies unless acts or omissions could be attributed to persons on the managerial level of the legal entity. The Convention for International Carriage of Goods by Road (CMR) clearly imputes the misconduct by ‘the agents or servants of the carrier’ as well as ‘by any other persons of whose services he makes use for the 5 Regrettably, courts often fail to recognise the important purpose of the monetary limits. The risk of losing the benefit of monetary limitation is rather aggravated by placing the burden on the carrier to clarify the circumstances giving rise to the loss or damage (in German ‘Figur der sekundären Darlegungslast’—a concept which places the burden to clarify the circumstances resulting in loss or damage on the tortfeasor even though the principal burden of proof rests with the affected party) which, in practice, frequently results in the loss of the right to limit liability. See the decision of the Supreme Court of the Federal Republic of Germany (BGH) TranspR 2003 467 and cf the decision of the Supreme Court of Sweden NJA 1998 390.

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performance of the contract’ to the carrier.6 The conventions for international carriage by rail, sea and combination of several modes of transport (COTIF/CIM,7 the Hague and Hague-Visby Rules,8 the Hamburg Rules9 and the 1980 UN Convention on Multimodal Transport10) have no corresponding provision but merely refer to the ‘railway’, ‘the carrier’ and the ‘multimodal transport operator’ (MTO). The Hamburg Rules11 and the 1980 UN Convention on Multimodal Transport12 also add that persons other than the carrier and the MTO lose the right to limit their liability in cases of misconduct sufficient to break the limitation of liability. In the deliberations on the Hamburg Rules, I suggested the insertion of the word ‘personal’ in order to avoid any doubt as to whether the carrier would retain his right to limit liability if misconduct could only be attributed to his servant or agents or other persons used for the performance.13 After a rather intense debate on the matter, where the majority seemed to favour the retention of the carrier’s right to limit where the misconduct could not be attributed to himself, it was decided not to insert the word ‘personal’. Nevertheless, it seemed to be the opinion of the majority that the same result would also follow even in the absence of the word ‘personal’. The structure of the Convention supports that opinion as ‘servants or agents’ are included in Article 5.1 on liability but are not included in Article 8.1 on the loss of the right to limit. The abstract formulae used to describe the behaviour needed to defeat the carrier’s right to limit liability differ. The words ‘with the intent to cause such damage, or recklessly and with knowledge that such damage would probably result’ are used in all conventions except the Warsaw Convention14 and CMR,15 where a reference is made to ‘wilful misconduct’ defined as ‘default . . . as, in accordance with the law of the court or tribunal seized of the case, is considered equivalent to wilful misconduct’. This definition highlights the difficulty of interpreting what is meant by ‘wilful misconduct’, although the word ‘wilful’ cannot be interpreted to mean something other than ‘intent’ or dolus. Semantically, ‘wilful’ relates to ‘misconduct’ and, therefore, would only exclude unintentional misconduct. In other words, ‘wilful misconduct’ requires that the person know that he is misbehaving. Nevertheless, it is also Art 29.2. Arts 37 and 39. 8 Art 4.5. 9 Art 8.1. 10 Art 21.1. 11 Art 8.2. 12 Art 21.2. 13 Cf Art 4 of the 1976 Convention on the Limitation of Liability for Maritime Claims. 14 Art 25.1. 15 Art 29.1. 6 7

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necessary to decide the relationship between that knowledge and the damage.16 Although, with the exception of theft, it is not very likely that damage will be inflicted intentionally, the intent may well be based on indifference, resulting in the disregard of the likelihood of damage or, even worse, the intent may be to achieve economic benefit from a speedy but careless handling of the cargo. Such an intent may not be covered by the words ‘with knowledge that such damage would probably result’ as the word ‘probably’ invites the conclusion that damage would be more likely than not, in which case the intent approaches dolus indirectus. With the word ‘possibly’ the intent would have been reduced to dolus eventualis. The reference in CMR to the law of the forum tends to create confusion as to the correct interpretation of ‘wilful misconduct’ which, at times, has been interpreted rather arbitrarily to mean gross negligence in cases where there is no wilfulness at all in the sense referred to in the present analysis.17 It would appear that, in these cases, the very purpose of monetary limits, unless they are in principle unbreakable, is lost. In the 1999 Montreal Convention, ‘wilful misconduct’ has been replaced, with respect to passenger claims, by a new formula referring to an act or omission committed intentionally or recklessly with the knowledge that damage would probably result. The Montreal Protocol 4 to the Warsaw Convention assimilated wilful misconduct with the latter formula18 but, in any event, wilful misconduct is no longer referred to in the 1999 Montreal Convention.19 Liability for cargo under the Montreal Convention 1999 is strict, but the limit of 17 SDR per kilo is unbreakable. Another reason not to let the misconduct of ‘servants, agents or other persons’ defeat the carrier’s right to limit liability follows from the difficulty of deciding whether they have acted within the scope of their employment. Theft can be mentioned as an example. Obviously, they have not been employed to steal, but their employment may well give them 16 This appears from the test used in Horabin v British Overseas Airways Corporation [1952] 2 Lloyd’s Rep 450, 459: The ‘person who did the act knew . . . that he was doing something wrong not caring whether he was doing the right thing or the wrong thing’ and then it is added ‘. . . quite regardless of the safety of things . . . for which . . . he was responsible’. Standard terms sometimes define ‘gross negligence’ (see, eg Orgalime S 2000 cl 15: ‘In these General Conditions gross negligence shall mean an act or omission implying either a failure to pay due regard to serious consequences, which a conscientious supplier would normally foresee as likely to ensue, or a deliberate disregard of the consequences of such act or omission’). 17 See the cases by the Supreme Court of Sweden reported in NJA 1992, 130. But cf NJA 1986, 61 and the observations by J Ramberg and C Ramberg, Allmän avtalsrätt (Stockholm, Norstedts Juridik, 2007) 216. 18 See In re Crash Near Cali, Columbia 985 F Supp 1106 (SD Fla 1997), confirming the standard of Butler v Aeromexico 714 F 2d 429 (11th Cir 1985), reversed in relevant part by the CA of the 11th Circuit sub nom Cortes v Am Airlines 177 F 3d 1272 (1999). 19 See P Mendes de Leon and W Eyskens, ‘The Montreal Convention: Analysis of Some Aspects of the Attempted Modernisation and Consolidation of the Warsaw System’ (2001) 66 Journal of Air Law and Commerce 1155.

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better opportunities to steal than those available to ‘outsiders’.20 Again, there is no international uniformity as to the question to what extent the carrier is liable for thefts by his servants, agents or other persons. So, at least in some cases, theft of the cargo may not entail the carrier’s liability. As a practical matter, a better solution would appear to be to allow the carrier to limit his liability, as provided in the applicable convention, by paying the limited amount in every case where the cargo fails to reach the consignee, unless the carrier could disprove presumed fault or neglect, or would otherwise benefit from an exception of liability. In many cases, the costs of investigations of finding out whether the cargo has been stolen or not may become disproportionate to the amount to be compensated. All conventions, except CMR, clearly require that the claimant must prove (‘if it is proved’) the circumstances required to defeat the carrier’s right to limit his liability and, presumably, Article 29.1 CMR should be interpreted in the same manner.21 In most cases, the burden of proof and the costs of investigations would discourage the claimant from trying to defeat the carrier’s right to limit and this invites the question whether he should be induced to try to do so by a regulation which imposes an unlimited liability on the carrier in case of theft.

V

SC O P E A N D E F F E C T O F PART I C U L A R O B L I G AT I O N S

Although a contract term is accepted as such, there is frequently a need to consider its scope and effect. The literal wording may be semantically clear, but the true purpose of the term may not emerge unless it is read in conjunction with other terms of the contract by the so-called holistic interpretation method.22 This method was used by the Supreme Court of Sweden23 when establishing the legal consequences of a sole distributor’s failure to sell a defined minimum quantity of goods. The obligation to do so was sufficiently clear, but what was the liability for non-performance? The parties agreed that the supplier had a right of termination but it was disputed whether the sole distributor was liable to pay damages for non-performance. As the term setting forth the distributor’s obligation to sell a minimum quantity was not incorporated in the term dealing with See, as an example, the case by the Supreme Court of Sweden reported in NJA 1960,644. However, as appears from the decision by the German BGH TranspR 2003, 467, the burden to clarify the circumstances causing loss or damage (‘Figur der sekundären Darlegungslast’) may in practice frequently support the assumption that the carrier has been guilty of a sufficiently blameworthy behaviour to defeat his right to limit liability. A similar reasoning appears in NJA 1998, 390. 22 See Art 5.105 of the Principles of European Contract Law (PECL) and Art 4.4 of the UNIDROIT Principles of International Commercial Contracts (UP) on Reference to the Contract as a Whole. 23 Case reported in NJA 1992, 403. 20 21

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liability in damages for breach, the Supreme Court held that that remedy was unavailable to the supplier. The case demonstrates the necessity to clearly define not only the extent of obligations but also the legal effects of non-performance. In some cases, it may be important for a supplier to limit his obligation to provide conforming goods. The sources from which he may obtain such goods may be limited or under governmental control or, in cases of high technology products, conformity with their functional specifications may be difficult to ascertain and guarantee. It may then be appropriate to reduce the normal obligation to achieve a specific result to a more restricted obligation to use best or reasonable efforts.24 Preferably, this should be done expressly as it would otherwise be difficult to establish the nature of the obligation. Article 5.1.5 UP suggests that a number of factors may become relevant, such as: (a) (b) (c) (d)

the way in which the obligation is expressed in the contract; the contractual price and other terms of the contract; the degree of risk normally involved in achieving the expected result; the ability of the other party to influence the performance of the obligation.

VI

L I A B I L I T Y F O R ‘ T H I R D P E RS O N S ’

Although it would seem to be universally accepted that a party who entrusts performance of the contract to another person remains responsible for performance,25 confusion nevertheless arises with respect to liability for acts or omissions by subcontractors. Where a party may freely choose to perform the contract by those engaged in his own legal entity or, alternatively, to outsource performance to other persons, it is difficult not to hold this party liable for non-performance by such other persons. It would therefore, at first sight, seem that Article 79(2) CISG states the obvious when it imposes the same liability on a party engaging ‘a third person’ for performance as would have been imposed on him if he had had to perform himself. Nevertheless, this principle does not necessarily apply where a party has no freedom of choice, in particular, where the other party has required him to use a nominated subcontractor for performance. It may then be necessary to examine closely the link between the main contract and the subcontract.26 For the distinction, see Art 5.1.5 UP. See Art 8:107 PECL. 26 See D Tallon in CM Bianca and MJ Bonell (eds), Convention on the International Sales Law: The 1980 Vienna Sales Convention (Milan, Giuffrè, 1987) 585. 24 25

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As a general rule, a party including the performance of another party in his own contractual performance would have to accept liability for the included party, irrespective of whether the included party belongs to his own enterprise or not. Otherwise, it would normally be difficult for a party, in case of breach of contract, to succeed with his claim as he would have to direct it against a party to a contract with somebody else. True, in some instances it may well be possible to establish a contractual link between the affected party and the subcontractor of another party, for example, when the subcontractor is aware of the main contract and of the need to protect the aggrieved party when loss is inflicted upon him as a direct result of the subcontractor’s act or omission. Various legal concepts are used to achieve this aim, such as an implied authority given by the subcontractor to allow the contractor to establish a contractual link between him and the party in the main contract. However, such arrangements are not, generally, to be recommended in view of the resulting complications. First, it would have to be decided whether such an implied authority shall be understood as creating a contractual link on the terms usually applied by the subcontractor or, alternatively, upon the terms of the main contract. Secondly, the relationship between the parties to the main contract may give rise to complications when a claim by the aggrieved party against the party in the main contract could be defeated by counter-claims and set-off. It would then have to be decided what the effect of such counter-claims and set-off possibilities would be when the claim is directed against the subcontractor. Normally, therefore, the doctrine of privity of contract should apply rather than the concept of direct action against non-contracting parties. As has been suggested, Article 79(2) CISG seems to state the obvious. However, it might be reasonable to accept a presumption that the article is intended to have some meaning and is not only a superfluous reminder. It is reasonable to assume that it purports to solve any particular problems, such as those suggested here. In any event, it seems that the article triggers problems which supposedly could have been avoided in the absence of the article. Thus, when a contract of sale involves carriage of goods, it is necessary to establish whether the carriage is included in the seller’s obligation. If so, Article 79(2) CISG applies and the seller becomes responsible for the carrier as a ‘third person’, although it may perhaps be inappropriate for the seller to be exposed to a more stringent liability than the carrier himself.27

27 Eg where the 1924 Bill of Lading Convention—the Hague Rules—apply and exempt the maritime carrier for an error in the navigation or management of the ship (Art 4(2)(a)).

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AVO I D I N G L I A B I L I T Y F O R ‘ T H I R D PE RS O N S ’

Where the obligation of a party includes responsibility for persons outside his own legal entity, there is, of course, nothing to prevent him from either contracting out of such responsibility or, alternatively, from limiting his liability for non-performance. A seller having sold the goods on delivered terms may reduce his liability by either declining liability for loss of or damage to the goods in transit or limiting his liability to the amount recoverable from the carrier. Similarly, when a buyer appoints a subcontractor, the seller may exclude his normal liability under Article 79(2) CISG altogether.28 In order to avoid any discussion on the reasonableness29 of such a disclaimer, he may undertake to transfer his rights under the subcontract to the buyer or invite the buyer himself to conclude the contract with the nominated subcontractor.

VIII

LIMITING PERFORMANCE OR LIABILITY FOR NON-PERFORMANCE

Exemption and relief clauses usually limit the obligation rather than the liability for non-performance.30 Thus, if certain enumerated events or the general exemption for circumstances beyond the parties’ control are applicable, the effect is usually to extend the time of delivery and not to exempt from liability. If time is extended, the delivery will conform to the contract if performed within the extended period and the matter of liability becomes redundant. This is the method used in the ICC Force Majeure Clause 2003 Article 431 (‘A party successfully invoking this Clause is . . . relieved from its duty to perform its obligations’ (emphasis added)), while the ICC International Sale Contract32 in its Clause 13 on Force Majeure stipulates that ‘A party is not liable for a failure to perform’.33 In both cases, it may be necessary to deal with the legal effect of events relieving from performance or liability during a longer period of time. The ICC International Sale Contract in Article 13.4 gives either party the right to terminate the contract when the grounds of relief subsist for more than six months, while the ICC Force Majeure Clause 2003 in Article 8 has no fixed period but instead permits termination by the use of a formula akin to Article 25 CISG (‘has the effect of substantially depriving either or both of the contracting parties of what they were reasonably entitled to expect under the contract’). 28 29 30 31 32 33

See Art 6 CISG. See Art 8:109 PECL and Art 7.1.6 UP. See, eg Orgalime S 2000 cl 12 compared with cl 39. ICC Publication 650. ICC Publication 556. Emphasis added.

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What has been said above demonstrates that irrespective of the method used—relief from performance or from liability for non-performance—the end result will be the same. Consequently, when referring to the test of reasonableness, UP, in its Article 7.1.6 on exemption clauses, deals not only with the limitation or exclusion of liability but also with clauses permitting ‘one party to render performance substantially different from what the other party reasonably expected’. In either case, the clause may not be invoked ‘if it would be grossly unfair to do so, having regard to the purpose of the contract’.34

IX

SURPRISING STANDARD TERMS

One might think that, in B2B transactions, it matters less what the parties choose to undertake or which of the parties must carry the risk for non-performance as long as they know in advance what their contract means. However, as expressed by Lord Denning some 50 years ago: ‘We no longer credit a party with the foresight of a prophet or his lawyer with the draftsmanship of a Chalmers’.35 And particular problems arise when contracts are not negotiated individually and include unexpected and burdensome terms by reference to standard forms. Although, as expressed in Article 2:104(1) PECL, there is a requirement that the party invoking terms which were not individually negotiated must take ‘reasonable steps to bring them to the other party’s attention before or when the contract was concluded’, this may be cold comfort when the terms are not scrutinised to the extent which would disclose the existence of unusual terms substantially eroding the expected benefits. When such terms are unclear, it may be appropriate to apply the Contra Proferentem Rule of Article 5:103 PECL or Article 4.6 UP.

X

RE S T R I C T I O N O F F R E E D O M O F C O N T R AC T I N TRANSPORT L AW

The principle of freedom of contract does not apply to all B2B transactions. In particular, the law of carriage of goods is to a large extent governed by mandatory law. True, this has contributed to a worldwide unification of the law within this field. But, at the same time, mandatory law now constitutes a serious impediment for the development of rules appropriate for the modern era of transport logistics.36 Also, it is somewhat difficult to explain 34 Cf Art 8:109 PECL, which only refers to a clause limiting or excluding remedies for non-performance. 35 See British Movietonews v London & District Cinemas [1952] AC 166. 36 See J Ramberg, The Law of Transport Operators in International Trade (Stockholm, Norstedts Juridik, 2005) 184–7.

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why the principle of freedom of contract under the CISG has not been extended to the ancillary contracts of carriage. As we have seen, if a CISG-seller includes, in his contract, carriage of goods sold upon ‘delivered’ terms, he may escape liability for the included carriage. But if he concludes two separate contracts, one contract of sale EX Works (EXW) and an additional contract of carriage, he may not contract out of the mandatory liability applying to the latter. The problem of limiting obligations rather than limiting liability had some particular features in the English case of Jordan II.37 Here, the question arose whether the shipowner could limit his obligation to load the goods by placing that obligation on the charterer under a charterparty to which the bill of lading contained a reference. In the Court of Appeal, LJ Nigel Teare observed: The distinction between, on the one hand, having a duty and seeking to protect oneself from failure to perform that duty and, on the other hand, having no duty may be a fine one but it is a clear distinction nevertheless.

And, in the House of Lords, Lord Steyn made a distinction between the non-delegable obligation of the shipowner to ensure the seaworthiness and cargoworthiness of the vessel, on the one hand,38 and the delegable obligation of loading the cargo on the other.39 As a result, no protection was extended to consignees not having seen the charterparty. A comparative investigation would have demonstrated that matters are looked upon somewhat differently in other convention countries, such as the United States and the Scandinavian countries, but the House of Lords thought it inappropriate to assume a function as legislator, the more so as the whole matter is now under consideration in the legislative work of UNCITRAL.40

XI

CONCLUSION

What conclusion, if any, could be drawn from this rather rhapsodic presentation? Perhaps it is true to say that, except in the area of the law subject to mandatory rules, an analysis of the risk distribution under the contract—be it in the form of the limitation of obligations or of liability for non-performance—combined with a test of reasonableness based upon what the party in question may reasonably expect would give an appropriate answer: ‘Promise or no promise—this is what the contract purports to give you!’ 37 Jindal Iron and Steel Co Ltd and Others v Islamic Solidarity Shipping Co Jordan Inc [2005] 1 Lloyd’s Rep 57. 38 The Hague Rules, Art III, r 1. 39 The Hague Rules, Art III, r 2. 40 Now dealt with in Art 11 of the draft convention (A/CN.9/WG.III/WP.81), conforming with the decision in Jordan II.

12 Remoteness: New Problems with the Old Test REMOTENES S

ADAM KRAMER * ADAM KRAMER

I

I NTRO DUCTION

It is my view that the application of the test of contractual remoteness is really a determination (through the usual process of contextual interpretation) of the scope of the responsibility impliedly undertaken by the promisor, and that no other explanation makes sense of the law either descriptively or as a justification.1 Further, and importantly for the present piece, mainstream opinion accepts at least a watered down version of this thesis, ie that foreseeability may not always be sufficient for recoverability and implied assumption of risk has at least some role to play in the remoteness test.2 Given support for the agreement-centred view of remoteness in recent cases,3 now is a good opportunity for us to put our heads round a few of the doors opened by the implied assumption of risk theory of remoteness and see the problems that await us within. The first problem arises in concurrent liability cases. The implied assumption of responsibility might, in some circumstances, not only * Barrister, 3 Verulam Buildings, London. I must express my thanks to Professors Joost Blom, Stephen Smith and Andrew Robertson, who made some helpful comments on an earlier version of this chapter. 1 A Kramer, ‘An Agreement-centred Approach to Remoteness and Contract Damages’ in N Cohen and E McKendrick, Comparative Remedies for Breach of Contract (Oxford, Hart Publishing, 2005) 249. Of course, this is an attempted resurrection of the old theory often associated with the decision in British Columbia and Vancouver’s Island Spar, Lumber, and Saw-Mill Co v Nettleship (1868) LR 3 CP 499 (CCP). 2 For example, GH Treitel observes in Remedies for Breach of Contract: A Comparative Account (Oxford, Clarendon Press, 1988) 158 that ‘the defendant’s liability in contract should be limited at least to some extent by the risks that he may be supposed to have agreed to undertake’. 3 See the comments of Clarke J in Transfield Shipping Inc v Mercator Shipping Inc (‘The Achilleas’) [2006] EWHC 3030 (Comm) [64]–[65] aff'd [2007] EWCA Civ 901 and Beazley JA in Stuart Pty Limited v Condor Commercial Insulation Pty Limited [2006] NSWCA 334, paras 53–61.

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govern the recovery of damages for breach of contract but also displace (through the sovereignty of the parties’ agreement) the tortious rules of remoteness that would apply to a concurrent tort. It is well known that tortious liability can be affected by exclusion clauses or notices by the defendant and by assumptions of risk (volenti non fit iniuria) by the claimant, and the implied allocation of risk in the contract can sometimes be a source of such exclusions or assumptions. This chapter concludes that, at least when the matter to which the tortious obligation relates is also central to the contract, the (stricter) contractual remoteness test should apply even to the tort. Behind the next door is the difficult case of H Parsons (Livestock) v Uttley Ingham & Co,4 and all the questions of concurrent liability and of remoteness in relation to physical damage that it raises. The conclusion reached here is that, for a variety of reasons, physical damage and personal injury are less likely to be too remote in contract (ie more likely to be within the scope of responsibility impliedly assumed by the promisor) than economic losses. The question of the remoteness test applicable to the Hedley Byrne5 assumption of responsibility negligence liability is easier. It is largely agreed that such liability, like contractual liability, is based upon an assumption of responsibility, and so the contract test should apply to Hedley Byrne cases not because there is a concurrent contractual action (if there is), but because Hedley Byrne liability is agreement-centred and so the reasons justifying the Hadley v Baxendale6 test in contract cases are also applicable to Hedley Byrne cases. Finally, the assumption of responsibility basis of remoteness has a perhaps surprising consequence: in some cases where there is an assumption of responsibility subsequent to the formation of the contract, such as by way of variation or perhaps on continuation of a long-term contract that is terminable at will, the contractual remoteness test should be applied as at this later date.

II

CO N CURREN T L I A B I L I T Y I N CO N T R AC T A N D TO RT

It has been clear since Henderson v Merrett Syndicates Ltd7 that the agreement of the parties is sovereign and so tortious obligations will be excluded where that is the intention of the parties, but that such an intention will not be lightly inferred and in its absence a person has a free choice between contractual and tortious causes of action. 4 5 6 7

[1978] QB 791 (CA). Hedley Byrne v Heller [1964] AC 465 (HL). (1854) 156 ER 145, 9 Exch 351. [1995] 2 AC 145 (HL).

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The rules of remoteness, alongside those of limitation, contribution and service out of the jurisdiction, give rise to one of the ‘practical issues’ identified by Lord Goff in Henderson that might lead a claimant to choose between contractual and tortious causes of action since, as Lord Goff observed, the rules of remoteness ‘are less restricted in tort than they are in contract’.8 At the risk of recapping the familiar, the contractual remoteness test is more restrictive to the claimant than the tortious (especially negligence) remoteness test in the following three ways:9 (i) the contractual test takes account of what was foreseen at the time of contracting,10 whereas the tort test is applied to what was foreseen at the later time of the commission of the tort; (ii) under the contractual test losses are recoverable if foreseeable as not unlikely to occur (The Heron II, Koufos v C Czarnikow Ltd11), whereas the tortious test gives recovery of losses that are merely foreseeable as sufficiently possible that a reasonable man would take steps to avoid them (The Wagon Mound (No 2)12)13; and (iii) implied assumption of risk (inferred from the relationship, price, etc) has an effect on contractual but not tortious recovery (save where there are contractual exclusion clauses or notices, or where the SAAMCO14 scope of duty principle applies).15 However, if remoteness is about the implied assumption and allocation of risk, then it is about what was agreed between the contractual parties. Consequently, in cases of concurrent contractual and tortious liability, a further question arises after that in Henderson has been answered. Even if there can be found in the contract no implied or express intention to exclude a concurrent tortious obligation, it may be that the contractual assumption and allocation of the risk of harmful outcomes should Ibid, 185. See further the table in D Harris, D Campbell and R Halson, Remedies in Contract & Tort (London, Butterworths, 2nd edn, 2002) 331–3. 10 Perhaps subject to the comments towards the end of this chapter on variation and terminable-at-will long-term contract cases. 11 [1969] 1 AC 350 (HL). 12 Overseas Tankship (UK) Ltd v Morts Dock and Engineering Co Ltd [1967] 1 AC 617 (PC). 13 If one adopts a fully agreement-centred approach, the ink spilled on discussing the difference between ‘foreseeable as possible’ for tort and ‘foreseeable as not unlikely’ for contract is wasted ink. The ‘not unlikely’ label is little more than a useful rule of thumb, and does not replace the underlying (fairly complicated) investigation of what risks the promisor can be understood to have impliedly undertaken. See further Kramer, above n 1. 14 South Australia Asset Management Corp v York Montague Ltd [1997] AC 191 (HL). 15 There are, however, dicta showing an intuitive resistance to any difference between contractual and tortious remoteness tests, see especially Scarman LJ in Parsons v Uttley Ingham, above n 4, 806 and Lord Cooke in Johnson v Gore Wood [2002] 2 AC 1 (HL) 46. There are also explicit judicial denials of any differences between the two tests: Asamera Oil Corpn v Sea Oil & General Corp [1979] 1 SCR 633 (SCC) 673; Kienzle v Stringer (1981) 130 DLR (3d) 272 (Ont CA) 276; Canlin Ltd v Thiokol Fibres Canada Ltd (1983) 40 OR (2d) 687 (Ont SC) 694; BDC Ltd v Hofstrand Farms Ltd [1986] 1 SCR 228 (SCC); Abitibi-Price Inc v Westinghouse Canada Inc (1988) 73 Nfld & PEIR 271 (Nfld SC) 306–8. It seems likely that, in making these comments, some of these judges had in mind only the level of foreseeability, not the timing of the foreseeability. 8 9

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nevertheless exclude or modify the remoteness rules ordinarily applicable in tort. In other words, should the contractual remoteness test sometimes be applied even to the cause of action in tort? As a matter of logic, if a primary contractual duty can sometimes comprise an implied exclusion of a tortious obligation, cannot a secondary contractual allocation of the risks of harm carry with it the coin of which the two sides are an implied exclusion of liability by the promisor and an implied assumption of responsibility (often labelled in tort discussions ‘volenti non fit iniuria’, ‘no injury to the willing’) by the promisee?16 In such cases, to permit the ordinary tort remoteness test to apply would be (adapting Lord Goff’s words in Henderson) to permit the plaintiff to circumvent or escape a contractual exclusion or limitation of liability for the [relevant loss] that would constitute the tort.17

As we shall see, for the contract test to prevail, there would need to be not only an implied agreement as to the allocation of risk (which exists in every contract if one adheres to an agreement-centred view of remoteness) but also a further implied agreement that the allocation of risk in the contract is the last word on the matter and should therefore exclude any alternative tortious determinations of risk (tantamount to a waiver of tortious rights by the promisee).

III

C O N C U R R E N T L I A B I L I T Y AN D TO RT S O F M A K I N G T H I N G S WO RS E

Starting with what I will call ‘the torts of making things worse’ (which contrast with the Hedley Byrne duty of care that arises following an assumption of responsibility, which is really ‘a tort of not making things better’), it is then necessary to ask when the tortious test should be displaced by the contract test and its implied exclusion/assumption of the risks of particular harms. To do so, we should start with a real case. The issue arose in Woodman v Rasmussen18 and divided the Queensland Court of Appeal. A planing machine in three boxes was damaged by the carelessness of the defendant common carrier when one of the boxes fell off the truck on its way to the mill where it was to be used for saw-milling, causing a loss of profits. This 16 Tilbury and Carter, principally in the context of a discussion of contributory negligence, agree that the incidents of the contractual rules should take precedence where the contract provides, expressly or impliedly, that it or they should do so: M Tilbury and JW Carter, ‘Converging Liabilities and Security of Contract: Contributory Negligence in Australian Law’ (2000) 16 Journal of Contract Law 78, 90. 17 See n 7, 191. 18 [1953] St R Qd 202 (Qd CA).

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gave rise to an action both in contract (as the common carrier liability was treated for these purposes) and in the tort of negligence.19 The Court found that the loss had not been proven. However, obiter, Macrossan CJ held that the contractual remoteness test was applicable, and so remoteness was a further reason for the claimant’s failure to recover the loss of profits because: Assuming that the damage arose from special circumstances beyond the reasonable prevision of the parties which had not been communicated to the appellants and the risk of which they are not to be taken to have agreed to bear under the contract, it would, I think, be unjust and contrary to authority that they should be held liable to the other contracting parties to any greater extent if the latter sued in tort and not on the breach of contract. 20

Phip J, on the other hand, held that the tortious test of remoteness applied and so the loss of profits would (if proven) have been recoverable, because: if I sue [the carrier] for negligent damage I need not rely upon the contract . . . at all. The contrary view involves that there is an implied term in every contract made with a common carrier that when he is sued in any form of action for negligent damage he is not liable for loss of profits. On the modern doctrine of implication of terms in a contract no such term could be implied . . . I hold that a common carrier who negligently damages the chattel carried is in no better case than is an ordinary carrier or a stranger who commits the tort of negligent damage.21

If the common carriage element is disregarded, the view of Macrossan CJ seems preferable in principle, since the fragility of the equipment and potential losses arising from its damage are the very things that will have been factored into the price and will have been in the parties’ mind at the time of contracting. At that point in time, the risks of losses such as these will have been impliedly allocated: those risks notified to the carrier or foreseeable as fairly likely by him are assumed, and others are excluded. To the extent that it differs, this allocation of risk should prevail over the default rule of bare foreseeability that applies in tort. Phip J is right that a paid carrier would therefore be in a better position than a stranger, but this is proper because the carrier was invited to carry the goods and did so only because of the fee he received and therefore as part of a calculated commercial enterprise, and his arrangement with the sender (fixed at the 19 Blom also posits a variation of the facts, by which the courier had been told after contracting but before driving away with a package of the loss of profits that would result from its loss: J Blom, ‘Fictions and Frictions on the Interface Between Contract and Tort’ in PT Burns and SJ Lyons (eds), Donoghue v Stevenson and the Modern Law of Negligence: The Paisley Papers (The Continuing Legal Education Society of British Columbia, 1991) 157. In Blom’s example, timing, rather than the degree of foreseeability, is the factor to give the choice between the two tests significance. 20 See, above n 18, 211. 21 See, above n 18, 214. The third judge, Townley J, expressed no view.

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time of contracting) should be honoured. In contrast, a third-party’s involvement with the goods would be an unbidden interference. However, common carriage is not ordinary contracting, and can involve less freedom to contract and to set the price on the part of the carrier than ordinary contracting does.22 In addition, if the carrier is a professional it may well price and insure generally, rather than negotiating price and insurance for each carriage, and therefore the scope of risk impliedly assumed may be greater (because more general) than otherwise and may be little different from the tort test.23 A slightly more difficult carrier case was The Arpad,24 in which the plaintiffs sued their carriers in both contract and conversion for short delivery of a shipment of wheat. Despite there being no market to buy replacement goods, the profits lost from abortion of an on-sale were held by the majority to be too remote to be recovered in the action for breach of contract, and irrecoverable in conversion because where the wrong complained of may be stated either in tort or in contract, the same rules as to damages must be applied.25

Nevertheless, this point was not considered in any detail and, as Michael Tilbury observes, This result is now explicable by reference to the date of the case: it reflects the pre-eminence of contract law and predates the modern understanding of the implications of concurrent liability.26

Further, the ratio decidendi of the case has been taken to be that the measure of damages for conversion is the same (in these relevant respects) as the contract measure, whether or not there is a concurrent contract.27 This need not stop us asking ourselves whether, had the test for remoteness in conversion been more generous than it was by this case held to be, we think the contract test should have limited the plaintiff’s recovery. The answer is surely yes, since the lost profits are exactly the sort of thing that the contractors would have had in mind as relevant to the price and as worth communicating. The same problem as arose in the carrier cases also arose in the telegraph cases in which American public service telegraph companies owed (often statutory) duties of care as well as contractual duties. The See Kramer, above n 1, 269. See Kramer, above n 1, 263 and 270–1. [1934] P 189 (CA). Greer LJ, ibid, 219. See also the comments of Maugham LJ, ibid, 234. MJ Tilbury, ‘Two Models of Concurrent Tort/Contract Liability and Their Application to Remoteness and the Measure of Damages’ in J Berryman, Remedies: Issues and Perspectives (Toronto, Carswell, 1991) 437. 27 See H McGregor, McGregor on Damages (London, Sweet & Maxwell, 17th edn, 2003) para 19-009. 22 23 24 25 26

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courts applied the contractual remoteness test. For example, Cardozo CJ held in Kerr SS Co v Radio Corp of America28 that, although the action is one in tort for the breach of a duty owing from a public service corporation . . . the contract . . . defines and circumscribes the duty . . . A different question would be here if the plaintiff were seeking reparation for a wrong unrelated to the contract, as, eg, for a refusal to accept a message or for an insistence upon the payment of discriminatory rates.29

This seems right (disregarding the possibility that, again, the telegraph companies were common carriers, as some are) because, as Cardozo CJ observed, the wrong is ‘related’ to the contract, and therefore arises out of risks that could have been assumed to have been in the parties’ minds when the price and insurance were set and when the special risks were notified. The contractual allocation of risk therefore ‘circumscribes’ the tortious duty. Over 50 years later, Posner J in the US Seventh Circuit Court of Appeals decision of Evra Corp v Swiss Bank Corp,30 citing Cardozo CJ in Kerr v Radio Corp, went further. The case concerned a negligent failure of a bank in losing a telex that sought to wire $27,000 from a charterer to a shipowner, which failure led to the shipowner being able to cancel the charterparty, which had been agreed at much lower rates than prevailed at the time of cancellation. The damages claimed exceeded $2m. Posner J applied the contract test of remoteness even though there was no concurrent contract. He agreed that On the one hand, it seems odd that the absence of a contract would enlarge rather than limit the extent of liability.

He did so because, he said, the animating principle of Hadley was applicable: ‘[t]his case is much the same, though it arises in a tort rather than a contract setting’.31 Typically for Judge Posner, he formulated that animating principle in terms of economic efficiency: the costs of the untoward consequence of a course of dealing should be borne by that party who was able to avert the consequence at least cost and failed to do so.32 245 NY 284 (1927), 157 NE 140. Earlier cases also applying the contract test include Western Union Telegraph Co v Green 153 Tenn 59 (1926), 281 SW 778 and 153 Tenn 522, 284 SW 898; Western Union Telegraph Co v Hall 287 F 297 (1923); Western Union Telegraph Co v Hogue 79 Ark 33 (1906), 94 SW 924; Kennon v Western Union Telegraph Co 126 NC 232 (1900), 35 SE 468; and Murdock v Boston & AR Co 133 Mass 15 (1882). 30 673 F 2d 951(1982), available at http://www.projectposner.org/case/1982/673F2d951 (accessed 27 June 2007). 31 In the later decision of Jack Rardin v T & D Machine Handling Inc 890 F 2d 24 (1989) (7th Cir), Posner said of his decision in Evra that ‘We held that the principle of Hadley v Baxendale is not limited to cases in which there is privity of contact between the plaintiff and the defendant’. 32 See, above n 30, 957. 28 29

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He also linked the result with the tortious standard of care, explaining that if the defendant has not been told of the possible consequences of loss it does not know how much care to take (how much insurance to buy and what failsafe features to install in its telex rooms).33 Although Posner J was concerned with efficiency, his decision makes sense on other grounds. On the thesis set out in this chapter, there does not necessarily have to be a coexisting contract for the contract test to be appropriate. It is perfectly possible to have an implied exclusion of liability or volenti non fit iniuria assumption of risk without a contract in any situation in which there is a pre-existing relationship and/or opportunity to communicate with a potential tortfeasor prior to the tort. As Andrew Burrows observes: Admittedly the scope for the defendant to deal with that information is more restricted than where there is a contractual relationship: in particular there is no price to modify. But the defendant can exclude or limit its tortious liability (eg for negligent advice) by a non-contractual disclaimer.34

Thus Joost Blom suggests that the question we should be asking is whether there is a ‘bargainable relationship’ which provides an opportunity to raise an improbable but foreseeable loss with the other party before a wrong had been done. Rather than distinguishing between contract and tort claims in determining which remoteness test should apply, he says, it might be better to ask whether the claim is ‘contract-related . . . (breach of contract, negligence or conversion)’ or ‘non-contract related . . . (negligence or conversion not arising out of any contractual relationship)’.35 However, the fact that a pre-existing relationship affords the opportunity for one party to exclude the risk of a foreseeable consequence and the other to assume it does not mean that the parties have availed themselves of the opportunity, just as the existence of a contractual obligation does not without more mean that the parties have intended to exclude any tortious obligation (under the Henderson v Merrett principle). Put another way, the mere opportunity to give notice of a special risk does not necessarily imply an agreement as to the allocation of that risk. Thus, although Blom and Burrows appear to argue that the contract test should apply whenever there is a pre-existing relationship and therefore the opportunity to convey information about a special risk and to then 33 Stevens makes a similar point, observing that a harm is less foreseeable if one is not told about any risk of it occurring in circumstances where one would expect to be told: R Stevens, Torts and Rights (Oxford University Press, 2007) 207. 34 A Burrows, Remedies for Torts and Breach of Contract (Oxford University Press, 3rd edn, 2004) 92 and ‘Limitations on Compensation’ in A Burrows and E Peel (eds), Commercial Remedies: Current Issues and Problems (Oxford University Press, 2003) 36. 35 J Blom, ‘Remedies in Tort and Contract: Where is the Difference?’ in Berryman, above n 26, 413.

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bargain about that risk,36 this cannot be justified by an agreement-centred approach to remoteness (although it may be justified if fairness or efficiency are the basis of one’s theory of remoteness). The test for when the contract test should be applied that was being suggested during the earlier discussion of the carriage and telegraph cases turned on the centrality of the loss (and the means of its being caused) to the matters that were governed and priced by the contract.37 Accordingly, Tilbury suggests that it will only be in exceptional cases that contractual rules should be applied to limit the effect of tortious rules (and gives the possible example of carrier liability).38 One case that seems to fail this test is Murano v Bank of Montreal,39 in which a bank committed trespass and/or conversion by taking possession of a customer’s properties through a receiver. The bank’s contract with its customer would have provided a defence because it gave the bank the right to impose a receiver, but that defence was unavailable because the right depended upon the bank giving reasonable notice, which it had not done. The Ontario Court of Appeal ignored the contractual test of remoteness and, as the tort was an intentional tort, applied no test of remoteness (at least as far as foreseeability is concerned) and the customer’s loss of profits was held to be recoverable.40 Here the customer’s possible loss of profits from putting in a receiver were not central to the contract, albeit that they were very closely linked to one part of that contract, viz the right to put in a receiver. That right was not, however, a core term with regard to which the price and insurance would have been set at the time of contracting. Imagine a temporary worker employed for a week to enter data, whose very serious pollen allergy is discovered after a day. Without that knowledge, the employer would not foresee that leaving flowers on the employee’s desk would cause any harm, and so would not be in breach of his tortious duty of care or contractual duties. With that knowledge, the employer’s breach of duty is clear. If the employer does leave flowers on the employee’s desk, can the employer then evade liability by arguing that at the time of contracting the employer did not contemplate that such a 36 Blom, ibid, 413; Burrows (2004), above n 34, 92; Burrows (2003), above n 34, 36. See also W Bishop, ‘The Contract–Tort Boundary and the Economics of Insurance’ (1983) 12 Journal of Legal Studies 241, 259 and 261; P Cane, Tort Law and Economic Interests, (Oxford, Clarendon Press 2nd edn, 1996) 145 and 477; J Cartwright, ‘Remoteness of Damage in Contract and Tort: A Reconsideration’ [1996] CLJ 488, 504; J Swanton, ‘Concurrent Liability in Tort and Contract: the Problem of Defining the Limits’ (1996) 10 Journal of Contract Law 21,43; E Peel, ‘Review of Andrew Burrows, Understanding the Law of Obligations’ (1999) 115 LQR 335, 338. 37 Cartwright puts it in not entirely dissimilar terms when he says that the contract remoteness test should apply to tort claims where the ‘basis and content of the contract and tort duties are identical’ and the ‘sources of the obligations are . . . coincident’: ibid, 504. 38 Tilbury, above n 26, 439. 39 (1998) 163 DLR (4th) 21 (Ont CA). The first instance decision of which is discussed below at the text to n 91. 40 Ibid, para 45 (Morden ACJO).

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serious harm could arise in this way and would have paid the employee less or taken out greater insurance against the harm? The answer is no. First, the safety of the employee is probably not sufficiently central that it can be said that the tortious test was impliedly excluded (or, to use Stevens’s terminology, ‘cut back’41) by the contractual test. Secondly, to complicate matters, it is likely that the contractual assumption of responsibility would encompass the harm anyway because the scope of such assumption would be broad in personal injury matters (for reasons given later in this chapter) and such harm would be the sort of thing that an employer would have insurance against as a possible occurrence at work, even though this particular harm was not foreseeable. However, if a motorcycle courier was engaged by me to bring my post from work to my home, and upon arrival I warned him of my pollen allergy and he nevertheless brought a package containing flowers (and labelled as such) up to me, then the tortious test should apply uninhibited. Even though the contract covers bringing packages to me, there is probably no breach of contract committed and, more importantly, damage to me was not contemplated when the deal was done (any more than the price of a haircut takes account of the possibility of my hairdresser reversing over my foot in the car park). The relationship governed by the contract may have provided the opportunity for the tort, and at the inception of the relationship there may have been an opportunity to agree special terms and exchange information regarding anything and everything, but that cannot be enough. 42

IV

, CO N C U R R E N T L I A B I L I T Y AND PHYSICAL DAMAG E

The most fertile ground for discussing contractual remoteness in cases of concurrent tortious liability for ‘making things worse’ was laid by the famous Court of Appeal decision in H Parsons (Livestock) v Uttley Ingham and Co. The plaintiff pig-farmers bought from the defendant manufacturers and suppliers, for £280 including carriage, a large metal hopper to store the pignuts on which the plaintiffs fed their pigs (a ‘fine herd’, according to Lord Denning MR). The 28-foot hopper was, per the order terms, to have a ventilated top, but the ventilator had been tied shut to stop it rattling during the journey and the defendant’s delivery man forgot to open it upon installation. The pignuts stored in the hopper went mouldy. (Swanwick J found as a fact that this was foreseeable as a not unlikely consequence of leaving the ventilator closed.) However, the plaintiff fed Stevens, above n 33. As Cooke observes in support of the Polemis decision: R Cooke, ‘Remoteness of Damages and Judicial Discretion’ (1978) 37 CLJ 288, 289. 41 42

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them to the pigs knowing the nuts to be mouldy but accepting conventional wisdom that mouldy nuts do not injure pigs. (Swanwick J found as a fact that it was not at the time of contracting reasonably foreseeable as not unlikely that the feeding of mouldy pignuts would cause illness to pigs.43) Conventional wisdom was wrong and 254 pigs of the herd of around 700 died of E coli. The value of the pigs was around £10,000 and there was a claim for loss of profits of at least that amount again. Lord Denning MR said that the relevant breach of contract was probably the negligent assembly of the hopper rather than the breaches of Sale of Goods Act warranties.44 His view was that, in any event, in physical damage cases the tort test of remoteness should apply.45 He relied in particular on the apparent unfairness of a purchaser of faulty goods suing in contract being in a worse position than if he were suing the manufacturer or supplier in the tort of negligence, or a visitor being in a worse position if suing an occupier in contract than in tort.46 He therefore found the defendant liable for the value of the pigs but not for the loss of profits they would have fetched. Scarman LJ, with whom Orr LJ agreed, disagreed with Lord Denning on the matter of the correct test, applying the contract test but holding (in reliance upon somewhat manipulated comments of the trial judge Swanwick J) that it was reasonably foreseeable as not unlikely that a hopper unfit for storing pig nuts would lead to illness of some kind in the pigs, or their death. His rejection of Lord Denning’s views was, however, made less forceful than it might otherwise have been because he agreed47 with Lord Denning that the test in contract and tort should be the same. The three judges were, therefore, agreed that the appeal should be dismissed and that only damages for loss of the pigs, rather than loss of the profit that could have been made from the pigs, was recoverable. This decision raises several important issues. The first relates to contractual remoteness. Is the contract test more relaxed in cases of physical damage than economic loss cases, as Lord Denning suggests? How should it be applied in these circumstances? The second question relates to concurrent liability. Although the action was brought only in contract, it could have been brought in the tort of negligence because there 43 Scarman LJ thought, obiter, that he might have found differently if he were the first instance judge, but did not allow the appeal on this point. 44 [1978] QB 791 (CA) 800. Scarman LJ disagreed at 809. 45 Ibid, 803–4. 46 He also relied at 804 upon the apparent unfairness of a gratuitous recipient of medical services being in a better position when suing in tort than the patient who has paid for his services and sues in contract. As far as failing to improve the position of the patient rather than making things worse, this is dealt with below, where it is suggested that the contract test should apply because the duty of care in tort arises out of a contract-like assumption of responsibility in a pre-existing relationship. 47 Ibid, 806.

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was a breach of a duty of care and the hopper caused physical harm.48 If a tort claim had been brought, should the contractual remoteness test have applied to such a claim as well? Taking the first question first, how does the contact test operate in the circumstances of Parsons? If the same standard of foreseeability were applied then one would expect the loss of profits, as well as the value of the pigs, to be recoverable. As Hugh Collins observes, the loss of profits is so closely tied to the illness or death of the pigs that if (as the Court found) the latter was foreseeable, the former must also have been.49 There must, therefore, be more at work than simply a test of foreseeability. The answer must be, as Collins observes, that the loss of profits was outside the scope of responsibility implicitly assumed by the manufacturers of the hopper.50 This seems right since, although the defendants were sheet-metal workers specialising in the manufacture of bulk food storage hoppers and automatic feeding systems, with comparable knowledge of the risks of bad food to that of food compounders (as Scarman LJ held51), this does not mean that they would have any ideas about the profits made by pig-farmers from their pigs. Consequently, given that the defendants could not realistically have allowed for the risk of paying for such loss of profits in their price and insurance, the parties might have therefore assumed that such a risk was outside that assumed by the defendants under the contract. Of course, the claimant also knew more about the value of the pigs themselves, but the defendant nevertheless could not without more assume that the value of the pigs was allocated to the claimant as in that case the defendant would have by far the better of the bargain, being left with no significant liability at all. Indeed, it is generally the case that physical damage or personal injury will be more likely than losses of profits to be within the liability assumed 48 Presumably the claim was brought in contract to avoid a reduction in damages for contributory negligence (although we know now that there can be such a reduction in cases of a contractual duty of care concurrent with a tortious duty). As a further aside, despite Lord Denning saying that there was no issue of causation, it would seem to me arguable that the actions of the plaintiffs in knowingly feeding mouldy nuts to pigs broke the chain of causation (given that it was ex hypothesi foreseeable that the mouldy nuts might harm the pigs). 49 H Collins, The Law of Contract (London, LexisNexis Butterworths, 4th edn, 2003) 513. 50 Stevens gives a different explanation, namely that damages for the death of the pigs are substitutive damages for interference with a property right and therefore not subject to the rules of remoteness: Stevens, above n 33, 152–8 and 208. See also T Weir, ‘Volume XI Torts, Chapter 12 Complex Liabilities’ in The International Encyclopedia of Comparative Law (Tübingen, Mohr, 1976) 11; HLA Hart and A Honoré, Causation in the Law (Oxford University Press, 2nd edn, 1985) 314; Cooke, above n 42, 299. But see AM Tettenborn, D Wilby and D Bennett, The Law of Damages (London, Butterworths, 2003) para 6.57, who argue that consequential losses should be subject to the Wagon Mound test but direct damage should be subject to the Heron II test in contract cases. 51 [1978] QB 791 (CA) 808, although this may in fact point in favour of liability if an approach based purely on foreseeability were applied, since although a pig-farmer would assume that mouldy nuts would not harm pigs, a lay person ignorant as to pig-farming may well assume that mouldy nuts would be not unlikely to harm pigs.

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by the supplier.52 Purchasers can be assumed by suppliers to be less willing to assume the risk of these harms (which are generally considered to be more significant and less matters of mere balance sheet valuation), even if they are unlikely.53 Further, suppliers can be assumed by purchasers to be less likely (as compared with purchasers) to be able to assess the value of losses of profits than physical losses, and so to factor them into the price or to take out insurance against them, and so less willing to assume the risk of these harms. However, even if the contract test is more relaxed in physical damage cases, and so is closer to or the same as the tort test in terms of the foreseeability required, the timing of the two would still differ (such that information conveyed to the defendant after contracting but before the breach would be irrelevant to the application of the contractual remoteness test but relevant to the tort test). As for the second question, as to whether the contract test should govern any tortious action, the answer at first sight is in the affirmative, for the reasons discussed earlier in this chapter. Clearly the risk of damage to pigs is one of the central features of a contract for supply of a hopper to hold pig-food. However, the above conclusions as to remoteness in concurrent liability situations may require modification in product liability cases. Manufacturers and suppliers know that their products may cause damage to third parties and not only the person to whom they supplied them. They price and insure accordingly. Further, it is well known by them and by (at least some) consumers that there is a tortious action for damage and injury against all suppliers and manufacturers. It may be that in such cases the parties cannot be taken to have intended to exclude concurrent tortious duties. As Katherine Swinton observes (in slightly different terms), it is arguable that if it is fair to impose liability in tort on the defendant, it must be fair to impose liability in contract on those engaged in similar activities, if they have not chosen to allocate the risks expressly. There is no real surprise to the defendant in imposing such liability.54

The present approach of the courts is certainly to apply the contractual test to the contract claim and the tortious test to the tortious claim (see, for example, Vacwell Engineering Co Ltd v BDH Chemicals Ltd55). Further, and whether or not this is correct and whether or not the tortious test is excluded, this provides additional support for the conclusion above that the contractual assumption of responsibility will often be broader in cases of 52 Kramer, above n 1, 263. See also F Dawson, ‘Reflections on Certain Aspects of the Law of Damages for Breach of Contract’ (1995) 9 Journal of Contract Law 20, 45–7. 53 Indeed, in consumer contracts any express limitation of liability for negligently caused personal injury or property damage would be subject to challenge under the Unfair Contract Terms Act 1977. This should also apply to such limitations impliedly agreed by the parties. 54 K Swinton, ‘Foreseeability: Where Should the Award of Contract Damages Cease?’ in BJ Reiter and J Swan, Studies in Contract Law (Toronto, Butterworths, 1980) 89. 55 [1971] 1 QB 88 (QB).

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personal injury and physical damage (and therefore more like the tortious test) than in cases of economic loss. There is a possible further justification for a more relaxed contractual test in warranty cases. It is logical to think that the strict nature of the relevant duty should have some effect on the contractual remoteness test. A strict duty that a product will be fit for a known purpose (storing pig-nuts) might well indicate an assumption of responsibility for unlikely or even unforeseeable but directly caused results. Swanwick J in Parsons held that the Hadley test did not apply to warranties and a mere proximate cause test applied. This approach to seller’s warranties, at least as regards personal injury and property damage, can be found in the United States in the Uniform Commercial Code at section 2.715(2)(a).56 However, this approach was rejected by all of the Court of Appeal in Parsons, although Lord Denning MR applied the tort test from The Wagon Mound, which is intermediate between the contract test and the proximate cause test.57 The one thing that does not shed much light on Parsons or any case is the assertion that a defendant, to be liable, must be able at the time of contracting to contemplate only the type or kind of loss and not the actual loss suffered. This was what the majority relied upon, and is often thought of as the major contribution of the case to the law.58 Of course, it is right that only the type of loss must be foreseeable, but the level of generality with which a ‘type’ can be drawn depends upon all the things upon which the assumption of responsibility depends. In other words, a type that is recoverable can be circumscribed and distinguished from a type that is unrecoverable only by identifying what factors are significant from the point of view of the scope of risk, for example, because they indicate an order of risk that has not been priced or insured for.59

V

NEGLIGENCE

The debate about concurrent liability arises more often, and is also easier, in the context of situations such as that in Henderson, of a contractual duty concurrent with a tortious duty of care where the latter arose out of an assumption of responsibility (through the principle from Hedley Byrne). One of the crucial features of the Hedley Byrne duty (including liability for misstatements, services and omissions), as contrasted with other Comment 4 to which explains that this is the ‘usual rule as to breach of warranty’. See further, eg Bence Graphics International Ltd v Fasson UK Ltd [1998] QB 87 (CA), which makes it clear that the full Hadley v Baxendale/ Heron II test applies to breach of warranty claims. 58 See eg Burrows (2003), above n 36, 34. 59 Kramer, above n 1, 274. 56 57

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tortious duties, relates to what goes on inside the claimant’s head. All tortious duties, once they have been recognised by the courts, may be said to give rise to reasonable reliance upon the skill or honesty, etc of those owing the duties (in driving a car, publishing information, etc). However, it is only in the case of breach of a Hedley Byrne duty of care that reasonable reliance upon that skill is necessary for loss to be caused at all. Driving a car into someone causes them harm even if their back was turned: in that sense the harm is direct. However, making a statement, omitting to act or failing to make things better can only cause loss if the victim is in fact relying upon the truth of the statement, the commission of the act or the actor’s making things better: in that sense the harm is indirect.60 One cannot cause harm in such cases to people whose back is (metaphorically) turned. Only by relying does the claimant open herself up to loss. Put like this, one might say that the claimant is the author of her own misfortune by relying on the defendant rather than relying upon herself or those she has contracted with (that is, paid) to act. The law takes the same view, except where there are special circumstances that make it reasonable to nevertheless rely upon the defendant, for example, because the defendant has expressly or impliedly intimated that the claimant could rely, or the defendant has taken control of a situation, or the defendant has a public or other obligation towards the claimant. Whilst this may not amount to a contractual promise, the crucial features of the Hedley Byrne duty (as compared with other torts) are that, as in the case of contracts: (i) the claimant (or group of claimants) and the defendant are in a specific relationship of some sort that predates the occurrence of the loss (in contrast with the usual position, where there is no relationship between the tortfeasor and the claimant other than through their shared membership of a society); and (ii) the claimant decides to rely upon the defendant’s skill. Because of this pre-existing relationship, and the conscious decision by the claimant to rely upon the defendant, it is inappropriate to nevertheless hold the defendant liable for all losses foreseeable at the time of the careless action or inaction. The defendant is not (in breaching the Hedley Byrne duty of care) invading the claimant’s life, or interfering with the claimant’s interests, unbidden and by surprise, through the careless action or inaction, and therefore liable for (most of) what follows. Rather, the claimant is able to avoid all loss and avoid all invasion of his life and interests by not relying upon the defendant. There is thus no infliction of harm, but rather a justified delegation of responsibility (that is, a reliance) by the claimant. The scope of the duty of the defendant is fixed at the point of the forming of the relationship and the delegation (at which point, 60 See further A Kramer, ‘Proximity as Principles: Directness, Community Norms and the Tort of Negligence’ (2003) 11 Tort Law Review 70.

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as with contracts, the claimant has an opportunity to tell the defendant about particular susceptibilities and the reason why he is relying upon the defendant) and not at the (often) later date of the carelessness. Accordingly, the scope of the duty is fixed by reference to the scope of the justified delegation or reliance. As John Cartwright has observed: If it is right in the law of contract to draw the line for recoverable damage at the genuinely foreseeable consequences of the breach for the reason that the defendant has agreed to undertake a liability within the scope of that risk, then it ought to be equally right to draw a similar line in those tort cases where the existence of the duty of care depends on a similar notion of a risk assumed voluntarily by the defendant . . . In those cases where the duty arises only because the courts characterise the situation as one of an assumption of responsibility on the model of contract, the extent of the defendant’s duty (and consequent liability) is limited by reference to a relatively high level of foreseeabilty, in similar fashion to the contract test of remoteness set out in The Heron II. 61

Stevens agrees. His view is that in most (but not all) cases of Hedley Byrne negligence and gratuitous bailment both the tortious/bailment action and the contractual action are based upon failure to keep the promise to take care, and in such cases remoteness should be tested at the time of and by reference to the voluntary undertaking or assumption of responsibility, since the scope of liability for breach depends upon the construction of that undertaking or assumption.62 However, the case law on this is less than conclusive. In Brickhill v Cooke,63 an engineer who carelessly prepared a survey of a house for the plaintiffs was held liable for the AUS$1,500 that the plaintiffs had paid to a builder who they had contracted to do certain work that was discontinued once the carelessness of the engineer had been revealed. The Court of Appeal of New South Wales found that, although it may not be recoverable in contract, to which must be applied the Heron II test of remoteness, it was recoverable under the concurrent tortious duty of care and the tortious remoteness test of reasonable foreseeability which ‘is much less demanding than in contract’. Further, in the Cadoks case, discussed below64, the client property purchaser recovered damages in negligence against a solicitor for the lost opportunity of making profits on 61 J Cartwright, ‘Remoteness of Damage in Contract and Tort: A Reconsideration’ [1996] CLJ 488, 502 and 505. 62 Stevens, above n 33, 203 and 207. It should be noted that for Stevens this mainly affects the time of the test, since in his view there should be no difference in the degree of foreseeability required by the contract and tort tests. 63 [1984] 3 NSWLR 396 (NSW CA). 64 Text to n 95.

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the delayed on-sale, despite such profits being too remote under the Heron II test of contractual remoteness. Faintly pointing in the opposite direction to Brickhill is the decision in BDC Ltd v Hofstrand Farms Ltd.65 In that case the majority of the Supreme Court of Canada (Wilson J being silent on the point), obiter and without much argument or discussion, applied the contractual test of remoteness to a case in which (it was assumed for the purposes of that part of the judgment) a courier had assumed responsibility to a third party for economic loss arising from late delivery of the package (see Estey J at paragraph 27). As the terms of the contract between the third party and a fourth party, which gave rise to a right of the fourth party to terminate if the Crown grant contained in the package was not registered by a certain date, were unusual, the loss would only have been recoverable had the terms of that contract (and so the likelihood of a loss if delivery was delayed) been communicated under the second limb of Hadley v Baxendale. The Court did not say whether or not the loss would have been recoverable under the tort test. Given that there was no Hedley Byrne duty of care found, not to mention that the issue received no analysis, this is not strong authority for the proposition that the contractual remoteness test should apply to Hedley Byrne cases: the contract test is inapt for the same reasons that no duty was found, that is, the courier had no relationship with the plaintiff such as would give an opportunity to communicate the risk or to limit the duty assumed and therefore justify the application of the contract test.66 Further, in a concurrent contract and Hedley Byrne case, Brown v KMR Services Ltd67, the Court of Appeal applied the contract test and found that the losses resulting from the Lloyds members’ agents’ negligence were too remote. There was no discussion of the tort test or the issue. Burrows argues that nevertheless the decision is authority for the proposition (which he supports) that where the parties are in a contractual relationship, the . . . contract test applies even where the claim is being brought in tort because of the equal opportunity that the claimant has had to inform the other party of unusual risks.68

Certainly this seems logical for the reasons given above. Where there is a contract, it might be said that the contractual duty (and the scope of liability for consequences of breach of those duties) delimits the tortious duty (see the discussion below in relation to other torts). However, the better view is that in Hedley Byrne cases the scope of the tortious duty is [1986] 1 SCR 228 (SCC). See further Blom, above n 35, 413–14. [1995] 4 All ER 598 (CA). Burrows (2004), above n 36, 94 and Burrows (2003), above n 36, 36. Stevens also cites this case for the same proposition: Stevens, above n 33, 208. 65 66 67 68

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fixed at the time of and by reference to its assumption (by the application of the Caparo v Dickman,69 SAAMCO and volenti principles), irrespective of whether there is a concurrent contractual obligation.70 If this is right, remoteness is no longer a relevant factor in a claimant’s decision whether to sue in contract or in Hedley Byrne negligence. That still leaves limitation, contribution and service out of the jurisdiction on Lord Goff’s list of ‘adventitious’ rules of law71 that make shopping for a cause of action a matter of practical importance, although the Law Commission of England and Wales would harmonise the rules of limitation if it had its way.72 As regards Hedley Byrne duties, the difference between the English system and the French system of non cumul (contract liability only) looks less stark than it once did.

VI

A SSUM P T I O N S O F R E S P O N S I B I L I T Y AF T E R C O N T R AC T F O R M AT I O N

Putting concurrent liability and related issues to one side, we turn now to a further problem area in the rules of remoteness in contract, that of the time for determining what was in the parties’ possible contemplation and therefore what is or is not too remote. It is well established that the time of contracting is the relevant time for these purposes, the orthodox justification being the promisor’s opportunity to protect herself at the time of contracting, but not subsequently. This was clearly explained by Hobson CJ in the Kentucky Court of Appeal decision in Patterson v Illinois Cent R Co73, a case in which a shipper was notified of the urgency of the delivery of cattle feed only after the contract had been made: If one party could by a subsequent notice make the other party liable for such special damages, then the rights of the parties would not be determined by the contract between them or by their situation at that time, but by the act of one of the parties alone. The rule that notice should be given at the time the contract is entered into rests upon the ground that the person to whom the notice is given may have an opportunity to protect himself by the contract which he makes or by special precautions to avoid loss. A notice given afterwards by one party would afford no such opportunity for self-protection.74 [1990] 2 AC 605 (HL). Although it may be that there can be further assumptions of responsibility under the Hedley Byrne principle after the commencement of the relationship, in similar although perhaps wider situations than are discussed in the latter part of this chapter in relation to relationship contracts. See further Cartwright, above n 36, 503. 71 Henderson, above n 7, 186. 72 Law Commission, ‘Limitation of Actions’ (Law Com No 270, 2001). 73 97 SW 423 (1906). 74 Or, as Lord Hope put it more recently in the House of Lords decision in Jackson v Royal Bank of Scotland [2005] UKHL 3, [2005] 1 WLR 377 (HL)[36]: ‘The parties have the 69 70

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A fortiori, the time of contracting rule is the correct time if one holds the view (in pure or watered down form) that remoteness is actually about the implied assumption of risk by the promisor.75 This is one rule, at least, about which few doubts have expressed, and as to which there has been little comment.76 The only significant exceptions are Sir Robin Cooke, who advocates a discretionary approach to remoteness which takes into account the foreseeability of loss both at the date of contracting and immediately before the breach,77 and Samek, who argues that the date of breach should be used when the breach was wilful.78 Patterson must therefore be right. So is the decision in Kollmann v Watts,79 in which the Supreme Court of Victoria allowed an appeal because the purchaser of a business did not know at the time of contracting, although he did know before breach, that the seller needed the money promptly to buy a house and might therefore have to borrow money at a high rate of interest if the purchaser of the business was late in making payment.

opportunity to limit their liability in damages when they are making their contract. They have the opportunity at that stage to draw attention to any special circumstances outside the ordinary course of things which they ought to have in contemplation when entering into the contract.’ 75 And even if one’s view is that the remoteness rule is really founded upon and justified by the promotion of economic efficiency, the time of contracting is, again, probably the proper time: I Ayres and R Gertner, ‘Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules’ (1989) 99 Yale Law Journal 87; JM Perloff, ‘Breach of Contract and the Foreseeability Doctrine of Hadley v Baxendale’ (1981) 10 Journal of Legal Studies 39; LA Bebchuk and S Shavell, ‘Information and the Scope of Liability for Breach of Contract: The Rule of Hadley v Baxendale’ (1991) 7 Journal of Law, Economics and Organization 284. However, for the contrary view see in particular CA Goetz and RE Scott, ‘The Mitigation Principle: Toward a General Theory of Contractual Obligation’ (1983) 69 Virginia Law Review 967, 1014, who argue that liability should include needs unknown to the promisee but of which the promisor should have known before the time for performance, and MA Eisenberg, ‘The Emergence of Dynamic Contract Law’ (2000) 88 California Law Review 1743, 1772–7, who criticises the current ‘time of contract formation’ rule as being ‘static’, preferring the ‘dynamic’ proximate cause rule which looks to the circumstances existing at the time of breach, and argues that the current rule encourages the breaching party to ignore relevant costs and benefits merely because he was not aware of them at the time of contracting, and therefore to profit from making an inefficient breach and paying damages limited by the current remoteness rule. 76 Although, for an early suggestion that the rule may be wrong, see the comments of Bramwell B in Gee v Lancashire and Yorkshire Railway Company (1860) 6 H & N 211, 218: ‘I am not sure that another qualification might not be added which would be in favour of the plaintiffs in this case, viz that in the course of performance of the contract one party may give notice to the other of any particular consequences which will result from the breaking of the contract, and then have a right to say: “If, after that notice, you persist in breaking the contract I shall claim the damages which will result from the breach”.’ See also the decision in Stanish v Polish Roman Catholic Union of America 484 F 2d 713 (1973), where the date of breach was applied in a contract case, and see the discussion by Treitel, above n 2, 160–1. 77 Cooke, above n 42, 298. 78 RA Samek, ‘The Relevant Time of Foreseeability of Damage in Contract’ (1964) 38 Australian Law Journal 125. JM Perillo, ‘Volume 11: Damages’ in Corbin on Contracts (Lexis Nexis, 2005) seems to agree. 79 [1963] VR 396, discussed by Samek, ibid.

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Similarly, the reasoning (although not the decision) of the Court of Appeal in 100 Old Broad Street v Sidley80 was probably wrong. In that case a surveyor negligently advised a developer that the neighbours’ rights to light would not give them rights to an injunction against the proposed development. Glidewell J for the Court of Appeal stated that: That, however, leaves open the question, what was the relevant time—in other words at what date must the particular loss have been reasonably foreseeable? We have not been referred to any authority which deals with this question. In my opinion, the answer to the question is clearly, when the cause of action arose. In this case, that is when the defendants’ contract of retainer was breached, and in tort when the damage to the plaintiffs was caused ie when they expended the fees which were wasted . . . Mr Fernyhough [QC for the Defendant] accepts that this is correct . . .

His Lordship then applied the date of breach to the question of what was foreseeable, finding the losses to have been in the parties’ contemplation at that date. It is noteworthy that this was all obiter because no damages were awarded in the end (damages for wasted expenditure had not been properly pleaded or proven, and the rectification works for which damages were claimed had not been and would not be undertaken). It was probably also obiter for a further reason, since it seems likely that the date would have made no difference (since a surveyor would probably contemplate at the time of being retained that if he negligently advised as to rights to light it was not unlikely that the project would have to be abandoned upon discovery of the mistake). Nevertheless, it is interesting that the Court and counsel accepted the date of breach of contract as the correct date. No doubt they were influenced by the concurrent action in negligence (with the relevant foreseeability date being the date of loss), and by the fact that the contract was an ongoing retainer (more about both of these below). Yet, for the reasons given above, it seems unfair and legally incorrect to take the date of breach as the relevant date for applying the remoteness test. However, as the following sections seek to demonstrate, there are situations in which a later date for the assessment of remoteness may be justifiable.81

[1999] All ER (D) 432 (CA). It is noteworthy that the developments suggested here are all but impossible where there is a codified rule of remoteness specifying, for example, that foreseeability must be assessed ‘at the time of the conclusion of the contract’, as the CISG does. See further the discussion of that provision by F Ferrari, ‘Hadley v Baxendale v Foreseeablity under Article 74 CISG’, this volume. 80 81

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VARIATIONS OF CONTRACT

The first wrinkle in the time of contracting rule comes with contractual variation. In Spang Industries Inc Ft Pitt Bridge Div v Aetna C & S Co82 a bespoke steel supplier entered into a contract in September 1969 with the date of supply to be agreed. At the time of contracting the supplier understood from the specifications that the work on the construction project was expected to end in December 1971 and therefore that it would have to supply the steel in 1971. The work went quickly and in November 1969 the delivery date was agreed as being June 1970. Delivery was delayed until September 1970, causing various costs because of the difficulties of pouring steel in the colder months. Circuit Judge Mulligan stated that: It would be a strained and unpalatable interpretation of Hadley v Baxendale to now hold that, although the parties left to further agreement the time for delivery, the supplier could reasonably rely upon a 1971 delivery date rather than one the parties later fixed . . . We conclude that, when the parties enter into a contract which, by its terms, provides that the time of performance is to be fixed at a later date, the knowledge of the consequences of a failure to perform is to be imputed to the defaulting party as of the time the parties agreed upon the date of performance. This comports, in our view, with both the logic and spirit of Hadley v Baxendale.83

This is strange. The same result should have been reached on the basis that at the time of contracting it was in the parties’ contemplation that the date of delivery subsequently agreed might be mid-1970 and that if delivery was late (in whichever year) it was not unlikely that there would be steel-pouring costs. The risks and rewards of the parties were fixed at the time of contracting and it seems unfair if something unforeseeable at that date were later recoverable merely because of the deferred fixing of time for delivery, that deferral being agreed in the original contract. The fixing of the time was not, in this case, a variation of the contract. In Roanoke Hospital Association v Doyle & Russell Inc84 a construction completion date had been fixed in the original contract. Change orders were agreed with the builders and the customer then claimed that the builders had failed to complete by the due date. The court concluded that the change orders did not amount to ‘a meeting of the minds upon an amendment altering the completion date first fixed in the contract’, and so the date of contracting was applied as the correct date for assessing what damages were recoverable and what damages were too remote. However, Justice Poff stated obiter that

82 83 84

512 F 2d 365 (1975) (2nd Cir). Ibid, 369. 214 SE 2d 155(1975) (Virg SC) 160–1.

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When the breach alleged is an unexcused delay in completion, if the completion date has been altered by consensual amendment, contemplation is to be determined as of the date of amendment.

Corbin on Contracts cites the Roanoke Hospital Association case for the proposition that ‘[w]hen the contract has been modified by mutual assent, foreseeability is to be determined as of the date of amendment’.85 This makes a lot of sense. Where there has been an actual amendment or variation to a contract (rather than merely the fixing of a date that was left open at the date of contracting) there is much to recommend the idea that the remoteness test should be applied at that date, at least with regard to the obligations that were varied (a qualification correctly added by Justice Poff), since there was a renewed assumption of responsibility at that time. If the promisor had felt that she was now aware of further risks of loss arising out of the varied obligation of which she had not been aware at the time of formation, then she might renegotiate the price or other matters as a condition for giving her agreement to the variation. In the circumstances, as in the case of formation, this opportunity to renegotiate the obligations might well give rise to an implied assumption of further risk with regard to the varied obligation. It is less clear that such a principle can be applied to situations in which there is no renegotiation but there is the opportunity for such renegotiation.

VIII

L O N G - T E R M CO N T R AC T S

Long-term contracts will often include agreed variations to the work to be provided or the price to be paid for it, and that may give rise to a delaying of the relevant date for assessing remoteness to the date of variation, in accordance with the principle identified in the previous section. However, it may be that in such contracts which are not single transactions for a single price but rather are relationship contracts (banker and customer, solicitor and client, employer and employee, etc), the date of contracting may not be the best date as of which to apply the remoteness test even where there has not been a variation. Before briefly discussing why this might be so, it is worth looking at the only three decisions that I could find that tested this hypothesis. All three are first instance decisions: Malyon v Lawrence, Messer & Co (1968) in the English High Court, Murano v Bank of Montreal (1995) in the Ontario Court of Justice and Cadoks Pty Ltd v Wallace Westley & Vigar Pty Ltd (2000) in the Supreme Court of Victoria. 85

Perillo, above n 78, para 56.3.

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In Malyon v Lawrence, Messer & Co86 a solicitor was engaged to prosecute a civil claim arising out of a car crash. After the solicitor had been retained, and to the solicitor’s knowledge, the client developed and was diagnosed with severe anxiety, which adversely affected the client’s business (and its profitability) and was unlikely to abate until the claim against the negligent driver had been settled. However, the solicitor’s negligent breach of contract by delaying pursuit of the client’s claim led to the claim becoming time-barred. The plaintiff recovered £1,250 of contract damages to compensate for his anxiety even though the defendant solicitor only learned of the plaintiff’s condition after being engaged. Brabin J (at 550–1) rejected the contention that the only relevant time for assessing contemplation was ‘the moment when the plaintiff, as it were, walked into the defendants’ office’, focusing on the continuing nature of the solicitor’s obligation while his retainer operates and the likelihood that circumstances will supervene which require action after the date of commencement of the retainer. This appears to have been the ratio of the case, since at the date when it was decided it was thought that there could be no concurrent duty of care in tort.87 Further, while in some cases, such as Heywood v Wellers,88 severe anxiety may be foreseeable at the time of contracting, it appears from what Brabin J indicated that in Malyon the anxiety was too remote as at the date of the commencement of the retainer. As Jonathan Hill observes, the decision seems to be fair, but is not easy to reconcile with the authorities on remoteness.89 The appeal decision in Murano v Bank of Montreal was discussed above.90 It will be remembered that a bank, in breach of its contract with its customer, failed to give reasonable notice before putting the customer into receivership. It was clearly foreseeable at the time of retaining the bank that the receivership would destroy the client’s business. Although the issue we are interested in was not live in the case, since the losses were foreseeable at the time of the inception of the banking relationship and further there were concurrent tortious causes of action in trespass/conversion, Adams J made some interesting observations in giving the first instance judgment.91 He explained (at paragraph 153) that the timing of the remoteness rule in contract applies because: Parties to contracts voluntarily assume risk in return for negotiated consideration. Risk is therefore judged by the parties at the outset of their relationship. To assess the foreseeability of loss at some later point in time, such as the date 86 87 88 89 90 91

[1968] 2 Lloyd’s Rep 539 (QB). Following Groom v Crocker [1939] 1 KB 194 (CA), referred to in Malyon at 550. [1976] QB 446 (CA). J Hill, ‘Litigation and Negligence: A Comparative Study’ (1986) 6 OJLS 183, 210. Text to n 39. (1995) 20 BLR (2d) 61 (Ont CJ, Adams J), (1998) 163 DLR (4th) 21 (Ont CA).

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of breach, carries with it the potential for changing the risks voluntarily assumed, ie the bargain.

But he then observed that: this case severely tests the reasonableness of this ancient rule because of the ‘at will’ nature of the contractual relationships. Where a party can demand full payment of a loan at will, that party can assess daily whether to break off its contractual relationship. In the case of a demand loan, it can do so without breaching its contract provided it gives reasonable notice. In that particular context, it seems strange to be thrown back to the original date of contract for the purposes of foreseeability. In fact, confining loss assessment to the formation of a long standing ‘at will’ banking relationship seems artificial and may be inconsistent with the general trend of authority harmonizing rules in tort and contract. Indeed, in this case, judging the foreseeability of loss in light of the Bank’s knowledge closer to the date of breach is not likely to upset contractual intentions given the expectations of the parties at the date of contract formation that the plaintiffs’ changing conditions would be closely monitored.92

He later observed that:93 in an ‘at will’ banking relationship of this type I see no unfairness in also assessing foreseeability in contract near the date of breach. The Bank sought and received regular updates on Murano’s situation. Such monitoring was expected by the parties on contracting. The Bank could have extricated itself at any time by giving reasonable notice.94

In Cadoks Pty Ltd v Wallace Westley & Vigar Pty Ltd,95 a solicitor was engaged to conduct the purchase of a farm. Three years after the solicitor was engaged, the purchaser made it clear that he intended to sell on the property he was buying, for a profit. Due to the negligence of the solicitor, the completion was delayed by another year and the market fell, reducing the profits that the purchaser eventually made from the on-sale. The plaintiff was refused contract damages for lost profits from the resale of the property because the discussion between the parties as to the purchaser’s intention to sell the property on after it had been bought, ‘which might well be said to show special circumstances, took place long after the time when the contract [with the solicitor defendant] was made’.96 At the date of commencement of the retainer, the loss was too remote under the Heron II test. It should be noted, however, that this decision was obiter because the loss was held to be recoverable in the tort Ibid, para 160. The Court of Appeal in Murano, although dismissing the appeal as far as these heads of losses were concerned, took the view that the primary cause of action was in the tort of trespass or conversion, as is discussed above at the text to n 39. The Court did not comment on Adams J’s dicta. 94 Ibid, para 193. 95 [2000] VSC 167 (Vic SC, Ashley J). 96 Ibid, para 205. 92 93

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of negligence, since the loss was not too remote under the tortious test of reasonable foreseeability at the time of the negligence.97 Notably, Hobson CJ in the Patterson decision above98 observed that no new contract was made at the time that the special information about the urgency of delivery of the cattle feed was communicated to the carrier. We have already seen that in cases of a variation of contracts the correct date for application of the remoteness test should be the date of the variation (at least with regard to the varied obligation). In the same vein, in relationship cases it might be said that, in essence, a new contract is formed at each and every point in any continuing and terminable relationship contract, at least as regards the parts of duties that are terminable (that is, not obligations for which the time for performance has come about or which could otherwise not be avoided by termination of the relationship). As Adams J observed in Murano, in cases of relationships terminable (and therefore renegotiable) at will (such as those with periodic payment or payment as and when work is done), the basic justification for the remoteness rules in contract does not point to the ‘time of contracting’ rule.99 In such cases the remoteness test should be applied at all relevant times before breach up until the last moment at which the defendant could have terminated (without paying damages) the contractual obligation that was breached. Malyon seems right and Cadoks wrong.100 However, the remoteness test will not necessarily operate in exactly the same way at the later times as it would at the time of contracting. At the time of contracting it is usually reasonable to infer an assumption of risk from the failure of the claimant to exclude liability for not unlikely losses. This is probably also true (albeit to a lesser extent) of variations, at least with regard to the varied obligation. But this inference will be weaker still at later stages where, although there is a theoretical opportunity for termination and renegotiation, there was no actual reconsideration or renegotiation of the obligations. Further, at the time of contracting there is a mutual assumption of obligations, and it is only really on the rare occasions on which the price is vastly disproportionate to the risk that one See further above at the text to n 64. See n 73. Cf Cartwright’s discussion of the liability of a solicitor in the tort of negligence, above n 36, 503. Note also that, under the Unfair Terms in Consumer Contracts Regulations 1999 sch 1(j) and sch 2(b), clauses giving the power to one party to unilaterally vary interest rates and charges are not considered unfair where the customer is free to dissolve the contract immediately (presumably since the failure to do so signals a sort of freely given consent). 100 In 100 Old Broad Street v Sidley, above n 80, and accompanying text, we saw that the time of breach was applied as the relevant time for the remoteness test in a surveyor’s negligence case. Although a surveyor might be said to have an ongoing relationship with his client, Glidewell J was probably still wrong, because the action related to an obligation to advise that was undertaken at the outset of the retainer and could not have been terminated at will (although the retainer could have been terminated later so as to refuse to perform further services or undertake obligations that had not yet arisen). 97 98 99

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might not infer an assumption of risk for foresight of a not unlikely possible loss. At the later stage, however, there is less incentive for assumption of risk, since the defendant is getting nothing in return (and, indeed, if the assumption of extra risk were instead assumption of an extra obligation, we might say that there was no consideration for the variation of contract). Foreseeability of the risk of a (new) loss, even when a party could have left the relationship, should not necessarily give rise to an inference of assumption of risk, and to adopt the contrary point of view would in some ways be analogous to treating silence as acceptance of a contractual offer. So we are left with some uncertainty as to when the date of the assessment of remoteness should be put off past the date of contracting in terminable at will relationship contracts. However, this problem rarely arises in practice, principally because, even more than in other cases, in long-term contracts the parties’ assumptions of risk will usually be broadly defined for the very reason that the contract is a long-term contract and the parties can be assumed to understand that things will change throughout the life of the contract, and the price and insurance will accordingly be calculated generally and with an eye on the long term101 (although this is even more likely where the contract is not terminable and the parties are locked into their original deal for the full term). An employee cannot complain because his carelessness led to the loss of a deal or type of profit that was not even a twinkle in anyone’s eye at the time he took the job, because it is understood that the deals and opportunities of his employer are likely to develop over time and his wage is not fixed according to a specific transaction.102

IX

CONCLUSION

If one takes seriously the idea that the contractual remoteness rule is at least partly about assumption of risk, then various results obtain. First there is the question of concurrent liability. If an agreementcentred view of contract remoteness is accepted, then the contractual private ordering that includes the allocation of risks of harm that the See further Kramer, above n 1, 263 and 270–1. A further difficulty with regard to timing is raised in cases of duties of care. Should the implied allocation of risk at the time of contracting or assuming a Hedley Byrne duty of care colour the evaluation of whether the contractual or Hedley Byrne duty of care has been broken, or should a risk learned of after contracting or assuming the Hedley Byrne duty (such as the fragility of goods being carried) be taken into account in determining whether the defendant fell below the standard of the reasonable man? Although a finding of breach that took into account the defendant’s failure to avoid the remote (because learned of too late) risk would not lead to recovery of damages for that harm (as they are excluded by remoteness), it may lead to damages for other harms suffered where, absent the new risk, there would have been no breach found at all. 101 102

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promisee might suffer should sometimes displace the default ordering that exists under the concurrent tortious obligation (where the existence of the contract has not excluded the tortious obligation altogether). This displacement should occur whenever the tortious obligation covers a matter that is central to the contract and to the risks allocated in it (especially when the matter may have had an impact on the price paid for the promise), as in such a situation it can be inferred that the promisor intended to exclude any concurrent tortious liability for other risks he has not assumed, and the promisee intended to accept responsibility for such other risks. However, this (and the much-disputed differences between contract and tort remoteness) are likely to have little application in practice. One of the main reasons is revealed by the discussion of Parsons v Uttley Ingham, namely that most of the losses that are recoverable in both contract and tort (excluding under a Hedley Byrne assumption of responsibility) are physical, and in the majority of cases it will be easier to imply an assumption of risk for physical harm and personal injury than for economic loss. In other words, in physical harm and personal injury the contract test will be so close to the tort test (in terms of how foreseeable a loss must be to be recoverable) as to be difficult to distinguish. This conclusion is of some importance in modifying the general understanding of how the contractual remoteness test applies because it shows that, in effect (although not in reasoning), Lord Denning was right in Parsons. Hedley Byrne liability is different, however, not because it covers economic loss, but because it arises from a voluntary assumption of responsibility and the contractual remoteness test should therefore apply for the same reasons it applies to contracts (and whether or not there is a concurrent contract)—because the contractual test determines the scope of responsibility allocated by the parties. This removes one of the advantages of the Hedley Byrne cause of action as against the contractual cause of action, and so will affect the choice made by claimants in concurrent liability cases. For most contracts the fixing of the deal (the price and other obligations) at formation will also fix the scope of responsibility, but an agreement-centred approach to remoteness allows for the possibility that sometimes the scope of responsibility will be adjusted at a later date. The clearest example is that of a variation of the contract, but the discussion above shows that in some cases of long-term contracts that are terminable at will the mere persistence of the contract without termination might indicate a continuing assumption of responsibility. In those circumstances, the correct date for assessing which losses were foreseeable would be much later than the date of inception of the relationship and the contract underlying it. This too will rarely be determinative in practice, because in long-term contracts the scope of responsibility is likely to be broadly

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defined and therefore encompass subsequent unforeseen changes, but the very idea of adjusting the sacred date of contracting when assessing remoteness is significant to our understanding of remoteness. It thus seems that the new problems, while not requiring us to rewrite the old rule of Hadley v Baxendale, do reveal the need for re-examination of old certainties in small and not so small ways. Indeed, the clamour caused by some of these problems may yet threaten the tranquil world of quiet (but always reasonable) contemplation.

13 Hadley v Baxendale v Foreseeability under Article 74 CISG FORES EEABI LI TY UNDER ARTI CLE 74 CI S G

FRANCO FERRARI* FRANCO FERRARI

I

I NTRO DUCTION

It has been common knowledge for some time1 that, in order to create legal uniformity, it is insufficient to merely create and enact uniform law instruments2 because even when outward uniformity is achieved . . . uniform application of the agreed rules is by no means guaranteed, as in practice different countries almost inevitably come to put different interpretations upon the same enacted words.3 * Professor of International Law, Verona University School of Law, Former Legal Officer, United Nations Office of Legal Affairs, International Trade Law Branch. 1 See O Riese, ‘Einheitliche Gerichtsbarkeit für vereinheitlichtes Recht’ [1961] Rabels Zeitschrift für ausländisches und internationales Privatrecht 607; K Zweigert, ‘Die Rechtsvergleichung im Dienste der europäischen Rechtsvereinheitlichung’ [1951] Rabels Zeitschrift für ausländisches und internationales Privatrecht 395. 2 See D Martiny, ‘Autonome und einheitliche Auslegung im Europäischen Zivilprozeßrecht’ [1981] Rabels Zeitschrift für ausländisches und internationales Privatrecht 427; P Melin, Gesetzesauslegung in den USA und in Deutschland (Tübingen, Mohr Verlag, 2005) 333; C Rudolf, Einheitsrecht für internationale Forderungsabtretungen (Tübingen, Mohr Verlag, 2006) 11; L Ryan, ‘The Convention on Contracts for the International Sale of Goods: Divergent Interpretations’ [1995] Tulane Journal of International Comparative Law 101; I Sannini, L’applicazione della Convenzione di Vienna sulla vendita internazionale negli Stati Uniti (Padova, Cedam, 2006) 10; M Sturley, ‘International Uniform Law in National Courts: The Influence of Domestic Law in Conflicts of Interpretation’ [1989] Virginia Journal of International Law 731. 3 See RC Munday, ‘The Uniform Interpretation of International Conventions’ (1978) 27 International and Comparative Law Quarterly 450. For similar, more recent, statements, see C Baasch Andersen, ‘Furthering the Uniform Application of the CISG Sources of Law on the Internet’ (1998) 10 Pace International Law Review 404; JC Duncan, ‘Nachfrist Was Ist? Thinking Globally and Acting Locally: Considering Time Extension Principles of the U.N. Convention on Contracts for the International Sale of Goods in Revising the Uniform Commercial Code’ [2000] Brigham Young University Law Review 1368; F Ferrari, ‘Do Courts Interpret the CISG Uniformly?’ in F Ferrari (ed), Quo Vadis CISG? Celebrating the 25th Anniversary of the United Nations Convention on Contracts for the International Sale of Goods

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In order to reduce the risk of diverging interpretations of one and the same text,4 that text must also be interpreted uniformly, since, as stated by Viscount Simonds on behalf of the House of Lords in Scruttons Ltd v Midland Silicones Ltd,5 it would be deplorable if the nations should, after protracted negotiations, reach agreement . . . and that their several courts should then disagree as to the meaning of what they appeared to agree upon.6

The drafters of the 1980 United Nations Convention on Contracts for the International Sale of Goods (hereinafter referred to as the ‘CISG’),7 as well as those of many other uniform law conventions, such as the 1980 EEC Convention on the Law Applicable to Contractual Obligations and the 1988 UNIDROIT Conventions on International Factoring and on International Financial Leasing, were aware of this problem, and this is why they inserted a provision into the CISG, namely Article 7, designed to help reach uniformity by requiring that, in interpreting the CISG regard is to be had to its international character and to the need to promote uniformity in its application and the observance of good faith in international trade.8

Many legal writers construe the reference to the obligation to have regard to the Convention’s ‘international character’ in its interpretation to mean that the CISG is to be interpreted ‘autonomously’,9 not ‘nationalistically’; (Brussels, Bruylant, 2005) 3; L Graffi, ‘Divergences in the Interpretation of the CISG: The Concept of Fundamental Breach’ in F Ferrari (ed), The 1980 Uniform Sales Law. Old Issues Revisited in the Light of Recent Experiences (Milan, Giuffrè, 2003) 306; UP Gruber, Methoden des internationalen Einheitsrechts (Tübingen, Mohr Siebeck, 2004) 79; BK Leisinger, Fundamental Breach. Considering Non-conformity of the Goods (Munich, Sellier European Law Publishers, 2007) 1; G Schmid, Einheitliche Anwendung von internationalem Einheitsrecht. Die Berücksichtigung der Rechtsprechung und Literatur anderer Vertragsstaaten am Beispiel des CISG (Baden-Baden, Nomos, 2004) 17–18. 4 It has often been stated that it is only possible to reduce the danger of diverging interpretations; it is not possible to eliminate it as such: see, eg J Lookofsky, Consequential Damages in Comparative Context (Copenhagen, Jurist- og Økonomforbundet, 1989) 294. 5 Scruttons Ltd v Midland Silicones Ltd [1962] AC 446, 471 (HL). 6 For similar statements, see F Ferrari, La vendita internazionale. Applicabilità ed applicazioni della Convenzione di Vienna del 1980 (Padova, Cedam, 2nd edn, 2006) 10ff. 7 Many abbreviations have been used for the United Nations Convention on Contracts for the International Sale of Goods; for a court decision which gives an overview of the existing ones, see Case No 13 U 51/93, 20 April 1994, Oberlandesgericht Frankfurt (1994), Recht der internationalen Wirtschaft 593, available at http://cisgw3.law.pace.edu/cisg/wais/db/cases2/ 940420g1.html (accessed 28 June 2007). For a discussion in legal writing of the various abbreviations, see A Flessner and T Kadner, ‘CISG? Zur Suche nach einer Abkürzung für das Wiener Übereinkommen über Verträge über den internationalen Warenkauf’ [1995] Zeitschrift für Europäisches Privatrecht 347. 8 Art 7(1) CISG. See also Art 4(1) of the UNIDROIT International Factoring Convention; Art 6(1) of the UNIDROIT International Financial Leasing Convention; Art 18 of the EEC Convention on the Law Applicable to Contractual Obligations. 9 See B Audit, La vente internationale de marchandises (Paris, LGDJ, 1990) 47; MJ Bonell, ‘Commento all’Article. 7 della Convenzione di Vienna’ [1989] Nuove Leggi civili commentate

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that is, not in the light of domestic law,10 despite the fact that, once put in force, international conventions become part of the domestic law.11 Consequently, one should not have recourse to any domestic concept in order to solve interpretive problems arising from the CISG.12 Many commentators have argued that this suggestion is true even where the expressions employed by the CISG are textually the same as expressions which, within a particular legal system, have a specific meaning—such as ‘avoidance’, ‘reasonable’, ‘good faith’ or ‘trade usages’ (indeed, this is generally true for any uniform law convention).13 In effect, such expressions have to be considered as independent and different from the domestic concepts14 since 21; F Diedrich, ‘Maintaining Uniformity in International Uniform Law via Autonomous Interpretation: Software Contracts under the CISG’ (1996) 8 Pace International Law Review 303; G Hager, ‘Zur Auslegung des UN-Kaufrechts—Grundsätze und Methoden’ in T Baums, J Wertenbruch, M Lutter (eds) Festschrift für Ulrich Huber zum siebzigsten Geburtstag (Tübingen, Mohr Siebeck, 2006) 320; M Jametti Griener, ‘Der Vertragsabschluß’ in H Hoyer (ed) Das Einheitliche Wiener Kaufrecht. Neues Recht für den internationalen Warenkauf (Vienna, Orac, 1992) 42; M Torsello, Common Features of Uniform Commercial Law Conventions. A Comparative Study Beyond the 1980 Uniform Sales Law (Munich, Sellier European Law Publishers, 2004) 18. For a reference in recent cases as to the need to interpret the CISG ‘autonomously’, see XX Cucine SpA v Rosula Nigeria Ltd, 9 December 2005, Tribunale di Modena (Italy, Modena District Court), available at http://www.cisg-online.ch/cisg/ urteile/1398.pdf (accessed 28 June 2007). 10 See JO Honnold, ‘The Sales Convention in Action—Uniform International Words: Uniform Applications?’ (1988) 8 Journal of Law and Commerce 208 (‘one threat to international uniformity in interpretation is a natural tendency to read the international text through the lenses of domestic law’). See also A Babiak, ‘Defining “Fundamental Breach” under the United Nations Convention on Contracts for the International Sale of Goods’ (1992) 6 Temple International & Comparative Law Journal 117. 11 Cf SM Carbone, ‘L’ambito di applicazione ed i criteri interpretativi della Convenzione di Vienna sulla vendita internaizonale’, in La vendita internazionale. La Convenzione di Vienna dell’11 Aprile 1980 (Milan, Giuffrè, 1981) 84; W Witz, ‘Art 7’, in W Witz, HC Salger and M Lorenz (eds), International Einheitliches Kaufrecht. Praktiker-Kommentar und Vertragsgestaltung zum CISG (Heidelberg, Verlag Recht und Wirtschaft, 2000) 81. 12 See JO Honnold, Uniform Law for International Sales under the United Nations Convention (Deventer, Kluwer, 3rd edn, 1999) 89, stating that ‘the reading of a legal text in the light of the concepts of our domestic legal system [is] an approach that would violate the requirement that the Convention be interpreted with regard to its international character’. For a similar affirmation in case law, see Cassazione civile decision of 24 June 1968 (Italy, Supreme Court), reported in [1969] Rivista di diritto internazionale privato e processuale 914. 13 See R Bariatti, Interpretazione delle convenzioni internazionali di diritto uniforme (Padova, Cedam, 1985); BWM Trompenaars, Pluriforme unificatie en uniforme interpretatie—in het bijzonder de bijdrage van UNCITRAL aan de internationale unificatie van het privaatrecht (Deventer, Kluwer, 1989). 14 For discussion, see R Herber and B Czerwenka, Internationales Kaufrecht. Kommentar zum Übereinkommen der Vereinten Nationen vom 11. April 1980 über Verträge über den internationalen Warenkauf (Munich, CH Beck Verlag, 1991) 47; see also F Ferrari, ‘The Relationship between the UCC and the CISG and the Construction of Uniform Law’ (1996) 29 Loyola of Los Angeles Law Review 1026; A Lanciotti, Norme uniformi di conflitto e materiali nella disciplina convenzionale della compravendita (Naples, ESI, 1992) 287. Cf F Van der Velden, ‘Indications on the Interpretation by Dutch Courts of the United Nations Convention on Contracts for the International Sale of Goods’ in Hondius et al (eds), Netherlands Reports to the Twelfth Congress of Comparative Law: Sydney–Melbourne (The Hague, Asser Instituut/Martinus Nijhoff, 1986) 33.

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the expressions employed by uniform law conventions, such as the CISG, are intended to be neutral as they are the result of a compromise and therefore cannot correspond to the reception of a concept peculiar to a specific domestic law.15 However, where it is apparent from the legislative history that the drafters intended a specific concept to be interpreted in the light of a specific domestic law, it should be allowed to have recourse to the ‘domestic’ understanding of that concept.16 This does not mean that one should resort to that ‘domestic’ understanding whenever the language of the relevant CISG provisions tracks that of a particular domestic law, as has been suggested by some US courts.17 In my opinion, the mere fact that the wording of a particular CISG provision corresponds to that of a specific domestic rule (whether created by statute or case law) is per se insufficient to allow one to resort to the interpretation of that domestic rule. It is also for this reason that it must be doubted, for instance, whether it really is true, as suggested, once again, by a US court, that the CISG’s foreseeability requirement . . . is identical to the well-known rule of Hadley v. Baxendale, 156 Eng. Rep. 145 (Ct. Exch. 1854), [and] that relevant inter-

15 For further discussion here, see MJ Bonell, ‘Art. 7 CISG’ in CM Bianca and MJ Bonell (eds), Commentary on the International Sales Law (Milan, Giuffrè, 1987) 74; B Zeller, ‘International Trade Law—Problems of Language and Concepts?’ (2003) 23 Journal of Law Commerce 39; UNCITRAL statement to the UNGA in ‘Introduction to the Digest of Case Law on the United Nations Sales Convention’ (9 June 2004) UN document A/CN.9/562, 1: ‘The drafters of the Convention took special care in avoiding the use of legal concepts typical of a given legal tradition’. Diedrich, above n 9, 310, states that ‘the [entire] text of the CISG consists of unique, supranational collective terms formed out of compromises between state delegates based on several systems of laws’. For statements regarding the CISG being the result of a compromise, see E Diederichsen, ‘Commentary to Journal of Law & Commerce Case I, Oberlandesgericht Frankfurt am Main’ (1995) 14 Journal of Law Commerce 177; B Selden, ‘Lex Mercatoria in European and US Trade Practice: Time to Take a Closer Look’ (1995) 2 Annual Survey of International & Comparative Law 121. See also F Enderlein, D Maskow and H Strohbach, Internationales Kaufrecht: Kaufrechtskonvention, Verjährungskonvention, Vertretungskonvention, Rechtsanwendungskonvention (Berlin, Haufe, 1991) 61. 16 See W-A Achilles, Kommentar zum UN-Kaufrechtsübereinkommen (CISG) (Neuwied, Luchterhand, 2000) 29; F Ferrari,‘Artt. 89–101 CISG’ in P Schlechtriem and I Schwenzer (eds), Kommentar zum Einheitlichen UN-Kaufrecht (Munich, CH Beck Verlag, 4th edn, 2004) 142; U Magnus, Wiener UN-Kaufrecht—CISG (Berlin, Sellier–de Gruyter, 2005) 171; C Niemann, Einheitliche Anwendung des UN-Kaufrechts in italienischer und deutscher Rechtsprechung und Lehre (Frankfurt, Peter Lang, 2006) 42. 17 See The Travelers Property Casualty Company of America and Hellmuth Obata & Kassabaum, Inc. v Saint-Gobain Technical Fabrics Canada Limited, 3 January 2007 (US District Court, Minnesota), available at http://www.nysd.uscourts.gov/courtweb/pdf/D08MNXC/ 07–00494.PDF (accessed 28 June 2007); Genpharm Inc v Pliva-Lachema AS, 19 March 2005 (US District Court, Eastern District of New York), available at http://www.cisg.law.pace.edu/ cisg/wais/db/cases2/050319u1.html (accessed 28 June 2007); Raw Materials Inc v Manfred Forberich GmbH & Co KG, 2004 WL 1535839 (ND Ill), 6 July 2004. For a criticism of this tendency, see HM Flechtner, ‘The CISG in US Courts: The Evolution (and Devolution) of the Methodology of Interpretation’, in Ferrari, above n 3, 92ff.

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pretations of that rule can guide the Court’s reasoning regarding proper damages.18

Of course, if the foreseeability requirement set forth in Article 74 CISG were truly based on the Hadley v Baxendale rule, it is submitted that it would be permissible to have recourse to the interpretations of that common law rule, and this despite the mandate that in interpreting the CISG regard ‘be had to its international character and to the need to promote uniformity in its application autonomously.’ It is for this reason that this chapter seeks to examine whether the CISG’s foreseeability requirement really goes back to the Hadley v Baxendale rule and, by doing so, it will make it possible to answer the question of whether it should be allowed to resort to common law interpretations of that rule when discussing the foreseeability requirement in Article 74 CISG.

II

F O R E S E E A B I L I T Y U N D E R ART I C L E 7 4 C I S G

According to Article 74 CISG, Damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. Such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.

This ‘brief but powerful’19 provision, which in itself does not constitute a basis upon which to claim any damages but rather a rule on how to measure them,20 lays down what, according to both commentators21 and 18 TeeVee Tunes, Inc et al v Gerhard Schubert GmbH, 12 August 2006 (US District Court, Southern District of New York), available at http://cisgw3.law.pace.edu/cases/060823u1.html (accessed 28 June 2007). 19 Honnold, above n 10, 445. 20 See MW Brölsch, Schadensersatz und CISG (Frankfurt, Peter Lang, 2007) 41; F Enderlein and F Maskow, International Sales Law (New York, Oceana, 1992) 300; Magnus, above n 16, 722; H Rudolph, Kaufrecht der Export- und Importverträge. Kommentierung des UN-Übereinkommens über internationale Warenkaufverträge mit Hinweisen für die Vertragspraxis (Freiburg, Haufe, 1996) 379; H Stoll and G Gruber, ‘Arts. 74–77 CISG’ in P Schlechtriem and I Schwenzer (eds), Commentary on the UN Convention on the International Sale of Goods (CISG) (Oxford University Press, 2nd edn, 2005) 745–6. 21 See S Eiselen, ‘Unresolved Damages Issues of the CISG: A Comparative Analysis’ [2005] Comparative International Law Journal of Southern Africa 36; F Ferrari, ‘General Principles and International Uniform Law Conventions: A Study of the 1980 Vienna Sales Convention and the 1988 UNIDROIT Conventions on International Factoring and Leasing (1998) 13 Pace International Law Review 173; DP Flambouras, ‘The Doctrines of Impossibility of Performance and Clausula Rebus Sic Stantibus in the 1980 Convention on Contracts for the International Sale of Goods and the Principles of European Contract Law—A Comparative Analysis’ (2001) 13 Pace International Law Review 289; U Magnus, ‘Die allgemeinen Grundsätze im UN-Kaufrecht’ [1995] Rabels Zeitschrift für ausländisches und internationales Privatrecht 484;

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courts,22 constitutes one of the general principles upon which the CISG is based, namely that of full compensation,23 ‘designed to place the aggrieved party in as good a position as if the other party had properly performed the contract’,24 as also pointed out in case law,25 and thus ‘to give the aggrieved party the “benefit of the bargain”‘.26 Since, however, the full compensation of the expectation and reliance interests would operate either as too strong a disincentive to the assumption of contractual obligations, or to an undue raising of charges to cover such unlimited liability27 Mather, ‘Choice of Law for International Sales Issues not Resolved by the CISG’ [2001] Journal of Law Commerce 158; K Neumayer and C Ming, Convention de Vienne sur les contrats de vente internationale de marchandises. Commentaire (Lausanne, CEDIDAC, 1993) 487; MP van Alstine, ‘Dynamic Treaty Interpretation’ [1998] University of Pennsylvania Law Review 752. 22 See SO M AGRI sas di Ardina Alessandro & C v Erzeugerorganisation Marchfeldgemüse GmbH & Co KG, 25 February 2004, Tribunale di Padova, (Italy, Padova District Court), available at http://cisgw3.law.pace.edu/cases/040225i3.html (accessed 28 June 2007); Al Palazzo Sri v Bernardaud di Limoges SA, 26 November 2002, Tribunale di Rimini (Italy, Rimini District Court), available at http://cisgw3.law.pace.edu/cisg/wais/db/cases2/021126i3.html (accessed 28 June 2007); Case No 7 Ob 301/01t, 14 January 2002, Oberster Gerichtshof (Austria Supreme Court), available at http://cisgw3.law.pace.edu/cases/020114a3.html (accessed 28 June 2007); Case No 6 Ob 311/99z, 9 March 2000, Oberster Gerichtshof (Austria Supreme Court), available at http://cisgw3.law.pace.edu/cases/000309a3.html (accessed 28 June 2007); Internationales Schiedsgericht der Bundeskammer der gewerblichen Wirtschaft, Arbitral Awards SCH-4366 and SCH-4318, Recht der internationalen Wirtschaft, 1995, 590ff (Austria Arbitral Tribunal), available at http://www.unilex.info/case.cfm?pid=1&do=case&id= 55&step=FullText (accessed 28 June 2007);, available at http://www.unilex.info/case.cfm?pid= 1&do=case&id=56&step=FullText (accessed 28 June 2007). 23 See C Brunner, UN-Kaufrecht—CISG. Kommentar zum Übereinkommen der Vereinten Nationen über Verträge über den internationalen Warenkauf von 1980 (Bern, Stämpfli Verlag AG, 2004) 415; F Faust, Die Vorhersehbarkeit des Schadens gemäß Art. 74 Satz 2 UN-Kaufrecht (CISG) (Tübingen, Mohr Verlag, 1996) 8; I Saenger, ‘Art. 74 CISG’ in HG Bamberger and H Roth (eds), Kommentar zum Bürgerlichen Gesetzbuch, Band 3 (Munich, CH Beck Verlag, 2003) 2879; Stoll and Gruber, above n 20, 763. 24 Honnold, above n 10, 445; also F Bonelli, ‘La responsabilità per danni’, in La vendita internazionale, La Convenzione di Vienna dell’11 aprile 1980 (Milan, Giuffrè, 1981) 253; M Claeys, ‘De bijzondere rechtsmiddelen van de partijen’, in H van Houtte, J van Erauw and P Wautelet (eds), Het Weens Koopverdrag (Antwerpen, Intersentia, 1997) 249; H Gabriel, Practitioner’s Guide to the Convention on Contracts for the International Sale of Goods (CISG) and the Uniform Commercial Code (UCC) (New York, Oceana, 1994) 230; IB Majumdar and S Jha, ‘The Law Relating to Damages under International Sales: A Comparative Overview between the CISG and Indian Contract Law’ [2001] Vindobona Journal of International Commercial Law & Arbitration 193; N Whittington, ‘Reconsidering Domestic Sale of Goods Remedies in Light of the CISG’ [2006] Victoria University Wellington Law Review 443. 25 See Case No 7 Ob 301/01t, Oberster Gerichtshof, above n 22; Case No 10 Ob 518/95, 6 February 1996, Oberster Gerichtshof (Austria Supreme Court), available at http:// cisgw3.law.pace.edu/cases/960206a3.html (accessed 28 June 2007). 26 CISG-AC Opinion No 6, Calculation of Damages under CISG Article 74, rapporteur Professor JY Gotanda, available at http://cisgw3.law.pace.edu/cisg/CISG-AC-op6.html (accessed 28 June 2007), citing at text to n 3: AE Farnsworth, ‘Damages and Specific Relief’ (1979) 27 American Journal of Competition Law 249; J Sutton, ‘Measuring Damages Under the United Nations Convention on the International Sale of Goods’ (1989) 50 Ohio State Law Journal 742. 27 D Saidov, ‘Methods of Limiting Damages under the Vienna Convention on Contracts for the International Sale of Goods’ [2002] Pace International Law Review 333, citing GH Treitel, Remedies for Breach of Contract: A Comparative Account (Oxford, Clarendon, 1988) 143; see

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Article 74 mitigates the principle of full compensation by limiting the recoverable damages to the foreseeable loss.28 This is not the place to analyse either Article 74 CISG29 or its foreseeability rule in depth.30 For the purposes of this chapter it suffices to make a few remarks in respect of the foreseeability requirement in Article 74 CISG, which will be relevant when comparing this foreseeability requirement with the Hadley v Baxendale rule. First of all, it should be mentioned that ‘Article 74 makes it clear that it is only the party in breach who is required to foresee’31 or ought to have foreseen the loss as a possible consequence of the breach.32 It should also be pointed out that according to Article 74 CISG the foreseeability ‘must refer to losses that can be a possible consequence of a breach of contract.’33

also P Huber in Münchener Kommentar zum Bürgerlichen Gesetzbuch, Band 3, Schuldrecht. Allgemeiner Teil (Munich, CH Beck Verlag, 2004) 2626; Magnus, above n 16, 728. For a different rationale of the foreseeability rule, see Faust, above n 23, 225ff. 28 See Case No 10b 292/99v, 28 April 2000, Oberster Gerichthof (Austria Supreme Court), available at http://cisgw3.law.pace.edu/cases/000428a3.html (accessed 28 June 2007); see also Case No 7 Ob 301/01t, Oberster Gerichtshof, above n 22. 29 For detailed analyses of Art 74 CISG, see Bonelli, above n 24, 251ff; MW Bröisch, Schadensersatz und CISG (Frankfurt, Peter Lang Verlag, 2007); KS Cohen, ‘Achieving a Uniform Law Governing International Sales: Conforming the Damages Provisions of the United Nations Convention on Contracts for the International Sale of Goods and the Uniform Commercial Code’ (2005) 26 University of Pennsylvania Journal of International Economic Law 601; A Dawwas, ‘Non-performance and Damages under the CISG and the UNIDROIT Principles’ (1997) 31 Comparative Law Review 225; J Gotanda, ‘Awarding Damages under the United Nations Convention on the International Sale of Goods: A Matter of Interpretation’ (2005) 37 Georgetown Journal of International Law 95; AA Kirby, ‘Punitive Damages in Contract Actions: The Tension Between the United Nations Convention on Contracts for the International Sale of Goods and US Law’ (1997) 16 Journal of Law Commerce 215; N Kranz, Die Schadensersatzpflicht nach den Haager Einheitlichen Kaufgesetzen und dem Wiener UN-Kaufrecht (Frankfurt, Peter Lang Verlag, 1989); Majumdar and Jha, above n 24, 185ff; D Roßmeier, ‘Schadensersatz und Zinsen nach UN-Kaufrecht—Art. 74 bis 78 CISG’ [2000] Recht der Internationalen Wirtschaft 407; G Ryffel, Die Schadenersatzhaftung des Verkäufers nach dem Wiener Übereinkommen über internationale Warenkaufverträge vom 11. April 1980 (Bern, Lang, 1992); D Saidov, ‘Damages: The Need for Uniformity’ (2005) 25 Journal of Law & Commerce 393; H Stoll, ‘Inhalt und Grenzen der Schadensersatzpflicht sowie Befreiung von der Haftung im UN-Kaufrecht im Vergleich zu EKG und BGB’ in P Schlechtriem (ed), Einheitliches Kaufrecht und nationales Obligationenrecht (Baden-Baden, Nomos, 1987) 257ff; B Zeller, Damages under the Convention on Contracts for the International Sale of Goods (New York, Oceana, 2005). 30 For an in-depth analysis of Art 74 CISG’s foreseeability rule, see A Dawwas, ‘The Concept of Foreseeability under the UN Convention on Contracts for the International Sale of Goods’ (1995) 19 Journal of Law Commerce 3; Faust, above n 23. 31 Saidov, above n 27, 339. 32 See Neumayer and Ming, above n 21, 490; Stoll and Gruber, above n 20, 764–5; L Vekas, ‘The Foreseeability Doctrine in Contractual Damage Cases’ [2002] Acta Juridica Hungarica 159. 33 Case No 7 Ob 301/01t, above n 22. See also Magnus, above n 16, 728; Saidov, above n 27, 342; Vekas, ibid, 161; RH Weber, ‘Vertragsverletzungsfolgen: Schadenersatz, Rückabwicklung, vertragliche Gestaltungsmöglichkeiten’ in E Bucher (ed), Wiener Kaufrecht (Bern, Stämpfli, 1991) 198.

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Consequently, ‘[t]he foreseeability of a breach of contract or fault regarding breach does not matter’.34 Foreseeability in Art. 74 CISG refers therefore only to losses that at the time of the conclusion of the contract were an assessable consequence of a possible breach of obligation, and for which the obligor cannot exempt himself under Art. 79 CISG by proving that the failure to fulfil his contractual obligations was due to an impediment beyond his control, which he was not expected to take into account at the time of the conclusion of the contract and was not obliged to have avoided or overcome.35

According to most commentators,36 Article 74 CISG does not require foreseeability of the precise amount of loss.37 At the same time, however, a mere possibility that a breach of contract will produce some type of loss is not sufficient.38 Rather, it is necessary that the obligor could recognize that a breach of contract would produce a loss essentially of the type and extent that actually occurred.39

Whether the obligor actually did recognise this is generally irrelevant since ‘[w]hether the damages arising from a breach of contract were foreseeable is, basically, to be judged according to objective standards.’40 In other words, The obligor must reckon with the consequences that a reasonable person in his situation (Art. 8(2) CISG) would have foreseen considering the particular circumstances of the case. Whether he actually did foresee this is as insignificant as whether there was fault.41

This means, among other things, that the party claiming damages need not prove that the party in breach really foresaw the loss. It will be enough if he proves that the party in breach was objectively in a position to foresee it.42 34 Case No 7 Ob 301/01t, above n 22; also Brölsch, above n 20, 53; Huber, above n 27, 2626; Stoll and Gruber, above n 20, 765–6; Witz, above n 11, 502. 35 Case No 7 Ob 301/01t, above n 22. 36 See Faust, above n 23, 12; V Knapp in CM Bianca and MJ Bonell (eds), Commentary on the International Sales Law. The 1980 Vienna Sales Convention (Milan, Giuffrè, 1987) 541; Magnus, above n 16, 728; Roßmeier, above n 29, 411; Rudolph, above n 20, 382; Saidov, above n 27, 342; H Schönle in H Honsell (ed), Kommentar zum UN-Kaufrecht (Berlin, Springer Verlag, 1997) 940; Vekas, above n 32, 164. 37 See Case No 7 Ob 301/01t, above n 22. 38 Ibid. 39 Ibid; see also Magnus, above n 16, 728; Saidov, above n 27, 343; Stoll and Gruber, above n 20, 766. 40 Stoll and Gruber, above n 20, 765; Achilles, above n 16, 225; Brunner, above n 23, 420; Schönle, above n 36, 940. 41 Case No 7 Ob 301/01t, above n 22. See also Case No 10 Ob 518/95, above n 25; Huber, above n 27, 2626; Magnus, above n 16, 729; Witz, above n 11, 500. 42 Knapp, above n 36, 541. See also JA Goddard, El contrato de compraventa internacional (Mexico City, UNAM/McGraw-Hill, 1994) 297–8. This view is in accord with how the burden

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The above reasoning has led some commentators to argue that the Article 74 foreseeability rule contains normative elements which must be taken into account, such as the allocation of risks under the contract, its purpose, and the specific protective purpose of the individual obligations under the contract43

and, as a consequence, to suggest that, despite the need for a case-by-case analysis,44 it is possible to identify some cases45 in which the loss caused by the party in breach can generally be considered as being in the realm of what that party ‘ought to have foreseen’,46 that loss being one that can occur in the normal course of business of the kind and between the parties involved.47 This is true, for instance, in respect of non-performance loss.48 For example, one court has stated that if the buyer loses profits, which [it] could have realized by reselling the goods had the seller not breached his obligations, the seller is only liable for this loss of profit if he had to reckon with the buyer’s resale. In the case of the sale of commercial goods to a merchant, this can always be assumed without any further indications.49 of proof in this matter is generally allocated; according both to scholars (see P Schlechtriem, Internationales UN-Kaufrecht (Tübingen, Mohr Verlag, 3rd edn, 2005) 202) and to the courts (see Case No 3 U 83/98, 13 January 1999, Oberlandesgericht Bamberg (Germany, Provincial Court of Appeal), available at http://cisgw3.law.pace.edu/cases/990113g1.html (accessed 28 June 2007)), it is the injured party who has to prove that the loss was foreseen or ought to have been foreseen by the party in breach. 43 Stoll and Gruber, above n 20, 765. See also A Lüderitz and M Dettmeier, ‘Art. 74 CISG’, in Soergel Bürgerliches Gesetzbuch mit Einführungsgesetz und Nebengesetzen, vol 13. Schuldrechtliche Nebengesetze. Übereinkommen der Vereinten Nationen über Verträge über den internationalen Warenkauf (CISG) (Stuttgart, Kohlhammerm 2000) 153; Magnus, above n 23, 729; F Pantaleon Prieto in L Diez-Picazo (ed), La compraventa internacional de mercaderias. Comentario de la Convencion de Viena (Madrid, Civitas, 1998) 606; Witz, above n 11, 501. 44 See Neumayer and Ming, above n 21, 491. 45 For relevant references see Brölsch, above n 20, 57ff; Faust, above n 23, 17ff; Mankowski, ‘§§ 373–406 CISG’ in Schmidt (ed), Münchener Kommentar zum Handelsgesetzbuch, vol 6 (Munich, CH Beck Verlag, 2004) 670ff. 46 Witz, above n 11, 501. 47 See Achilles, above n 16, 225; Magnus, above n 16, 729ff; Stoll and Gruber, above n 20, 766ff; Schlechtriem, above n 29, 204ff. 48 See Stoll and Gruber, above n 20, 766. 49 Case No 10 Ob 518/95, above n 25. See also Case No 4R 219/01k, 24 January 2002, Oberlandesgericht Graz (Austria Provincial Court of Appeal), available at http:// cisgw3.law.pace.edu/cases/020124a3.html (accessed 28 June 2007) (‘The loss of profit a seller suffers from reselling the goods to another customer is to be considered foreseeable damages in the sense that Art. 74, sentence two, requires’); Case No 22 U 4/96, 21 May 1996, Oberlandesgericht Köln (Germany Provincial Court of Appeal), available at http://cisgw3.law.pace.edu/ cases/960521g1.html (accessed 28 June 2007) (‘The damages claimed by the [buyer] are recoverable within the meaning of arts 74 et seq. CISG. The damages of the [buyer] are so-called consequential damages within the meaning of Art. 74 CISG in the form of a liability damage, which arose as the breach of contract by the [seller] has made the [buyer] liable towards third parties. As required by the CISG, the [buyer] has calculated his damages precisely. Under these requisites, the damages would only be unrecoverable if they would have to be classified as unforeseeable. This is to be denied’). For similar statements, see Saenger, above n 36, 2880.

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The same can be said in respect of ‘costs incurred for the expedited shipment of alternative goods’,50 in addition to costs ‘for the assessment of the damage, as well as for its prevention or reduction’,51 as long as they are not disproportionate.52 Fees resulting from a dishonoured check are also considered to be generally foreseeable.53 Further, in cases where the goods delivered do not conform to the contract, the buyer can claim the loss of value of the goods actually delivered compared with that of the goods contracted for.54 Similar statements have been made in connection with consequential loss. According to the German Supreme Court, the [seller]’s liability includes the consequential damages that the [buyer] suffered through reimbursement to its customer for the damages caused by the foil non-conformity55

a view shared by the Austrian Supreme Court, which stated that a buyer of defective goods can foresee an obligation to pay damages to his own customers, as long as the obligation does not exceed the usual extent.56

Moreover, it has also been suggested that

50 CISG-AC, above n 26; I Sannini, L’applicazione della Convenzione di Vienna sulla vendita internazionale negli Stati Uniti (Padova, Cedam, 2006) 363; Arbitral Award SCH-4366, above n 22 (‘The claim for reimbursement of the storage costs incurred as a result of the lateness in taking delivery of the goods or refusal to take delivery, as well as the entitlement to payment of the difference between the contractually agreed price and the proceeds of the substitute sale of the residual goods of which delivery was not taken should also be regarded as justified’). 51 Case No VIII 2R 300/96, 25 June 1997, Bundesgerichtshof (Germany Supreme Court), available at http://cisgw3.law.pace.edu/cases/970625g2.html (accessed 28 June 2007). For a further illustration of foreseeable losses in case law, see Delchi Carrier, SpA v Rotorex Corp, 6 December 1995 (US Circuit Court of Appeals (2d Cir)), available at http://cisgw3.law.pace.edu/ cases/951206u1.html (accessed 28 June 2007). 52 See Brunner, above n 23, 428; Case No VIII 2R 300/96, Bundesgerichtshof, above n 51. 53 See Case No 7 U 3771/97, 28 January 1998, Oberlandesgericht München (Germany Provincial Court of Appeal), available at http://cisgw3.law.pace.edu/cases/980128g1.html (accessed 28 June 2007); L DiMatteo, L Dhooge, S Greene, V Maurer, M Pagnattaro International Sales Law. A Critical Analysis of CISG Jurisprudence (Cambridge University Press, 2005) 155; Witz, above n 11, 504. 54 See Faust, above n 23, 17; J Heilmann, Mängelgewährleistung im UN-Kaufrecht— Voraussetzungen und Rechtsfolgen im Vergleich zum deutschen internen Kaufrecht und zu den Haager Einheitlichen Kaufgesetzen (Berlin, Duncker & Humblot, 1994) 574; Magnus, above n 16, 730; Ryffel, above n 29, 63ff. 55 Case No VIII 2 R 259/97, 25 November 1998, Bundesgerichtshof (Germany Supreme Court), available at http://cisgw3.law.pace.edu/cases/981125g1.html (accessed 28 June 2007). See also China International Economic and Trade Arbitration Commission (CIETAC), 31 January 2000, available at http://cisgw3.law.pace.edu/cases/000131c1.html (accessed 28 June 2007). 56 Case No 7 Ob 301/01t, above n 22; also Case No 10 Ob 518/95, above n 25 (‘Upon the sale of commercial goods to a merchant, the seller has reason to believe that the buyer will be held liable by her customers if the seller delivers non-conforming goods or does not fulfil his duty to deliver at all.’).

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damages [simply] resulting from the fluctuation of market prices must be categorized as those consequences of breach that had to be foreseen at the time of contracting57

at least where the currency to be used for payment is different from that used in the creditor’s country.58 Under certain circumstances, loss of goodwill can also constitute a foreseeable loss.59 According to the Swiss Supreme Court, the seller is liable for this loss, provided that the buyer is obviously an intermediary in a sensitive market and in addition has no possibility to otherwise supply its clients with complying goods within the time limit set due to its precautions.60

Nevertheless, I believe that the fact that a party has to pay punitive damages cannot be considered ‘foreseeable’ under the CISG.61 It should be noted, however, that subjective risk evaluation cannot be completely ignored: if the obligor knows that a breach of contract would produce unusual or unusually high losses, then these consequences are imputable to him.62

Thus, if a party considers that a breach by the other party would cause exceptionally heavy losses or losses of an unusual nature, and wants to ensure that it will be able to recover those losses, it has to make this known to the other party for the liability to be extended to cover those losses.63 In other words, The actual knowledge of the [obligor] at the time of the conclusion of the contract may . . . lead to his liability being extended. 64

It is required, however, that that knowledge existed at the conclusion of the contract65: See Vekas, above n 32, 164. Magnus, above n 16, 732ff. For a detailed analysis of this issue, see Mankowski, above n 45) 675. EK, L & A v F (Case No 4 C 179/1998/odi), 28 October 1998, Schweizerisches Bundesgericht (Switzerland Supreme Court), 28 October 1998, available at http:// cisgw3.law.pace.edu/cases/981028s1.html (accessed 28 June 2007). 61 See CIETAC decision of 1 February 2000, available at http://cisgw3.law.pace.edu/cases/ 000201c1.html (accessed 28 June 2007). 62 Case No 7 Ob 301/01t, above n 22; also Schönle, above n 36, 940. 63 See Knapp, above n 36, 542; Achilles, above n 16, 225; Brunner, above n 23, 421; Claeys, above n 24, 248; DiMatteo et al, above n 53, 153; Enderlein and Maskow, above n 20, 302; Neumayer and Ming, above n 21, 491; H Stoll, ‘Inhalt und Grenzen der Schadensersatzpflicht sowie Befreiung von der Haftung im UN-Kaufrecht im Vergleich zu EKG und BGB’, in P Schlechtriem (ed), Einheitliches Kaufrecht und nationales Obligationenrecht (Baden-Baden, Nomos, 1987) 257, 263; Sutton, above n 26, 745. 64 Stoll and Gruber, above n 20, 765. 65 See Claeys, above n 24, 247; Enderlein and Maskow, above n 20, 300; Lüderitz and Dettmeier, above n 43, 152; Neumayer and Ming, above n 21, 491; Pantaleon Prieto, above n 43, 606; Rudolph, above n 20, 381; Saenger, above n 23, 2880. Also EK, L & A v F, above n 60. 57 58 59 60

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The liability risk assumed by the [obligor] cannot be extended by the fact that, after the conclusion of the contract, he learned of circumstances that indicate additional risk.66

Finally, it is worth mentioning that Article 74 CISG requires no more than the foreseeability of the loss as a possible consequence of the breach of contract.67

III

F O R E S E E A B I L I T Y: F RO M RO M E TO N E W YO R K

According to some commentators, the limitation of damages to foreseeable losses found in Article 74 CISG stems from Anglo-American law68 and, in particular, it has been suggested that this limitation is a derivative of the common law rule in Hadley v Baxendale.69 This view has also been taken in some cases under the CISG.70 It would appear that those taking this view are unaware not only of the fact that ‘[f]oreseeability of damages is not a concept unique to the common law’71 and that many civil law systems limit damages to foreseeable ones,72 but also of the impact that civil law teachings had on the Hadley v Baxendale case itself, which constitutes the very basis of all the (different) rules on limiting damages to be found in common law, such as UCC § 2-715(2)(a) (2003). They also overlook the fact that both the Hadley v Baxendale rule and other common law rules modelled on it differ from the Article 74 foreseeability rule in various respects. So far as the issue of origin is concerned, it may suffice to recall that 66 Stoll and Gruber, above n 20, 765; see also Achilles, above n 16, 225; Brunner, above n 23, 421; Knapp, above n 36, 542; Magnus, above n 16, 729; G Reinhart, UN-Kaufrecht. Kommentar zum Übereinkommen der Vereinten Nationen über Verträge über den internationalen Warenkauf (Heidelberg, CF Müller, 1991) 171; Schönle, above n 36, 941; Witz, above n 11, 502; Case No 3 U 83/98, Oberlandesgericht Bamberg, above n 42. 67 See Brölsch, above n 20, 55ff; Gotanda, above n 26, 104; H Stoll and G Gruber, ‘Artt. 74–77 CISG’ in P Schlechtriem and I Schwenzer (eds), Kommentar zum Einheitlichen UN-Kaufrecht—CISG, 4th edn ( Munich, CH Beck Verlag, 2004) 709. 68 See Enderlein and Maskow, above n 20, 301; R Herber and B Czerwenka, Internationales Kaufrecht. UN-Übereinkommen über Verträge über den internationalen Warenkauf. Kommentar (Munich, CH Beck Verlag, 1991) 333; I Schwenzer, ‘Das UN-Abkommen zum internationalen Warenkauf’ [1990] Neue Juristische Wochenschrift 606. 69 See Cohen, above n 29, 611; Magnus, above n 16, 171; JM West and JKM Ohnesorge, ‘The 1980 UN Convention on Contracts for the International Sale of Goods: A Comparative Analysis of Consequences of Accession by the Republic of Korea’ (1999) 12 Transnational Law 97. 70 See EK, L & A v F, above n 60. 71 AJ Bolla and RB Tipton, ‘A Brief Prelude: Hadley v. Baxendale, Y2K, and Maritime Trade (Sometimes the Bowsprit Gets Attached to the Rudder)’ (1999) 8 Currents: International Trade Law Journal 74. 72 See Gotanda, above n 26, 104; Reinhart, above n 66, 170.

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The true origins of this principle are actually found in the civil law, and can be traced to Roman times.73

In effect, a first attempt to limit recoverable contract damages to foreseeable losses was made in early Roman law,74 but those attempts were nullified by the constitution enacted in 531 AD by Justinian according to which damages were limited ad duplum,75 that is, to twice the amount of the loss suffered. It is this 531 AD constitution that can be considered the starting point for the foreseeability limitation which can now be found in many civil law systems, since, according to Du Moulin, the idea underlying the constitution enacted by Justinian was that generally the debtor could foresee only such loss (that is, the duplum).76 On the basis of this reasoning, Du Moulin established, about one millennium later, the general rule according to which damages, resulting from a breach of contract, had to be limited to foreseeable damages.77 It is this rule that formed the basis of Pothier’s statement that le débiteur n’est tenu que des dommages et intérêts qu’on a pu prévoir, lors du contrat, que le créancier pourrait souffrir de l’inexécution de l’obligation; car le débiteur est censé ne s’être soumis qu’à ceux-ci.78

This idea found its way into the French Civil Code in the guise of Article 1150 pursuant to which

73 Bolla and Tipton, above n 71, 74; also WR Barnes, ‘Hadley v. Baxendale and Other Common Law Borrowings from the Civil Law’ (2005) 11 Texas Wesleyan Law Review 637; Brölsch, above n 20, 51; F Ferrari, ‘Comparative Ruminations on the Foreseeability of Damages in Contract Law’ (1993) Louisiana Law Review 1264; Saidov, above n 27, 334; Pantaleon Prieto, above n 43, 604. 74 For the discussion of the foreseeability rule in early Roman law, see F Pringsheim, ‘Zur Schadensersatzpflicht des Verkäufers und des Käufers’, in Studi in onore di Salvatore Riccobono VI (Palermo, 1936) 316ff. See also H Weitnauer in H Dölle (ed), Kommentar zum Einheitlichen Kaufrecht. Die Haager Kaufrechtsübereinkommen vom 1. Juli 1964 (Munich, CH Beck Verlag, 1976) 537 (drawing attention to a specific Roman source: D.19.1.43–44). 75 See D Medicus, Id quod interest (Cologne, Heymanns, 1962) 288–90. 76 See Ferrari, above n 72, 1264; also Dumas, ‘Les origines romaines de l’article 1150 du Code civil’ in Etudes d’histoire juridique offertes à P.F. Girard II (Paris, Geuthner, 1913) 110; J Gordley, ‘Why Look Backward’ (2002) 47 American Journal of Contract Law 667 (‘In the 16th century, a French jurist named Du Moulin devised an explanation for one text which limited the damages recoverable in certain contracts to twice the contract price. Damages greater in amount, he said, might have been unforeseeable when the promise was made, and the promisor might not have been willing to contract if he had thought he might be liable for them’). 77 See Ferrari, above n 73, 1265; Weitnauer and Dölle, above n 74, 537. 78 ‘The debtor is bound to pay only the damages and interests which one could foresee, when the contract was made, as being possibly suffered by the creditor in non-performing the obligation, because the debtor is considered as having accepted only the these’, cited according to Oeuvres de Pothier (Paris, Thomine & Fortic, 1821) 181. See also J Gordley, ‘The Foreseeability Limitation on Liability in Contract’ in A Hartkamp (ed), Towards a European Civil Code (Nijmegen, Ars Aequi, 2004) 218ff; Pantaleon Prieto, above n 43, 604.

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The debtor is held liable only for damages that were foreseen, or that one could have foreseen, at the time of contracting, when it is not by his ill will that the obligation was not carried out.79

It is due both to Pothier’s teachings and to the influence of the French Civil Code that the foreseeability requirement can nowadays be found in many, albeit not all, civil law countries.80 For example, in Germany, as well as Austria and Switzerland, the foreseeability limit does not exist.81 However, in civil law systems influenced by the French Civil Code, the foreseeability requirement is the rule. Therefore, it is not surprising that the Italian Civil Code, which is heavily influenced by the French Civil Code, states that Unless the non-performance or the delay depends on the debtor’s fraud, the compensation is limited to the damages which could be foreseen at the time when the obligation came into existence.82

Furthermore, the Belgian Civil Code contains a rule that is textually the same as that in the French Civil Code.83 Pothier’s teachings not only influenced the French-based civil law systems, they also had a (major) impact on the common law, on contract 79 ‘Le débiteur n’est tenu que des dommages et intérêts qui ont été prévus ou qu’on a pu prévoir lors du contrat, lorsque ce n’est point par son dol que l’obligation n’est point exécutée.’ (translation by the author). For a thorough analysis of the foreseeability requirement in Art 1150 of the French Civil Code, see H Souleau, La prévisibilité du dommage contractual (dissertation Université Paris II, 1979, Xeroxed). 80 See also J Spurlock, ‘Remarks Offered at the Panel Discussion on the Occasion of the Symposium: The Common Law of Contracts as a World Force in Two Ages of Revolution: A Conference Celebrating the 150th Anniversary of Hadley v. Baxendale’ (2005) 11 Texas Wesleyan Law Review 709. Cf W Tetley, ‘Mixed Jurisdictions: Common Law v. Civil Law (Codified v. Uncodified)’ [2000] Louisiana Law Review 714 (‘In civil law, it is not sufficient that contractual damages be the immediate and direct consequence of the non-performance; they must have been foreseen or foreseeable at the time that the obligation was contracted unless there is intentional or gross fault’). 81 It its 1881 version, the Swiss Code of Obligations provided for the foreseeability requirement. See E Rabel, Das Recht des Warenkaufs II (Berlin, W de Gruyter, 1958) 479. For further discussion see F Faust, ‘Remarks Offered at the Panel Discussion on the Occasion of the Symposium: The Common Law of Contracts as a World Force in Two Ages of Revolution: A Conference Celebrating the 150th Anniversary of Hadley v. Baxendale’ (2005) 11 Texas Wesleyan Law Review 709ff; Faust, above n 23, 2; Ferrari, above n 73, 1263; TF Volyn, ‘Agreement Consummation in International Technology Transfers’ (1993) 33 Journal of Law Technology 259. For the history of the foreseeability limit with special references to German law, see, eg D König, ‘Voraussehbarkeit des Schadens als Grenze vertraglicher Haftung—zu Art. 82, 86, 87 EKG’, in H Leser and W Freiherr Marschall von Bieberstein (eds), Das Haager Einheitliche Kaufgesetz und das deutsche Schuldrecht. Kolloquium zum 65: Geburtstag von E. v. Caemmerer (Heidelberg, CF Müller, 1973) 75ff. 82 Art 1225. For papers on foreseeability in Italian contract law, see M Dell’Utri, ‘Inadempimento colposo del contratto e prevedibilità del danno’ [1989] Giurisprudenza italiana 1695ff; A Pinori, ‘Prevedibilità del danno’ [1994] Rivista di diritto civile 139ff; A Pinori, ‘Il criterio della prevedibilità del danno’ [1995] Vita notarile 187ff; C Romeo, ‘Inadempimento doloso e risarcimento del danno imprevedibile’ [2004] Responsabilità civile e previdenza 972ff; G Valcavi, ‘Sulla prevedibilità del danno da inadempienza colposa contrattuale’ [1990] Foro italiano 1946ff. 83 See Art 1150 of the Belgian Civil Code.

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and sales law in general84 and, in particular, on the development of the common law equivalent of the foreseeability limit in Article 1150 of the French Civil Code. It may suffice to recall a recent statement by Perillo, according to which ‘the whole structure of the common law of contracts and sales is based largely on Pothier’s treatises on obligations and sales’.85 This statement cannot come as a surprise, considering, on the one hand, that an English justice declared in 1822 that Pothier’s authority was ‘[a]s high as can be had, next to a decision of a Court of Justice in this country’86 and, on the other hand, in that very same year in the United States, Justice Story, in an admiralty case, referred to ‘the sober judgment of Pothier’ and his ‘moral perspicacity.’87 ‘Near the end of the nineteenth century, the primary author of England’s Sale of Goods Act wrote in his treatise that he had “made frequent reference to Pothier’s Traité du contrat de vente. Although published more than a century ago—for Pothier died in 1772—it is still probably the best reasoned treatise on the law of sale that has seen the light of day.”’88 As for Pothier’s influence on the limitation of recoverable damages, this goes back to the period prior to Hadley v Baxendale,89 as evidenced by the fact that several earlier court decisions expressly referred to the French scholar when dealing with the limitation of recoverable damages in contract law. The earliest such (contract)90 case in a common law jurisdiction91 is Blanchard v Ely,92 a case decided by the Supreme Court of

84 See JH Baker, An Introduction to English Legal History (Oxford University Press, 4th edn, 2002) 352–3 (‘The most influential sources of ideas, though not always followed slavishly, were the Traité d’Obligations (1761) by the French jurist Robert Joseph Pothier (1699– 1772), published in English in 1806, and the university textbook Principles of Moral and Political Philosophy (1785) by William Paley (1743–1805), archdeacon of Carlisle. Both works included discussions of elementary contractual ideas so long absent from the common law. In them we find the seeds of the English law of offer and acceptance, mistake, frustration, and damages’). 85 J Perillo, ‘Robert J. Pothier’s Influence on the Common Law of Contract’ (2005) 11 Texas Wesleyan Law Review 267. 86 KM Teeven, ‘Consensual Path to Abolition of Pre-existing Duty Rule’ (1999) 34 Valparaiso University Law Review 44, citing to Cox v. Troy, 106 Eng Rep 1264, 1266 (KB 1822) (per Best, J.). 87 Peele v Merchants’ Ins Co, 19 F Cas 98, 113 and 102 (CCD Mass 1822). 88 Perillo, above n 85, 269 citing MD Chalmers, ‘Introduction to the First Edition’, in The Sale of Goods Act, 1893, Including the Factors Acts, 1889 & 1890 (London, Butterworths, 10th edn, 1924) vii and x. 89 See F Ferrari, ‘Prevedibilità del danno e contemplation rule’ [1993] Contratto e impresa 764ff. 90 For a tort case in which reference was made to Pothier’s teachings on the limitation of damages, see Clark v Brown, 18 Wend 213 (NY 1837). 91 For a decision rendered by a court of what civil law jurisdiction, Louisiana, that refers to the Pothier’s teachings and precedes the one referred to in the text, see Lobdell v Parker, 3 La 328 (1832). For a decision rendered by a Louisiana court which refers to the teachings of Pothier on the limitation of damages, see Williams v Barton, 13 La 404 (1839). 92 Blanchard v Ely, 34 Am Dec 250 (NY 1839).

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Judicature of New York in 1839, 15 years before Hadley v Baxendale.93 In respect of the relevant issue here, that decision stated that our courts are more and more falling into the track of the civil law, the rule of which is thus laid down by a learned writer

that learned writer being none other than Pothier.94 Moreover, the Blanchard court quoted Pothier, stating: In general, the parties are deemed to have contemplated only the damages and interest which the creditor might suffer from the non-performance of the obligation, in respect to the particular thing which is the object of it; and not such as may have been accidentally occasioned thereby in respect to his own affairs.95

IV

T H E CI V I L I A N O R I G I N O F

96

From the passage quoted at the end of the previous section, one can easily derive that the Blanchard court had similar thoughts as the Hadley court about the foreseeability limitation on the recovery of damages for breach of contract97

but it is Hadley v Baxendale that became the ‘fixed star in the jurisprudential firmament’98 in the area of limiting recoverable damages to foreseeable losses and perhaps the most well known case in all contract law,99 the importance of which is evidenced by the fact that it is cited 93 94

See also Barnes, above n 73, 636; Ferrari, above n 73, 1265; Perillo, above n 85, 273ff. See Blanchard v Ely, above n 92, 254. See also Barnes, above n 73, 635; Faust, above n 81,

723. 95 Blanchard v Ely, above n 92, 250, 254. For a criticism of the way the Blanchard court applied Pothier’s rule, see Griffin v Colver, 16 NY 489 (1858). 96 For the discussion of Hadley v Baxendale, see also B Adler, ‘The Questionable Ascent of Hadley v. Baxendale’ [1999] Stanford Law Review 1547; LA Bebchuk and S Shavell, ‘Information and the Scope of Liability for Breach of Contract: The Rule of Hadley v. Baxendale’ (1991) 7 Journal of Law Economics Organizations 284; contributions to (2005) 11 Texas Wesleyan Law Review; TA Diamond and H Foss, ‘Consequential Damages for Commercial Loss: An Alternative to Hadley v. Baxendale’ (1994) 63 Fordham Law Review 665; MA Eisenberg, ‘The Principle of Hadley v. Baxendale’ (1992) 80 California Law Review 563; GS Geis, ‘Empirically Assessing Hadley v. Baxendale’ (2005) 32 Florida State University Law Review 897; JT Landa, ‘Hadley v. Baxendale and the Expansion of the Middleman Economy’ (1987) 16 Journal of Legal Studies 455; JM Perloff, ‘Breach of Contract and the Foreseeability Doctrine of Hadley v. Baxendale’ (1981) 10 Journal of Legal Studies 39; PS Turner, ‘Consequential Damages: Hadley v. Baxendale under the Uniform commercial Code’ (2001) 54 SMU Law Review 655; LE Wolcher, ‘Price Discrimination and Inefficient Risk Allocation under the Rule of Hadley v. Baxendale?’ [1989] Research in Law Economics Annual 9. 97 Barnes, above n 73, 635. 98 G Gilmore, The Death of Contract (Columbus, OH, Ohio State University Press, 1974) 83. Note, however, that earlier Gilmore had described the same decision as an ‘essentially uninteresting case, decided in a not very good opinion by a judge otherwise unknown to fame.’ 99 See R Korobkin, ‘The Status Quo Bias and Contract Default Rules’ (1998) 83 Cornell Law Review 616.

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as an authority more frequently than any other case in the law of damages.100 As is commonly known, in Hadley v Baxendale the plaintiffs owned and operated a flour mill in Gloucester, England. At some point, the crankshaft of their mill broke, stopping the mill. The next day, the plaintiffs discovered the broken shaft and sent one of their employees to a carrier to enquire as to the time needed for transporting the broken shaft across England to Greenwich to the original manufacturer, ‘as a pattern for a new one’.101 The employee was told that if the shaft were to be received by noon on any given day, it could be expected to reach the original manufacturer by the following day. Eventually, the broken shaft was handed to the carrier, who delayed its replacement by five days, causing the plaintiffs to suffer lost profits (argued to be in the amount of £300) for which they sued the carrier’s managing director, Baxendale. After the jury had awarded damages of £50, Baxendale appealed. After hearing arguments from both the plaintiffs and the defendant, that the Exchequer Court announced its famous rule: Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it. Now, if the special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily follow from a breach of contract under these special circumstances so known and communicated. But, on the other hand, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such a breach of contract. For, had the special circumstances been known, the parties might have specially provided for the breach of contract by special terms as to the damages in that case; and of this advantage it would be very unjust to deprive them.102

Since, however, it was not foreseeable to the carrier that the plaintiffs’ mill would be shut down during the period of delay, the Court decided that

100 See F Faust, ‘Hadley v. Baxendale—An Understandable Miscarriage of Justice’ (1994) 15 Journal of Legal History 41 quoting Corbin, Corbin on Contracts V (St Paul, MN, West Publishing Co, 1951) 93. 101 Hadley v Baxendale, 156 Eng Rep 145, 147 (Ex 1854). 102 Ibid, 155–6.

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Baxendale could not be held responsible for the lost profits thus incurred.103 In the primary opinion (above), no reference to prior cases, as authority for the Court’s proposition, can be found. No reference is made to other statutes, treatises or commentaries. It appears, therefore, that this was the great common law at work: down in the trenches, ingeniously coming up with practical and experientially-derived rules to govern the affairs of society.104

Although the primary opinion does not bear witness to this, the Exchequer Court was very well aware of the existence of the civil law foreseeability limitation referred to earlier and ultimately adopted it, albeit not slavishly.105 As for the Court’s awareness of the civil law solution, it can be derived, first, from a remark made by Baron Parke, one of the judges of the three-judge court, in respect of the principle upon which damages are to be assessed. According to Baron Parke, The sensible rule appears to be that which has been laid down in France, and which is declared in their code—Code Civil, liv. iii. tit. iii. ss 1149, 1150, 1151 . . .106

Also, both counsel for the plaintiffs and Baron Parke referred to passages from a treatise on damages by Sedgwick, ‘passages [that] were largely based on Pothier’s treatise, which Sedgwick cited and quoted’.107 It is therefore unsurprising that the Court used the civil law solution to solve a problem for which, at the time, no clear solution existed in common law.108 What is surprising is that some commentators109 do not want to Ibid, 156–7. Barnes, above n 72, 630. See also R Danzig, ‘Hadley v. Baxendale: A Study in the Industrialization of the Law’ (1975) 4 Journal of Legal Studies 254, stating that the Hadley court’s opinion ‘broke new ground by establishing a rule for decision by judges in an area of law—the calculation of damages in contracts suits—which had previously been left to almost entirely unstructured decision by English juries’. 105 As mentioned in the text to nn 81 and 82, in many civil law systems, such as in France and Italy, the foreseeability limit does not operate where the breach is due to fraud; see Bonelli, above n 24, 257–8; Enderlein and Maskow, above n 20, 301. 106 Hadley v Baxendale, above n 101, 347. 107 Perillo, above n 85, 276. See T Sedgwick, A Treatise on the Measure of Damages (New York, John S Voorhies, 2nd edn, 1852). 108 See, eg WS Simpson, ‘The Source of Alabama’s Abundance of Arbitration Cases: Alabama’s Bizarre Law of Damages for Mental Anguish’ (2004) 28 American Journal of Trial Advocacy 140 (‘Prior to the 1850s, there were almost no widely-recognized rules of contract damages law’). 109 See Treitel, above n 27, 152, stating that ‘Whether the concept [of foreseeability] was indeed imported from the French C[ode] C[ivil] into the Common Law through Hadley v. Baxendale or was the result of subsequent interpretations of that case, is a question which it would be hard now to answer. Whatever the historical origins of the matter may be, the subsequent development of the Common Law concept of foreseeability as a test of remoteness in contract owes little or nothing to its French counterpart. It probably owes more to the analogous concept which in Common Law countries limit liability in tort, an area to which the requirement of foreseeability does not apply in French law.’ See also G Treitel, ‘Remedies for 103 104

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acknowledge this civil law lineage of Hadley v Baxendale, which appears rather irrefutable110—so much so that it has been acknowledged even in case law, as early as in 1860 and as recently as in 1989.111 These commentators seem to forget that, historically speaking, the importation of a civil law rule into the English common law system is not a startling phenomenon at all because, although Hadley v Baxendale is a prominent example of where common law borrowed from civil law, it is by no means the only one.112 From what has been said thus far, it follows113 that the Hadley v Baxendale rule cannot be considered, as suggested by Professor Danzig, as ‘a judicial invention in an age of industrial invention’.114 Rather, it came about as a result of the transplantation of a foreign rule, invented by scholars rather than courts, and made necessary by the age of industrial invention.115 In effect: The French rule stated in Pothier, after all, existed long before the industrial revolution had swept across Europe . . . It is quite arguable that, rather than the adoption of the rule by Hadley in 1854 being the product of the industrial era of the day, that was simply a fortuitous circumstance—a historical accident. That the rule existed in pre-revolutionary France and Rome suggests that there is nothing inherent in the rule which suggests that the need for it has anything exclusively to do with an industrialized society. Rather, it is an inherently logical resolution of the problem of uncontemplated damages scenarios befalling the contracting parties. When finally the English and American courts grappled with and focused on the problem, they found their continental brethren had already addressed the issue, and there was simply no need for them to attempt

Breach of Contract’, in International Encyclopaedia of Comparative Law VII (Tübingen, Mohr Verlag, 1976) 83. 110 For references to the civil law influence on the Hadley v. Baxendale rule, see also L Nottage, ‘Who’s Afraid of the Vienna Sales Convention (CISG)? A New Zealander’s View from Australia and Japan’ (2005) Victoria University Wellington Law Review 826; J Perillo, ‘Misreading Oliver Wendell Holmes on Efficient Breach and Tortious Interference’ (2000) 68 Fordham Law Review 1096; Weber, above n 33, 192, note 147. 111 See Jones v George, 61 Tex 345 (Tex 1884) (stating that the rule is ‘largely drawn from the civil law’); Rumely Products Co v Moss, 175 SW 1084, 1088 (TexCivApp 1915); Manss-Owens Co v HS Owens & Son, 105 SE 543, 549 (Va 1921); Sinclair Refining Co v Hamilton & Dotson, 164 Va 203, 209 (Va 1935); Goddard v Barnard, 16 Gray 205, 207 (Mass 1860); Vitol Trading SA, Inc v SGS Control Services, Inc, 874 F 2d 76, 81 (NY 1989). 112 Barnes, above n 73, 643, where the author refers to further examples of common law borrowings from civil law, relating, among others, to the privilege against self-incrimination, the ‘mitior sensus’ doctrine in law of defamation and the mistake doctrine in contracts cases. 113 For this conclusion, see Ferrari, above n 89, 766ff. 114 Danzig, above n 104, 250. 115 See Ferrari, above n 73, 1267. The fact that the foreseeability limit constitutes a scholarly invention rather than a judicial one should not come as a surprise, considering that ‘the new ideas [were] largely plagiarised from the civil law, and it is to the rise of the treatise that we must attribute the change in the character and structure of basic contract law, rather than to judicial originality’ (AWB Simpson, ‘Innovation in Nineteenth Century Contract Law’ (1975) 91 LQR 277).

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to craft an entirely different solution when the civilian one was already so elegantly articulated.116

V

CO N C L U S I O N

The overall conclusion to be drawn is that the foreseeability limit set forth in Article 74 CISG does not stem from the common law,117 as the rule after which the various expressions of the foreseeability limit to be found in common law are modelled118 is itself not a rule invented in the common law. As pointed out in Sinclair Refining Co v Hamilton & Dotson, the common law foreseeability limit is known as the rule in Hadley v Baxendale, and is sometimes spoken of as having originated in that case, though it is in reality an embodiment of civil law principles, and is substantially a paraphrasing of a rule on the subject as it had been stated at an earlier date in the Code Napoleon, by Pothier.119

Therefore, because the Article 74 CISG foreseeability limit is not a derivative of the Hadley v Baxendale rule, it is incorrect to state, as did one US court, that the ‘CISG requires that damages be limited by the familiar principle of foreseeability established in Hadley v. Baxendale.’120 This ‘frankly preposterous’121 statement is nothing but ‘a consummate illustration of a court unwittingly seeing a provision of the Convention through a domestic lens’, which it should not do.122 The foreseeability requirement in Article 74 CISG, like most other concepts and expressions used in the CISG, is to be interpreted autonomously123 and not in the light of any given Barnes, above n 73, 641. For a different view, see P Schlechtriem, ‘Uniform Sales Law in the Decisions of the Bundesgerichtshof’, available at http://cisgw3.law.pace.edu/cisg/biblio/schlechtriem3.html (accessed 28 June 2007) (translation by TJ Fox); H van Houtte, The Law of International Trade (London, Sweet & Maxwell, 1995) 146, n 23. 118 See AG Murphey, ‘Consequential Damages in Contracts for the International Sale of Goods and the Legacy of Hadley’ (1989) 23 George Washington Journal of International Law and Economics 438 (referring to Restatement (Second) of Contracts § 351 (1979) and UCC § 2-715(2)). 119 164 Va 203, 209 (Va 1935). See, eg the decisions in n 111. 120 Delchi Carrier, above n 51. 121 Flechtner, above n 17, 103. 122 JE Murray, ‘The Neglect of CISG: A Workable Solution’ (1998) 17 Journal of Law Commerce 371. For similar criticism, see SV Cook, ‘The UN Convention on Contracts for the International Sale of Goods: A Mandate to Abandon Legal Ethnocentricity’ (1997) 16 Journal of Law Commerce 259; HM Flechtner, ‘The U.N. Sales Convention (CISG) and MCC-Marble Ceramic Center, Inc. v. Ceramica Nuova D’Agostino, S.p.A.: The Eleventh Circuit Weighs in on Interpretation, Subjective Intent, Procedural Limits to the Convention’s Scope, and the Parol Evidence Rule’ (1999) 18 Journal of Law Commerce 269; B Zeller, ‘The UN Convention on Contracts for the International Sale of Goods (CISG)—a Leap Forward Towards Unified International Sales Laws’ (2000) 12 Pace International Law Review 89. 123 It has often been pointed out that not all expressions and concepts used in the CISG have to be interpreted autonomously; see F Ferrari, ‘La jurisprudence sur la CVIM: un nouveau défi 116 117

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domestic law, whether US, English or even French, from which the foreseeability limitation originates. In other words, the rule of interpreting the CISG autonomously, pursuant to which it should be allowed to have recourse to the ‘domestic’ understanding of a concept, where it is apparent from the legislative history that the drafters of the CISG wanted to adopt that specific concept’s domestic understanding, does not apply to the foreseeability limit in Article 74 CISG. From a methodological point of view, it is therefore incorrect to state (as did another US court in a recent decision referred to above) that the ‘relevant interpretations of [the Hadley v Baxendale] rule can guide the Court’s reasoning regarding proper damages’124 under the CISG. This statement is nothing but another excellent example of the errors that result from the failure to interpret and apply the Convention as an international, rather than a domestic, body of law125

and shows too that that court ‘was clearly unable to overcome its own ethnocentric bias’.126 This inability led the court to state that the CISG’s ‘foreseeability requirement . . . is identical to the well-known rule of Hadley v. Baxendale’,127 a statement that is clearly incorrect. Even a ‘cursory reading of the two formulations of “foreseeability” illustrates the[ir obviously] dissimilar content’.128 It is worth recalling that, under Article 74 CISG, the foreseeability of loss must be judged from the standpoint of the party in breach, and of that party alone.129 In contrast, at common law foreseeability is determined by reference to the reasonable contemplation of both parties.130 It is to be noted, however, that more recent English decisions, although still always referring to Hadley v. Baxendale, essentially focus on examining foreseeability only on the side of the pour les interprètes?’ [1998] International Business Law Journal 497; Ostroznik Savo v La Faraona soc coop arl, 11 January 2005, Tribunale di Padova (Italy, Padova District Court), available at http://www.unilex.info/case.cfm?pid=1&do=case&id=1005&step=FullText (accessed 28 June 2007); SO M AGRI sas di Ardina Alessandro & C v Erzeugerorganisation Marchfeldgemüse GmbH & Co KG, Tribunale di Padova, above n 30. TeeVee Tunes, Inc et al, above n 18 and text thereto. J Bailey, ‘Facing the Truth: Seeing the Convention on Contracts for the International Sale of Goods as an Obstacle to a Uniform Law of International Sales’ (1998) 32 Cornell International Law Journal 288. 126 Cook, above n 122, 262. See also B Zeller, ‘Downs Investments Pty Ltd (in liq) v Perwaja Steel SDN BHD [2001] 2 Qd R 462’ (2002) 9 Vindobona Journal of International Commercial Law and Arbitration 46. 127 TeeVee Tunes, above n 18. 128 Cook, above n 122, 260. 129 See the text to nn 31 and 32. See also Stoll and Gruber, above n 20, 765; Brölsch, above n 20, 52; Huber, above n 27, 2627; Murphey, above n 118, 435, stating that Art 74 CISG, ‘in limiting reference to the party in breach, surely does not envision delivering a windfall to the plaintiff, because the plaintiff recovers something not foreseen. Rather, this language reflects the view that the focus should be on the party who will have to answer for the amount of the loss’. 130 See Whittington, above n 24, 443, according to whom, ‘[t]his is not a significant difference’. 124 125

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party [in breach]. Despite some uncertainty a similar tendency can be observed in American judicial practice as well and the UCC specifically provides this very rule.131

Further, while Article 74 CISG refers to the ‘foreseeability’ of losses, the original Hadley v Baxendale rule refers to the ‘contemplation’ of losses. There is a difference in the meaning behind these different expressions132 and this has an impact on the limitation of the recoverable damages. In effect, a rule that provides that damages only need to be ‘foreseeable’ surely ought to narrow the limitations of Hadley and widen the scope of recovery.133

Also, as stated earlier,134 Article 74 CISG limits damage recovery to those damages which the party in breach ‘knew or ought to have known as a possible consequence of the breach’,135 while the (original) Hadley v Baxendale rule limits recovery of lost profits to those that were ‘in the contemplation of both parties, at the time they made the contract, as the probable result of the breach’.136 ‘Thus, [under the CISG] a claimant need not show awareness that the loss was a ‘probable result’ or a substantial probability.’137 This means that the breaching party ought to be liable for a greater range of consequential damages under the CISG (those that were foreseeable as a ‘possible’ consequence of the breach) than under the common law or UCC (only those that were foreseeable as a ‘probable’ consequence of the breach)138

Vekas, above n 32, 160 (footnotes omitted). See J Ziegel, ‘The Remedial Provisions in the Vienna Sales Convention: Some Common Law Perspectives’ in N Galston and H Smit (eds), International Sales: The United Nations Convention on Contracts for the International Sale of Goods (New York, Matthew Bender, 1984) 9-05, where the author refers to Lord Reid’s example in The Heron II, 1 AC 350 (HL) (1969), in order to illustrate the difference between the ‘possible consequences’ and the ‘probable result’: ‘to borrow from Lord Reid’s example in The Heron II, if one takes a well-shuffled pack of cards it is quite possible, though not likely, that the top card will prove to be the nine of diamonds even though the odds are 51 to 1 against’. 133 Murphey, above n 118, 435–6; see also JM Darkey, ‘A US Court’s Interpretation of Damage Provisions under the U.N. Convention on Contracts for the International Sale of Goods: A Preliminary Step towards an International Jurisprudence of CISG or a Missed Opportunity?’ (1995) 15 Journal of Law Commerce 145. 134 See the text to n 78. 135 Brölsch, above n 27, 55ff. 136 Pantaleon Prieto, above n 53, 604; also Stoll and Gruber, above n 28, 763–4. 137 Gotanda, above n 38, 104–5; Neumayer and Ming, above n 29, 492. 138 WS Dodge, ‘Teaching the CISG in Contracts’ (2000) 50 Journal of Legal Education 92. See also Cohen, above n 38, 612–13; Darkey, above n 132, 145, n 31; Whittington, above n 32, 443. Cf Farnsworth, above n 34, 253, stating that ‘[a]lthough the use in Article.7[4] of “possible consequence” may seem at first to cast a wider net than the Restatement’s “probable result”, the preceding clause (“in the light of the facts . . .”) cuts this back at least to the scope of the Code language’. 131 132

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or, to put it differently, that ‘Hadley’s [original] “probable result” limitation is much more restrictive than the “possible consequence” limitation of Art. 74’.139 Given these differences, that unequivocally show that the rules on limiting damages in Article 74 CISG and in Hadley v Baxendale are rather different, there can only be one overall conclusion: in interpreting Article 74 CISG, ‘US judges should try [much harder] to divorce themselves from the influence of Hadley as much as possible’.140

139 140

Majumdar and Jha, above n 32, 193. Dodge, above n 138, 92, borrowing from a statement by Murphey, above n 118, 417.

14 The Role of Mitigation in the Assessment of Damages MI TI GATI ON I N THE AS S ES S MENT OF DAMAGES

HARV EY McGREGOR QC * HARVEY MCGREGOR QC

I

S E T T I N G T H E S TAG E

The starting rule for the assessment of contract damages in the common law of England goes back to the mid-nineteenth century to Baron Parke’s famous formulation in Robinson v Harman1: the contracting party sustaining loss by reason of breach of contract is entitled to be put, as far as money can do it, in the position he would have been in if the contract had been performed. Do not be deflected by Lord Hoffmann’s disagreement in the House of Lords in the case popularly known as SAAMCO—South Australia Asset Management Corp v York Montague Ltd 2—with Sir Thomas Bingham MR’s proposition in the Court of Appeal that Baron Parke’s rule, which he cited, forms the necessary point of departure to arrive at the correct measure of contract damages.3 Sir Thomas Bingham was right. But then come the limitations, of which Lord Hoffmann’s scope of duty, which he seeks to place in advance of Baron Parke’s rule,4 is one. The most important limitation is of course that of remoteness, which is addressed in other contributions to this volume. The one I am to deal with comes under the banner heading ‘mitigation’. The term is, as we shall see, a peculiarly English one. Mitigation is a limit of great importance which I view as not being sufficiently highlighted in the cases and in many texts. It follows on in the scheme of things from remoteness, to which it may be said to have played second fiddle. At the outset we must distinguish between two aspects of mitigation as they are completely different from each other, the one, and * 1 2 3 4

Barrister, Hailsham Chambers, London. (1848) 1 Ex 850. [1997] AC 191 (HL) 211A. [1995] QB 365 (CA) 403. See Lord Hoffmann’s speech generally in SAAMCO, n 2.

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the much more frequently invoked, relating to loss that should have been avoided, the other to loss that has in fact been avoided. The terms which I use here—which indeed I coined when I first wrote my book on damages—are therefore avoidable loss and avoided loss.

II

AVO I DAB L E L O S S

I start, naturally, with avoidable loss, for it lies at the heart of mitigation. Indeed, some regard this as the only true mitigation; it is mitigation proper. Yet, despite its central aspect within mitigation, the term makes no appearance in Continental legal systems. Even the important Principles of European Contract Law do not mention mitigation. Article 9:505, where the concept makes its appearance, is headed ‘Reduction of Loss’, and it cannot be said that, as might be thought, the reason for using this expression is to allow the sub-article to cover both mitigation by, and fault of, the party suffering the breach of contract because contributory negligence is catered for independently by the previous sub-article, Art 9:504, which is headed ‘Loss Attributable to Aggrieved Party’. Germany deals in its civil code, the Bürgerliches Gesetzbuch (BGB), with the matter under the heading of Mitverschulden—fault of both parties—rather than of mitigation,5 but provides that its rule as to contributory fault shall apply where ‘the aggrieved party’s culpability is limited to . . . having failed to avert or reduce the damage’6. Other European systems are similar to the German in accepting the concept but not the term. France, however, is the outstanding exception. French law so far has entirely rejected the idea of mitigation so that, to arrive at results similar to those reached in England, reliance has had to be placed on other principles, such as causation, good faith and, in particular, fault—faute de la victime. That there is no requirement of mitigation in France has recently been expressly decided in two cases, though they were decisions not quite at the highest level and decisions in delict rather than in contract.7

A

The Rule and Aspects Thereof

The rule is simple: the aggrieved party (there being no short term for the party who has suffered a breach of contract, I shall use ‘aggrieved party’ BGB §254. The terminology of BGB §254(2) after the reforms of 2002. Cass 2ème civ, 19 June 2003, No 230 (Xhauflaire c Decrept) and No 231 (Dibaoui c Flamand). The Avant-Projet de Réforme du Droit des Obligations dated 25 September 2005 and prepared under the direction of Professor Catala (commonly referred to as the Catala Project) has now proposed the introduction of mitigation into French law by a new Art 1373 of the Civil Code. 5 6 7

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here, this being preferable to the commonly used but unattractive ‘victim of the breach’) is required to take all reasonable steps to cut down and reduce his loss consequent on the breach of contract and may not claim for any part of the loss which is due to his neglect of taking such steps. Now it has been said, probably initially by Lord Goff in his early days in The Elena d’Amico (otherwise known as Koch Marine Inc v D’Amica Società di Navigatione),8 that the rule as to avoidable loss is merely an aspect of the principle of causation; the aggrieved party can only recover in respect of damage caused by the breach of contract. In other words, loss which could reasonably have been avoided is not to be regarded as caused by the breach of contract. Lord Goff’s basing the mitigation rule on causation was said in Standard Chartered Bank v Pakistan National Shipping Corp9 to represent the orthodox view, but I would dispute this. The need to climb the slippery slopes of causation is thought to be unfortunate. While no doubt the matter can be put in terms of causation, doing so does not tell us much, for the crucial question in each case is whether the aggrieved party has acted, or has failed to act, reasonably. Adding causation into the mix gives no assistance in answering this question. Indeed, there is a danger, here as elsewhere, of using causation as a disguise for the real ground of a decision. Significantly, the many cases on avoidable loss are not loaded with references to causation. When it comes to ascertaining whether the aggrieved party has acted reasonably, which is what he is required to do (we all know that, although it is convenient and common to speak of a ‘duty’ to mitigate, strictly speaking there is no duty as there is no correlative right10), two features of this requirement immensely favourable to the aggrieved party must be kept in mind. The first, established very early in Roper v Johnson,11 is that the burden of proof on the issue of mitigation lies on the contracting party in breach, and thus in contrast to the position with remoteness. It is important to emphasise this because in practice the decision of a court may well turn on where the burden of proof lies and also because the courts have occasionally got it wrong even at the highest level. Thus, only some 20 years ago, the Privy Council in Selvanayagam v University of the West Indies12 held that the burden lay upon a party complaining of physical injuries—and physical injuries can result from breach of contract—to show that his refusal to undergo medical treatment for the alleviation of his injury was reasonable. Fortunately the court righted itself in Geest plc

[1980] 1 Lloyd’s Rep 75 (Comm). [1999] 1 Lloyd’s Rep 747 (Comm) by the trial judge in a passage, at ibid, 758, referred to without disapproval on the appeal: [2001] 1 All ER Comm 822 (CA). 10 The correct analysis is well set out by Pearson LJ in Darbishire v Warran [1963] 1 WLR 1067 (CA) 1075. 11 (1873) LR 8 CP 167 (CP). 12 [1983] 1 WLR 585 (PC). 8 9

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v Lansiquot.13 The second feature favourable to the complaining party is that the standard of reasonableness is not an exacting one. The rationale for this has been best put by Lord Macmillan in Banco de Portugal v Waterlow,14 where he laid down that the measures adopted by a contracting party to extricate himself from the position in which he has been placed by the breach of contract ought not to be weighed in nice scales at the instance of the party whose breach of contract has occasioned the difficulty.

He added that the law is satisfied if the aggrieved party has acted reasonably—which, as we have seen, is the acid test— in the adoption of remedial measures and he will not be held disentitled to recover the cost of such measures merely because the party in breach can suggest that other measures less burdensome to him might have been taken.

This is a compelling passage to which in case after case one comes back.

B Built-in Mitigation In countless cases the issue of mitigation does not make an appearance. While this is commonly because the aggrieved party has in his own interests taken the necessary steps in mitigation, it can also be because, the way to mitigation being so clear, mitigation has become incorporated into the normal measure of damages. When this happens mitigation loses its identity and does not expressly appear as a separate issue. This is particularly true where the sale of goods is concerned. Thus, if a seller fails to deliver the goods contracted for, the buyer cannot sit back on a rising market, or wait till his sub-sale to a third party has fallen through, but must go into the market with all reasonable speed and buy equivalent goods there. This mitigating step was incorporated in the normal measure of damages by section 51(3) of the Sale of Goods Act 1893 (now the Sale of Goods Act 1979), which states that for a seller’s breach by non-delivery the prima facie measure of damages, where there is an available market, is the difference between the contract price and the market price at the time the goods should have been delivered or, if no such time is fixed, at the time of refusal to deliver. Section 50(3) has the equivalent provision, with necessary changes, for breach by the buyer by non-acceptance of the goods15 so that 13 [2002] 1 WLR 3111 (PC). Such had been the criticism of Selvanayagam that it was even accepted that it was wrong by counsel in Geest and the Privy Council agreed: ibid, [14]. While the two cases were in tort, there is no doubt that the position is the same with contract. 14 [1932] AC 452 (HL) 506. 15 There is also a prima facie measure for breach of warranty of quality in s 53(3), but no statutory provision for delayed delivery.

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the seller is required to move into the market and sell elsewhere.16 The position is the same with the sale of shares, though without the statutory provisions, but with some types of contract it has taken longer to effect such an incorporation and with other types it may yet not have fully come about. Thus, with contracts of carriage of goods by sea it was originally said that the shipowner who had lost freight by a failure of the charterer to supply cargo must mitigate by filling his ship with other cargo, but the trend today is to abandon the mitigation approach and state the damages as contractual freight less substitute freight.17 With contracts of employment there is still a tendency to regard the salary obtained by a wrongfully dismissed employee specifically as mitigation rather than as built into the normal measure,18 but incorporation into the normal measure of the obvious mitigating step of finding fresh employment should be encouraged. The practical importance of defining the normal measure in this way, of course, lies in the burden of proof. The normal measure of damages in cases of sale of goods, or shares, not delivered or not accepted is therefore the difference between the contract price and the market price, assuming an available market. The time of assessment is generally at breach, so the market price is taken as at that date; this is the so-called breach date rule. There will, however, be cases where the aggrieved party wishes to base his claim on the market price at a later—sometimes substantially later—date should the market after breach have moved against him. If the court decides that he is so entitled, this will be because he has acted reasonably: if a buyer, in not immediately replacing the goods or shares with others; if a seller, in not reselling the goods or shares elsewhere. It could be reasonable not to replace or resell, for instance, if the aggrieved party was in a position to claim specific performance: see, in this connection, the important Johnson v Agnew,19 dealing with sale of land. Mitigation therefore does not come into it and there is no need to say that the failure to replace or to resell is not a failure to mitigate. Similarly, if the court decides that the aggrieved party is not entitled to adopt the market price at a time later than the time of breach because it has not been reasonable to wait before replacing or reselling, there is no need to say that he has failed to mitigate; one simply takes the market price at breach and applies the normal measure. It is important to 17 Care must be taken, however, to ensure that a seller of goods is not limited to this normal measure. Thus, where a buyer has failed to accept goods sold to him and the seller has succeeded in selling the goods to a third party, this may not be a substitute contract mitigating the seller’s loss since, if the market is such that supply exceeds demand, the seller would have been able to fulfil both contracts and make both profits. Contrast Charter v Sullivan [1957] 2 QB 117 (CA) with Thompson v Robinson [1955] Ch 177 (Ch), dealing with the sale of cars. 18 One can see the change beginning to happen at the time of Aitken Lilburn v Ernsthausen [1894] 1 QB 773 (CA), with the rule being stated by AL Smith LJ in its modern form at 781 and by Kay LJ in its earlier form at 777. 18 This approach can be seen in Ministry of Defence v Wheeler [1998] 1 WLR 637 (CA). 19 [1980] AC 367 (HL).

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be clear on all this in the context of avoidable loss before considering the interesting contrast—to which we shall come—with the situation in the context of avoided loss when the market has moved in the aggrieved party’s favour after the breach of contract.20

C

What is Required in Mitigation: Two Controversies

Illustrations of circumstances raising the issue of whether loss from breach of contract should have been avoided abound, as do illustrations of what is and what is not required of the aggrieved party in mitigation. English law on such issues being fairly straightforward, I leave these on one side21 and confine myself to looking at two areas of some controversy. (i)

Whether There is a Need to Discontinue Performance in Mitigation

The first controversy addresses the question of whether the aggrieved party need mitigate by discontinuing his contractual performance upon the repudiation of the contract by the other party. The view that repudiation cannot give rise to a mitigation requirement is based upon the rule of English law that an anticipatory repudiation by one contracting party does not constitute a breach of contract until accepted by the other party, the further rule that until there is a breach of contract there is no right to damages and the supposition, rather than the rule, that where there is no right to damages in the one party there is no need to mitigate on the part of the other. This situation is well illustrated by the facts of White & Carter v McGregor.22 Advertising agents signed a contract with a garage proprietor’s sales manager to display on litter bins advertisements for the garage over a three year period. Explaining that his sales manager had misunderstood his wishes, the garage proprietor wrote to the agents on the very same day as the contract was signed to cancel it, but the agents refused to cancel, displayed the advertisements in accordance with the contract for three years and then sued in debt for the price. A bare majority of the House of Lords held that they were entitled to do so. Though their performance in face of the repudiation had been rendered useless, they were not obliged to accept the repudiation and sue for damages when mitigation would clearly have come into play. Can this still be right? (The case was decided not far short of 50 years ago.) Does it not appear that technicality is winning out over good sense? Certainly it was not the view of the Scots Discussed further at nn 40–5 and the accompanying text. Illustrations are all to be found in H McGregor, McGregor on Damages (London, Sweet & Maxwell, 17th edn, 2003), of the former at paras 7-040 to 7-063 and of the latter at paras 7-064 to 7-082. 22 [1962] AC 413 (HL). 20 21

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Court of Session which the House of Lords was reversing; nor has it ever been the position in the US, where the courts take the uncomplicated view that, whether the repudiation is accepted or not, the aggrieved party is always obliged to mitigate. There have indeed been attempts to limit the case’s operation—by route of economic waste, requiring a legitimate interest in performing, and the like—but they are not yet clearly accepted. It is thought that the line that should be adopted is to apply the mitigation requirement but with the proviso that performance in certain circumstances, as by a contracting party with a legitimate interest in performing, will not constitute a failure to mitigate.23 (ii) Whether There is a Need to Negotiate Further with the Party in Breach The second controversial area is to be found in certain decisions where the route to mitigation has been presented by the party in breach, the most abundant authority on contractual mitigation appearing in cases where the opportunity of mitigating has arisen thus. In Payzu v Saunders24 a seller had contracted to deliver a consignment of silk in instalments on an agreed credit and then refused in breach of contract to deliver except against cash, an offer that was refused on a rising market. It was held that in mitigation the offer should have been accepted so that the damages were limited to the loss of the useful period of credit. In The Solholt25 delivery of a ship a day late gave the buyers the right to cancel, a right which they exercised, although the market value of the ship had since appreciated well above the contract price. They were awarded nominal damages because they had failed to mitigate by negotiating a further contract for the purchase of the ship at the original contract price, it having been found that such an offer, if made to the sellers, would have been accepted by them. These two decisions have been criticised on the basis that they leave the seller in breach with an adventitious profit and the buyer not in breach with an uncalled-for loss in that, to acquire substitutes, whether silk or ship, he must expend more money. Nevertheless, I consider that the result in Payzu is justifiable as the buyer has only himself to blame for refusing the seller’s favourable offer—it is not clear why he turned it down—but that The Solholt, in requiring the buyer to seek out the seller with a further proposal, is surely taking a step too far. 23 Reichman v Beveridge [2006] EWCA Civ 1659 (CA), a recent decision of the Court of Appeal concerning the termination of a tenancy, accepts that in cases of unaccepted repudiation of contract the need for mitigation does arise, but only if it can be shown that it was wholly unreasonable for the aggrieved party to elect to keep the contract alive and that damages would be an adequate remedy or that the aggrieved party had no legitimate reason for making such an election. 24 [1919] 2 KB 581 (CA). 25 [1983] 1 Lloyd’s Rep 605 (CA).

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In steps taken in mitigation the aggrieved party may incur further loss; however, this will generally be loss which is not in addition to, but in place of and less than, the loss that is being mitigated. This is particularly true of expenses; an obvious example is the expenditure of money by a buyer of defective machinery in acquiring substitute machinery which is up to the warranted standard.26 But English law goes further and will properly allow recovery for losses and expenses which, though reasonably incurred, are unsuccessfully incurred because the resulting loss in the event turns out to be greater than it would have been had the mitigating steps not been taken.27 When I first started on the subject of damages, now exactly 50 years ago, this principle, which I proposed, boasted no clear illustration in English law but soon thereafter illustrations started to appear. The initial cases concerned recovery for loss due to unsuccessful mitigating action instigated by the party in breach but today the principle is accepted however the unsuccessful action has come about. Metelmann & Co v NBR (London)28 may be seen as the earliest clear illustration of this. Sellers of many tonnes of sugar, immediately upon their acceptance of their buyers’ repudiation, made a sale of the sugar on the then rapidly falling volatile sugar market but, as events turned out, on the date fixed for acceptance, at which time the damages are prima facie to be calculated, the market had recovered and the market price was higher. As the Court of Appeal put it, the sellers were entitled to be compensated for the additional damage flowing from their attempt to mitigate.29

III

AVO I D E D L O S S

Moving to avoided loss we come upon a topic of great difficulty. It needs to be handled with great care for the authorities are in a bit of jumble, though it is the tort cases, with which we are not concerned, that are in the greatest jumble. The first thing to note is that loss to the aggrieved party may be avoided in a variety of ways. Undoubtedly the principal way is by action of the aggrieved party himself after the breach has been inflicted on him. This represents the core of the problem of mitigation by way of avoided loss 26 The Principles of European Contract Law, having stated in Art 9:505(1) that there can be no recovery for loss that could have been avoided, expressly provide in Art 9:505(2) for the recovery of expenses reasonably incurred. But there can be losses other than expenses for which recovery should be allowed. 27 I have heard such mitigating action referred to as ‘backward mitigation’, but the term does not appear very helpful. 28 [1984] 1 Lloyd’s Rep 614 (CA). 29 For further examples, see McGregor, above n 21, para 7-088.

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and, as we shall see, specific rules have been formulated to help resolve what actions are, and what actions are not, to be regarded as constituting mitigation.30 But loss can also be avoided by actions after the wrong taken by third parties, and in addition there is a limited class of case where it is the action of the aggrieved party himself before the contractual breach that leads to a reduction in loss. A wide delineating formulation is therefore called for. The formulation commonly resorted to is this. Matters completely collateral cannot be used in mitigation; in other words, collateral benefits are to be ignored. Such a formulation has the merit of stating the overall rule concisely and of being applicable to all actions, by whomever and whenever taken. Its demerit is that it does not tell us much, and does not give any clue as to what is and what is not collateral. Moreover, the home ground for the learning on collateral benefits—and non-collateral—is tort, or delict, and the collateral principle finds little mention in the contractual sphere. In England a term alternative to ‘collateral benefits’ that has begun to make an appearance, though in texts rather than judicially, is ‘compensating advantages’. This is used by Professor Burrows in his excellent book on remedies. One interesting feature of Professor Burrows’s exposition is that he deals with compensating advantages well away from his treatment of what he regards as mitigation proper, namely, avoidable loss.31 But, again, the term does not tell us much. It is thought, therefore, that the simplest thing is to continue with the term mitigation—and this is what the courts certainly do—and to speak of mitigation in fact as distinct from mitigation that is imposed, at the same time exploring, in all three areas identified above, what tests are to be applied to find out what constitutes mitigation and what does not. As for the position elsewhere, the Principles of European Contract Law in Article 9:5 on Damages do not even mention this topic and French law once more is, not surprisingly, silent. However, the use in England of ‘compensating advantages’ reflects the approach in Germany, the BGB here talking of Vorteilsausgleichung, a literal translation of which could be ‘advantage balancing’, ‘advantage levelling’ or indeed ‘compensation advantage’.

A

Action by the Aggrieved Party Following Breach

You may well ask: what is the difference between avoidable loss and avoided loss when the loss is avoided by action after the breach by the aggrieved contracting party? Can it not be said that such avoided loss Discussed in initial paragraphs of section III.A. A Burrows, Remedies for Tort and Breach of Contract (Oxford University Press, 3rd edn, 2004) 122–8 and 156–61. 30 31

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simply represents the result of his carrying out his so-called duty to avoid loss? It is in fact a good deal more than that. It is where the aggrieved party has gone further than he need and, by sound action, has avoided more loss than the dictates of the law required of him. This is neatly illustrated by the leading case on this particular aspect of mitigation, British Westinghouse Co v Underground Rly.32 Turbines supplied to a railway company were deficient in power and economy of working. The railway company had to replace them, which it did with a different make and design, bringing in greater profit than the original machines would have done even if they had been up to standard. The railway company would have fulfilled the requirement of mitigation by buying the same type of machine as it had been supplied with and would then have been entitled to the cost of the substitutes less the value, if any, of the useless machines. But, because it had gone further, the cost of the substitutes was not recoverable since against that cost there had to be set the increase in profits, resulting in no net loss.33 The tricky question is: when is conduct giving rise to a benefit to be taken into account? The clue is to be found, not surprisingly, in British Westinghouse, where a century ago Viscount Haldane formulated the basic rule in an important speech. He there laid down that ‘the subsequent transaction, if to be taken into account, must be one arising out of the consequences of the breach’ and, further, that it ‘formed part of a continuous dealing with the situation . . . and was not an independent or disconnected transaction’. For what it is worth, my own formulation, in addition to these, is that the benefit must arise out of the mitigating act itself. Lavarack v Colchester34 is a valuable, later case since it is illustrative both of a benefit which was to be taken into account in the computation of the damages and of a benefit which was to be left on one side. A company employee, whose contract prohibited him from investing in other companies, was wrongfully dismissed. He took employment with a second company at a lower salary and, freed from the earlier contractual prohibition, acquired shares both in the second company, his new employer, and in a third company. The shares in these two companies increased in value. The Court of Appeal held that the profit from the shares in the second company was to be taken into account, but that in the third was not. The purchase of the shares in the new employer company followed from action taken to avoid the consequences of the wrongful dismissal, and so arose

[1912] AC 673 (HL). Two further cases illustrating a benefit taken into account in somewhat similar situations, cases which are also of the 1910s and of the highest authority, are Erie County Gas Co v Carroll [1911] AC 105 (PC) and Hill v Showell (1918) 87 LJKB 1106 (HL). From the dates it will be seen that Viscount Haldane’s definitive ruling on the test for mitigation in this context in British Westinghouse (see next paragraph) was available to the court in Hill but not in Erie. 34 [1967] 1 QB 278 (CA). 32 33

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out of the act of mitigation itself, while the purchase of the shares in the company independent of his employment could not be so classified. I do not agree with all the results the courts have come to here. Hussey v Eels35 is a case which is particularly suspect. Buyers of a house prone to subsidence unrevealed by the sellers—a house which, because repair was uneconomic, they demolished and sold with acquired planning permission to rebuild—did not have their profit on that sale brought into account in the damages awarded. Since the acts of applying for planning permission and then selling were designed to deal with the subsidence problem, it is difficult to see why those acts did not arise from the consequences of the wrong and the benefit from acts taken in mitigation. Indeed, these tests were not referred to by the court, which relied only upon the need for the action conferring the benefit to be part of a continuous transaction commencing with the original purchase of the house. This does reflect Viscount Haldane’s requirement that the subsequent transaction must form part of a continuous dealing with the situation if it is to be taken into account, but it ignores his additional, contrasting requirement that what is done must not be an independent or disconnected transaction. It is difficult to see the application for planning permission followed by sale as such. The benefit was not taken into account in mitigation in the early case of Jebsen v East and West Indian Dock Co,36 where delay in breach of contract in discharging a ship and redelivering it to its owner resulted in the owner’s losing passengers emigrating to America on the ship although another two of the owner’s ships gained these passengers. Jebsen was distinguished by Viscount Haldane in the key British Westinghouse37 case on the basis that ‘mitigation did not arise out of the transactions the subject matter of the contract’.38 Yet surely all aspects of his own tests were satisfied in that the taking on of passengers on to the other ships that arose out of the consequences of the late ship redelivery constituted a continuous dealing with the situation and was not an independent or disconnected transaction. It is thought that today the case would be decided differently. Certainly a recent, not widely reported decision of Neuberger J, as he then was, goes the other way. In Platt v London Underground39 a trader lost trade at one of the two kiosks leased to him because his lessor had restricted access to it and in consequence the other kiosk gained an increased trade. The gain was taken into account in the damages; Jebsen was not cited. There is, however, one important situation where action by the aggrieved party following breach is properly not brought into account. 35 36 37 38 39

[1990] 2 QΒ 227 (CA). (1875) LR 10 CP 300 (CP). [1912] AC 673 (HL). Ibid, 691. [2001] 2 EGLR 121 (Ch).

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Here we return to the sale of goods and of shares. Where the aggrieved buyer or seller after the breach of contract by non-delivery or non-acceptance makes an advantageous substitute purchase or resale because the market has moved in a direction favourable to him, is this to be regarded as an act of mitigation by him? In the cases the universal answer given has been that it is not. It was the answer first given in the leading case of Jamal v Moolla Dawood,40 where a seller of unaccepted shares resold them without loss because the market had risen. This was later followed and applied in Campbell Mostyn (Provisions) Ltd v Barnett Trading Co,41 where a seller of goods wrongfully rejected by the buyer sold them subsequently without loss, the market having risen above the price at breach and even above the contract price. Why is this so? Why is not the resale, or the substitute purchase, to be regarded as an action arising out of the consequences of the breach, as part of a continuous dealing with the situation, as a connected transaction, and therefore to be taken into account in mitigation of the damage and reduction of the damages? It is because such a sale or purchase is to be regarded as an independent transaction, independent of the breach, made by buyer or seller on his assessment of the market. This analysis appears at its clearest in The Elena d’Amico,42 that little known decision already referred to in another connection,43 where the principle behind the sale cases was explained at first instance by the now Lord Goff in the context of a contract of carriage of goods by sea. Taking the case of sale, Lord Goff pointed out that, if the seller chose not to sell the goods which were on his hands through non-acceptance and the market fell, he would not be able to claim against the buyer for the fall in price, and this result was reached for carriage in The Elena d’Amico, where the claimant charterer had misjudged the market, which rose, by failing immediately to hire a substitute ship. It follows that, if a seller chooses not to sell and the market rises, this will not go in mitigation of the damages claimable against the buyer. As was cogently said by Lord Wrenbury, giving the judgment of the Privy Council in Jamal, in a passage relied on by two members of the Court of Appeal in Campbell: if the seller retains the shares after the breach, the speculation as to the way the market may subsequently go is the speculation of the seller, not of the buyer.44

It can be said that in these cases the aggrieved party’s loss crystallises on breach by non-delivery or non-acceptance so that later actions by way of buyer’s substitute purchase or seller’s resale are to be ignored. This 40 41 42 43 44

[1916] 1 AC 175 (PC). [1954] 1 Lloyd’s Rep 65 (CA). Above n 8. See n 8 and text thereto. [1916] 1 AC 175 (PC) 179.

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approach may be regarded as complementary to the other tests; actions subsequent to the crystallisation are not to be considered as arising out of the consequences of the breach, as taken in mitigation, as part of a continuous dealing with the situation, as dependent or connected.45

B Action Other Than by the Aggrieved Party Following Breach It is clear that what Viscount Haldane was envisaging in British Westinghouse were steps taken by the aggrieved party himself after the breach of contract, no doubt because he was thinking of mitigation in fact as an extension of mitigation that is imposed. Accordingly, actions other than those taken after breach by the aggrieved party cannot be within the principles laid down in British Westinghouse.46 (i)

Action by Third Parties Following Breach

It is not surprising that, in the contract cases involving actions by third parties which reduce the loss, the courts have attempted to emulate Viscount Haldane and use being part of a continuous transaction and arising from the consequences of breach as tests of mitigation or no mitigation—use of arising out of the mitigating act itself is, of course, precluded—as this is the best that is available. To the extent that they have done so, however, they have tended to arrive at the wrong result in ignoring the benefit instead of taking it into account. Let me examine the principal authorities. In Gardner v Marsh & Parsons47 buyers of a leasehold property with a serious structural defect which their surveyor had failed to detect were held entitled, though only by a majority of the Court of Appeal, to damages based on the value of the property in its defective state, although the defects had been rectified at the buyers’ landlord’s expense two years after the discovery of the defect and five years after the purchase. In light of the long interval of time elapsing between breach of contract and avoidance of loss, the repairs eventually executed were said to be res inter 45 It is, however, questionable whether the same result should follow and whether there should be a crystallisation of loss where there is not non-delivery or non-acceptance but delivery of defective goods which the buyer succeeds in selling at a higher price than at breach, the market having risen. This is because there is unlikely to have been speculation by the buyer as to market movements. In an early case, Jones v Just (1868) LR 3 QB 197, the award to a buyer of sub-standard hemp who sold it well on a rising market ignored this sale but there was no argument on damages, all the discussion being on whether there was a breach of warranty. It is merely stated that the jury was told to award the normal measure of the difference in values at the time of delivery of quality hemp and sub-standard hemp and that this would give the buyer the benefit of the rise in the market: ibid, 200–1. 46 For these see initial paragraphs of section III.A. 47 [1997] 1 WLR 489 (CA).

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alios acta and therefore collateral—familiar terminology—and not to be part of a continuing transaction of which the purchase was the inception. It is thought, however, that the passage of years should not control the result and that the dissent, holding that once the property was repaired at no cost to the buyers they could not be allowed double recovery, is far more convincing. In somewhat similar circumstances the same result was reached by the trial judge in Devine v Jefferys.48 Buyers of a house on a building society mortgage at too high a price on account of their surveyor’s overvaluation were awarded the normal measure of damages based on the amount by which the house had been overvalued. This was despite the fact that loss had been averted by reason of the buyers having come to an arrangement with the building society whereby the entire mortgage debt was released. Though the time gap was even longer than in Gardner—11 years rather than five—the releasing of the mortgage debt need not have been seen as a transaction independent of or disconnected from the surveyor’s overvaluation. Precedent, the trial judge thought, required him to award in this way windfall damages, commenting that such damages represented a loss which had never actually hit the buyers’ pockets. In both Gardner and Devine the courts dealt with the case before them as being in the conventional category of loss avoided by actions of the aggrieved party himself. This, of course, helps to explain the reliance of both courts on the tests of continuous transaction and arising from the consequences of breach. However, it is thought more realistic to regard the cases as involving a benefit provided by a third party. In Needler Finance v Taber49 the benefit was clearly received from a third party, with its receipt being in no way instigated by the aggrieved party. A victim of pensions mis-selling was advised in breach of contract to transfer from his existing pension to a new one, which turned out, when on retirement some years later he came to take his pension, to be not so favourable, paying him less. By this time his new pension holding had entitled him, on account of a demutualisation, to shares which on their receipt he had sold. It was held that this sale price did not have to be deducted from the damages based on the difference in value between the two pensions; in the words of the Vice-Chancellor who heard the case, the benefit did not flow as part of a continuous transaction from the breach of contract. I doubt the wisdom of this decision, which again gives a windfall, here to the pension holder. I would advocate the simple approach of comparing everything the pension holder had acquired by virtue of the new pension with everything he would have received under the abandoned pension, with the ongoing pension regarded as a continuous transaction. The shares that eventually came to the 48 49

[2001] Lloyd’s Rep PN 301 (QB). [2002] Lloyd’s Rep PN 32 (Ch).

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pensioner by virtue of his holding the pension may surely be equated with the shares that, in Lavarack,50 came to the employee by virtue of his being employed, so that the benefit that arose from their sale should have been brought into account in the one case as much as in the other. (ii) Action by the Aggrieved Party Before Breach: the Particular Case of Sub-sales Carried Out Despite Breach Finally, we come to this limited but much discussed category. For this we again return to the sale of goods, and of shares, but we come to them from a different angle than discussed so far. Whereas, when earlier considering avoided loss in contracts for the sale of goods, or shares, where there is a resale of the goods, or shares, or a repurchase of substitute goods, or shares, after the breach of contract has occurred,51 both breach by seller and breach by buyer were relevant, here we are concerned with sub-sales, which can only be made by the buyer, and we are therefore concerned only with breach by the seller. The situation envisaged is this. The buyer has sub-sold the goods, or shares, contracted for before the seller’s breach has occurred, or even before the contract has been made. The three major forms of seller’s breach fall to be considered: by non-delivery, by delayed delivery and by defective delivery. Breach by non-delivery brings us the nearest to the situations considered earlier. The leading case is Williams Bros v Agius.52 Having bought a cargo of coal from Agius, Williams resold before the time fixed for delivery a cargo of similar amount and description to a third party at a price higher than the contract price but lower than what turned out to be the market price at the time when Agius failed in breach of contract to deliver. The House of Lords held that the normal measure of damages applied and that the sub-sale price was irrelevant to reduce Williams’s damages. In so doing their Lordships strongly approved the Court of Appeal’s decision in Rodocanachi Sons & Co v Milburn Bros,53 where the contract that was breached was not one of sale but of carriage of goods, the non-delivery resulting from the goods being lost at sea in the course of carriage. The price at which the charterer had sold the goods in advance of the breach of contract, a price lower than that at the time of due delivery, was not allowed to reduce the damages. Over the years these two decisions have been followed consistently.54 The argument that this result overcompenSee n 34 and text thereto. See final two paragraphs of section III.A. [1914] AC 510 (HL). (1886) 18 QBD 67 (CA). The suggestion, which has surfaced, that Williams and Agius cannot be reconciled with Hall v Pim (1928) 33 Com Cas 324 (HL) is misconceived since Hall was concerned with whether loss was too remote and not with whether loss had been mitigated: see McGregor, above n 21, para 20-027 for details. 50 51 52 53 54

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sates seller and charterer and shows a failure to apply principles of mitigation is met by the counter-argument that overcompensation is avoided because seller and charterer will either have had to buy in the market to deliver to their buyer or be subject to a damages claim by their buyer for non-delivery. The difficulty with this justification is that seller and charterer may not go into the market and may in the circumstances not be subject to a claim for damages. In the Agius case the position was not made clear as to whether the third party would have had a damages claim but in Rodocanachi there could have been no question of one. The cargo had been sold at the lower price on a ‘to arrive’ basis so that nondelivery by the shipper relieved the charterer of all liability to his buyer. Where delivery had only been delayed, a contrary result was reached in Wertheim v Chicoutimi Pulp Co.55 Goods were delivered some eight months late to a buyer who had sub-sold to several third parties, the sub-sales being made even before the principal contract had been entered into.56 The price at which the sub-sales were made turned out to be much higher than the price to which the market had fallen by the time of actual delivery, but, notwithstanding the delay, the buyer had been able successfully to fulfil the sub-sales when the goods eventually arrived.57 In these circumstances the Privy Council considered it right to take the sub-sales into account in mitigation of the damages, thereby avoiding overcompensation.58 While the result in Wertheim has been widely doubted by commentators, it seems to me to be entirely correct, and indeed has now received some endorsement in the House of Lords in The Golden Victory.59 It is thought that the result should only be different if the seller’s failure to deliver at the contractual time could have put the buyer into breach of his sub-sale contract, requiring him, to avoid breach, to buy substitute goods while the market was still high or to face an action for damages from his sub-buyer. Where defective goods were sold in Slater v Hoyle & Smith60 but the buyer was able to carry through a sub-sale, concluded prior to the breach, as the sub-buyer waived objections to the defects, the sub-sale was not taken into account in mitigation of damages, Scrutton LJ preferring the analogy of non-delivery and the Agius case to that of delayed delivery and Wertheim, of which case he was critical. In Bence Graphics v Fasson61 75 years later Auld LJ considered that the time had come for Slater to be reconsidered but Bence Graphics was not itself a case of a sub-sale [1911] AC 301 (PC). This appears only at page 302 in fin of the report. This appears only at page 314 in fin of the report. The award, however, should have been of nominal damages rather than the market price at the contractual time of delivery less the price at which the sub-sales had been made. 59 [2007] 2 WLR 691 (HL). See further discussion of this case in section III.C. 60 [1920] 2 KB 11 (CA). 61 [1998] QB 87 (CA). 55 56 57 58

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concluded before the seller’s breach. Rather it concerned sub-sales of goods into which the defective goods after their acquisition had been incorporated, with sub-buyers not objecting to the defects, and the sub-sales were brought into account because it was held to be in the contemplation of the parties to the head sale that the goods would be resold and therefore, under established law, the damages fell to be assessed by reference to the sub-sales whether the head buyer liked it or not. Mitigation was not under consideration; no mention of it is made in the judgments. In this uncertain and fluid state of the authorities in this small but important corner of the mitigation issue it is thought that the best solution may be this. Whatever the breach, whether it be by non-delivery, delayed delivery or defective delivery, the presumption should be that the buyer is entitled to have his sub-sale at the higher price ignored but the seller is also entitled to rebut this presumption if he can show positively that the buyer neither has bought substitute goods after the breach nor is subject to a damages claim from his sub-buyer. This is in accordance with the rule that the burden of proof on the issue of mitigation is on the party in breach.62

C

Addendum: the Potential Influence of The Golden Victory

In conclusion on avoided loss, I want to bring in the very recent decision, albeit by a bare majority, of the House of Lords which is now on the lips of everyone in the field of contract damages—Golden Strait Corporation v Nippon Yusen Kubishika Kaisha,63 a case destined to be known as The Golden Victory after the ship concerned there. Although the decision has no direct connection with mitigation, there is an inherent relationship between the rules of mitigation and the rules as to the time of assessment of damages, the date by reference to which damages fall to be assessed. By their decision to take into account matters occurring after the breach of contract so as to reduce the damages recoverable, the majority may have opened the way to the revisiting of some of the cases in which a transaction entered into by the aggrieved party subsequent to the breach has been left out of account in the assessment of damages. Thus it is interesting to note that, a week after the House of Lords decision was handed down, Langley J in Oxus Gold plc v Templeton Insurance Ltd,64 faced by the dictates of the highest authority in the shape of the Rodocanachi and Agius decisions,65 which he cited at length, with having to award a buyer of undelivered shares more than he appeared to have lost, confessed with what he called 62 63 64 65

As also highlighted earlier in this chapter. [2007] 2 WLR 691 (HL). [2007] EWHC 770 (Comm). For further details on these two cases, see nn 52–4 and the accompanying text.

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‘some very limited encouragement from The Golden Victory’ to ‘the irrelevant and presumptuous thought that there is not much to be said for a law of damages as absolutist as’66 that carved out by Rodocanachi and Agius. Perhaps he should have been more hopeful and have found greater support in The Golden Victory, where, as has already been noted,67 one of the principal cases favouring deduction, Wertheim,68 appears to have been endorsed, and by majority and minority alike.69 Who knows what may now be in store for us in the possibly near future?

66 67 68 69

[2007] EWHC 770 (Comm) [80]. See n 59 and subsequent discussion in the text thereto. [1911] AC 301 (PC). [2007] 2 WLR 691 (HL) [13] (Lord Bingham, minority) and [30] (Lord Scott, majority).

15 Expectation Damages: Avoided Loss, Offsetting Gains and Subsequent Events EXPECTATI ON DAMAGES

D AV ID Mc L A U C H L A N * DAVI D MCLAUCHLAN

I

I NTRO DUCTION

Academic commentaries on the common law of damages for breach of contract have tended to be dominated in recent times by debates over such theoretically interesting and challenging issues as the juridical basis of remoteness, the correctness of the decision to deny Mr Forsyth recovery of the cost of reconstruction of his swimming pool in the Ruxley case,1 the ramifications of the award of loss of amenity damages in that case for the wider availability of damages for non-pecuniary loss, and the circumstances in which so-called restitutionary damages might be awarded. Other issues that are arguably of greater practical significance in the sense that they arise more often in the day-to-day work of the courts, and perhaps are no less challenging, have been largely neglected by comparison. These issues relate to the actual quantification of expectation damages: how we work out the difference between the claimant’s ‘promised’ position and his or her actual position, which of course is what is involved in applying the fundamental compensatory (or Robinson v Harman2) principle. They include: the date of assessment, which may be the breach date, the hearing date or some date in between; the relevance of external events occurring subsequent to breach which may appear to reduce or eliminate the loss claimed; and, most importantly, whether all or part of the loss has been * Professor of Law, Victoria University of Wellington; Honorary Professor, The University of Queensland. I wish to thank my research assistant, Nick Hegan, for his input to, and astute comments on, on an earlier draft of this chapter. All errors, of course, are my responsibility. 1 Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344. 2 (1848) 1 Ex 850 (Exch) 855 (Parke B) (‘where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed’).

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avoided through actions in mitigation or there is some other relevant compensating advantage that ought to be offset against the amount of damages otherwise recoverable. Such issues, as with many other remedial issues, often provoke much judicial disagreement. A notable recent example is provided by the decision of the House of Lords in The Golden Victory.3 All of their Lordships adopted the compensatory principle as their starting point. Lord Bingham described the principle as ‘the governing principle in contract’.4 The other Law Lords expressed similar sentiments. The principle was variously described as ‘fundamental’,5 ‘overriding’6 and ‘clear’.7 Nevertheless, although it was also said that ‘[t]he basic facts of this case could hardly be simpler’,8 their Lordships were divided 3:2 as to the application of the principle. As this case and others to be discussed in this chapter demonstrate, the task of implementing the compensatory principle can be extremely difficult and give rise to legitimate differences of opinion. In The Golden Victory, previous cases that the majority treated as analogous were regarded by the minority as bearing ‘little, if any, resemblance to the present’.9 An award that the minority regarded as consistent with the compensatory principle was said by the majority to ‘offend’10 that principle. And we will see other instances where what is a windfall to one judge is proper compensation to another. This chapter, which is a substantially abridged version of the paper presented at the Contract Damages Conference,11 will address the (often overlapping) issues I have identified, albeit with the main emphasis being on the problem of avoided loss and offsetting gains. The first section contains three case studies to illustrate some of the issues in a preliminary way. The next section traces the development of the law concerning the distinction between compensating advantages, which reduce the damages recoverable by the plaintiff, and so-called ‘collateral benefits’, which do not, and analyses some of the difficult leading cases. The following sections deal with some specific applications of the distinction in sales and non-sales cases. 3 Golden Strait Corporation v Nippon Yusen Kubishika Kaisha [2007] UKHL 12; [2007] 2 WLR 691 (HL). 4 Ibid, 696 [9]. 5 Ibid, 705 [29] (Lord Scott) and 724 [83] (Lord Brown). 6 Ibid, 708 [35] and 709 [37] (Lord Scott). 7 Ibid, 709 [38]. 8 Ibid, 719 [69] (Lord Brown). 9 Ibid, 697 [12] (Lord Bingham). 10 Ibid, 709 [38] (Lord Scott). 11 The conference paper included, inter alia, a section highlighting the necessity, before one can begin to calculate expectation damages, of both accurately identifying the contractual obligation broken and categorising the loss or losses in respect of which the damages are claimed and another section examining the commonly perceived difficulties of combining wasted expenditure and expectation claims.

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S O M E P RO B L E M CAS E S

In this section I propose to analyse three modern cases. My purpose is not only to introduce the issues that are the main concern of this chapter but also to highlight some of the difficulties and tensions faced by the courts as they attempt to award damages in accordance with the compensatory principle. Arguably, in the first two cases the plaintiffs were overcompensated, whereas in the third (The Golden Victory) they were undercompensated.

Turner v Superannuation & Mutual Savings Ltd12

A

This New Zealand High Court case concerned the sale of a commercial building which was due for settlement in early 1983. The vendor (Superannuation) had purchased the property in 1980 for $375,000 with a view to establishing its head office there, but had a change of heart when Mr Turner agreed to pay the extravagant price of $1.1m (arrived at by doubling the vendor’s assessment of the value of the property). Shortly after the contract was formed, the vendor bought a substitute building in the same street for $510,000. However, Turner was unable to settle and eventually the vendor decided to revert to its original plan and retained the building for its head office. In 1985 Turner, most unwisely as it transpired, issued proceedings to recover his deposit of $60,000, whereupon the vendor counter-claimed for damages, seeking to recover $400,000—the difference between the contract price and the market value of the property at the date of the breach. For technical reasons, the deposit was held to be a penalty and therefore recoverable. That was of no consequence for the vendor, however, because its damages claim was successful. It received what I am sure many would regard as a windfall because, by the time of trial in 1986, the property in question had risen in value to $4m, nearly four times the contract price. The capital gain on the substitute building was ‘even more dramatic’.13 It was on-sold just prior to the trial for $3m, nearly six times the original purchase price, an outcome that would not have occurred but for the intervention of Turner (and to whom the vendor should perhaps have been grateful!). The judge, Smellie J, conceded that the award was ‘a hard result’ for Mr Turner, for whom he had ‘the greatest sympathy’.14 The vendor had been able to retain its building which [had] increased in value enormously and in addition had enjoyed a substantial capital gain on the other building which it 12 13 14

[1987] 1 NZLR 218 (NZHC). Ibid, 221. Ibid, 232.

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purchased on the faith of the contract that it had made [with Turner] for the sale of the original property.

Nevertheless, the latter ‘knew that he was paying an extravagant price for the building’ and that this meant inevitably that if he did not complete he could face a claim for damages for the difference between the bargain at $1,100,000 and the true market value which by consent is now agreed at $700,000.15

His Honour held that while damages may be assessed at a later date or at date of trial in order to fully compensate an innocent party they may not be so assessed to the benefit of the defaulting party which of course is [Turner] in this case.16

The latter observation seems curious at first sight. If, in appropriate cases, the date for assessment of damages can be postponed from the date of breach until some other date in order to compensate the innocent party fully, why should not similar considerations apply in favour of the party in breach where subsequent events establish that awarding breach-date damages will ‘overcompensate’ the plaintiff? In other words, if proper compensation of the plaintiff sometimes requires departure from the breach-date rule and assessment at the date of trial, why cannot a defendant contend that assessment at the date of breach will overcompensate in the light of subsequent events? The explanation lies in the principles of mitigation of damage which in large measure inform or even determine the date for assessment.17 Thus, the only likely circumstance in which the vendor in a case like Turner could have damages assessed at the date of trial would be where it had reasonably sought specific performance (and hence did not come under a duty to mitigate) but the court declined that remedy or the vendor elected to claim damages at trial. If the property market had fallen and the building had declined in value by, say, $100,000, down to $600,000, the court might award the difference between that sum and the contract price of $1.1m (ie, $500,000).18 Otherwise, if specific performance were not Ibid. Ibid, 231. As Oliver J pointed out in Radford v De Froberville [1977] 1 WLR 1262 (Ch) 1272: ‘No doubt the measure of damages and the plaintiff’s duty and ability to mitigate are logically distinct concepts . . . But to some extent, at least, they are mirror images.’ His Lordship later said (at 1285) that the rationale behind the often expressed ‘ordinary rule’ that damages are to be assessed at the date of breach is that this is the date that the plaintiff could ‘reasonably have been expected to mitigate the damages by seeking an alternative to performance of the contractual obligation’. 18 Logically, the position should be the same where it would be more advantageous to the vendor to claim assessment at the date of breach because property values had risen by the time it elected, or was forced to elect, to claim damages. Thus, in the example in the text, the damages 15 16 17

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sought, the damages would fall to be assessed at the date upon which the vendor ought reasonably to have mitigated by seeking alternative performance, which would ordinarily be the date of breach or a reasonable time thereafter. It is at this point that the loss crystallises, so that subsequent rises or falls in the value of the property would be the vendor’s advantage or risk.19 This analysis suggests that the decision in Turner, though harsh on the purchaser, is unexceptionable according to generally accepted damages principles. However, the case does highlight some confusion as to the relationship between mitigation and date of assessment principles. The judge’s reasoning does not quite conform to the above model. In particular, his Honour made a finding of fact that the vendor owed no duty to mitigate by attempting to resell the property: the company acted reasonably in retaining the building and reverting to its original plan to use it for a head office. But, if this is so, does it not mean that the damages no longer fell to be assessed at the date of breach, or, in other words, that the loss had not crystallised so that the subsequent gains through retention of the building could properly be taken into account as extinguishing the loss claimed?20 There were, however, extenuating circumstances. Counsel’s argument for Mr Turner was that even if it were not accepted that the point of time for assessing damages should be other than the date of breach, nonetheless the defendant had failed to mitigate.21

This argument makes no sense because, if the loss crystallised at the date of breach, subsequent inaction on the part of the vendor was irrelevant. In any event, it is difficult to fathom quite what counsel sought to gain from a general failure to mitigate argument because its acceptance would still have left the vendor entitled to recover the amount claimed (the difference between the contract price and the agreed market value of the property at the date for completion). It is in fact, as I have already indicated, the rejection by the judge of the purchaser’s argument—the finding that the vendor had not failed to mitigate—that perhaps ought to have redounded to the purchaser’s benefit. Since the vendor had acted reasonably in not reselling, the damages award should have been for the vendor’s actual loss taking into account subsequent events as they occurred (here nil), not the would be reduced to $200,000 if the evidence established that the value of the building had risen to $900,000. See generally A Burrows, Remedies for Torts and Breach of Contract (Oxford University Press, 3rd edn, 2004) 192–3. See Jamal v Moolla Dawood, Sons & Co [1916] 1 AC 175 (PC). According to Oliver J in Radford, above n 17, 1286, ‘the proper approach is to assess the damages at the date of the hearing unless it can be said that the plaintiff ought reasonably to have mitigated by seeking an alternative performance at an earlier date, in which event the appropriate measure would seem to me to be the cost of the alternative performance at that date’. 21 Turner, above n 12, 231. 19 20

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breach-date loss. Of course, having earlier resolved that it was appropriate to assess the damages under the ordinary rule as at the date of breach, the appropriate response on the part of the judge would have been simply to rule that the vendor was ‘obliged’ to mitigate but that this did not mean that an actual resale of the property had to be attempted, only that damages were to be assessed on the basis that it had been sold at fair market value.22

B Semelhago v Paramadevan23 The plaintiff in this case agreed to buy a house from the defendant for $205,000. The purchase was to be funded by $75,000 cash and bridging finance of $130,000 on the security of the plaintiff’s existing house, which he proposed to sell within six months of settlement. When the defendant repudiated the contract, the plaintiff sued for specific performance or, alternatively, damages. However, at the trial, more than three years later, he elected to claim damages only. By this time the house had risen in value to $325,000. The trial judge, though recognising that the plaintiff was receiving a windfall, awarded the difference between this sum and the contract price, ie $120,000. No account was taken of the fact that the plaintiff’s existing house had also risen in value from $190,000 to $300,000. On appeal by the defendant to the Ontario Court of Appeal, the award was reduced to $81,700. It was held that the plaintiff would be 22 The principles applied in Turner were adopted in Choon Sang Yoon v Cullen (1999) 4 NZ ConvC 192,973. The respondents had validly cancelled a contract to sell rural properties to the appellant for the latter’s breach. They were awarded damages of $140,000 in respect of the costs they had incurred in retaining the properties during the four years from the settlement date to the date of hearing. These costs included mortgage interest, legal expenses, local authority rates and the cost of readvertising the properties. The case proceeded on the assumption that the respondents had taken reasonable steps to mitigate their losses and, most importantly, that the properties had risen in value by more than $100,000 during the same period. Nevertheless, Potter J rejected the appellant’s argument that this gain should be deducted from the respondents’ damages. Awarding the full amount claimed would not put them in a better position than if the contract had been performed or result in an ‘unwarranted windfall’ (at 192,979). In my view, the decision is wrong. It is important to appreciate that this was not a case where the vendors were claiming the usual damages measure of the difference between the contract price and the market value of the properties as at the settlement date, where it is generally accepted that subsequent gains do not reduce the damages recoverable, just as subsequent diminutions in value do not increase them: see Jamal, above n 19, discussed in text following n 113. In the present case the vendors were claiming in respect of consequential losses incurred whilst they held on to the land, and one would have thought that contemporaneous gains should be offset against those losses. Otherwise they are put in a better position than if the contract had been performed. This would be so even if there were evidence that the breach deprived them of the opportunity to buy an alternative property which would likely have increased in value to a similar extent, because no doubt that alternative purchase would have incurred some of the costs (eg mortgage interest and rates) visited upon the appellant as a result of the damages award. 23 (1996) 136 DLR (4th) 1 (SCC).

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overcompensated unless deductions were made in respect of the mortgage costs he had avoided and notional interest on the $75,000 cash contribution that he had been able to retain. Not satisfied with this small victory, the defendant appealed to the Supreme Court of Canada, arguing that a deduction should have been made in respect of the increase in value of the plaintiff’s existing house. The court unanimously rejected the argument and even doubted the correctness of the deductions made by the Court of Appeal.24 It was held that a deduction for the increase in value was not appropriate because if the plaintiff had received a decree of specific performance, he would have had the property contracted for and retained the amount of the rise in value of his own property.25

The principle to be applied, which was said to be derived from the jurisdiction to award damages in substitution for specific performance in Lord Cairns’s Act (which, in truth, had no application because the plaintiff had himself elected to terminate the contract and claim damages26), was that ‘damages are to be a true equivalent of specific performance’.27 Therefore there was ‘no basis for deductions that are not related to the value of the property which was the subject of the contract’.28 In my view, the Supreme Court’s decision is wrong.29 There can be no quarrel with the assessment of damages as at the date of the trial since the plaintiff prima facie had a legitimate claim for specific performance, but it does not follow that an award of damages should give him the financial equivalent of specific performance. Once he elected to terminate the contract his claim became the ordinary one of damages for loss of bargain, albeit assessed as at the date of hearing. He was entitled to be put in the position he would have occupied if the contract had been performed and this necessarily entailed an award of the difference between his actual financial position and his financial position had the contract gone ahead. 24 Ibid, 11 [24]. There was no cross-appeal by the purchaser against these deductions. Logically, if the offsetting gains from the notional interest and avoidance of mortgage costs were taken into account, so too should the increase in value of the existing house. 25 Ibid, 9 [19]. 26 See generally DW Greig and JLR Davis, The Law of Contract (Sydney, Law Book Co, 1987) 1500–1. 27 Semelhago, above n 23, 9 [19]. 28 Ibid. 29 So too is the earlier decision of the Ontario Court of Appeal in 306793 Ontario Ltd v Rimes (1979) 100 DLR (3d) 350 (Ont CA), where the plaintiff purchaser recovered damages in lieu of specific performance of $145,000—the difference between the value of the land at the date of trial ($725,000) and the contract price ($580,000)—without deduction for the estimated ‘carrying costs’ of $120,000 that would have been incurred if the contract had been performed. See generally SM Waddams, ‘Inflation and Mitigation of Damages’ (1981) 1 OJLS 134; J Cassels, Remedies: The Law of Damages (Toronto, Irwin Law, 2000) 372–5; JD McCamus, The Law of Contracts (Toronto, Irwin Law, 2005) 944–6; and J Swan, Canadian Contract Law (Ontario, LexisNexis, 2006) 358–9.

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Given the trial judge’s finding that the existing house would have been sold within six months of settlement, calculation of the former surely had to include an allowance for the gain resulting to the plaintiff from the increase in value occurring after the expiry of six months from the stipulated settlement date. The calculation would also have to include, inter alia, credits for the benefit of retaining the cash contribution and for mortgage costs and other outgoings avoided due to the delay, with the likely end result being an award of nominal damages only.30

C

The Golden Victory31

In this case the Court of Appeal and the House of Lords were called upon to grapple with first principles of damages law relating to the date for assessment of damages upon a repudiation of a commercial contract where there is an available market, the relationship between mitigation principles and assessment of loss, and the relevance of subsequent events. The respondent charterers wrongfully repudiated a charterparty three years into its seven-year term. The appellant owners accepted the repudiation and claimed damages according to the normal measure of the difference between the charter rate and the market rate for the remaining four years of the term. There would have been no doubt as to their entitlement to such recovery but for the following circumstances. First, the contract contained a ‘war clause’, giving each party the right to cancel the charter if war broke out between any two or more of several countries, including the United States, the United Kingdom and Iraq. Secondly, in March 2003, some 14 months after the repudiation, the Second Gulf War commenced. Thirdly, the arbitrator found that the charterers would have cancelled the charter had it remained on foot because they were ‘fundamentally disenchanted’32 with it. The Court of Appeal upheld the trial judge’s ruling that, although at the time of the repudiation such a war would have been considered a mere possibility, damages were to be measured by taking into account that the owners would only have had the benefit of the charter until the outbreak of the war. According to Lord Mance (with whom Auld and Tuckey LJJ concurred), this conclusion was not only consistent with the basic compensatory objective of contract damages, but required by it. In 30 For useful discussions, see DH Clark, ‘“Will that be Performance ... or Cash?”: Semelhago v Paramadevan and the Notion of Equivalence’ (1999) 37 Alberta Law Review 589, 610–19 and Swan, above n 29, 396–8. 31 Golden Strait Corporation v Nippon Yusen Kubishika Kaisha [2006] 1 WLR 533 (CA), [2007] UKHL 12, [2007] 2 WLR 691 (HL). This section draws on D McLauchlan and N Hegan, ‘Contract Damages: Fundamental Principle, Fundamental Disagreement’ (2008) 46 Canadian Business Law Journal 89. 32 [2006] 1 WLR 533 (CA) 537 [6].

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this case the considerations of certainty, finality and ease of settlement which underlie the normal measure had to yield to the greater importance of achieving an assessment of damages and compensation which more accurately reflects the actual loss which the owners can, at whatever is the date of assessment, now be seen to have suffered as a result of the charterers’ repudiation.33

The rejection of the owners’ argument that subsequent events were irrelevant in a case where there is such a well-established normal measure of damages capable of application as at the date of breach received a mixed reaction from commentators,34 but the Court of Appeal’s decision was upheld by the House of Lords, albeit by a narrow 3:2 majority. The majority35 essentially endorsed the reasoning of Lord Mance. To allow the owners’ claim in respect of the whole of the four-year period after the repudiation ‘would be inconsistent with the overriding compensatory principle on which awards of contractual damages ought to be based’.36 Since the contract would have been brought to an end pursuant to the war clause within 14 months it followed that ‘in principle, the owners . . . are not entitled to any damages in respect of the period thereafter’.37 The minority,38 on the other hand, accepted the owners’ argument that the quantification should be made when, the repudiation having been made and accepted, they charter out (or may reasonably be expected to charter out) the vessel

and that [e]vents occurring later, not affecting the value of the contractual right which the owner has lost at that time, are irrelevant.39

In their view, the decision of the Court of Appeal undermines the quality of certainty which is a traditional strength and major selling point of English commercial law, and involves an unfortunate departure from principle.40

Upon the owners’ acceptance of the repudiation, they had been deprived of an asset of marketable value (a charter with four years to run) and that Ibid, 544 [26]. Compare GH Treitel, ‘Assessment of Damages for Wrongful Repudiation’ (2007) 123 LQR 9 and Q Liu, ‘Accepted Anticipatory Breach: Duty of Mitigation and Damages Assessment’ [2006] Lloyd’s Maritime and Commercial Law Quarterly 17. 35 Lord Scott of Foscote, Lord Carswell and Lord Brown of Eaton-under-Heywood. 36 [2007] 2 WLR 691 (HL) 708 [35] (Lord Scott). 37 Ibid, 709 [37]. 38 Lord Bingham of Cornhill and Lord Walker of Gestingthorpe. 39 [2007] 2 WLR 691 (HL) 693 [1] (Lord Bingham). 40 Ibid, 694 [1]. 33 34

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value was not affected by the ‘outside chance’ at that time of war with Iraq.41 I suspect that the outcome in this case and the reasoning of the majority will be widely supported amongst contract scholars42 but, as we shall see later in this chapter, the majority’s approach has not always been taken in other cases involving the assessment of damages for breach where there is an available market for the subject matter of the contract. Moreover, the tendency to characterise the issue as involving a determination of whether considerations of certainty and finality should prevail over the compensatory principle is, in my view, overly simplistic. The assumption is made that, if it is permissible to have regard to subsequent events, the owners suffered much less ‘actual loss’ than they were claiming: more particularly, that true compensation for loss would limit recovery, in view of the finding that the charterers would inevitably have cancelled upon the outbreak of the Second Gulf War, to the amount of lost revenue for the 14-month period between that event and the acceptance of the repudiation. But is that necessarily so? My present inclination is to favour the minority’s outcome. There was no sufficient reason in this case to depart from the ordinary rule that, when a repudiation is accepted, damages are to be assessed as at the date of acceptance. Indeed, it is not easy to understand why repudiating charterers should be entitled to the benefit of an election right premised on the charter remaining on foot and being duly performed up until the time of its exercise.43 In my view, the only basis for reducing recovery in the circumstances before the court would be a finding that a substitute charterer would also have cancelled pursuant to the war clause. Such a finding seems to me highly improbable, although not according to a remarkable statement by Lord Brown, the third majority judge and the only one of the five judges to address this matter. His Lordship said: Any substitute contract here—albeit, as the arbitrator found, for the four-year balance of the original seven-year term—would have been subject to the selfsame conditions as the repudiated contract. And it can be assumed that the hypothetical substitute charterers would similarly have cancelled their contract on the outbreak of the War.44 Ibid, 703 [22]. See Q Liu, ‘The Date for Assessing Damages for Loss of Prospective Performance under a Contract’ [2007] Lloyd’s Maritime and Commercial Law Quarterly 273. For a brief negative reaction, however, see J Morgan, ‘A Victory for “Justice” over Commercial Certainty’ [2007] CLJ 263. See also B Coote, ‘Breach, Anticipatory Breach, or the Breach Anticipated’ (2007) 123 LQR 503 (commenting more on some implications of the decision, but slightly negative). 43 It may be that this is what Lord Bingham had in mind (at 702–3 [22]) when, after stating that there were ‘several answers’ to the charterers’ argument that ‘the owners would be unfairly over-compensated if they were to recover as damages sums which, with the benefit of hindsight, it is now known that they would not have received had there been no accepted repudiation’, he said: ‘The first is that contracts are made to be performed, not broken. It may prove disadvantageous to break a contract instead of performing it.’ 44 [2007] 2 WLR 691 (HL) 724 [82] (emphasis added). 41 42

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It is my understanding that charterparties are by no means invariably cancelled by charterers upon the outbreak of war between the designated countries, particularly since market rates are likely to have risen.45 Most importantly, the dismissal by the majority of the rationale underlying the ‘market’ cases such as Jamal v Moolla Dawood, Sons & Co46 seems to me to be incorrect. It is usually accepted that, where there is a ready market for the subject matter of the contract, the so-called ‘duty’ to mitigate means that a plaintiff cannot claim damages in respect of subsequent adverse market movements which could have been avoided. In other words, the plaintiff’s damages are calculated as if the mitigating transaction had occurred. I suggest that the same approach should apply here, given that it was accepted that a substitute term charter was available; in other words, the owners’ damages should be calculated assuming a substitute charter had been obtained. Of course, charter rates having fallen, the owners would have to have paid an upfront sum to obtain the substitute charter on exactly the same terms, which sum would clearly have been calculated by reference not only to the differential between the contract and market rates but also to the low likelihood of cancellation at the time of acceptance of the repudiation.47 Damages should therefore be equal to that sum, and the fact that the owners chose not to seek the replacement charter was their own risk or advantage (depending on future rises and falls in the charter market). Even if the owners had obtained a substitute charter at the then current market rate, the existence of the war clause would only be relevant to the extent that it affected this market rate, and the fact that the charterers would have cancelled had the contract 45 According to the Case for the Appellants in the House of Lords (at [75]), counsel argued that there was no basis for a presumption that the substitute charterers or the owners would have cancelled upon the outbreak of war. I also understand that the charterers in the present case had several other charters that were not cancelled. The arbitrator found that the charter of the Golden Victory would have been cancelled, despite an increase in market rates, because the charterers were ‘fundamentally disenchanted’ with it, but, most interestingly for present purposes and curiously, he also considered that they were ‘entitled to the benefit of a presumption that they would . . . have cancelled the charter under [the war clause] had it not already been terminated on account of their repudiation’: [2006] 1 WLR 533 (CA) 537 [6]. 46 Above n 19. 47 As Lord Bingham pointed out (Golden Strait Corporation, above n 3), ‘what the owners lost at [the date of acceptance of the repudiation] was a charterparty with slightly less than four years to run’ and ‘[o]n the arbitrator’s finding, it was marketable on that basis’. Furthermore, the prospect of war was only ‘an outside chance, not affecting the marketable value of the charter at that time’. In the same vein, Lord Walker concluded (at 711 [45]) that ‘[t]he whole thrust of the arbitrator’s findings . . . is that [war] was at the date of repudiation the sort of outside possibility which would, in the commercial world, be severely discounted (or even entirely disregarded)’. However, even if, as Lord Brown suggested (at 721–2 [77]), the arbitrator may have considered the chance of war to be much higher, on the argument in the text this merely goes to the amount of the up-front sum the owners could have paid to obtain a replacement charter. That sum (and hence the damages) would have been lower. This method also addresses Lord Brown’s discomfort over his interpretation of the minority’s approach in a scenario where, as at breach, war was quite likely but did not in fact eventuate (at 724–5 [84]). In that case, the high likelihood of war would also operate to reduce the up-front sum required to replace the charter.

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remained on foot is irrelevant because the right to damages for the loss of value of the charter had already crystallised. It is true that the minority’s view results in the owners being better off than they would have been if the contract had remained on foot or if, after the termination, they had re-chartered for the same term at the then market rate and the substitute charter had been cancelled when war broke out. However, in these ‘market’ cases it can certainly be argued that it is beside the point whether the plaintiffs ‘ended up’ being better off because there is an earlier question to be answered. That question is whether termination for repudiation or breach has the effect of reallocating market risk to the plaintiffs. If there is such a reallocation, it follows from the principles applied in mitigation cases that subsequent market changes are for the plaintiffs’, not the defendants’, account. Of course, this does not mean that the plaintiffs were under an ‘obligation’ to deal with the risk, only that they must be treated as if they had.48 Such a principle not only promotes certainty and efficiency of settlement, it makes good economic sense by placing responsibility for dealing with market risk in the hands of those best able to do so. Although the precise criteria qualifying a case as being a ‘market’ case are not entirely clear, there can be little doubt that the facts of The Golden Victory fell within the category. All of their Lordships were in agreement that the compensatory principle is a cornerstone of the law of contract. Perhaps the main source of their disagreement over its application was the apparent failure of the majority fully to appreciate that the principle does not mean that plaintiffs can never end up better off than they would have been absent the breach. The ‘market’ cases, and other cases where damages crystallise at breach, are instances when this can occur. Unfortunately, it is not always recognised that, before the compensatory principle can be applied, the earlier question of whether the plaintiff’s loss should be treated as crystallised must be addressed.

III

AVO I D E D L O S S , C O M P E N SAT I N G A DVAN TAG E S , AN D C O L L AT E R A L B E N E F I T S

One of the most intractable areas of the law relating to the assessment of damages for breach of contract concerns the circumstances in which subsequent gains made by the plaintiff or other apparent compensating advantages are to be taken into account to reduce the loss and hence the damages otherwise recoverable. The cases are difficult and replete with fine distinctions, and many of them are irreconcilable. 48

See the passages from the judgment of Oliver J in Radford, above n 17.

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The British Westinghouse Case

The leading case is still the decision of the House of Lords in British Westinghouse Electric and Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd.49 Westinghouse contracted to sell machines for power generation to the railway company at a price of £250,000. The machines delivered did not comply with the contract specifications and, after fruitless attempts by Westinghouse over an extended period to remedy the difficulties, the railway company purchased replacement machines from another manufacturer at a cost of £78,186. Not only did the replacement machines exceed the specifications of the Westinghouse machines but their efficiency was such that the railway company would have profited from replacing the Westinghouse machines even if they had complied with the specifications. In other words, the extra cost was more than offset by the efficiency gains and hence the railway company was better off than it would have been if it had continued to operate Westinghouse machines that did comply with specifications. Nevertheless, the railway company claimed damages for the extra expenses they had incurred whilst operating the Westinghouse machines until their replacement (about which there was no dispute) and the cost of purchasing and installing the replacement machines. The Court of Appeal held that the railway company was entitled to recover this cost.50 It had been reasonably and prudently incurred for the purpose of avoiding future damage and no account was to be taken of ‘any concomitant and ancillary advantages which accrued to the buyers’.51 The House of Lords disagreed. The railway company had taken action ‘arising out of the consequences of the breach and in the ordinary course of business’52 which had the effect of diminishing the loss and this action, even if there had been no duty to take it, had to be taken into account, otherwise the company would have been put in a better position than if the contract had been performed. The purchase of the new machines formed part of a continuous dealing with the situation in which [the buyers] found themselves, and was not an independent or disconnected transaction.53

In other words, the transaction was not res inter alios acta, as the Court of Appeal had implicitly found. Given the fundamental compensatory purpose of contract damages, few would quibble with the result in Westinghouse, but the reasoning did sow the seeds for the later difficulties. For example, the decision in Jebsen v East and West India Dock Co54 was distinguished as 49 50 51 52 53 54

[1912] AC 673 (HL). [1912] 3 KB 128 (CA). Ibid, 153 (Kennedy LJ). Westinghouse, above n 49, 690 (Viscount Haldane LC). Ibid, 692. (1875) LR 10 CP 300 (CP).

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a case in which what was relied on as mitigation did not arise out of the transactions the subject-matter of the contract.55

In that case the defendant’s breach of contract in delaying the unloading of the plaintiffs’ ship meant that they lost the fares of passengers who were booked to sale in the ship to America. However, the passengers were in fact carried on other ships that were partly owned by the plaintiffs. The decision that this did not affect the plaintiffs’ damages seems defensible only if the need to accommodate the passengers on those ships prevented the plaintiffs taking on board other passengers or otherwise putting the ships to profitable use.56 The House of Lords also approved the decisions of the Privy Council in Erie County Natural Gas and Fuel Co Ltd v Carroll57 and Wertheim v Chicoutimi Pulp Co,58 in both of which subsequent gains were taken into account to reduce damages. The latter decision has since been regularly doubted,59 although significantly the principle on which the decision is based was recently endorsed by members of both the majority and minority in The Golden Victory.60 The former is generally accepted as correct, but it is difficult to reconcile with later cases.

B Wertheim v Chicoutimi Pulp Co In Wertheim the defendants agreed to sell to the plaintiff a quantity of wood pulp for delivery in November 1900. Delivery was delayed until June 1901, by which time the market price had fallen from 70s per ton (at the Westinghouse, above n 49, 691 (Viscount Haldane LC). The decision is disapproved by SM Waddams, The Law of Damages (Toronto, Canada Law Book Inc, 4th edn, 2004) para 15.810, AI Ogus, The Law of Damages (London, Butterworths, 1973) 374, and (it seems) H McGregor, McGregor on Damages (London, Sweet & Maxwell, 17th edn, 2003) para 7.125. 57 [1911] AC 105 (PC), discussed below in text following n 81. 58 [1911] AC 301 (PC). Their Lordships also endorsed the controversial rule in Joyner v Weeks [1891] 2 QB 31 (CA). Under this rule, where a lessee in breach of contract delivered up the premises at the end of the term in a state of disrepair, the lessor could recover the cost of effecting the repairs notwithstanding that this would result in a windfall because, for example, the premises were about to be demolished, had been sold or had been leased to a new lessee who had assumed an obligation to redevelop or carry out the repairs. Since the rule has now been reversed by statute in some jurisdictions or is treated in others as laying down a prima facie measure only which can be displaced by evidence as to the lessor’s true loss (if any), it will not be considered further in this chapter. See generally Maori Trustee v Rogross Farms Ltd [1994] 3 NZLR 410 (NZCA) and McGregor, above n 56, paras 7.147–7.150. 59 See, eg GH Treitel, The Law of Contract (London, Sweet & Maxwell, 11th edn, 2003) 949–50; HG Beale (ed), Chitty on Contracts (London, Sweet & Maxwell, 29th edn, 2004) vol I, para 26-102, and vol II, para 45-434; RM Goode, Commercial Law (London, Penguin, 3rd edn, 2004) 375–6; PS Atiyah, JN Adams and H MacQueen, The Sale of Goods (New York, Pearson/Longman, 11th edn, 2005) 543–4; and Ogus, above n 56, 345. 60 [2007] 2 WLR 691 (HL) 706 [30] (Lord Scott) and 699 [13] (Lord Bingham). 55 56

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due date) to 42s 6d. The plaintiff sought to recover the difference of 27s 6d, the normal measure for delayed delivery. However, the claim was rejected by the Privy Council because in the circumstances it would have put the plaintiff in a much better position than if the contract had been performed. The evidence established that he had made various sub-sales of the goods at a price of 65s per ton and that these contracts were able to be fulfilled despite the delay. Accordingly, it was ‘against all justice’ to allow the plaintiff to receive compensation ‘for a loss he never suffered’.61 Damages were restricted to 5s per ton, the difference between the market price at the due date for delivery and the price obtained on resale. As Professor Waddams has observed, the position would have been different and the claim would have been entitled to succeed if the plaintiff could have shown that in fact he would have resold the goods (at 70s) on timely arrival, accurately anticipating the extraordinary drop in the market (to 42s 6d) that would enable him a profit separately on the subcontracts62

but there was no such proof. Ironically, despite the emphasis on ensuring that the plaintiff was put in no better position than if the contract had been performed, it seems that the award of 5s did in fact overcompensate him.63 Prima facie no loss at all was suffered, hence there should have been an award of nominal damages only. The plaintiff’s position if the contract had been performed and his actual position were exactly the same since he was able to fulfil the sub-sales without buying in substitute goods at the higher market price. That price was irrelevant to the damages calculation on the particular facts. The explanation for the award of 5s may lie in the fact that the defendants conceded that this was the plaintiff’s loss.64 Certainly, there was no cross appeal from the award by the lower courts, and it is interesting to note that the Privy Council simply observed that 5s per ton was ‘the highest rate’ at which an award ‘could properly be fixed’.65

Wertheim, above n 58, 308. Waddams, above n 56, para 1.1930. Professor Waddams supports the decision in Wertheim and argues, for reasons quoted later in n 93, that cases of late delivery are distinguishable from those of non-delivery and delivery of defective goods. See also Greig and Davis, above n 26, 1403. 63 As pointed out by a number of commentators: see, eg McGregor, above n 56, para 7.142; Burrows, above n 18, 217; Greig and Davis, above n 26, 1403; and Ogus, above n 56, 345. 64 See counsel’s argument in Wertheim, above n 58, 303. 65 Ibid, 307. 61 62

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Wertheim was distinguished by the House of Lords three years later in Williams Bros v Ed T Agius Ltd,66 a difficult case involving non-delivery. The defendants failed to deliver coal which they had agreed to sell to the plaintiffs for 16s 3d per ton. At the time of the breach the market price was 23s 6d per ton. Applying the normal measure of damages, the plaintiffs were entitled to recover the difference between the two prices of 7s 3d. However, they had agreed to resell the coal to a third party for 19s and, accordingly, the defendants argued that the damages should be limited to the ‘actual loss’ of 2s 9d, the difference between the contract price and the resale price. This argument was rejected and the normal measure awarded. Counsel’s attempt to apply the late delivery case of Wertheim arose from ‘a confusion of thought’.67 In Wertheim the plaintiff did eventually get the goods and the only question was what prejudice was suffered as a result of the delay. However, when there is no delivery at all ‘the position is quite a different one’ because [t]he buyer never gets them, and he is entitled to be put in the position in which he would have stood if he had got them at the due date

and [t]hat position is the position of a man who has goods at the market price of the day.68

There can be no question that in ordinary circumstances the lower resale price is irrelevant and that an award of the full difference between the contract and market price is appropriate. The buyer will either have bought the goods in the market to fulfil the contract with the sub-buyer or become liable to pay out the difference between the sub-sale price and the market price in damages. In Williams Bros, however, the facts, though never satisfactorily determined, were much more complex than described above. The plaintiff buyers had not bought in substitute goods at the higher market price and also, according to at least two of their Lordships,69 there was no chance of a successful damages suit by the sub-buyer because it was a term of the contract with the plaintiffs that the latter had no obligation to deliver if the defendants defaulted in their delivery obligation.70 In these circumstances, despite the strong support for the decision of Stephen Waddams,71 I agree with Andrew Burrows that [1914] AC 510 (HL). Ibid, 529 (Lord Atkinson). Ibid, 528 (Lord Atkinson) and 531–2 (Lord Moulton). It is not overlooked that, for the peculiar and factual and legal reasons that need not detain us here, the defendants’ argument that recovery was limited to the difference between the contract and sub-sale prices (as well as the Court of Appeal’s acceptance of that argument) relied on the failure to incorporate this term in the contract. 71 Waddams, above n 56, paras 1.1360–1.1440 and 1.1940. 66 67 69 70

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‘ignoring the resale wrongly overcompensated the [plaintiffs]’.72 As Burrows concludes a lower resale price should displace the market buying price, except where the claimant has reasonably bought substitute goods to fulfil the resale, in which case damages should be the price paid for the substitutes minus the original contract price.73

Interestingly, this now appears to be the majority position in the US.74 In reaching the contrary view in Williams Bros their Lordships approved the decision of the Court of Appeal in Rodocanachi, Sons & Co v Milburn Bros,75 a case that seems even more starkly to involve overcompensation. The plaintiff charterer recovered from the defendant shipowner the market value of a cargo lost due to the latter’s negligence notwithstanding that the cargo had been sold at a lower price on a ‘to arrive’ basis (that is, non-delivery by the defendant relieved the plaintiff of any obligation to the sub-buyer). The argument of counsel for the defendant that a plaintiff ‘ought never to obtain more than he would have obtained if the contract had not been broken’76 was rejected. The value of the cargo was recoverable independently of any circumstances peculiar to the plaintiff, and so independently of any contract made by him for sale of the goods.77

No account was to be taken in estimating the damages of anything that was ‘accidental as between the plaintiff and the defendant’.78 This decision, of course, pre-dated British Westinghouse, but in Williams Bros Viscount Haldane LC (who delivered the judgment in British Westinghouse) argued that the two were ‘quite in harmony’ because the mitigation principle in the former only applies to benefits arising ‘out of transactions naturally attributable to the consequence of the breach, and must not be of an independent character’.79 Burrows, above n 18, 213. Ibid. See also Ontario Law Reform Commission, Report on Sale of Goods (1979) 410 (rejecting ‘the concept that the market price test provides a liquidated measure of damages which the seller (and, in a converse case where the seller is in breach, the buyer) should be entitled to recover as a statutory minimum’). 74 Compare Williams Bros with the outcomes in H-W-H Cattle Co v Schroeder 767 F 2d 437 (8th Cir, 1985) and Allied Canners & Packers v Victor Packing Co 209 Cal Rptr 60 (Cal Ct App, 1985). See generally DW Barnes and D Zalesne, ‘A Unifying Theory of Contract Damage Rules’ (2005) 55 Syracuse Law Review 495, 507–14 and RR Anderson, ‘Damage Remedies under the Emerging Article 2—An Essay Against Freedom’ (1997) 34 Houston Law Review 1065, 1071 (the courts allow ‘sellers and buyers the use of market-based damages only where the facts of the case do not demonstrate actual damages of a different amount’) and 1104–9. 75 (1886) 18 QBD 67 (CA). Indeed, this decision was also approved by the Privy Council in Wertheim, above n 58, 307–8. 76 Ibid, 71. 77 Ibid, 77 per Lord Esher MR. See also 78–9 (Lindley LJ) and 80 (Lopes LJ). 78 Ibid. 79 Williams Bros, above n 66, 520. 72 73

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In my view, it is difficult to see any principled basis for distinguishing the two cases. If the plaintiff’s actions after the breach in Westinghouse operated to reduce recovery, why should not the arrangement prior to the breach in Rodocanachi, an arrangement under which the plaintiff assumed the risk of a disadvantageous market price rise, do likewise? In other words, why should relevant compensating advantages be limited to those derived from actions consequential upon the breach of contract and which are construed as being taken in order to mitigate the loss?80 Sometimes the action taken after the breach may be just as ‘accidental’ as the action prior to the breach in Williams Bros and Rodocanachi. It may not be an action that the plaintiff was required to take as part of a legal duty to mitigate but, nevertheless, if it reduces the loss, recovery ought to be correspondingly reduced. An illustration is provided by Erie County Natural Gas and Fuel Co Ltd v Carroll,81 another of the cases that, as noted earlier, was referred to with approval by the House of Lords in British Westinghouse. The respondents had sold gas leases to the appellants subject to their reserving the right to draw sufficient gas to operate the plant of their own business. In breach of contract, the appellants cut off the gas supply, whereupon the respondents purchased other gas leases and carried out the works necessary to supply their plant at a cost of $58,000. They later sold their business and the gas leases, with the price attributable to the latter being $75,000. It was held by the Privy Council that, since the respondents had made a profit as a result of their endeavours to obtain substitute gas, only nominal damages were recoverable from the appellants. This was so despite the fact that the actions taken by the respondents went beyond any duty to mitigate. If they had not made the capital expenditure and, for example, had purchased gas or obtained an alternative fuel for their plant from another supplier, the cost of doing so would clearly have been recoverable. The fact that they did make a capital investment from which they eventually derived a net profit had the effect that the appellants fortuitously escaped scot-free from their breach. Counsel argued that the appellants should not benefit from the respondents’ ‘courage and enterprise’,82 but the Privy Council was more concerned to avoid the ‘somewhat grotesque result’83 whereby the latter could make a substantial profit from the appellants’ breach. The decision of the lower courts to award damages representing the price for which the gas consumed in their business could 80 See Ontario Law Reform Commission, above n 73, 502 (recommending ‘that the buyer should be limited to such damages as he has actually suffered without distinguishing between events occurring before or after the date of breach’). 81 [1911] AC 105 (PC) (followed on analogous facts in I T Walker Holdings Ltd v Tuf Shoes Ltd [1981] 2 NZLR 391 (NZCA)). 82 Ibid, 119. 83 Ibid, 115.

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have been sold was ‘erroneous’.84 The true measure of damages was the cost to the respondents of obtaining the alternative gas supply and, on the facts, since their expenditure had been more than recouped, that cost was zero. No doubt the result would have been different if the respondents had been in the business of producing gas and the acquisition of the gas leases could have been explained otherwise than as an alternative means of obtaining the gas that the appellants were contractually obliged to provide.

IV

SAL E O F G O O D S — M A R K E T VA L U E O R L O S T P RO F I T S ?

There is an obvious tension between the approach to assessment in British Westinghouse and Wertheim and the approach in Rodocanachi and Williams Bros. The former emphasises the compensatory purpose of damages. Its concern is the actual position of the plaintiff if the contract had been performed and the actual consequences of the breach. A court should never compensate the plaintiff for a loss which it knows has not been suffered. To award more than the ‘real’ loss is, by definition, to allow an unjustifiable windfall. The Rodocanachi and Williams Bros approach, on the other hand, favours a simpler, convenient and seemingly even-handed market price test to determine the level of recovery. The disadvantages of occasional overcompensation or undercompensation are outweighed by the advantages of having a uniform rule which is more certain in its application and thus more likely to facilitate settlements. It is more certain because a market-based approach to damages focuses on the objective ‘value’ of the promise broken without regard to the plaintiff’s specific circumstances or intentions, ignores extraneous events, such as ‘accidental’ transactions between the plaintiff and third parties, and thereby avoids the need for prolonged factual inquiries. This tension is further reflected in the line of cases dealing with the situation where a seller breaches a warranty of quality yet the defective goods are successfully on-sold by the buyer. Application of the latter approach allows the buyer to recover the difference between the value of the goods promised and the value of those actually delivered, whereas the former confines the buyer to recovery of the actual loss, if any, suffered.

A

Slater v Hoyle & Smith

Until recently, the leading case was Slater v Hoyle & Smith Ltd.85 The respondent buyers bought cloth from the appellant sellers, some of which 84 85

Ibid, 116. [1920] 2 KB 11 (CA).

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they used, after bleaching, to fulfil an earlier contract of sale to a third party. The cloth was inferior in quality than warranted and the buyers recovered damages based on the difference between the market value of the cloth if it had been as warranted and the market value of the cloth delivered, notwithstanding that they had received the full contract price in respect of the cloth on-sold to the third party. The Court of Appeal rejected the sellers’ argument that there was no loss, and therefore no damages were recoverable, in respect of that cloth. Bankes LJ applied the principle in Rodocanachi and Williams Bros and held that no account was to be taken in assessing the damages of the sub-sale, which was merely ‘accidental’ as between the parties. He thought that Wertheim could not be ‘extended to apply to a case where damages are claimed for a breach of warranty of quality’86 but did not find it necessary to decide the point because the rule in Wertheim would only be capable of application in any event where the sub-sale relied on in mitigation of damages is a sale of the identical article which was the subject of . . . the principal sale. 87

Here the buyers bought unbleached cloth and sold bleached cloth. Warrington LJ adopted essentially the same approach as Bankes LJ, albeit that he was prepared to rule that Wertheim only applied to cases of late delivery. The buyers in this case had received goods inferior to those specified in the contract. They had ‘lost the difference in the two values’ and it was ‘immaterial that by some good fortune’ they had been able to on-sell the cloth at a profit.88 If the cloth had been as warranted they might have on-sold it at an even higher price and used other cloth to fulfil the subcontracts in question. The third judge, Scrutton LJ, also applied the principle in Rodocanachi and Williams Bros. The result of the sub-sale was res inter alios acta. It was a matter ‘peculiar to the plaintiff’ which could not affect the damages ‘one way or the other’.89 His Lordship further said: If the buyer is lucky enough, for reasons with which the seller has nothing to do, to get his goods through on the sub-contract without a claim against him, this on principle cannot affect his claim against the seller any more than the fact that he had to pay very large damages on his sub-contract would affect his original seller.90

His Lordship was also strongly critical of the Privy Council’s decision in Wertheim. He thought that the principles applicable to delay in delivery (as in Wertheim) and delivery of inferior goods were the same as the principles applicable to non-delivery which were established in Rodocanachi and 86 87 88 89 90

Ibid, 15. Ibid. Ibid, 18. Ibid, 23. Ibid.

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Williams Bros, and that ‘the Privy Council judgment was erroneous as departing from those principles’.91 Interestingly, his Lordship acknowledged that this may result in the plaintiff recovering ‘more than an indemnity’,92 but he had no qualms about that, pointing to cases illustrating that English law sometimes gives plaintiffs more and sometimes less than their real loss. If, as I have earlier argued, Rodocanachi and Williams Bros ought no longer to be followed, the decision in Slater ought to suffer the same fate. The argument that the buyers might well have used other goods to fulfil the on-sale is unconvincing because the assessment of damages in this context, which involves a comparison between actual and promised positions, must surely be based on what they did do. The fact that, in other circumstances, they might have been entitled to a higher award is irrelevant. Equally unconvincing is Scrutton LJ’s argument based on evenhandedness of treatment: that is, a buyer should be no more accountable for compensating advantages stemming from an on-sale than the seller should be affected by the fact that the buyer is liable for ‘very large damages’ arising from the on-sale. The question whether the seller is liable in the latter situation is one of remoteness of damage—was the loss claimed by the buyer within the reasonable contemplation of the parties at the time of the contract? On the other hand, ‘foreseeability has nothing to do with the question whether damages higher than those actually suffered should be recoverable’.93

Ibid, 24. Ibid. Ontario Law Reform Commission, above n 73, 502. As noted earlier (see n 62), Professor Waddams argues (n 56, para 1.1930) that cases of late delivery are distinguishable from those of non-delivery and delivery of defective goods: ‘In the case of non-delivery, as of destruction of goods, the plaintiff is entitled to their value at the time of the loss notwithstanding that she would have failed to realize the value if the goods had been duly delivered. Again, in the case of delivery of defective goods, as of damage to goods, the plaintiff is entitled to the diminution in the value of the goods even though he succeeds in selling them to a third party at a price appropriate to sound goods. These are cases where the plaintiff can realistically assert that a capital loss is suffered at the date of the wrong and is entitled to have it made good. What would have been done with the goods later or what actually is done with the defective goods can justifiably be excluded as irrelevant . . . [T]here are strong arguments of simplicity for excluding such considerations. These arguments, however, are not so easily applicable to the case of delay. There the substance of the plaintiff’s complaint is not that a capital loss has been suffered. He does not demand a sum of money that will stand instead of the property he ought to have had. A sum of money to compensate for temporary deprivation of the property is demanded and the plaintiff ought to show therefore that, had the wrong not been done, some profitable use of the property would have been made.’ Waddams therefore concludes (at para 1.1940) that Wertheim, Rodocanachi, Williams Bros and Slater ‘are all rightly decided’. 91 92 93

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B Bence Graphics v Fasson In any event, the authority of Slater has now been undermined by the decision of the Court of Appeal in Bence Graphics International Ltd v Fasson UK Ltd.94 Although the reasoning of the majority judges in this case suffers from its own set of difficulties, one thing is clear: they were not prepared to countenance an award in respect of an alleged loss which the evidence plainly showed had not been suffered. The facts were relatively straightforward. The plaintiffs bought a substantial quantity of vinyl film from the defendants which they used in the manufacture of labels for identifying shipping containers. The film was defective. It did not have the durability of at least five years, as warranted by the defendants. Complaints were made by the end users, but these resulted in only one relatively minor claim which was duly settled by the plaintiffs and reimbursed by the defendants. The plaintiffs sought to recover the whole purchase price of some £564,000. They invoked the normal measure of damages for breach of warranty of quality as codified in section 53(3) of the Sale of Goods Act 1979. They succeeded at first instance, with the judge ruling that the film actually delivered was worthless. However, the Court of Appeal, by a majority, allowed the defendants’ appeal. The plaintiffs were awarded £22,000 in respect of unused film and the case was remitted for an assessment of any consequential damage they had suffered. It was held that the prima facie measure was displaced where, as in this case, the parties contemplated that the goods would be used to manufacture a product for on-sale. The damages were to be assessed on the basis of the buyers’ liability to end users as a result of the sellers’ breach of warranty, regardless of whether that amount would be higher or lower than the amount resulting from application of the ordinary measure. This was the true loss to be compensated according to the Hadley v Baxendale principle.95 In reaching this conclusion, both majority judges declined to follow Slater. Otton LJ thought that the latter could be ‘narrowly distinguished’ because In the instant case the goods were substantially converted or processed by the buyer and the sellers were aware of the precise use to which the film was to be put at the time the contract was made

whereas in Slater ‘the sub-sale was of the same goods albeit after bleaching’ and ‘the seller did not know of the contemplated sub-sale’.96 However, Auld LJ reasoned, convincingly in my view, that the cases were not distinguishable: in Slater the cloth was processed by bleaching before being on-sold, which was not ‘materially different . . . from incorporating the 94 95 96

[1998] QB 87 (CA). (1854) 9 Ex 341. Bence Graphics, above n 94, 99.

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goods in a manufactured product for onward sale’,97 and the sellers, who were dealing with commercial buyers of a large quantity of cloth, must have known that it would be on-sold. His Lordship concluded that the time has come for [Slater] to be reconsidered at least in the context of claims by a buyer for damages for breach of warranty where he has successfully on-sold the subject matter of the contract in its original or modified form without claims from his buyers’.98

The reasoning in Bence Graphics has been strongly criticised.99 Some of that criticism is valid. In particular, as Treitel argues, the discussion of the rules of remoteness and the factual analysis of what the parties reasonably contemplated were largely beside the point. The case was about measurement or quantification of loss. The general issue before the court was: did the buyers suffer loss as a result of the sellers’ breach and, if so, how much worse off were they than they would have been if the contract had been performed? More specifically, the issue was one concerning avoided loss: the buyers had no doubt suffered a prima facie loss when they received goods that were less valuable than promised, but was that loss avoided when they, for the most part successfully, on-sold the goods in their modified form? However, although the judges’ reasoning unnecessarily embarked on an analysis of remoteness principles, it is fair to say that what primarily prompted their disagreement with Slater and the trial judge’s decision in the instant case was their conviction that it was wrong ‘to award a buyer more than the evidence clearly showed he had lost’.100 Treitel argues that the diminution in value did cause a loss to the buyers in both Slater and Bence Graphics, and that the loss was not avoided through receipt of the gains from the ‘sub-sales’ because they ‘clearly fell’ into the category of collateral benefits.101 The buyers in those cases would have been entitled to deliver other goods to their sub-buyers and ‘might have wished to do so if the market had fallen’.102 They would ‘then be left with the defective (and hence less valuable) goods delivered under the original contract’103 in respect of which damages based on the difference between actual and warranted values would clearly be payable. Thus, it is Ibid, 103. Ibid, 102. GH Treitel, ‘Damages for Breach of Warranty of Quality’ (1997) 113 LQR 188; C Hawes, ‘Damages for Defective Goods’ (2005) 121 LQR 389 and ‘Sale of Goods Contracts: The Effect of Subcontracts on Damages for Breach of Warranty of Quality’ (2005) 11 New Zealand Business Law Quarterly 253. See also MG Bridge, ‘Defective Goods and Sub-sales’ [1998] Journal of Business Law 259, 262 (‘outcome in Bence is not self evidently correct’). 100 [1998] QB 87, 105 (Auld LJ). 101 Treitel, above n 99, 193. 102 Ibid, 192. Treitel concedes that the rule in Slater does not apply where the buyer ‘has entered into a subsale on such terms that it can be performed only by delivery of the goods bought under the original contract’. The distinction was applied in Louis Dreyfus Trading Ltd v Reliance Trading Ltd [2004] 2 Lloyd’s Rep 243 (Comm). 103 Ibid. 97 98 99

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argued that, being ‘initially in the position of having received goods worth less than they should have been’, if the buyers are skilful or fortunate enough subsequently to avoid or reduce that loss, there is no good reason for passing this benefit on to the seller[s].104

As already indicated in response to the same arguments by the judges in Slater, I disagree. There is no justification for foisting a damages bill on a defendant in respect of a loss that has been avoided or reduced. It is true that the sellers in Bence could count themselves lucky that the defect in the goods they supplied was not discovered until long after those goods were incorporated into the manufactured product and that most of the end users of the product did not seek legal redress. But, one might ask, why should that be relevant when the goal is compensation? Upholding the buyers’ damages claim smacks of punishment rather than compensation. Damages should be awarded on the basis of what actually happened, not on the basis of what might have happened in worst-case scenarios from the defendants’ point of view. Suppose that in Bence (i) all of the defective film supplied by the defendants had been consumed; (ii) the labels manufactured by the plaintiffs began to deteriorate on average after four years; (iii) despite some complaints, no claims for compensation were made against the plaintiffs; and (iv) the latter suffered no other consequential business loss. Would we really wish to allow the substantial damages claim for diminution in value, or even a somewhat reduced (and perhaps more realistic) claim which did not attribute a nil value to the defective film?

C

McSherry v Coopers Creek

The argument that there should be an award of nominal damages only in such a scenario is further supported by the decision of Panckhurst J in the recent New Zealand High Court case of McSherry v Coopers Creek Vineyard Ltd.105 The facts were very simple. A wine producer and wholesaler sold bottles of wine to a retail wine merchant. The wine was mislabelled. Its quality was inferior to that stated on the labels. The buyer on-sold all of the wine on his normal terms to retail customers. None of it was returned. Nevertheless, the buyer claimed damages of $23,000, the alleged difference between the value of the wine the seller agreed to supply and the value of the wine actually supplied. The judge viewed the decisions in Slater and Bence as presenting ‘a stark choice of options’.106 His Honour outlined Professor Treitel’s criticisms of Bence but was not persuaded by them because the ‘overarching principle’ was that 104 105 106

Ibid, 192–3. (2005) 8 NZBLC 101,619 (NZHC). Ibid, 101,623 [14].

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damages for breach of contract are designed to place the innocent party in the same position he would have been in if the contract had been performed.107

He concluded: While I accept that the approach in Slater has some commercial appeal, in terms of consistency, predictability of outcome and placement of responsibility on the errant seller, the attainment of those ends does not in my view outweigh the problem of principle. That is for a seller to be entitled to damages when, in the event, the transaction has not occasioned him loss, is to subvert, not promote, the purpose of damages in contract. Money will not have restored his position, but rather elevated it on the basis of a theoretical loss. This, in my view, cannot be right.108

I suggest that the judge was correct to so rule. It ‘cannot be right’ to award substantial damages for financial loss to a plaintiff who is already in exactly the same financial position as if the contract had been performed. Nevertheless, as with Bence, the decision has not escaped criticism.109 It has been argued that the buyer should have recovered in respect of the diminution of value even though he made the same profit from on-sales that he would have made if the goods had been as warranted and there had been no claims by disgruntled sub-buyers. The judge’s reasoning is criticised as resting on ‘the fundamentally questionable assumption that the buyer had suffered no loss’.110 The author’s argument here is difficult. On the one hand, she suggests that it is ‘a loss to the buyer to receive goods which do not answer to their warranty’ and that ‘there exists an underlying assumption in s 54 [s 53 of the UK Act] that loss results to the buyer in consequence of the breach of warranty itself’.111 On the other hand, she concedes that ‘in a particular case, the result of the application of that section might be that no damages are payable at all’,112 presumably because there might be no loss, as perhaps where the defect is so minor as to have no impact on market value. The author amplifies her argument as follows: If one applies [s 53] to the facts of McSherry (and to Bence), it is not clear that it can be said that the buyer suffered no loss. The loss suffered by the buyer who contracts for good wine but receives bad wine is that the buyer has paid too much for the inferior wine under the original contract. Let us suppose that a buyer contracts to pay $10 for wine; the wine is delivered by the seller as warranted to the buyer who then onsells it in his restaurant to a customer for $15. The buyer has received as contemplated a profit of $5. If, however, inferior 107 108 109 110 111 112

Ibid, 101,624 [17]. Ibid, 101,625 [20]. See Hawes, above n 99. Hawes, ‘Sale of Goods Contracts’, above n 99, 258. Ibid, 259. Ibid, 258.

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wine is delivered, the buyer has suffered a loss, even if the wine is on-sold for $15 to an uncomplaining customer; the breach of warranty means that the buyer has paid more than the buyer would have paid were it known that the wine was of inferior quality. The agreement to pay $10, whether that was the market price or not, was achieved in exchange for a promise that the agreed quality of wine would be delivered. The buyer would not have agreed to pay $10 for superior wine in exchange for a delivery of inferior wine. The buyer who remains uncompensated has, therefore, in consequence of the seller’s breach of warranty, paid too high a price for the wine which was delivered and has received inadequate consideration for the payment.113

There is a hint here of application of an inappropriate tort measure of damages: if the buyer had known of the breach of warranty he would not have entered into the contract. But let us leave that to one side. It is undoubtedly true that if I pay for a high-quality wine but inferior wine is delivered I can usually recover the difference in value (even if I and my party guests happily consumed it without noticing that anything was amiss). But if the facts are the same except that I bought the wine for on-sale and I did sell it for the expected price, the loss I might otherwise have suffered has surely been avoided.

D

The Jamal Case

If the foregoing analysis is accepted, the correctness of the well-known decision of the Privy Council in Jamal Moolla Dawood, Sons & Co114 might also be questioned. In this case, decided four years after British Westinghouse and at first sight inconsistent with it,115 the appellant agreed to sell shares to the respondents, with completion to take place some months later on 30 December 1911. In the meantime, however, the market price of the shares fell substantially (by some 109,000 rupees) below the contract price, and the respondents refused to complete. Negotiations between the parties, which failed to resolve the dispute, continued until late February, whereupon the appellant began to resell the shares. He managed to do so at prices that, overall, were significantly higher than the market price at the completion date, but still some 80,000 rupees less than the contract price. When he sued for damages the respondents argued that the latter sum represented the true loss suffered, but the Privy Council upheld the appellant’s claim for the difference between the contract price and the market price at the completion date.

Ibid, 259–60. Above n 19. Viscount Haldane, who delivered the main speech in British Westinghouse, was also a member of the Board in Jamal. 113 114 115

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This conclusion is supported by all the leading damages texts. Interestingly, Jamie Cassels argues, inter alia, that a logical explanation for the apparent overcompensation of the appellant is that ‘the case can be considered one of “lost volume”’,116 that is, it involved a situation where the seller’s ability to supply exceeded demand and hence it was appropriate to treat the second sale, not as a substitute transaction, but rather as a separate sale because if the first buyer had not breached there would have been two sales, not just one. The author continued: Shares are a fungible property and the plaintiff was in the business of buying and selling shares. Had the original sale gone through, it is at least possible that the plaintiff might have purchased other shares in order to undertake further transactions.117

However, it is not entirely clear from the report in Jamal that the appellant was a dealer in shares and, in any event, it would surely be incumbent on him to demonstrate not just the capacity to make an additional sale but also the likelihood that he would indeed have made it. The author also suggests a ‘more important’ policy reason for the decision: [T]he result in Jamal is consistent with the policy of mitigation and fair post-breach risk allocation. Had the plaintiff sold the shares at the time of the breach, the defendant would have been liable for the loss. Having chosen to retain the shares, the plaintiff took the risk that their price might fall even further and he would not then be able to claim any additional damages due to that decline. The result is therefore fair in that the plaintiff takes both the risk and the reward of post-breach fluctuations in the value of the shares.118

This argument essentially repeats the reasoning of the Privy Council. Lord Wrenbury, who delivered the judgment of the court, held that the principle that ‘market value at the date of breach is the decisive element’,119 which was applied in Rodocanachi120 and accepted by the House of Lords in Williams Bros,121 was applicable regardless of whether the breach was by the seller or the buyer. His Lordship said: The question . . . may be stated thus: In a contract for sale of negotiable securities, is the measure of damages for breach the difference between the contract price and the market price at the date of the breach—with an obligation on the part of the seller to mitigate the damages by getting the best price he can at the

Cassels, above n 29, 358. Ibid. Ibid. See also McGregor, above n 56, paras 7.111–7.115 and Waddams, above n 56, paras 5.1480–5.1500. 119 Jamal, above n 19, 180. 120 Rodocanachi, above n 75. 121 Williams Bros, above n 66. 116 117 118

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date of the breach—or is the seller bound to reduce the damages, if he can, by subsequent sales at better prices? If he is, and if the purchaser is entitled to the benefit of subsequent sales, it must also be true that he must bear the burden of subsequent losses. The latter proposition is in their Lordships’ opinion impossible, and the former is equally unsound. If the seller retains the shares after the breach, the speculation as to the way the market will subsequently go is the speculation of the seller, not of the buyer; the seller cannot recover from the buyer the loss below the market price at the date of the breach if the market falls, nor is he liable to the purchaser for the profit if the market rises. It is undoubted law that a plaintiff who sues for damages owes the duty of taking all reasonable steps to mitigate the loss consequent upon the breach and cannot claim as damages any sum which is due to his own neglect. But the loss to be ascertained is the loss at the date of the breach. If at that date the plaintiff could do something or did something which mitigated the damage, the defendant is entitled to the benefit of it . . . But the fact that by reason of the loss of the contract which the defendant has failed to perform the plaintiff obtains the benefit of another contract which is of value to him does not entitle the defendant to the benefit of the latter contract . . .122

This reasoning is unsatisfactory in a number of respects. First, the references to mitigation, as in so many other cases, are confusing. We may wish to restrict the seller to recovery of the contract/market price differential at the date of the breach, but there ought to be no question of an ‘obligation’ to resell. The appellant in Jamal was perfectly free to retain the shares. There is also no question of the seller being ‘bound to reduce the damages, if he can, by subsequent sales at better prices’. If he had sold immediately, he would plainly have been entitled to recover the full amount claimed even if informed opinion was that prices would rise again. Secondly, it is now axiomatic that assessment at the date of breach is not an inflexible rule and may be departed from if justice so requires.123 As Lord Wilberforce pointed out in Johnson v Agnew: In cases where a breach of a contract for sale has occurred, and the innocent party reasonably continues to try to have the contract completed, it would to me appear more logical and just rather than tie him to the date of the original breach, to assess damages as at the date when (otherwise than by his default) the contract is lost.124

Jamal was arguably a case where the plaintiff reasonably sought to have the contract completed, in which case, under the principle in Johnson v Agnew, if the share price had fallen further while the parties negotiated settlement of their dispute, this additional loss (assuming no subsequent profitable Jamal, above n 19, 179–80. Johnson v Agnew [1980] AC 367 (HL) 401; Smith New Court Securities Ltd v Scrimgeour Vickers (Asset Management) Ltd [1997] AC 254 (HL) 265–6; Carbopego-Abastecimento De Combustiveis v AMCI Export Corpn [2006] 1 Lloyd’s Rep 736 (Comm) 742–4. 124 [1980] AC 367 (HL) 401. 122 123

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resales) ought to have been recoverable. Full recovery of the actual loss suffered should only be denied if the seller ought reasonably to have resold at or shortly after the time of breach. If, on the other hand, prices had risen, there ought to be a corresponding reduction in the damages. And since the parties were negotiating, there would be no question of depriving the seller of the benefit of his speculation. Thirdly, the false premises tend to undermine the hypothetical reasoning in the second and ensuing sentences of the passage quoted above. The reasoning seems circular. Lord Wrenbury essentially says: if the seller is bound to seek subsequent sales and if he is successful in this regard and if the buyer is entitled to a corresponding reduction in damages, it must follow that he must bear the burden of subsequent losses, and since the latter is impossible so too must be the former. In my view, the references to mitigation and the date of assessment distracted attention from the fundamental compensatory principle. The question, which is inevitably dependent on the facts of each case, is: what sum is required to put the plaintiff in the position he would have occupied if the contract had not been breached? And, on the facts as reported, the appellant in Jamal was put in a better position. The fact that he could not recover, for whatever reason, the full loss suffered if the shares had dropped further in value is not a convincing reason for overcompensating him in the actual circumstances (at least those reported) that were before the court. Jamal was applied in the sale of goods context by the English Court of Appeal in Campbell Mostyn (Provisions) Ltd v Barnett Trading Co.125 In this case the defendants wrongfully rejected goods that they had agreed to buy from the plaintiffs. They were held liable to pay damages measured by the difference between the contract price and the market price at the date of breach notwithstanding that only two weeks later, due to a government announcement that goods of the type in question would in future be subject to import licence, the plaintiffs resold the goods at a profit (the price, it seems, being more than the price of the sale to the defendants). The Court recognised that, in such circumstances, where there has prima facie been no loss, ‘those who are called upon to pay damages have a quite natural sense of grievance’,126 but it had no apparent hesitation in applying Jamal. The result has been described by Andrew Burrows as ‘unfortunate’ because it left the plaintiffs in a better position than if the contract had been performed and therefore unjustifiably runs contrary to the avowed compensatory goal.127

I agree with this view. Of course, if the facts were different and there had actually been a further deterioration in the price during a period of 125 126 127

[1954] 1 Lloyd’s Rep 65 (CA). Ibid, 69 (Birkett LJ). See also 67 (Somervell LJ). Burrows, above n 18, 218.

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unreasonable delay in reselling the goods, that deterioration could not have been charged to the defendants. However, it is not obvious that on the actual facts considerations of mutuality necessarily required payment of damages for a loss that plainly had not been suffered. Interestingly, the latter perspective prevailed in the same court, and both Jamal and Campbell Mostyn were distinguished, in Pagnan & Fratelli v Corbisa Industrial Agropacuaria Ltd.128 In this case buyers, having validly rejected a cargo of goods because some of it was damaged, subsequently bought the whole cargo from the same sellers at a reduced price. In fact the price was substantially less than the market price at the date of the seller’s breach and thus extinguished the loss the buyers would otherwise have made based on the difference between that market price and the original contract price. They had in reality made a ‘handsome profit’,129 and the court refused to award damages for the ‘fictitious loss’130 claimed. The second sale formed part of a continuous dealing with the situation in which [the buyers] found themselves and was not an independent or disconnected transaction.131

The decision has been criticised,132 but it is difficult to disagree with the view of Salmon LJ that ‘[t]o allow the buyers’ claim would . . . be contrary alike to justice, common sense and authority’.133 The question arises, however, as to why the result should be different if the sellers, after the buyers’ rejection, had disposed of the cargo to a third party who immediately on-sold to the buyers at below market price.

V

CO L L AT E R A L B E N E F I T S I N N O N - SA L E S CAS E S

The difficulties in determining when a subsequent gain or other apparent compensating advantage reduces the amount of damages otherwise recoverable are by no means confined to the sales context. Several non-sales examples of arguable overcompensation as a result of ignoring offsetting gains or avoided loss are to be found in the modern case law. An examination of three cases will suffice for present purposes.134 The outcomes in the first two seem to me to be plainly wrong. The outcome in the third is at least questionable. [1970] 1 WLR 1306 (CA). Ibid, 1314. Ibid. Ibid, 1315–16 (Salmon LJ). See, eg Greig and Davis, above n 26, 1400. Pagnan & Fratelli, above n 128, 1316. See also Hussey v Eels [1990] 2 QB 227 (CA) (criticised in McGregor, above n 56, paras 7.119–7.120 and Burrows, above n 18, 160–1) and Devine v Jefferys [2001] Lloyd’s Rep PN 301 (QB) (‘result not to be commended’: McGregor, above n 56, para 7.133). 128 129 130 131 132 133 134

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Needler Financial Services Ltd v Taber135

A

In breach of, inter alia, its contractual duty of care, Needler persuaded Mr Taber to transfer his pension scheme to a personal pension plan with a mutual life assurance society. When he retired eight years later Taber discovered that the plan gave him a smaller pension than he would have received under his original scheme. His loss, in capital terms, was prima facie some £21,000. However, the previous year, when the life assurance society was demutualised, he had received an allotment of shares in respect of his personal pension plan. The shares were sold shortly afterwards for nearly £8,000. The issue before the court was whether this sum was an offsetting gain reducing the loss recoverable from Needler. Sir Andrew Morritt V-C answered in the negative. Although Mr Taber would not have taken out the pension plan and would not have received the demutualisation benefit but for Needler’s negligence the common law principles for the assessment of damages [did] not require the value of the benefit of the demutualisation shares issued to Mr Taber to be brought into account in diminution of the compensation to be awarded to him for Needler’s breach of duty.136

This was because the benefit was not caused by and did not flow, as part of a continuous transaction, from the negligence. In causation terms the breach of duty gave rise to the opportunity to receive the profit, but did not cause it.137

In my view, this case was wrongly decided (at least, that is, unless there is a new principle that unforeseeable or wholly fortuitous gains are to be ignored).138 If the test was whether the demutualisation and the resulting benefit were caused by the negligence, plainly the answer was no. The negligence had no effect on the society’s decision to demutualise. As Morritt V-C pointed out, that decision arose from the desire of the board of directors of the Society to have the corporate structure best suited to competing in the new markets for financial products they perceived to have arisen in the mid-1990s.139

However, the fact that his Lordship should feel obliged to make this point tends, in my view, to suggest that something is seriously amiss here. It is [2002] 3 All ER 501 (Ch). Ibid, 512 [28]. Ibid, 512 [26]. See also McGregor, above n 56, para 7.134 (the decision in Needler ‘is to be regretted. The simpler, and it is thought correct, approach is to compare everything which the defendant had acquired by virtue of the personal pension plan with everything he would have received under the abandoned pension. The ongoing personal pension plan can surely be regarded as a continuous transaction, the test which the authorities appear to be applying here.’) 139 Above n 135, 511 [25]. 135 136 137 138

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difficult to see how the concepts of causation and mitigation were even relevant to the issue before the judge. Thus, he viewed the case as requiring an application of Viscount Haldane’s principle concerning avoided loss in British Westinghouse: the subsequent transaction, if it [is] to be taken into account, must be one arising out of the consequences of the breach and in the ordinary course of business.140

The problem here is that Needler did not involve a subsequent transaction. Mr Taber received the benefit from the very transaction induced by the breach of contract. The question to be decided was one of measurement or quantification: what was the amount of the loss suffered by Mr Taber as a result of his being wrongfully induced to transfer to the new pension plan? In other words, how much better off would he have been if he had not acted in reliance on the negligent advice? The answer is that he would have had a pension that was £21,000 more valuable, but by the same token he would not have received the capital gain of £8,000 through the share allotment. To give him the former without bringing into account the latter is to give him an unwarranted windfall. The benefit seems far from ‘completely collateral and merely res inter alios acta’.141 It was a gain that accrued to Mr Taber as a result of his entry into the transaction and would not otherwise have been received.

B Gardner v Marsh & Parsons142 In this case the plaintiffs purchased a leasehold maisonette in a building that had been converted by the owner into four dwellings. They did so in reliance on a negligent report from the defendant surveyors. The report failed to reveal a serious structural defect which was only discovered three years later when the plaintiffs attempted to sell the property. A majority of the Court of Appeal held that they were entitled to recover the full amount of the diminution in value143 notwithstanding that, albeit after a two-year delay, the owner of the freehold had eventually repaired the defect. This action, which was no more than performance by the owners of the contractual obligation under the lease, was seen as ‘res inter alios acta and therefore collateral’,144 mainly because of the lapse of time and the ‘intervening events’: the repairs had only been secured by the plaintiffs after Ibid, 508 [18]. Ibid. [1997] 1 WLR 489 (CA). This was wrongly described by the trial judge as the difference between the value of the property without the defect and its actual value instead of the difference between price paid and actual value. 144 Gardner, above n 142, 503 (Hirst LJ). 140 141 142 143

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what Hirst LJ described as ‘tortuous and prolonged quadripartite negotiations’ with the other tenants, the engineers who had overseen the development and the owner ‘who originally denied responsibility, and only agreed to carry out the work after the threat of legal proceedings’.145 Hirst LJ therefore concluded that the repairs were not part of a continuous transaction of which the purchase of the lease as a result of [the surveyor’s] negligence was the inception.146

Such reasoning is particularly hard to fathom when it is considered that the lease purchased as a result of the negligence contained an obligation on the part of the owner to repair structural defects. By contrast, Peter Gibson LJ (dissenting) concluded that to allow the plaintiffs’ claim would be contrary to justice and common sense as well as the British Westinghouse principle,147 namely, the principle that, where an advantage accrues to a plaintiff from taking action to mitigate his loss, that advantage must be taken into account in assessing the loss, if any, to be recovered.148

The third judge, Pill LJ, however, did not think that there was anything ‘contrary either to principle or to common sense’149 in making an award to the plaintiffs in respect of diminution in value, even though that would amount to double recovery in the sense that they retain damages based on the failure of the chartered surveyor to detect a structural defect in 1985 which was rectified in 1990 without cost to them.150

He, too, relied on the delay and the protracted negotiations the plaintiffs had to undertake in the course of which the plaintiffs, because of the structural defect, were unable to sell the property when they wished to do so.151

In my view, this case was also wrongly decided.152 The fact that the plaintiffs faced delays and difficulties in enforcing their rights under the lease is no basis for treating the eventual carrying out of the repairs as a disconnected or independent transaction. As already stressed, the lease they were wrongfully induced to enter into conferred a contractual right to those repairs. The damages award should have been in respect of the real Ibid, 494. Ibid, 503. Ibid, 511. Ibid, 507. Ibid, 514. Ibid, 511. Ibid, 514. See also McGregor, above n 56, para 7.132 (‘Peter Gibson LJ’s well reasoned dissenting judgment is to be preferred’). 145 146 147 148 149 150 151 152

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losses the plaintiffs had suffered, losses which may well have been not insignificant: for example, the legal and other costs they incurred in the negotiations, the expenses of the attempted resale and gains prevented through their inability to resell, as well as the substantial inconvenience and distress they had to endure.

C

Primavera v Allied Dunbar Assurance Plc153

In this more complicated case the claimant, a restaurant owner, entered into a pension scheme in 1987 designed to produce a tax-free lump sum of £500,000 on his attaining the age of 60. He planned to use this sum to repay a loan that he had taken out in order to expand his highly successful restaurant business. Contributions to the scheme were to be invested in various of the defendant’s funds at the direction of the claimant. An agent of the defendant intentionally withheld the fact that, in order for the sum to be available tax-free, the claimant would have to receive certain minimum income in a particular tax category during three years of the scheme’s operation. This level of income was not achieved, but could easily have been arranged by the claimant through drawings from his company by way of salary rather than dividend. In March 1995, several months after reaching 60, he decided to take the lump sum, but discovered that only £125,875 was available tax-free. At this juncture, the pre-tax value of the fund was £792,896, but, because of the lesser tax-free component, the capitalised value after tax to the claimant was £101,000 less than it would have been had the qualifying income been received. The defendants then incorrectly told the claimant that Budget changes since the plan’s inception meant that in any event the lump sum would have been limited to £150,000. The claimant decided to leave the scheme in place but cease contributions and, in October 1996, he issued proceedings for negligent advice and misrepresentation. Then, in 1997, he discovered that in fact the £150,000 cap did not apply to him, and that a £500,000 tax-free lump sum withdrawal would be available if he achieved three years’ worth of qualifying income. This was arranged and in November 2000 the lump sum became available, the pre-tax value of the fund then having almost doubled to £1,451,760. As at trial, however, the claimant had not elected to withdraw it. The trial judge found that, if he had been properly advised at the outset, the claimant would still have entered the pension scheme but would have arranged the qualifying income, withdrawn the £500,000 tax free in March 1995, repaid the loan and purchased an annuity with the balance.

153

[2003] PNLR 276 (QB).

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The judge awarded damages of £101,000, together with £140,000 in respect of interest paid on the loan from March 1995 to November 2000. On appeal, damages under the second head were disallowed as double counting: the claimant could not claim that the loss was crystallised in 1995 and yet seek to recover the subsequent loan costs. The award of £101,000 was upheld, however, despite the claimant apparently being ‘substantially better off through being unable as a result of the [defendant’s] negligence to do what otherwise he would have done’.154 The Court of Appeal accepted his counsel’s argument that the benefits accruing to the fund through its being left in place . . . were the result of a number of decisions by the [claimant] . . . which were taken for his own benefit and at his own risk, and not so as to mitigate the loss already caused by the [defendant’s] negligent advice.155

In short, the Court held that the claimant’s 1995 choice to continue to be exposed to market risk crystallised the loss at that point. Interestingly, however, the position might have been different, at least for Mance LJ, if the misrepresentation concerning the £150,000 cap had not been made in March 1995 and therefore there had not been the delay of 18 months in arranging the qualifying income. His Lordship thought that there would then have been a strong case for arguing that the claimant’s loss had been mitigated, within the meaning of the British Westinghouse principle, through a continuous course of dealing with the situation in which the claimant found himself when the breach was discovered.156 Whether one agrees with the result in this case depends very much on whether one thinks that assumption of market risk crystallises a loss or is merely a factor to be assessed in quantifying actual loss. The Court of Appeal decided the former, but it can be argued that the latter is a better approach in this case. The after-tax value of the scheme depended on the independent factors of the performance of the underlying investments and the size of the tax-free lump sum available. However, the defendant’s wrongs went only to the tax factor. Crystallising the loss in this case as at 1995 ignored the fact that, ultimately, the claimant suffered no loss from the tax aspect. It is therefore arguable that, in calculating damages, the better approach is to ask what would have happened had the market risk been separated out as at discovery of the wrong. For example, suppose the claimant had switched the scheme’s investments to a low-risk call account in 1995. He would have continued to pay interest on his loan, but would have earned interest on the scheme funds and would have eventually become entitled to the full tax-free lump sum. In these circumstances, it would seem natural to calculate damages on the basis of his net interest 154 155 156

Ibid, 282 [15]. Ibid, 286 [21]. Ibid, 293–4 [44]–[45].

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expenditure, plus the value of the pension forgone by not withdrawing the lump sum in 1995. Why, then, should the claimant be in a better position than this vis-à-vis the defendant by reason of his choice to retain riskier investments?

VI

IS THERE A PRINCIPLE?

Attempting to formulate a general principle to be applied in determining whether a post-breach gain constitutes a relevant compensating advantage, as opposed to a mere collateral benefit, is hazardous, especially given, as the cases discussed above demonstrate, the multifarious range of factual circumstances that come before the courts. My tentative suggestion is as follows. Leaving to one side the special considerations that apply to third-party gifts and insurance payouts,157 a benefit accruing to the plaintiff ought generally to be taken into account as an offsetting gain which reduces the damages otherwise recoverable if: (i) it is received as a result of entry into the transaction in respect of which damages are claimed and it, or an equivalent benefit, would likely not have been received but for that breach; or (ii) it is a direct result of a dealing with the subject matter of the contract or action taken to avoid the consequences of the breach. When these requirements are satisfied, the benefit is not a ‘disconnected or independent’ gain. Given that the court seeks to ensure that the plaintiff is not put in a better position than if the contract had been performed, the touchstone should always be whether it can fairly be said that all or part of the loss in respect of which damages are claimed has either not been suffered or has been avoided, or is offset by a gain made.

VII

CONCLUSION

The main focus of this chapter has been an area of damages law which, despite its practical significance, commentators have largely neglected, namely, the circumstances in which apparent offsetting gains made by the plaintiff are to be taken into account as a compensating advantage. The general principle that I have suggested ought to govern this matter almost certainly requires refinement, but the discussion has at least demonstrated that the current law is in a dreadful muddle. Of course, the chapter has also ranged much further afield. One of the most intriguing, and difficult, issues thrown up by the cases I have discussed concerns the circumstances in which loss is crystallised at breach 157

See generally Burrows, above n 18, 161–74.

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so that subsequent events and apparent offsetting gains are irrelevant to the exercise of quantifying loss. My initial reaction to the awards in, for example, Turner158 and Jamal159 was that the plaintiffs were overcompensated because they ended up being better off than they would have been had there been no breach. But these were both ‘market’ cases and, as suggested earlier in the course of my discussion of The Golden Victory,160 it can certainly be argued that it is beside the point whether the plaintiffs ‘ended up’ being better off because there is an earlier question to be answered. That question is whether termination for breach has the effect of reallocating market risk to the plaintiff. If there is such a reallocation, subsequent market rises are for the plaintiff’s, not the defendant’s, account. On this approach, damages were correctly calculated in the above cases as if the market risk had been dealt with by the plaintiffs at the time of the breaches. If it is correct that the plaintiffs in Turner and Jamal bore the property and share price risks respectively, there are obvious ramifications for the correctness of the House of Lords’ decision in The Golden Victory. It should follow that there was also a risk reallocation in that case when the charter was terminated. Since the owners had the charter rate risk for the balance of the term, their damages should have been calculated as if they had dealt with that risk at the time of the termination. Finally, the importance and continuing troublesome nature of the issues I have discussed are further illustrated by two recent English High Court cases, one decided before and the other just after the conference at which an earlier version of this paper was presented. In Bear Stearns Bank Plc v Forum Global Equity Ltd161 the defendants were found to have breached a contract to sell to the claimants certain distressed debt securities which, as anticipated, were later converted into shares in a new company that were listed on the stock exchange. Andrew Smith J awarded damages of more than €1m for the non-delivery of the shares based on the difference between the contract price and the market price some 10 months after the breach, not the usual breach date, because, in the somewhat unusual circumstances, the claimants had until that time reasonably sought specific performance. They were therefore not required to go into the market upon the defendant’s breach to buy replacement shares. The significant feature of the case, however, is that the judge rejected the defendants’ argument based on Bence Graphics162 that the damages should be reduced to take into account the fact that the claimants had on-sold half of the very securities they had agreed to purchase from 158 159 160 161 162

[1987] 1 NZLR 218 (NZHC). See text following n 12. [1916] 1 AC 175 (PC). See text following n 114. See text following n 44. [2007] EWHC 1576 (Comm). Judgment was delivered on 5 July 2007. Discussed above in the text following n 94.

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the defendants at a substantially lower price and would therefore be overcompensated if they were awarded the full amount of the contract/market price differential. In rejecting this argument, the judge, who may have proceeded on the basis that the contract with the subbuyers was conditional on the defendants duly performing their obligations,163 ruled that Bence was restricted to cases of delivery of defective goods and held, in line with Williams Bros164 and Rodocanachi,165 that ‘in cases of non-delivery the impact of sub-sales should be ignored’.166 He also considered that, in any event, a sub-sale could only be taken into account where the parties contemplated that [the claimants] might sell on the notes or part of their interest in them under a contract which they could fulfil only by passing on to their buyer the very assets that they were to acquire under the contract with [the defendants].167

Here all that had been established was that it was within their reasonable contemplations that in the ordinary course of events [the claimants] would re-sell some or all of the notes.168

The distinction was seen to be ‘in accordance with the judgments in Bence’ because those judgments emphasise the importance of whether the parties to the contract are to be taken to have known (or to have had within their contemplation) sufficient details of the arrangements for sub-sale that the buyer had made.

However, as suggested earlier when discussing Bence,169 questions of what the parties reasonably contemplated are largely beside the point when the general issue before the court is: did the buyers suffer loss as a result of the sellers’ breach and, if so, how much worse off were they than they would have been if the contract had been performed? In my view, for this and the other reason considered in the earlier discussion of Bence, Williams Bros and Rodocanachi, the decision in Bear Stearns is not in accordance with the compensatory principle. Assuming that the claimants incurred no liability 163 Bear Stearns, above n 161, [82]. His Lordship referred to evidence given on behalf of the claimants that the agreement with the sub-buyers was conditional upon completion of the purchase from the defendants. He recorded his understanding that this was a matter of dispute between the claimants and the sub-buyers, and said that it was ‘unnecessary and undesirable that I explore that or express any view about it’. The problem here is that, if the sub-sale was not conditional and the claimants remained potentially liable to the sub-buyers, there would have been no basis for the defendant’s argument that the court should depart from the normal measure of the difference between the contract and market prices. 164 Discussed above in the text following n 66. 165 Discussed above in the text following n 75. 166 Bear Stearns, above n 161, [206]. 167 Ibid. 168 Ibid. 169 See text following n 99.

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to the third party, and were therefore not obliged to go into the market to buy replacement securities at their increased price, they were wrongly overcompensated. In the other case, Oxus Gold Plc v Templeton Insurance Ltd,170 Templeton exercised an option to purchase conferred by a warrants deed in respect of shares listed in the Alternative Investment Market of the London Stock Exchange. In breach of contract, Oxus refused to deliver the shares. Langley J held that the law was ‘clear and settled at the highest level’, as a result of the decisions in Williams Bros and Rodocanachi, that [t]he measure of damages is the market value of the shares in Oxus on the date they should have been delivered to Templeton and that value is the purchase price of the shares at that date.171

Nevertheless, his Lordship was dissatisfied with being obliged to so rule because, in his view, it led to Templeton being overcompensated. Upon exercising the option, the latter had stated its intention to sell the shares ‘at the earliest opportunity’,172 and the judge found that the company would have done so had they been delivered by Oxus. Given the substantial number of shares involved and the market conditions at the time, the market selling price would have been less than the buying price. His Lordship accepted that if, as the established authorities dictated, an actual on-sale is to be ignored, then an intended one can hardly be relied upon to achieve a different outcome173

but he said: I confess (with some very limited encouragement from the recent decision of the House of Lords in [The Golden Victory]) to the wholly irrelevant and presumptuous thought that there is not much to be said for a law of damages as absolutist as this. It does not apply in cases of delayed delivery: Wertheim v Chicoutimi Pulp Co [1911] AC 301. Nor do I find it unjust that a buyer may only recover for loss on an on-sale at a higher than market price in circumstances where the seller may be caught by the second rule in Hadley v Baxendale, because if there is a market he can buy in and still obtain his bargain. To my mind, in circumstances such as the present, which are probably unusual, the law might be better served by a straightforward application of the usual principles of causation. In this case, as a matter of probability, it is easy to conclude (as I find) that had Oxus delivered the shares, Templeton would have sold them and would in doing so have realised less than the cost of buying them in the market . . . I think there was a measurable difference between the two. It

170 171 172 173

[2007] EWHC 770 (Comm). Judgment was delivered on 4 April 2007. Ibid, [83]. Ibid, [51]. Ibid, [79].

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would have been commercially irrational for Templeton to have bought the shares.174

Readers of this chapter will not be surprised at my reaction to this statement. Despite the judge’s self-admonition, his remarks are both relevant and timely. The ‘absolutist’ rule in the authorities that he felt bound to apply is inconsistent with the compensatory principle. Further, a later court better placed to reconsider those authorities might regard the encouragement to do so from the House of Lords’ decision in The Golden Victory as more than ‘very limited’. After all, as noted earlier,175 both the majority and the minority endorsed Wertheim v Chicoutimi Pulp Co and, as we have also seen, the approach and the actual decision in that case are not easy to reconcile with the likes of Williams Bros and Rodocanachi.

174 175

Ibid, [80]. See text at n 60.

16 Damage to Business Reputation and Goodwill under the Vienna Sales Convention DAMAGE UNDER THE VI ENNA S ALES CONVENTI ON

DJAKHONGIR SAIDOV * DJ AKHONGI R S AI DOV

I

I NTRO DUCTION

Suppose that a buyer claims damages under the Sales Convention (hereafter the Convention or the CISG) because a seller has delivered defective goods which the buyer’s customers rejected, having refused to do business with the buyer in the future. The buyer now claims damages for loss of business reputation or goodwill, along with damages for loss of profit and loss of customers or business. To address this claim a judge or an arbitrator will have to answer a number of questions. For example, do these heads of damages imply the same loss? If it is assumed that such phenomena as business reputation or goodwill exist, how should they be defined and where is that definition to be found? Is the loss of reputation and goodwill the same thing? Even if a judge or an arbitrator adopts a particular definition, is loss of reputation and/or goodwill recoverable under the Convention? Assuming that they are, is there any rational method of measuring them? Will the award of damages for loss of reputation and/or goodwill duplicate the award for lost profits and/or loss of custom? There are no readily available answers to these questions. The existing commentaries do not reveal the existence of a uniform position on the interpretation of the Convention with respect to the issue of the recoverability of losses of reputation and goodwill,1 and there have been * Lecturer, University of Birmingham. I am grateful to Nelson Enonchong, Ralph Cunnington, Albert Kritzer, Sarah Green and Tanya Corrigan for their helpful comments on earlier drafts. 1 See, eg Stoll and Gruber, ‘Arts. 74–77 CISG’ in P Schlechtriem and I Schwenzer Commentary on the UN Convention on the International Sale of Goods (Oxford University Press, 2nd English edn, 2005) 753; F Blase and P Höttler, ‘Claiming Damages in Export Trade: On Recent Developments of Uniform Law’ in Pace International Law Review (ed), Review of the

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few attempts to analyse the nature of such losses and almost no attempts to rationalise possible ways of measuring them. The current state of case law is more frustrating as the reported decisions not only take different positions but often do not even make clear what their position is. There are several groups of relevant CISG cases, including those where: (i) damage to reputation and goodwill was held irrecoverable;2 (ii) the position on the recoverability of such losses was unclear;3 (iii) this type of loss was held recoverable;4 and (iv) claims for this type of loss were simply not addressed by tribunals.5 Against this background, I aim to address two sets of questions. First, should damage to reputation and goodwill be recoverable under the Convention? Secondly, if so, how should it be proved and measured, and what is its relationship with other potentially related losses, such as loss of profit, loss of custom and loss of a chance to enhance reputation?

II

A

I S DAM AG E TO R E P U TAT I O N A N D G O O DW I L L R E C OV E R A B L E U N D E R T H E C O N V E N T I O N ? 6

Arguments in Favour of the Recoverability

It is true to say that business reputation and goodwill are intangible phenomena. As argued below, in the context of breach of contract, business reputation and goodwill should be understood as referring to people’s perceptions and judgments about a company’s past performance and future prospects. The first question that needs to be addressed is whether damage to these intangible phenomena is recoverable under the Convention. Convention on Contracts for the International Sale of Goods (CISG) 2004–2005 (Munich, Sellier—European Law Publishers GmbH, 2006) 37, 49–51. See nn 12 and 13. China International Economic & Trade Arbitration Commission (CIETAC) Arbitration proceeding, 5 August 1995, available at http://cisgw3.law.pace.edu/cases/950805c1.html (accessed 27 June 2007). Damages for loss of goodwill were denied because ‘the company’s goodwill could not be proved’. It is not clear whether the tribunal took the view that this loss was irrecoverable in principle because of the difficulty of proof or whether it was simply the case that this loss could not be proved in that particular case; CIETAC Arbitration proceeding, 26 October 1996, available at http://cisgw3.law.pace.edu/cases/961026c1.html (accessed 27 June 2007) (see n 36). 4 See n 71. 5 CIETAC Arbitration proceeding, 30 March 1999, available at http://cisgw3.law.pace.edu/ cases/990330c2.html (accessed 27 June 2007); Summit Chemicals Pty Ltd v Vetrotex Espana SA, 27 May 2004, Supreme Court of Western Australia (Court of Appeal), available at http://cisgw3.law.pace.edu/cases/040527a2.html (accessed 27 June 2007). 6 For a comparative overview which includes the discussion of the recoverability of damage to reputation in various legal systems, see JY Gotanda (2006) ‘Damages in Lieu of Performance because of Breach of Contract’,Villanova University School of Law Working Paper 53 (2006), available at http://law.bepress.com/cgi/viewcontent.cgi?article=1053&context=villanovalwps (accessed 27 June 2007). 2 3

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The CISG does not contain a definition of loss7 and there is a general agreement that most financial losses flowing from a breach are in principle recoverable.8 As far as non-pecuniary losses are concerned, most such losses are unlikely to be relevant to commercial transactions because such transactions usually give rise only to pecuniary or economic considerations, and because most commercial players are legal entities which are incapable of suffering most types of non-pecuniary loss (such as emotional harm or mental distress).9 Nevertheless, business reputation and goodwill are those intangible phenomena which may be relevant to commercial transactions and, therefore, damage to these intangibles cannot be easily dismissed as being irrecoverable under the CISG. We are further warned not to dismiss such losses too readily by other international contract law instruments which expressly provide that non-pecuniary losses are, in principle, recoverable.10 Against this background, I argue that answering the question of whether damage to reputation and goodwill is recoverable requires an in-depth inquiry into the nature of this loss. I will begin by noting that some commentators argue that only pecuniary losses flowing from damage to intangibles are recoverable,11 and a similar attitude has been expressed in some cases decided under the CISG. For example, in one case, the court stated that [t]he [buyer] cannot claim a loss of turnover, on the one hand—which could be reimbursed in the form of lost profits—and then, on the other hand, try to get additional compensation for a loss in reputation. A damaged reputation is completely insignificant as long as it does not lead to a loss of turnover and consequently lost profits. A businessperson runs his business from a commercial point of view. As long as he has the necessary turnover, he can be completely indifferent towards his image.12

Likewise, another court has stated that ‘deterioration of commercial image [reputation] is not compensable damages in itself, if it did not entail proved pecuniary damages’.13 These cases seem to reflect the view that damage to See Art 74 CISG. See, eg Blase and Höttler, above n 1, 49. See, eg Camera Arbitrale Nazionale ed Internazionale di Milano (National and International Arbitral Tribunal of Milan), Arbitral Award No A-1795/51 (1 December 1996), available at http://www.unilex.info/dynasite.cfm?dssid=2377&dsmid=13618&x=1 (accessed 27 June 2007) (where the tribunal, applying the UNIDROIT Principles, excluded compensation for emotional harm and distress because the injured party was a corporate entity). 10 See Art 7.4.2(2) UNIDROIT Principles and Art 9:501(2)(a) PECL. 11 See Stoll and Gruber, above n 1, 753; CISG Advisory Council (CISG-AC) No 6, ‘Calculation of Damages under CISG Article 74 para 7.1’, available at http://www.cisg.law. pace.edu/cisg/CISG-AC-op6.html (accessed 27 June 2007). 12 Case No 10 O 72/00, LG Darmstadt (9 May 2000) (District Court Darmstadt, Germany), available at http://cisgw3.law.pace.edu/cases/000509g1.html (accessed 27 June 2007). 13 Sté Calzados Magnanni v SARL Shoes General International (21 October 1999) (Grenoble, Court of Appeal, France), available at http://www.cisg.law.pace.edu/cisg/wais/db/cases2/ 991021f1.html (accessed 27 June 2007). This decision overruled the decision in the first instance where compensation for loss of reputation had been awarded. 7 8 9

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reputation and/or goodwill is somehow not a ‘real loss’ in itself and that it only becomes such where adverse pecuniary consequences follow.14 The question is whether this is a proper approach to take under the CISG. The procedure that the CISG adopts to deal with issues which it does not expressly address is, first of all, to determine whether the issue in question is governed by the CISG.15 If so, the matter needs to be resolved on the basis of the Convention’s general principles.16 To deal with the first part of this procedure, it is submitted that the issue of the recoverability of losses is certainly within the Convention’s scope. The Convention expressly aims to deal with the issue of damages and, therefore, the answer to this question needs to be found within the Convention itself. Is there a relevant general principle which would help resolve the matter? It is often suggested that the principle of ‘full compensation’ can be regarded as a general principle17 and it is sometimes argued that it is this principle that dictates that loss of reputation and goodwill be recoverable.18 But this is probably too easy an answer,19 because full compensation would dictate the recovery of damage to intangibles only if such damage is regarded as a (recoverable) ‘loss’ within the meaning of Article 74 in the first place. It would appear, then, that the issue is one of the interpretation of Article 74, and the question to be answered is whether damage to reputation or goodwill is ‘a loss’ under the CISG. It is suggested that the answer depends on policies of the Convention, which are, in turn, informed by the Convention’s underlying values.20 This is, of course, not the place to explore such policies and values. For present purposes, it will suffice to state that the CISG aims to support international trade and commerce, and that it represents an attempt to provide a balanced set of rules that would be acceptable to international traders. It is often argued 14 This is the position that is sometimes taken in the context of English law: see N Enonchong, ‘Contract Damages for Injury to Reputation’ (1996) 59 MLR 592, 597. 15 The Convention defines its scope in very general terms by referring to the issues of formation and rights and obligations of the parties flowing from the contract (see Art 4). 16 See Art 7(2) CISG. 17 See Comment 3 to Art 70 of the 1978 Draft Convention; see also cases decided by the Internationales Schiedsgericht der Bundeskammer der gewerblichen Wirtschaft (Arbitral Tribunal Vienna, Italy) Case No SCH-4318 (15 June 1994), available at http:// cisgw3.law.pace.edu/cases/940615a4.html (accessed 27 June 2007); Case No SCH-4366 (15 June 1994), available at http://cisgw3.law.pace.edu/cases/940615a3.html (accessed 27 June 2007). 18 See A Burrows, Remedies for Torts and Breach of Contract (Oxford University Press, 3rd edn, 2003) 317. 19 The same can be said about the argument that Art 7.4.2 of the UNIDROIT Principles could supplement the CISG in this respect. 20 The connection between what constitutes loss, on the one hand, and underlying values of a legal system and of society as a whole, on the other, has been highlighted on a number of occasions. See, eg E McKendrick and K Worthington, ‘Damages for Non-Pecuniary Loss’ in N Cohen and E McKendrick (eds) Comparative Remedies for Breach of Contract (Oxford, Hart Publishing, 2005) 322; M Bridge, ‘Contractual Damages for Intangible Loss: A Comprehensive Analysis’ (1984) 62 Canadian Bar Review 323, 326–7.

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that to be able to facilitate commercial development legal rules need to meet the legitimate needs, expectations and practices of commercial men.21 This line of thinking leads to the question whether businessmen would view reputation or goodwill as something that is important for their business. Is reputation or goodwill something into which they will invest money, time, and effort? Is it something on which they rely in conducting their affairs? In short, is it reasonable to expect that commercial men would generally regard business reputation and goodwill as important assets? I suggest that it is the answer to these questions that should be decisive in resolving the question whether damage to reputation/goodwill is recoverable under the CISG. It does not seem possible to make generalisations in answering these questions.22 It is certainly true that in some industries or trade sectors reputation or goodwill may be regarded as an important asset whereas in others this may not be the case.23 It may also be the case that companies with bad reputations would be very profitable.24 Nonetheless, there is a substantial body of evidence, both in law and outside it, demonstrating that it is often the case that reputation and goodwill are viewed by business persons as important commercial assets. Although the reasons are many, they all revolve around benefits flowing from having a good reputation or goodwill. These benefits include a company’s ability to charge premium prices for their products/services,25 pay lower prices to its suppliers, incur lower marketing costs, attract top recruits, experience greater loyalty from customers and employees, have more stable profits, face fewer risks in times of crisis, obtain credit more easily and, more generally, have greater freedom of decision making.26 Because of these potential benefits, good reputation has been viewed as a strategic resource enabling a company to have a competitive advantage against its rivals.27 Legal research28 has also demonstrated that, in certain trade sectors, See, eg R Goode, Commercial Law (London, Penguin, 3rd edn, 2004) 1203–4. See R Chun, ‘Corporate Reputation: Meaning and Measurement’ (2005) 7 International Journal of Management Reviews 91, 100 (‘A good image/reputation is probably better than a bad image, but the results in the literature have in fact been inconsistent’). 23 See NA Gardberg, ‘Reputatie, Reputation, Réputation, Reputazione, Ruf: A CrossCultural Qualitative Analysis of Construct and Instrument Equivalence’ (2006) 9 Corporate Reputation Review 39, 51. 24 Ibid, 52. 25 See L Bernstein, ‘Private Commercial Law in the Cotton Industry: Creating Cooperation through Rules, Norms, and Institutions’ (2001) 99 Michigan Law Review 1724, 1748–9, nn 104 and 107. 26 There are numerous sources outlining these benefits: see, eg C Fombrun, Reputation: Realizing Value from the Corporate Image (Boston, MA, Harvard Business School Press, 1996) 11, 73, 75. 27 Ibid, 11 and 28. 28 See, eg the following sources with further references: H Collins, Regulating Contracts (Oxford University Press, 1999) 97–126; CP Gillette, ‘Reputation and Intermediaries in Electronic Commerce’ (2001–2002) 62 Louisiana Law Review 1165; L Bernstein, ‘Opting out 21 22

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reputation is an important factor in selecting a transactional partner, a non-legal sanction, a threat of which may deter a breach or help enforce an arbitral decision, or which refers to an injured party’s ability to damage the other party’s reputation by spreading the information about the latter’s breach among other participants in the market.29 There can be little doubt, therefore, that reputation and goodwill play a significant multi-functional role in commercial affairs, and it is not surprising to discover that some companies would make significant investments in terms of money, time and effort in developing and sustaining their reputations.30 The importance of reputation and goodwill is further reaffirmed by evidence and suggestions that companies would sometimes prefer to pay damages or fines than to take the risk of damaging their reputations.31 For these reasons, damage to these intangibles can be potentially quite significant for a company’s business standing, even if it does not immediately result in substantial financial losses. I hope that this discussion has sufficed to demonstrate that reputation and goodwill can be significant business assets and that it is reasonable to assume that commercial men often treat them as such. It also seems fair to suggest that if damage to these intangibles is not recoverable, incentives for commercial men to invest in reputation and goodwill will be reduced.32 All of this appears to point in favour of such damage being, in principle, recoverable. However, before putting this statement as my final suggestion, it is necessary to examine the existing objections to this position.

of the Legal System: Extralegal Contractual Relations in the Diamond Industry’ (1992) 21 Journal of Legal Studies 115; Bernstein, above n 25. 29 See Case No 32 O 508/04 (10 December 2004) LG Bayreuth (District Court Bayreuth, Germany), available at http://cisgw3.law.pace.edu/cases/041210g1.html (accessed 27 June 2007) (where the buyer alleged that its customer had warned other customers not to purchase tiles from the buyer). 30 See El Black and TA Carnes, ‘The Market Valuation of Corporate Reputation’ (2000) 3 Corporate Reputation Review 31; Collins, above n 28, 112. Cases provide a number of examples showing that building a solid reputation may require years to develop and expand business and establish good relations with other companies (eg suppliers and retailers), as well as much effort in ensuring the high quality of goods/services and proper contractual performance, and much financial investment in hiring new employees, promotion and advertising (see decision by Tampere Court of First Instance, 17 January 1997 (Finland), available at http://cisgw3.law.pace.edu/cases/970117f5.html (accessed 27 June 2007) (decided under the CISG); Barrett Co v Panther Rubber Mfg Co 24 F 2d 329, 331 (CA1 1928); Reo D Stott v Thomas Johnston (1951) 36 Cal 2d 864, 872–3 (the latter two cases were decided under the US law)). 31 Fombrun, above n 26, 84; TW Waelde, ‘Contract and Enforceability in International Business: What Works?’, available at http://www.dundee.ac.uk/cepmlp/journal/html/vol5/ vol5-8.html (accessed 27 June 2007). 32 It can also be argued that the recoverability of damage to reputation may, in some cases, create a disincentive for parties to breach their contracts. This would be in line with the idea of favor contractus, which is often said to underlie the CISG (see, eg U Magnus ‘General Principles of UN-Sales Law’, available at http://www.cisg.law.pace.edu/cisg/biblio/magnus.html (accessed 27 June 2007)).

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B Objections (i)

General

Arguments against the recoverability of damage to reputation/goodwill are well known. One objection is that the question of the recoverability of this damage cannot be properly dealt with unless reputation and goodwill are defined precisely for an obvious reason that this question cannot be meaningfully answered unless we know what it is that should or should not be recoverable,33 and the intangible nature of reputation and goodwill makes it impossible to develop a precise and workable definition of what constitutes damage to these phenomena. This also makes it impossible to identify a specific property to which damage has been done; such damages are too speculative, difficult to prove and not capable of a rational assessment.34 For this reason, it can be further argued that making a breaching party pay damages for this alleged loss is simply unfair. According to some courts, this unfair treatment becomes more acute because of the difficulty of setting limits to the recovery of such damages.35 Another objection is that such losses are never foreseeable as required by Article 74 and, for that reason, are not recoverable.36 Finally, the so-called ‘floodgate’ argument is often put forward according to which courts will be swamped with various claims which can be described as loss of reputation/goodwill.37 Each of these objections will be addressed in turn.

33 See D Saidov, ‘Damages: The Need for Uniformity’ (2005–6) 25 Journal of Law and Commerce 393, 395. It can also be argued that, since the ideal is for the Convention to be applied uniformly around the world, reaching an agreement on a uniform definition is important to achieve a uniform treatment of claims for damage to reputation and goodwill. 34 See, eg Kassab v Central Soya 246 A 2d 848, 858 (Pa 1968). Similar points have been made in the context of other disciplines. See SL Wartick, ‘Measuring Corporate Reputation: Definition and Data’ (2002) 41 Business & Society 371, 372 (‘any discussion of measurement must necessarily start with a look at definition. The following thought may be grossly oversimplified, but it seems to me that one cannot talk about measuring something until one knows what that something is’). 35 See Armstrong Rubber Co, Inc v Griffith 43 F 2d 689, 691 (CA2 1930). 36 For cases under the CISG, see CIETAC 26 October 1996, above n 3 (it is not clear, however, whether, loss of reputation was simply not foreseeable on the facts of this case or whether the tribunal took the view that this type of loss could never be foreseeable). This argument has also been raised in the context of other legal systems (for the discussion and further references in English law, see Enonchong, above n 14, 600; in the context of US law, see RP Barbarowicz, ‘Loss of Goodwill and Business Reputation’ (1975) Dickinson Law Review 63, 75; RR Anderson ‘Incidental and Consequential Damages’ (1987) 7 Journal of Law and Commerce 327, 421). 37 See, eg Enonchong, above n 14, 602 and Barbarowicz, above n 36, 68.

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(ii) Definition of Business Reputation and Goodwill The ‘definitional’ objection requires taking a closer look at the attempts made to define business reputation and goodwill.38 So far as the former is concerned, no uniform definition exists for the purpose of dealing with claims for damage to reputation either in the Convention or in some other major jurisdictions. Although the same can be said about the disciplines outside law, the difference is that whereas in law there seems to be paucity of attempts to provide a comprehensive definition, the world outside law is replete with various definitions reflecting different perspectives on reputation depending on the standpoint of a particular subject area.39 Nevertheless, this state of affairs has been criticised and there have been numerous calls for and attempts to form a more integrative and uniform view of reputation.40 Although, against this background, it is difficult to provide a comprehensive definition of reputation, I will begin by highlighting what seem to be the essential characteristics of business reputation. First, there seems to be an agreement that perceptions or impressions are central to the idea of reputation. Reputation is formed on the basis of the processing of information about the company’s past actions and making judgments about its future prospects by an individual, group or community (whichever is relevant). Therefore, reputation is ‘purely perceptual’.41 The second element which has just been mentioned relates to relevant observers’ making judgments about or assessing a company’s business standing. Thirdly, who should be regarded as the relevant ‘stakeholders’ whose perceptions and judgments we need to examine? Clearly, there are potentially a large number of individuals and groups who might be considered stakeholders, including customers, other companies whose 38 Since most players in international trade are companies as opposed to natural persons, the focus is on ‘corporate’ reputation and goodwill. 39 Some sources provide a helpful summary. ‘Economists view reputations as either traits or signals. Game theorists describe reputations as character traits that distinguish among “types” of firms and can explain their strategic behaviour. Signalling theorists call our attention to the informational content of reputations . . . To strategists, reputations are both assets and mobility barriers . . . In marketing research ‘reputation’ focuses on the nature of information processing, resulting in ‘pictures in the heads’ of external subjects, attributing cognitive and affective meaning to cues received about an object they were directly or indirectly confronted with . . . To organizational scholars, corporate reputations are rooted in the sense-making experiences of employees . . . To sociologists . . . reputations are indicators of legitimacy: they are aggregate assessments of firms’ performance relative to expectations and norms in an institutional field . . . [Accountants] highlight the widening gap between factual earnings reported in annual statements and the market valuations of companies’ (C Fombrun and C Van Riel, ‘The Reputational Landscape’ (1997) 1 Corporate Reputation Review 5, 6–9). 40 See, eg ibid, 10–11; ML Barnett, JM Jermier and BA Lafferty, ‘Corporate Reputation: The Definitional Landscape’ (2006) 9 Corporate Reputation Review 26, 27 (‘it seems clear that without a unified approach to the concept itself, we cannot effectively or efficiently advance research on corporate reputation’); Chun, above n 22. 41 Wartick, above n 34, 374.

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business activities are connected with the company in question, employees, investors and the broader community. So, when reputation is said to be damaged, is reference made to perceptions and judgments by all potentially relevant stakeholders, or only those of a particular group? It is probably true that, in the majority of the relevant cases under the CISG, it is damage to reputation amongst customers that is alleged. The reasons are twofold. First, some of the claims for damage to reputation and goodwill are accompanied by or clarified by reference to loss of customers.42 Secondly, it is difficult to deny that loss of customers will usually be the most immediate consequence flowing from the alleged damage to reputation because this consequence relates directly to an injured party’s main line of business.43 For instance, if the seller delivers defective goods which the claimant’s sub-buyers have rejected, it is likely that most of us would understand the claim for damage to reputation as referring primarily to the damage to the claimant’s business relationship with its sub-buyers44 and a possible loss of custom for its goods or services. Nevertheless, outside the Convention examples can be found where courts deemed it possible to define concepts not dissimilar to reputation on the basis that customers were not the only relevant stakeholders. In one US case involving a claim for loss of goodwill, the court stated that, although goodwill is primarily viewed as ‘a function of customer response and ongoing allegiance to a company’,45 the measure of goodwill can also take into consideration ‘a firm’s relationship with creditors, including relationship with its bank’. The court also alluded to the possibility of taking into account not only the relationship with the company’s creditors and banks but also the existence of goodwill in the ‘labour market’.46 This broad approach to defining reputation has also been taken in many writings in business and business-related disciplines. It has been argued that it is necessary to treat reputation as ‘a snapshot that reconciles the multiple images of a company by all of its constituencies’47 because corporate performance does not solely revolve around the relationship with customers but also depends on many other aspects of conducting business, such as the way a company is viewed by existing employees and potential recruits, and a company’s standing in the business world and the 42 See, eg CIETAC Arbitration proceeding 26 October 1996, above n 3. See also EK, L & A v F (Case No 4 C 179/1998/odi), 28 October 1998, Schweizerisches Bundesgericht (Switzerland Supreme Court), 28 October 1998, available at http://cisgw3.law.pace.edu/cases/ 981028s1.html (accessed 27 June 2007). 43 See, in this regard, the US case Toltec Fabrics v August Inc WL 3392801, 2 (SDNY 1993), where it has been stated that it is common for loss of goodwill to be primarily treated as the negative reactions of the injured party’s customers. 44 Who would have lost their trust in the buyer’s being a reliable business partner. 45 Toltec Fabrics, above n 43. 46 Ibid, 2. 47 Fombrun, above n 26, 72.

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local community. In light of these considerations, reputation has been defined as a collective representation of a firm’s past behaviour and outcomes that depicts the firm’s ability to render valued results to multiple stakeholders.48

According to another similar definition, business reputation is a perceptual representation of a company’s past actions and future prospects that describes the firm’s overall appeal to all of its key constituents when compared with other leading rivals.49

Would this approach to defining reputation be acceptable for dealing with the question of the recoverability of damage to reputation? Clearly, the main difficulty is the question of how the multiple stakeholders are to be determined. If multiple stakeholders imply all people with perceptions about a particular company,50 then such a definition is unlikely to be workable. It will not be possible to identify all people with perceptions about a particular business and, even if it were possible, determining exhaustively their perceptions and judgments would not be feasible.51 Should, then, the scope of the definition be confined to a particular group of stakeholders? If so, certain criteria for determining ‘key stakeholders’ will have to be developed. It has been suggested, for example, that ‘key stakeholders’ should include those who have direct monetary exchange relationships with the business, i.e. customers, employees, suppliers, investors and government (representing the community).52

This proposal still seems very broad, covering a wide range of individuals from different groups, and, once again, it is not realistic to expect that an exhaustive survey of all these groups will be possible for the purpose of establishing the existence and measure of reputation in a particular case. How can reliance on a comprehensive definition of reputation be reconciled with the need for its workability in practice? Presumably, one answer to this question is that although exhaustive surveys of relevant stakeholders will not be feasible, it may still be possible to gather enough evidence supporting the existence of reputation amongst the relevant Ibid, 243. Fombrun, above n 26, 72. Although these definitions of reputation have not been free from criticism, it would appear that they have been used more widely than other existing definitions. See, eg Wartick, above n 34, 374–80. 50 This is the position that the multi-dimensional definition of reputation seems to imply: see K MacMillan, K Money, S Downing and C Hillenbrand, ‘Reputation in Relationships: Measuring Experiences, Emotions and Behaviours’ (2005) 8 Corporate Reputation Review 214, 218. 51 ‘For a major company there will be millions of people who will have some sort of perception of it, gained widely in diverse ways . . . How can these millions of perceptions be captured and measured . . .?’ (Ibid, 217). 52 Ibid, 219. 48 49

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groups of stakeholders to satisfy a judge or an arbitrator. Thus, if it is accepted that the standard of proof under the Convention is that of ‘reasonable certainty’, this standard might then require only such an amount of evidence that can be reasonably expected of a claimant.53 Therefore, reliance on the ‘reasonably certainty’ standard may lead to the situation where incomplete evidence would be deemed sufficient for establishing the existence of and damage to reputation. If this is true, a broad definition of reputation might still prove to be acceptable. However, I strongly doubt the workability of this approach in practice and would suggest that a better approach is to refrain from a comprehensive definition and to admit that there is no one reputation. Instead, the relevant questions are: reputation to whom, for what, and for what purpose?54 Taking this position would mean that there are many aspects to the definition of reputation. A claimant may, for example, claim damages only for loss of reputation amongst a very specific group of stakeholders, such as customers or potential investors, and the question ‘reputation for what?’ would have to be answered depending on what a particular group is interested in. A company’s customers would presumably focus on the quality of goods and services, and on other aspects of contractual performance, such as timely delivery. So far as investors are concerned, reputation would relate to a company’s ability to maintain a financially healthy and stable business. In sum, it is possible to define business reputation in very general terms by referring to its essential characteristics of being based on people’s perceptions and judgments. However, it will have to be left to a claimant to answer the questions ‘reputation to whom, for what, and for what purpose?’ in the context of its particular case. Determining the meaning of goodwill is complicated by the existence of different definitions. First, goodwill is often defined in quite general terms by being described as the ‘expectation of continued public patronage’55 or the basic human tendency to do business with a merchant who offers products of the type and quality which the customer desires and expects.56

Although these characterisations lack specificity, they essentially refer to customers’ perceptions of a particular business and, if this is correct, this definition of goodwill refers to a company’s reputation for the quality of its products/services in the eyes of its customers. 53 See D Saidov, ‘Standards of Proving Loss and Determining the Amount of Damages’ (2006) 22 Journal of Contract Law 27, 32; CISG-AC, above n 11, para 2. 54 See PG Lewellyn, ‘Corporate Reputation: Focusing on Zeitgeist’ (2002) 41 Business & Society 446, 451. 55 Reo D Stott, above n 30, 353. 56 Porous Media Corporation v Pall Corporation 173 F 3d 1109, 1122 (CA8 (Minn) 1999).

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Secondly, goodwill is sometimes understood as referring to future lost profits.57 In some US cases it has been held that these are not the profits that were lost directly as a result of the delivery of defective goods but profits that would have been received from the sale of other goods had the relationship with customers not broken down.58 Although, at first sight, this definition appears to treat loss of goodwill as a purely financial loss by equating it with lost profits, I suggest that, just like the first definition, it is based on the view that goodwill refers to a business’s reputation amongst its customers. As will be explained below, establishing lost profits can, in some cases, be used as evidence of damage to reputation by revealing a general loss of custom, and it is lost profits from the rejection of goods other than those delivered by the breaching seller which can be indicative of the fact that loss of custom results from damage to reputation. However, defining goodwill by equating it with lost profits is unfortunate because it does not describe the essence of goodwill but merely refers to how it can be proved and measured. For this reason, I suggest that this definition of goodwill should be rejected. Thirdly, accountants sometimes define goodwill very broadly by viewing it as the value of all intangible assets of a company,59 which can include a great number of different assets, such as trademarks, trade and brand names, logos, patents, know-how, trade secrets and customer lists.60 While this definition goes beyond reputation (since it takes into consideration the value of other intangible assets), it would most probably cover reputation if the latter were regarded as an intangible asset. However, it is unlikely that this definition of goodwill woud be relevant in breach of contract cases since it is difficult to think of a case where a breach of contract damages all the intangible assets of a business. Fourthly, economists are said to define goodwill much less broadly by treating it as the capitalization of all of the economic income from a business enterprise that cannot be associated with any other asset (tangible or intangible) of the business.61 57 See Anderson, above n 36, 420; SC Schneider, ‘Consequential Damages in the International Sale of Goods: Analysis of Two Decisions’ (1995) 16 Journal of International Business Law 615. 58 AM/PM Franchise Association v Atlantic Richfield Company 526 Pa 110, 119 (Pa 1990) (‘goodwill damages refer to profits lost on future sales rather than on sales of the defective goods themselves’); Sol-O-Lite Laminating Corp v Thos W Allen 223 Or 80, 353 P 2d 843, 849 (where goodwill was regarded as referring to ‘the profits [the buyer] might have made on similar plastic he would have sold in the future or loss of profits on other items he would have sold had his customers not become disgusted with him’); Outboard Marine Corporation v Babcock Industries, Inc WL 296963 1, 4 (ND Ill 1995). 59 RF Reilly and RP Schweihs, Valuing Intangible Assets (New York, McGraw-Hill, 1999) 381. 60 For a much more detailed list and classification of intangible assets, see ibid, 19–20. 61 Reilly and Schweihs, above n 59, 383.

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It follows from this definition that goodwill constitutes a residual economic income, that is, that portion which cannot be attributed to any other identifiable tangible or intangible asset.62 Although goodwill in this sense is not defined expressly, it could be said to be defined implicitly as a ‘residual intangible asset’, and there have been statements which seem to suggest that ‘that residual asset’ might just be reputation.63 Finally, on occasions, damage to goodwill has been expressly equated with damage to reputation by treating goodwill as reputation among customers.64 Goodwill has also been understood as an intangible connection between a business, on the one hand, and the public and/or the market, on the other.65 This is reminiscent of the definition of reputation referring to the multiplicity of stakeholders. In some other cases, although the court treated goodwill and reputation as synonymous, goodwill was essentially interpreted from an accountant’s standpoint, extending beyond the scope of the notion of business reputation.66 Thus, this overview of definitions of goodwill demonstrates that, insofar as the existing definitions are relevant to breach of contract cases, goodwill has been generally treated synonymously with business reputation, and it seems sensible to suggest that claims for damages for injury to reputation and goodwill under the CISG should be understood as referring to damage done to perceptions and judgments about a company’s past performance and future prospects by a relevant group of stakeholders. While the possibility of reputation/goodwill being damaged in the eyes of multiple stakeholders should be recognised, it should be left to a claimant to define the particular group or groups of stakeholders that is relevant to its case. With this definition in mind, I now return to the objection that it is impossible to define damage to these phenomena with the degree of precision necessary to deal with the questions of the recoverability and measurement of this loss. In response, I submit that the suggested approach to defining this loss seems sufficient for dealing with the question of the recoverability because the degree of imprecision inherent in the nature of this loss is not so great as to deprive it of real substance and Ibid, 383–4. CJ Foreman, ‘Conflicting Theories of Goodwill’ (1922) 22 Colorado Law Review 638 (‘certain economists have defined goodwill as the reputation, business standing, or favour which the entrepreneur enjoys in the eyes of the public’); Toltec Fabrics, above n 43, 2 (where it has been stated that ‘Economists continue to adhere essentially to the original concept of goodwill as a relation between the business and the market’; it has been suggested in the main text above that there may be a significant overlap between this definition of goodwill and reputation as defined in this work). 64 See, eg Jacob Roundhouse and Jay Roundhouse, Trout Pond v Owens-Illinois, Inc 604 F 2d 990, 995 (CA Mich 1979). 65 See, eg Foreman, above n 63, 647. 66 Simpson v Restructure Petroleum Marketing Services 830 So 2d 480, 486 (La App 2 Cir 2002); see above for the discussion of accounting perspective on goodwill. 62 63

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should not prevent it from being recoverable if there are sufficient policy grounds in favour of the recoverability. I further submit that the impact of the definition of loss on its measurement should not be exaggerated. The translation of loss into money terms will depend largely on the particular method of calculation, rather than on the relatively vague characterisation of loss as ‘damage to people’s perceptions and judgments’. Thus, I suggest that, provided there are reliable methods of measuring this loss, the imprecision of its definition cannot prevent it from being recoverable. (iii) The Remaining Objections The next objection is that there are serious difficulties of proving and assessing such damages and that there is no reliable means of overcoming them. I address these issues in the following sections. Nevertheless, at this point it is relevant to note that some commentators who take the view that the difficulty of proving this loss prevents any rational means of its assessment do not let this argument stand in the way of the loss being recoverable as long as there is some degree of uniformity of awards. In such a case, it has been argued that awarding a reasonable and fair sum would be the way to deal with the difficulty of assessment.67 Further, the argument asserting the difficulty of setting the limits to the recovery does not seem to be a strong one as the Convention contains mechanisms such as the rules on foreseeability, causation, mitigation68 and standard of proof (if it exists under the Convention), which are capable of setting appropriate limits. The argument that such losses are never foreseeable also cannot prevent them from being recoverable. As has been pointed out on numerous occasions,69 it is perfectly possible, for example, for a seller to be in the position to foresee, at the time when the contract is made, that its delivery of a large quantity of defective goods is likely to damage a buyer’s reputation. Just like with any other loss, the question whether it was foreseeable is to be decided on the facts.

See, eg Burrows, above n 18, 319. See N.V. Maes Roger v N.V. Kapa Reynolds (10 May 2004) Hof van Beroep Gent (Appellate Court Gent, Belgium), available at http://cisgw3.law.pace.edu/cases/040510b1.html (accessed 27 June 2007) (where the claim for damage to reputation was dismissed on the grounds of causation and mitigation). 69 See Supreme Court 28 October 1998 (Switzerland), above n 42 (‘it is not possible to establish a general rule which says that certain damages are only foreseeable if they have been expressly dealt with in the contractual negotiations. This is also true for goodwill disadvantages and for damages that are caused because a buyer loses a client due to a deficient delivery. Such damages can be foreseeable by the seller if the buyer is obviously an intermediary in a sensitive market and in addition has no possibility to otherwise supply its clients with complying goods within the time limit due to its own precautions’) Anderson, above n 36, 421; Reo D Stott, n 30, 353; Enonchong, above n 13, 75; McKendrick and Worthington, above n 20, 315 (in the context of non-pecuniary losses generally). 67 68

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Finally, there also seems to be a general agreement that the ‘floodgate’ argument is not a reason to prevent the recoverability of damages to reputation/goodwill. As has been said in a well-known English case, it will not be right to allow floodgates’ arguments…to stand in the way of claims which, as a matter of ordinary legal principle, are well founded.70

Thus, subject to the discussion below, there is no good reason why damage to reputation/goodwill should not be recoverable, and it is submitted that the line of cases recognising this loss as compensable under the Convention should be followed.71

C

Proving and Calculating Damage to Reputation/Goodwill

(i)

Proving Damage to Reputation/Goodwill

Claims for damage to reputation and goodwill under the CISG are often rejected because of the claimants’ failure to prove such damage.72 This is, of course, not surprising, as it is difficult to prove damage to an intangible asset. But what has to be proved and what degree of precision in proving this loss is required? If the standard of ‘reasonable certainty’ is recognised under the Convention, losses will have to be proved with such a degree of precision as can be reasonably expected of a claimant in the light of all relevant circumstances. It is widely recognised that reasonable certainty does not require absolute precision or mathematical certainty.73 It has also been argued that the ‘reasonable certainty’ standard requires proving not only the fact of the loss but also its amount. Assuming this is correct so far as the CISG is concerned, how can the fact of damage to reputation/ goodwill be established? First of all, the existence of reputation/goodwill needs to be demonstrated74 and, secondly, it needs to be proved that a Malik v Bank Credit and Commerce International SA [1998] AC 20, 42. See Court of Arbitration of the International Chamber of Commerce (ICC) Arbitration Case No 11849 of 2003, available at http://cisgw3.law.pace.edu/cases/031849i1.html (accessed 27 June 2007); Case No HG 970238.1 (10 February 1999) HG Zürich (Commercial Court of Zurich Switzerland), available at http://cisgw3.law.pace.edu/cases/990210s1.html (accessed 27 June 2007); Case No S 00/82 (26 October 2000) Helsingin hoviokeus (Helsinki Court of Appeals, Finland), available at http://www.cisg.law.pace.edu/cisg/wais/db/cases2/ 001026f5.html (accessed 27 June 2007); Appellate Court Gent, above n 68. 72 See, eg Case No 7 O 43/01 (20 September 2002) LG Göttingen (District Court Göttingen, Germany), available at http://cisgw3.law.pace.edu/cases/020920g1.html (accessed 27 June 2007); Ginza Pte Ltd v Vista Corporation Pty Ltd (17 January 2003) Supreme Court of Western Australia, available at http://cisgw3.law.pace.edu/cases/030117a2.html (accessed 27 June 2007). For a similar case under the UNIDROIT Principles, see ICC Arbitral Award 10422 of 2001, available at http://www.unilex.info/dynasite.cfm?dssid=2377&dsmid=13618&x=1 (accessed 27 June 2007). 73 See Saidov, above n 53, 28–9. 74 See Flippe Christian v SARL Douet Sport Collections (19 January 1998) Tribunal de commerce de Besançon (District Court Besançon, France), available at http:// 70 71

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breach has caused damage to that reputation/goodwill. The nature of evidence that needs to be presented will depend on the relevance of the questions ‘reputation to whom, for what, and for what purpose?’ to a claimant’s case. However, because relations with customers are often by far the most important element of definition, the evidence that is usually presented relates largely to a company’s business with its customers (as opposed to its standing amongst other stakeholders). For example, the existence of and damage to reputation/goodwill may be established on the basis of records demonstrating the difference between the volume of sales and level of profits made before and after the loss,75 the testimony of competent witnesses in relation to the existence of and damage to reputation/goodwill,76 the dependence of the buyer’s business on the goods to be delivered by the seller,77 and testimony by former customers and other witnesses indicating that business was discontinued because of defective deliveries.78 A good example of how damage to reputation can be demonstrated is provided by one US case wherein the buyer, whom the court found to have had an ‘excellent reputation’ in the industry before the breach, claimed that its reputation had been damaged. One piece of evidence related to the fact that one customer, after becoming aware of the buyer’s problems, required the buyer to procure a performance bond before it would proceed with a project.79 Finally, the demonstration of lost profits can be used as evidence of loss of reputation/goodwill. It has to be stressed, in this regard, that the demonstration of lost profits should not necessarily lead to the conclusion cisgw3.law.pace.edu/cases/980119f1.html (accessed 27 June 2007) (where the buyer being a promoter of a judo club claimed damages to reputation resulting from the delivery of non-conforming uniforms. Although this claim was simply dismissed by the court without much explanation, it is interesting to note that the seller argued that the buyer was not a merchant and therefore could not claim such damages. This argument seems to imply that the buyer was not a trader in uniforms and no reputation in this area could therefore exist). 75 See ICC Arbitral Award 3880 of 27 September 1983 in S Jarvin and Y Derains Collection of ICC Arbitral Awards, 1974–1985: Recueil Des Sentences Arbitrales De LA CCI (Alphen aan den Rijn, Kluwer Law International, 1990) 161; Tampere Court of First Instance, above n 30; see also Appellate Court Gent, above n 68 (where the lower instance found that the buyer ‘could not realize sales and the quality problem led to cancelled or dismissed business relationships with the [b]uyer’. However, this finding was rejected by the Appellate Court). 76 Barrett, above n 30, 337 (‘The testimony of competent witnesses shows that the reputation of its product was high with jobbing trade . . .’); Delano Growers’ Cooperative Winery v Supreme Wine Co, Inc 473 N.E.2d 1066, 1076 (‘Supreme presented testimony of its former officers to support the evidence that Delano caused the injury to Supreme’s business reputation’); Simpson, above n 66. 77 Tampere Court of First Instance, above n 30 (‘the business activities of [the buyer] rested on shoulders of Diamante products’); Barrett, above n 30. 78 Tampere Court of First Instance, ibid; Sol-O-Lite Laminating, above n 58, 93 (‘Four customers who had done business with defendant . . . testified concerning their receipt of the defective material and how they had reduced or terminated their dealings because of it’); Davidson v Barclays Bank [1940] 1 All ER 316, 324. 79 Marvin Lumber and Cedar Company, Marvin Windows of Tennessee, Inc v PPG Industries, Inc 401 F 3d 901, 913 (CA8 (Minn) 2005).

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that damage to reputation/goodwill has occurred. The fact that several sub-buyers rejected defective goods and cancelled their contracts with the buyer does not in itself necessarily imply that these sub-buyers and other existing and potential customers do not regard this buyer as a reliable partner. Lost profits should be treated as evidence of damage to reputation only if such lost profits reveal a general loss of custom. This is probably why some US courts distinguish between profits the buyer intended to make from the sub-sale of contract goods which turned out to be defective and future profits that would have been received from the sale of other goods or other transactions had there been no breach.80 It is this latter category of lost profits which is more revealing of damage to a company’s reputation/goodwill because it may indicate a general unwillingness of existing and potential customers to do business with the buyer in question. Again, it seems that it is this logic that led some US courts to state that damage to reputation/goodwill is truly revealed only after the injured party is in the position to provide proper performance.81 This position reflects the view that if the buyer’s sales volumes and profits continue to decrease despite its ability to provide conforming goods, this fact may be an indication of negative perceptions of the buyer held by existing and potential customers. It is suggested that these guidelines could be helpful under the CISG in determining whether the fact of lost profits reveals any damage to reputation/goodwill.

D

Measuring Damage to Reputation/Goodwill

(i)

General

Lawyers usually assume that the most that can be done with respect to the assessment of damage to reputation/goodwill is fixing a fair and reasonable sum.82 It has also been suggested that great care needs to be exercised in awarding such damages and, therefore, the sums awarded should be modest.83 What is often stressed is that some degree of uniformity of the awards be maintained as this is essential for preventing arbitrary awards, for maintaining a degree of predictability and, more broadly, for a legal 80 AM/PM Franchise, above n 58 (‘goodwill damages refer to profits lost on future sales rather than on sales of the defective goods themselves’); Sol-O-Lite Laminating, above n 58, 849 (where goodwill was regarded as referring to ‘the profits [the buyer] might have made on similar plastic he would have sold in the future or loss of profits on other items he would have sold had his customers not become disgusted with him’); Outboard Marine Corporation, above n 58. 81 AM/PM Franchise, above n 58; Outboard Marine Corporation, ibid. 82 See, eg Burrows, above n 18, 319. 83 See McKendrick and Worthington, above n 20, 321 (in the context of non-pecuniary losses in English law).

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system to be credible and just.84 With these concerns in mind, some scholars suggest that setting a maximum amount of damages could be another way to introduce some order into the awards of damages for intangible losses.85 How do these points fare in the context of the Convention? It is certainly crucial for the Convention’s future that a uniform treatment of claims be achieved and maintained. At the same time, in the absence of some international institution responsible for monitoring the application of the CISG, the proposal to fix a maximum amount would not be a workable means of achieving and maintaining uniformity. Moreover, it could also be argued that this solution is somewhat arbitrary and possibly unfair as, in a particular case, it may be felt that the loss goes beyond the fixed maximum amount. So far as the argument in favour of fixing a fair and reasonable sum is concerned, my impression is that this is precisely what judges/arbitrators do in cases where damage to reputation/goodwill has been recovered.86 However, while maintaining some degree of uniformity of awards made on that basis may be possible in the context of a domestic legal system, it is much more difficult, if not impossible, to achieve something even remotely reminiscent of uniformity under the Convention, considering the multiplicity of courts and tribunals applying the Convention. This fact leads to the question whether there are some other, more rational and reliable means of quantifying damage to reputation/goodwill. If there are, it would be most unwise for lawyers to ignore them and not to consider whether the existing methods would be appropriate for assessing damages and contributing to uniformity in the application of the CISG. It is possible to go further by arguing that if damage to reputation/ goodwill is a ‘true’ loss, then surely there must be, in the light of developments in modern science and technology,87 some method of quantifying such damages with greater accuracy than the fixation of a reasonable sum. Indeed, in the last 20 years the practice of valuing intangibles has grown considerably.88 The discussion below will summarise some of the methods that could be used to quantify damage to goodwill/reputation.

84 ‘[J]ustice is not justice if it is arbitrary or whimsical, if that is awarded to one plaintiff for an injury bears no relation at all to what is awarded to another plaintiff for an injury of the same kind’ (McCarey v Associated Newspapers Ltd and Others (No 2) [1965] 2 QB 86, 108). 85 See Bridge, above n 20, 367. 86 See, eg ICC Arbitral Award 3880, above n 75. 87 See AM/PM Franchise, above n 58, 128 (where it has been stated that those earlier decisions where recovery of goodwill had been disallowed were made at the time when ‘market studies and economic forecasting were unexplored sciences’ whereas ‘[w]e are now in an era in which computers, economic forecasting, sophisticated marketing studies and demographic studies are widely used and accepted’). 88 See W Anson, ‘Corporate Identity—Value and Valuation’ (2000) 3 Corporate Reputation Review 164, 165.

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(ii) General Measure A general measure of damages for loss of reputation/goodwill is the difference between the value of present and former reputations/goodwill.89 One difficulty here relates to the determination of these two items of value. The nature of reputation/goodwill is volatile, and it seems widely recognised that the valuation of these intangibles is ‘like measuring the momentum of a moving car’.90 This means that the precise moment at which the valuation takes place may have an impact on the amount of an award. It may therefore be important to decide to which precise moments in time the words ‘present’ and ‘former’ refer. One possibility is that they mean reputation/goodwill as they were before and after the breach. However, the reference to the time ‘after the breach’ may not always be appropriate since damage to reputation/goodwill can only occur when the relevant stakeholders become aware of the breach and its consequences, and when that awareness makes a negative impact on their perception of a company in question or a particular aspect of its business. Thus, the reference to reputation/goodwill after the breach may be appropriate, for example, in cases where the stakeholders’ perceptions are being damaged as the breach occurs. This seems to have happened in one English case91 where the injured party hired the breaching party to advertise its goods by flying over various towns and trailing behind the aeroplane words advertising the products. The latter, in breach of contract, flew over a crowded square during the Armistice service and the two minutes’ silence, and it is likely that the damage to the innocent party’s reputation largely occurred during that time. In other cases, by contrast, there may be a substantial gap between the time of breach and the time when there occurs a negative impact on the perceptions of relevant stakeholders. For instance, a wholesaler may keep a large quantity of goods delivered by the breaching seller at its warehouse for several months before putting them on sale. In this type of case, damage to its reputation/goodwill is likely to occur long after the time of breach (namely, when a certain number of customers become aware of defects in the purchased products). In such a case, the reference to the time of breach is inappropriate and a later point in time at which injury to reputation/goodwill can be said to have occurred will have to be selected.92 Thus, the general measure should be the difference between the value of reputation/goodwill before and after the loss.93 See Burrows, above n 18, 319. BE Cookson, ‘The Significance of Goodwill’ (1991) 13 European Intellectual Property Review 248, 251. 91 See Aerial Advertising Co v Batchelors Peas Ltd [1938] 2 All ER 788. 92 I am grateful to Nelson Enonchong for this insight. 93 In theory, ‘before the loss’ would probably mean the moment immediately preceding the loss and, if no reasonable estimation at that time is possible for practical reasons (due to the lack of information, for example), the moment which is the closest in time to the loss and which 89 90

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However, it is not easy to determine a specific moment in time at which damage to reputation/goodwill occurs and, eventually, such a determination will depend on the particular circumstances of the case. Nevertheless, a workable solution would need to be based on tangible manifestations of such a loss. Because, in the vast majority of cases, customers will be regarded as relevant stakeholders, the moment or period at which the injured party can be said to have lost custom could perhaps provide a rough guideline in this respect. I will now turn to specific methods of calculating this loss. (iii) ‘Cost’ Approach One way to measure damage to reputation/goodwill is to estimate the costs incurred to repair the damaged reputation/goodwill, and this is what has been done in one case decided under the CISG where the buyer took measures and incurred expenses to regain its reputation as a supplier of canned food and to create ‘new customer networks’.94 In principle, this method can be used not only where an injured party has actually incurred costs to repair its reputation/goodwill, but also where no such expenses have been made,95 although the valuation is probably more difficult in the latter case. First, the claimant will have to face the task of determining components of reputation/goodwill in order to identify compensable items of expense.96 Secondly, where the claimant has actually incurred costs, it is easier to prove and calculate those costs because there will usually be some supporting evidence. Conversely, because, in the latter case, costs are determined in abstract, their proof and estimation becomes more difficult. In affords a reasonable opportunity for the estimation could be taken as the basis for valuation. The words ‘after the loss’ should probably mean the time immediately after the loss and, in any event, not later than a reasonable time thereafter. Tampere Court of First Instance, above n 30. See Reilly and Schweihs, above n 59, 387. Although the issue is not entirely settled, there are strong arguments in favour of the recoverability of future losses under the CISG (a similar position has been taken in CISG Advisory Council Opinion para 3.19). First, if future losses are not recoverable, the aggrieved party will either have to wait until the time when future losses become ‘actual’ losses or may be compelled to bring more than one claim for breach of one contract at different points in time (provided that this is allowed by the procedural rules of the forum; for example, this would not be possible under English law, Chitty on Contracts, vol 1, HG Beale (ed) (London, Sweet & Maxwell, 28th edn, 1999) 1275). Such a result would be unfair to the injured parties because claiming damages under the CISG may become an unduly time-consuming and expensive affair and may encourage the parties to exclude the CISG. The latter is certainly not in line with the aspiration of the CISG to become a uniform instrument. Secondly, Art 74 expressly refers to the recoverability of lost profits and this type of loss will often be a loss yet to be incurred at the time a claim is brought. This can be interpreted as an indication that future losses are recoverable (for a similar view, see S Eiselen, ‘Unresolved Damages Issues of the CISG: A Comparative Analysis’ (2005) 38 Comparative International Law Journal of Southern Africa 32, 37). 96 See Reilly and Schweihs, above n 59, 387. 94 95

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both cases, the mitigation rule97 will require that a claimant demonstrate that the costs of cure are reasonable and the causation requirement may require that these costs be truly necessary for and directed at curing damage to reputation/goodwill.98 It is also worth highlighting the question of whether the position that English law takes with respect to costs of cure would be relevant to the CISG. It is accepted in English law that, although courts are generally not concerned with the use to which an injured party will put the award of damages,99 costs of cure are subject to the requirement of reasonableness, which does not appear to derive solely from the mitigation rule.100 The requirement of reasonableness, in turn, has been said to necessitate an assessment of: (i) whether the innocent party has effected cure or intends to do so;101 (ii) the innocent party’s conduct subsequent to the breach; and (iii) whether there is a proportion between the cost of cure, the contract price, the benefit already received by the injured party and the benefit to be obtained from cure.102 I suggest that, similar to English law, costs of cure under the CISG are subject to a broader requirement of reasonableness stemming not only from the mitigation rule but also from a general principle of reasonableness underlying the CISG.103 If this is correct, it can certainly be argued that there is no reason why factors used in English law to assess the reasonableness of costs should not be relied upon in the context of the Convention. This method also becomes more complicated if costs are understood as including ‘opportunity costs’,104 that is, opportunity to earn profit lost during the period of repairing the reputation/goodwill. If so, and if a claimant also claims loss of profit, the duplication of recovery for lost profits must be prevented. Therefore, either ‘costs’ should not include a lost opportunity to profit or the recovery of lost profit for the period of repairing the damaged reputation/goodwill should be denied. See Art 77 CISG. It is not entirely clear whether such costs should be recovered as costs caused by the breach, in which case, I would argue that the suggestion in the main text is correct. However, it can also be argued that costs of curing damage to reputation/goodwill should not be recovered as costs caused by the breach but should be regarded as a method of calculating damage to reputation/goodwill and, in this case, the causal requirement will not apply to costs of cure but will only require that there be a causal connection between a breach and damage to reputation/goodwill (as opposed to a causal connection between a breach and costs of cure). 99 Ruxley Electronics and Construction Ltd v Forsyth [1996] AC 344, 359. 100 Ibid, 370 (‘I cannot accept that reasonableness is confined to the doctrine of mitigation’). 101 ‘[A] claimant’s intention to cure a particular breach is . . . evidence of the extent of his genuine non-pecuniary loss flowing from the breach’ (M Chen-Wishart, Contract Law (Oxford University Press, 2005) 534–5). 102 Ibid, 534; GH Treitel, The Law of Contract (London, Sweet & Maxwell, 11th edn, 2003) 946–7. 103 There is no doubt that reasonableness is a general principle underlying the CISG (see, eg AH Kritzer, ‘Reasonableness’, available at http://cisgw3.law.pace.edu/cisg/text/reason.html (accessed 27 June 2007), with further references). 104 Ibid. 97 98

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(iv)

‘Royalty’

Another method of calculation is to ask how much a third party would pay to lease a corporate name. Although this method has mostly been used in the context of the valuation of brands, it has been suggested that it is possible to use this method to value reputation/goodwill.105 If this is correct, then the present value of all expected royalty payments under such licensing/leasing arrangements could represent another estimate of a company’s reputation.106 This method would seem to dispense with the need of defining reputation/goodwill as it refers to royalty rates so far as the particular marketplace is concerned107 and market valuation has been said to correspond ‘roughly to overall regard in which the company is held by its constituents’.108 This valuation method would, therefore, seem to be based on a broad definition of reputation/goodwill covering a wide spectrum of stakeholders. Quantifying damages would require ascertaining the difference between the value of all royalty payments that would be payable before and after the loss. One potential difficulty with this method relates to the availability of information regarding royalty rates. For example, because royalty data may be confined to a specific market or sector, it may not be easily extrapolated outside those boundaries.109 Finally, what is the relationship between this valuation method and a claim for future lost profits? As noted, the royalty method aims to arrive at a value of reputation/goodwill so far as the market is concerned, and market value is generally regarded as reflecting the market’s guess regarding profits a company will make from an asset in question.110 Therefore, awarding damages for lost profits which can be attributed to reputation/goodwill along with damages calculated under the ‘royalty’ method will constitute a double recovery.111

105 M Sussdorff, ‘The Value to be Found in Corporate Reputation’, available at http://intranet.csreurope.org/news/csr/one-entry?entry%5fid=114278 (accessed 27 June 2007). 106 Ibid. 107 See Reilly and Schweihs, above n 59, 147, 152–3 and 194 (treating the royalty relief method as a specific type of valuation based on the ‘market approach’ the purpose of which is to provide an estimate of a market value of an asset (see ibid, 147)). 108 Fombrun, above n 26, 91. 109 R Shaw, ‘Brand Valuation’, available at http://www.mbpi.biz/Brand_Valuation.PDF (accessed 27 June 2007) (in the context of brand valuation). 110 See, eg S Waddams The Law of Damages (Toronto, Canada Law Book Co, 4th edn, 2004) 82–3; REB Inc v Ralston Purina Co 525 F 2d 749, 754–5 (CA Wyo 1975); RL Dunn, Recovery of Damages for Lost Profits (Westport, CT, Lawpress Corporation, 6th edn, 2006) 566. 111 Because royalty rates are often calculated as a percentage of profits (see Reilly and Schweihs, above n 59, 152–3 and 194), the amount arrived at from applying the royalty method would be precisely the amount which needs to be subtracted from the lost profit claim to avoid a double recovery.

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Market Value

Another well-known method of valuing business reputation/goodwill which is based on market valuation requires calculating the difference between the market value of a business112 and the value of all its tangible and identifiable intangible assets. It has been suggested that the difference resulting from this calculation will represent the value of business reputation/goodwill.113 In order to calculate damages using this method, the value of reputation/goodwill will have to be determined before and after the loss, and then the latter will need to be subtracted from the former. One advantage of this method is its clarity and soundness. Another advantage is that it dispenses with a need to define reputation/goodwill because, as noted earlier, market valuation can be said to correspond roughly to how a business is valued by multiple stakeholders. So far as the relationship of this calculation method with a lost profits claim is concerned, a possible overlap between the two must be avoided. Damages to reputation/goodwill are calculated as a residual derived from market value, and market value is usually understood as taking into consideration a market’s expectation of profits a business will make.114 Therefore, that part of future lost profits which can be attributed to reputation/goodwill cannot be awarded together with damages calculated under the ‘market value’ method.115 (vi)

Income Approach

Another approach to valuing reputation/goodwill as well as damage thereto is based on future profits a company would have been expected to 112 The market value of a company can be determined either on the basis of an actual sale of business or of a constructed value (see Reilly and Schweihs, above n 59, 387). 113 See, eg Reilly and Schweihs, ibid, 387. For further discussion and the proposal of a more complex formula, see R Bowd and L Bowd, ‘Assessing a Financial Value for Corporate Entity’s Reputation: A Proposed Formula’, Manchester Metropolitan University Business School Working Paper WPS030, available at http://www.ribm.mmu.ac.uk/wps/papers/02–01.pdf (accessed 27 June 2007). 114 See, eg Waddams, above n 110, 82–3; REB, above n 110, 754–5; Dunn, above n 110, 566; see also Hydraform Products Corp v American and Aluminum Corp 498 A 2d 339, 347 (NH 1985). 115 It may be very difficult to determine the part of lost profits attributable to reputation/goodwill. Nevertheless, it seems that it can be determined in the following way. Under the ‘market value’ method, the value of reputation/goodwill is determined as a residual from market value. It seems possible therefore to determine the percentage of market value which can be attributed to the value of reputation/goodwill and then to discount the amount of future lost profits claimed by the same percentage. In other words, the amount of future profits is reduced proportionately to the percentage that the value of reputation/goodwill occupies within the overall market value of a business. It is the amount by which future lost profits are reduced that cannot be claimed, together with damage to reputation/goodwill under the ‘market value’ method.

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earn but for the breach.116 One specific method of calculating damages for lost reputation/goodwill based on future lost profits has been used in some US cases117 where it has been suggested that, in cases of defective delivery, damage to reputation/goodwill should be measured not by future profits lost on the sub-sale or a failed attempt to sell defective goods, but by those lost due to the inability to provide other goods or services in the future. For example, if the buyer had purchased the goods to fulfil sub-sales which were either rejected or bought at reduced prices, the award of damages for lost profits caused by such rejection or resale at reduced price will not be, under this approach, an award for injury to reputation/goodwill. It will be the profits the buyer was unable to make when it was in the position to provide conforming goods on other future transactions unrelated to the initial sub-sales that will be the basis for calculating damages to goodwill/reputation. The buyer will, of course, have to prove that, had the seller performed the contract, the buyer would have made those future sales. This calculation method is based on the assumption that if the buyer’s sales continue to decrease despite its ability to provide proper performance, this may be an indication of negative perceptions of its business held by existing and potential customers. Provided that a judge/arbitrator is satisfied that the loss of future sales was caused by the damage to reputation/goodwill, I suggest that this method is sound and can be used for the purposes of quantifying this loss. Another, similar method of calculating damages to reputation/goodwill is more restrictive in requiring the estimation of the present value of future economic income to be earned from selling goods or providing services to unidentified future customers. It has been explained that these future customers are unidentified new customers who presumably will take the place of the company’s identified current customers, as those identified current customers retire or turn over.118

This method also requires assessing future profits from the point of the expiration of all current income-generating sources (that is, all its current tangible and identifiable intangible assets). It is clear that this method aims to define reputation/goodwill as a residual part of a business the value of which can only be determined by the amount of future income which cannot be attributed to any other identifiable tangible or intangible asset. Because it aims to identify and measure reputation/goodwill in its pure form, it has been said to be ‘one of the most intellectually appealing and conceptually correct’119 calculation methods. At the same time, however, 116 117 118 119

See Reilly and Schweihs, above n 59, 388. CISG-AC, above n 11, para 7.4. See nn 80 and 81. Ibid, 390. Reilly and Schweihs, above n 59, 391.

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the main disadvantage of this method is that it is extremely difficult to use in practice due to the uncertainty arising from making long-term projections and inquiries into numerous hypothetical events.120 If a lost profit claim is brought along with a claim for lost reputation/goodwill calculated under either of the two methods, care needs to be taken to avoid double compensation. If a lost profit claim is for damage suffered directly as a result of the buyer’s resale of or attempt to sell defective goods, no overlap occurs between this claim and a claim calculated under either of the two ‘income approach’ methods. If, however, a claim for lost profit relates to future sales which the buyer could have made had the contract been performed, there will be an overlap with the first ‘income approach’ method. If these future sales relate to unidentified future customers in the conditions where all current assets will expire, this lost profits claim will duplicate damages under the second ‘income approach’ method. (vii)

Concluding Remarks

Does the existence of these calculation methods counter the argument that there are no rational means of assessing damage to reputation/goodwill and that the only way of calculating damages is to fix a fair and reasonable sum? My answer is that the law of damages will never become a ‘precise science’ and each of the methods discussed will inevitably leave room, albeit to a different extent, for the exercise of judicial or arbitral discretion which will most likely be influenced by the notions of fairness and reasonableness. However, there is a difference between a calculation method based solely on judicial discretion and one which allows for the exercise of a certain amount of discretion. The latter will be the case if the described methods are used to calculate damages. Thus, the existence of several specific methods means that calculating damages will go beyond a mere fixation of a fair and reasonable sum. The next question is whether these methods are in themselves satisfactory and whether by using them it is possible to introduce a substantial degree of order and uniformity in the application of the CISG. In general, all of the methods seem conceptually sound and are capable of providing a reasonably accurate assessment of damage to reputation/goodwill.121 In my view, this is sufficient to argue that they can and, where appropriate, 120 The same applies to the first ‘income approach’ to calculating damages, albeit to a somewhat lesser extent. 121 All of the methods also demonstrate that what initially seemed to be an intangible loss is translated into money terms by means of purely tangible and financial factors, such as costs of cure, royalty rates, the market value of a business and its assets, and lost profits. Perhaps, for this reason, this loss can be said to be essentially a tangible, rather than an intangible, loss. If such a characterisation is correct, the argument that damage to reputation/goodwill is not recoverable under the CISG due to its intangible nature is significantly undermined.

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should be used. It can be further argued that the more judges and arbitrators become aware of these methods (and, no doubt, many of them are), the more uniform the treatment of such claims under the CISG is likely to become. In fact, using similar methods of calculation in similar circumstances seems the only workable means of maintaining a reasonable degree of consistency and uniformity in the Convention’s treatment of such claims. I suggest that this is the most that can and should be expected as far as Article 7(1) is concerned. However, there may still be significant problems relating to the practical application of the suggested methods. One concern is that the complexity and expense arising from the practical application of these methods may be incommensurate with those of an ordinary breach of contract case. Another concern is that, in some cases, either these methods of calculation will be irrelevant or it may not be possible to apply them. For example, costs of curing the damage may not be relevant because it is not possible to remedy the damage, or calculating future lost profits may be too speculative. In cases where the suggested methods are not relevant, some other way of calculating damages may have to be found or (more likely) the award of a reasonable and fair sum may be the only option. Both concerns are valid and it does not seem possible to alleviate them fully. Nevertheless, the following points are worth mentioning. First, the complexity and expense are often associated with the assessment of damages and are not unique to damages for this type of loss. A similar point can also be made, for example, in relation to calculating lost profits under a long-term supply agreement122 and this fact does not usually lead to the argument that a greater accuracy in the assessment should be abandoned because of the complexity and expense of calculation. In the same vein, I would submit that, if the suggested methods provide means of achieving a more rational, consistent and accurate assessment of damages, we should not dismiss the possibility of using them on the grounds of complexity and expense. So far as the second point is concerned, it is well known that it is not possible to have methods of calculation for all conceivable situations and it is often the case, even with other types of loss, that no specific formula exists for a particular situation.123 The very structure of the Convention’s rules on damages recognises this by 122 See, eg Soinco v NKAP (31 May 1996) Zürich Chamber of Commerce Arbitration proceeding (Switzerland), available at http://cisgw3.law.pace.edu/cases/960531s1.html#quantum (accessed 27 June 2007). 123 Take, for instance, the case of damages for delivery of defective goods where the contract has not been avoided. In this case, no specific formula may exist if: there is no market price for these goods in either their conforming or non-conforming state; the goods are not capable of cure (and, consequently, it is not possible to measure damages on the ‘cost of cure’ basis); or the buyer is unable to resell the defective goods (which presumably could, in some cases, provide a guide to their value). For a summary of calculation methods for breach of warranty where the goods are accepted in the context of English law, see Goode, above n 21, 378–9.

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containing a very general provision on measuring damages124 and two formulae targeting specific cases where the contract has been avoided.125 Finally, it is noteworthy that the suggested methods are well known to specialists involved in the valuation of business assets, and it is probably true that both law and lawyers often benefit from their knowledge and experience;126 the case of damage to reputation/goodwill may be just another such instance.127 Thus, for all the reasons mentioned, I submit that, despite possible concerns, the suggested methods might prove useful so far as the Convention is concerned.

E Relationship of Damage to Reputation and Goodwill with Other Types of Loss For the purposes of definitional clarity, proving and assessing damages, it is important to understand the relationship between the claims for damage to reputation/goodwill, on the one hand, and other related claims, on the other. Such related claims include claims for damages for lost profits, loss of custom and loss of a chance to enhance reputation. The precise relationship between loss of reputation/goodwill and loss of profits has been addressed in the context of each calculation method. In short, it can be said that, although damage to reputation/goodwill and lost profits are distinct types of loss, they are closely interlinked primarily because reputation/goodwill will usually be understood as referring to perceptions of a business among its customers and it follows that the main function of reputation/goodwill is to attract customers and generate profits from such relations. It has been shown that, due to this connection, lost profits can sometimes play a role in proving damage to reputation/goodwill as well as in calculating the loss caused thereby. The issue of whether and to what extent there is an overlap between claims for lost See Art 74 CISG. See Arts 75 and 76 CISG. The UNIDROIT Principles seem to recognise this, albeit somewhat indirectly, by providing that ‘[w]here the amount of damages cannot be established with a sufficient degree of certainty, the assessment is at the discretion of the court’ (Art 7.4.3(2)). 126 On the influence of economists on legal thinking on goodwill, see Foreman, above n 63, 652 (‘jurists are unconsciously influenced by the more popular theories of goodwill and . . . are gradually including in their opinion the common concepts of economists’). On the role of accountants in the context of the recoverability of ‘overhead’ costs under the UCC, see JJ White and RS Summers Uniform Commercial Code (St Paul, MN, West Group, 5th edn, 2000) 289–90. 127 See also A Komarov, ‘The Limitation of Contract Damages in Domestic Legal Systems and International Instruments’, this volume (arguing that relying on general standards of the law of damages is insufficient in the light of complexity and sophistication of modern business transactions, and seemingly implying that lawyers will benefit from engaging with other disciplines). 126 127

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profits and injury to reputation/goodwill will depend on the method of calculation used in each particular case.128 A claim for loss of custom, trade or business is another type of claim which is sometimes brought before judges and arbitrators.129 For example, a typical case is one where the buyer argues that, as a result of defective delivery, its sub-buyers cancelled the existing orders and/or decided not to do business with the buyer in the future. In such circumstances, damages have been awarded for loss of clientele, orders or trade.130 It is submitted, however, that it is misleading to treat loss of custom as a loss in itself for which damages may be given. It is suggested that loss of custom essentially describes the situation that has resulted from the breach and that situation, in turn, may give rise to specific losses for which damages may be awarded.131 Such specific losses are usually lost profits, but may include other types of loss as well. For instance, in one case, the injured party claimed that as a result of losing business relations with one customer he lost a group delivery arrangement which would increase the buyer’s future transportation costs.132

So far as the relationship between loss of custom and loss of reputation/goodwill is concerned, loss of reputation/goodwill may sometimes be a reason why an injured party has lost its customers.133 This See discussion above. For such claims brought under the CISG, see CIETAC Arbitration proceeding (31 January 2000) (China), available at http://cisgw3.law.pace.edu/cases/000131c1.html (accessed 27 June 2007) (where this loss was not held to be foreseeable and not sufficiently proved); Société TCE Diffusion Sarl v Société Elettrotecnica Ricci (29 March 2001) Cour d’appel d’Orléans (Appellate Court Orléans, France), available at http://cisgw3.law.pace.edu/cases/ 010329f1.html (accessed 27 June 2007) (where damages were awarded for commercial losses resulting from the loss of several customers). 130 See decision by Swiss Supreme Court, 28 October 1998, above n 42 (the abstract of the case refers to loss of clientele, while the translation of the case refers to loss of profit flowing from loss of clientele). Such damages have been awarded in several cases decided under English law (see Cointat v Myham & Son [1913] 2 KB 220; GKN Centrax Gears Ltd v Matbro Ltd [1976] 2 Lloyds Rep 555). 131 See, in this regard, Case No 12 HKO 5593/01 (30 August 2001) LG München (District Court Munich, Germany), available at http://cisgw3.law.pace.edu/cases/010830g1.html (accessed 27 June 2007) (where it has been held that ‘[t]urnover losses caused by the “loss” of customers, who, because non-conforming deliveries, fail to place new orders, do not constitute a—direct—loss of wealth caused by the [sellers’] breach of contract in the meaning of Art. 74 CISG’. It is not entirely clear what the court meant here. Did the court intend to make the same point as has been made in the main text to the effect that loss of custom is not a loss in itself or was it the court’s intention to hold that losses flowing from loss of custom are not in principle recoverable? If the latter was meant, then the holding is not correct as, subject to the rules of limiting damages, financial losses are generally recoverable under the CISG). 132 Federal Supreme Court of Germany, 24 October 1979 (decided under the Convention Relating to a Uniform Law on the International Sale of Goods (ULIS)). See Schneider, above n 57. 133 It is, of course, also possible that loss of custom is a reason why damage to reputation has occurred or has been exacerbated. 128 129

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relationship may be important for proving the fact of damage to reputation/goodwill in the sense that loss of customers may, in some cases, be regarded as evidence that damage has been done to a company’s reputation. Another type of loss which has some connection with reputation is loss of an opportunity to enhance reputation. Although some cases involving such claims under some domestic legal systems have concerned authors134 and actors,135 it is possible for such claims to arise in a purely commercial context. For example, the buyer may argue that, as a result of late delivery, it has been prevented from participating in a prestigious trade exhibition or from performing a contract with an important and well-known company and, consequently, lost a chance to enhance its business reputation. Although such claims are related to reputation, they are different from claims for damage to reputation in that the latter refers to the actual reduction of the existing intangible asset while the former refers to a lost opportunity to increase that intangible asset. Being essentially a claim for lost opportunity,136 the claim for lost chance to enhance reputation would nevertheless require an inquiry into the notion of reputation.

III

CONCLUSION

It is suggested that, because a company’s reputation and goodwill are often important business assets, damage to these intangibles should be, in principle, recoverable under the CISG. For the purposes of damages under the CISG, I suggest that reputation and goodwill should be understood as consisting of perceptions and judgments by relevant stakeholders of a company’s past performance and future prospects. It will have to be left to claimants to answer the questions ‘reputation/goodwill to whom, for what, and for what purpose?’. The importance of defining these concepts should not, however, be exaggerated, since placing a value on them will depend largely on the specific method of calculation rather than on an abstract definition. I have further argued that ‘translating angry or cautious Joseph v National Magazine Co Ltd [1958] 3 WLR 366. Herbert Clayton and Jack Waller v Oliver [1930] AC 209; Withers v General Theatre Corporation Co Ltd [1933] 2 KB 536. 136 The question whether loss of a chance is recoverable is still somewhat unresolved under the Convention. For discussion of this issue, see, eg CISG-AC, above n 11, paras 3.15–3.16; Saidov, above n 33, 400–2. In one case this loss was not held to be recoverable: Case No HG 970238.1 (10 February 1999) HG Zürich (Commercial Court of Zurich, Switzerland), available at http://cisgw3.law.pace.edu/cases/990210s1.html (accessed 27 June 2007). See also I Schwenzer and P Hachem, ‘The Scope of the CISG Provisions on Damages’, this volume (arguing in favour of the recoverability of loss of a chance). 134 135

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customers into dollars and cents’137 (if customers are regarded as relevant stakeholders) is not an impossible task. In fact, because the suggested calculation methods employ tangible and financial factors, it may even be possible to argue that, to that extent, damage to reputation/goodwill actually is a tangible pecuniary loss.138 One of my main assertions is that, thanks to the development of various valuation methods, predictability and uniformity in the treatment of these claims under the Convention may not be an entirely hopeless venture,139 as lawyers used to believe. Finally, a careful approach to defining and, most importantly, proving and measuring these losses would adequately deal with concerns that such claims could potentially be used to avoid difficulties of proof140 or that awarding damages for such losses could potentially be used to punish the breaching party rather than compensate the innocent party.141

137 Marvin Lumber and Cedar Company, Marvin Windows of Tennessee, Inc v PPG Industries, Inc, above n 79, 914. 138 See n 121. 139 See Bridge, above n 20, 389. 140 Ibid, 327. 141 Ibid, 257.

17 Actual Damages, Notional Damages and Loss of a Chance ACTUAL DAMAGES , NOTI ONAL DAMAGES AND LOS S OF A CHANCE

M IC H A E L FU R M S T O N * MI CHAEL FURMS TON

I

I NTRO DUCTION

For many years, traditional expositions of the law of damages in relation to breach of contract have started with Hadley v Baxendale.1 This is indeed one of the few English contract cases still regularly cited in American discussions.2 Nevertheless, this is, in a sense, to start in the wrong place since no one doubts that the plaintiff in Hadley v Baxendale suffered loss as a result of the defendant’s breach of contract in failing to carry the broken mill shaft with reasonable dispatch. The discussion commonly assumes that if the facts had been slightly different—if, for instance, the plaintiff had told the carrier that he did not have a spare shaft and would be out of business until the replacement arrived—he might have recovered damages to compensate for the loss. Hadley v Baxendale represents a major limitation on the plaintiff’s ability to recover for his loss,3 but logically it is preceded by the question, ‘What do we mean by loss?’ In this chapter, I want to discuss: some aspects of what we mean by loss (section II); some cases where, although we often talk about actual loss, we actually calculate damages on the basis of notional loss (section III); some problems about the time of calculation (section IV); and the impact on the process of the calculation of chances (section V). * Dean, School of Law, Singapore Management University, and Professor Emeritus, University of Bristol. 1 (1854) 9 Exch 341. 2 See, eg I R Macneil, Contracts: Exchange Transactions and Relations, Cases and Materials (New York, Foundation Press, 2nd edn, 1978), 142. 3 For a recent discussion of the significance of Hadley v Baxendale, see A Tettenborn, ‘Hadley v Baxendale foreseeability: a Principle beyond its Sell-By Date?’ (2007) 23 Journal of Contract Law 120.

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T H E ME A N I N G O F L O S S

The basic principle was stated in Robinson v Harman4 and has been repeated endlessly ever since. The plaintiff should, so far as money can do it, be put in the same position as if the contract had been performed. For most of the time since 1848, it has been assumed that it is relatively easy to apply this principle once it has been stated. Modern scholarship and many of the papers of this conference show that this is much too simplistic a view.5 The remoteness rules emanating from Hadley v Baxendale are obviously one of the limitations on this principle. Another important qualification, so obvious that it is barely stated in the books, is that the plaintiff must establish what the loss is. In practice, plaintiffs often have severe practical problems in proving the money value of their loss and many victims of breach of contract give up at this stage. Modern contract law has helped the claimant by recognising different ways of analysing loss. A straightforward application of Robinson v Harman is often described as expectation loss, but it is clear that in some cases the plaintiff can recover what is nowadays described as reliance loss, that is, typically expenditure which has been wasted because of reliance on the defendant performing the contract. A classic example is provided by the facts of Anglia TV v Reed,6 where the defendant, an actor, contracted to appear in a movie and then accepted a better offer elsewhere. The claimants abandoned the scheme to make the movie. They might have attempted to prove how much money the movie would have made, but this would be, to say the least, an uphill task. The history of movie making is littered with examples of expensive projects which nobody wanted to watch and, conversely, of movies which none of the big studios wanted to make but which were a tremendous success at the box office. The claimants in this case chose to claim for the expenditure which had been wasted before the defendant withdrew, such as commitments to other actors, scriptwriters and locations. It might be objected that the film might have been such a disaster that it would not have brought in enough revenue to cover these costs. It would undoubtedly be open to a defendant to prove this if he could, but it seems to be assumed that the burden of this is on the defendant. At some point in the process of reasoning, the burden of proof appears to shift from the plaintiff to the defendant in a way in which, in a case of this kind, is likely to prove decisive.7

(1848) 1Exch 850. See the enlightening paper by I Schwenzer and P Hachem, ‘The Scope of the CISG Provisions of Damages’, this volume. The difficulties under the CISG exist equally in national systems. 6 [1972] 1 QB 60. 7 C&P Haulage v Middleton [1983] 1 WLR 1461; CCC Films (London) v Impact Quadrant Films [1985] QB 16. 4 5

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The fullest discussion of many of these difficulties is to be found in the difficult case of Commonwealth of Australia v Amann.8 In this case, the Commonwealth government had made a contract with Amann to provide aerial surveillance of Australia’s northern coastline for three years. It was accepted by the time the case reached the High Court of Australia that the Commonwealth government had wrongfully repudiated the contract, but by then Amann had spent very substantial sums indeed on equipping itself to perform the contract. Amann’s business strategy was clearly based on the belief that, having got the initial three-year licence, it would be in a strong position to get renewals of the licence. The aircraft it had bought and equipped had an estimated life far beyond three years but a poor second-hand value. The Commonwealth government was clearly not under an obligation to renew the licence and therefore claims based upon expectation loss would have produced little, if any, recovery. The High Court held that Amann had a very substantial claim on a reliance loss basis because it could prove the expenditure and it could prove that it had a good chance of renewal, of which it had been deprived by the wrongful repudiation.9 There are significant differences of formulation and emphasis among the judges of the High Court and one may consider the case close to the line at least in the sense that one would not be surprised to find another court deciding a similar case the other way. In a business sense, the difficulties arise largely from the initial decision of the Commonwealth government to let on a three-year renewable basis a contract which required capital expenditure not easily recoverable over three years. Nevertheless, it was not unreasonable for Amann to tender on the basis that, when the time came for renewal, the Commonwealth would be under some practical and moral pressure to get best value for money, and it does not seem wrong to take this into account in calculating Amann’s loss. In the English cases, it has been stated that the claimant has a choice whether to formulate his claim on an expectation loss or a reliance loss basis. This view was criticised by some of the judges in the Amann case, but it may perhaps be suggested that the difficulty is largely theological. In an adversarial system, the claimant is bound to have the first go at formulating his claim, and he and his lawyers will naturally try to formulate the claim in the way which is most attractive to the court which is going to decide it. Of course, they may make a misjudgment in this respect, but that is another matter. One should say here that, at least in English law, the claimant may have a third option of formulating a claim on a restitutionary loss basis, as (1991) 174 CLR 64. This reasoning was forcefully criticised by G Treitel, ‘Damages for Breach of Contract in the High Court of Australia’ (1992) 108 LQR 226. See also S Waddams, ‘Damages: Assessment of Uncertainties’ (1998) 13 Journal of Contract Law 55. 8 9

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approved on the peculiar facts of the case by the House of Lords in Attorney General v Blake.10 Exactly what the limits of this decision are, and to what extent it will be adopted in other common law jurisdictions, are difficult questions and are beyond the scope of this chapter.

III

ACT UA L A N D N OT I O N A L L O S S

Suppose S contracts to sell to B 1000 tons of Columbian coffee beans at £1,000 per ton, delivery on 1 May. There is an available market in Columbian coffee beans to which both S and B have ready access. S fails to deliver on 1 May when the price is £1,050. On 2 May the price is £1,100 and on 3 May it is £1,000. In this situation it is said that B can recover damages for non-delivery at the rate of £50 a ton (it is conceivable that, in some circumstances, there will be other losses, but these are ignored for the present purposes). As I understand English law, this result follows whether B buys on 1 May, 2 May, 3 May or not at all. We can explain the result for the purchase at £1,100 on 2 May on the grounds that B should have mitigated, and could have done so by buying in the market on 1 May. We can be sure that in this situation B1, B2 and B3 will behave differently. Some buyers will undoubtedly take a view on the movement of the market and not buy because they are sure that the prices will come down within a day or two. I know of no English case in which a buyer who buys at £1,000 a ton on 3 May had been denied damages, and certainly the buyer does not have to have gone into the market and made an actual purchase in order to recover his notional loss. Of course, in an active market, where everybody is buying and selling all the time, it will very often be impossible to say which transaction should be lined up with which other transactions.11 Despite the large amount of loss-based rhetoric in the case law, there is little or no attempt to justify the application of the notional loss approach. It is taken as read. One might attempt to justify this by reference to the Sale of Goods Act, but, as we shall see, there are cases of notional loss well outside Sale of Goods. There is one question which has not yet been asked, much less answered: when do we calculate on an actual basis and when do we calculate on a notional basis?12 It is clear that the English rule is not universal. Many systems start off by dealing with the situation where B has actually gone into the market on 1 May and bought against S. Typically, they allow B to recover the [2001] 1 AC 268, [2000] 4 All ER 385. See the helpful discussion by H McGregor, ‘The Role of Mitigation in the Assessment of Damages’ this volume. 12 But there is much that is relevant in M Bridge’s contribution, ‘The Market Rule of Damages Assessment’ this volume. 10 11

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difference between what he has paid and the contract price (usually provided that he can show that he has paid the market price). This is not a difference between the common law and the civil law since, although it is found in many civil law systems, it is also found in the American version of the common law and in international provisions such as the Vienna Convention. Many of the systems which have this rule also go on to deal with the situation where B has not gone into the market on 1 May and state something very like the English rule. In these cases there is not much practical difference between the two systems except where B goes into the market on 1 May but pays what can be shown to be less than the market price. An excellent example of this dual approach is provided by the UNIDROIT Principles of International Commercial Contracts. Article 7.4.5(1) (Proof of harm in case of replacement transaction) reads: Where the aggrieved party has terminated the contract and has made a replacement transaction within a reasonable time and in a reasonable manner it may recover the difference between the contract price and the price of the replacement transaction as well as damages for any further harm.

Article 7.4.6 (Proof of harm by current price) provides: (1) Where the aggrieved party has terminated the contract and has not made a replacement transaction but there is a current price for the performance contracted for, it may recover the difference between the contract price and the price current at the time the contract is terminated as well as damages for any further harm. (2) Current price is the price generally charged for goods delivered or services rendered in comparable circumstances at the place where the contract should have been performed or, if there is no current price at that place, the current price at such other place that appears reasonable to take as a reference.

These differences embody a distinction between concrete and abstract assessments.13 The language of the UNIDROIT Principles is, of course, similar to that of Articles 75 and 76 of the Vienna Convention. In both cases, there may be problems about the relationship between the concrete and abstract tests. At first sight, the relationship appears clear. If the injured party makes a cover transaction, the concrete rule applies; if not, the abstract rule will applies. However, there will be difficulties. This way of stating the rule ignores the fact that a cover transaction may itself affect the market price. A large sale will drive the prices down and a large purchase will push the prices up. The abstract measure insulates the price from such pressure. It is not inconceivable that situations may arise in which it can be 13 There is an excellent discussion of this in G Treitel, Remedies for Breach of Contract (Clarendon Press, Oxford, 1988) 111–24.

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plausibly argued that the injured party should mitigate by entering into a substitute transaction. A second problem is that in an active market, where both buyer and seller enter into many transactions, it will be hard to be sure whether there has been a cover transaction. This will be important where there are many transactions on the same day of the contract amount but at different prices.14

IV

T H E T I M E O F AS S E S S M E N T

In the sale of goods example just discussed, it is clear that damages are assessed at the date of breach. Indeed, the existence of an available market at the date of breach is an essential part of the rule. It has been common in the past to talk as if this rule were universally applicable—the so-called ‘breach date’ rule. This, however, clearly goes too far.15 Even in sale of goods cases, if there is no available market it will be necessary to give the claimant time to find a substitute buyer/seller. In Dodd Properties v Canterbury City Council,16 the plaintiff recovered the cost of repairing the damage done to their building by the defendants’ power driving operations calculated at a date some 10 years after the damage had been done because in the circumstances, given their impecuniosity and the defendants’ denial of liability, it was reasonable for them not to have repaired before. This was a nuisance claim, but the same principle must apply in breach of contract. In cases where mitigation is a major factor, post-breach events may often be very relevant. Take the football manager, appointed to a five-year contract at £5,000,000 a year, who is dismissed at the end of his first season. It is clearly relevant if, three months later, he is offered a post as a manager of another club at £4,000,000 a year. Nevertheless, the claimant will normally suffer his or her loss at the moment of breach, and the situation at the date of breach will usually be very relevant to the assessment of the damage. How far this goes was a central question in the recent decision of the House of Lords in The Golden Victory.17 In this case, the owners (O) of a ship chartered it for seven years to the charterers (C). In December 2001, C wrongfully repudiated and a few days later O accepted the repudiation as terminating the contract, and in due course started an arbitration claiming damages. At this point the charterparty had 48 months to run. O did not re-let the ship on a long charterparty but it was held that there was an available market, even though it would take some three months to re-let the ship. Everyone involved in the case (the 14 See the useful discussion by Knapp in CM Bianca and MJ Bonell (eds), Commentary on the International Sales Law: The 1980 Vienna Sales Convention (Milan, Giuffrè, 1987) ch V, s II. 15 S Waddams, ‘The Date for the Assessment of Damages’ (1981) 97 LQR 445. 16 [1980] 1 WLR 433. 17 [2007] UKHL 12, [2006] 1 All ER Comm 235, [2005] 1 All ER (Comm) 467.

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parties, their lawyers, counsel, the arbitrator and all the judges) proceeded on the basis that damages should be assessed on the basis of the notional monthly hire obtainable in the available market (see the sale of goods examples discussed in section III). Nobody appears to have thought it necessary or appropriate to calculate on the basis of what the owners had actually done. There was, however, a major practical difference between this case and the sale of goods cases. In a sale of goods case, one would normally be dealing with a single figure, the price. In charterparty cases, however, the ship is not chartered for a price but, in the case of a time charter, as in Golden Victory, for a monthly payment of hire. The monthly figure has to be capitalised. As discussed in the reported judgments, it looks as if the owners were claiming 48 times the monthly notional hire on the grounds that the charter had 48 months to run. It is perhaps worth pointing out that that cannot actually be right. If, as would be the case if the arbitration proceeded in a normal way with reasonable dispatch, the owners received the money before the end of the term, they would have, as it were, to give a discount for getting the money in advance. Further, it is hardly conceivable that the ship would have been working continuously for the 48 months to the end of the charter. Almost certainly, there would have been periods when it was off hire and the charterers were not obliged to pay. Some effort would have had to be made to estimate the value of this possibility. These questions were not before the court in the present case. What was before the court was a provision in the charterparty under which, if war broke out between a number of countries, including USA, UK and Iraq, either party should be entitled to cancel. Such a war did in fact break out in March 2003 and C accordingly argued that the appropriate multiplier to apply for the notional monthly hire was therefore 15 and not 48. The arbitrator, Langley J, the Court of Appeal18 and the majority of the House of Lords (Lords Bingham and Walker dissenting) agreed. All five speeches in the House of Lords agreed on one proposition. Damages are often correctly assessed at the date of breach, but this is not a universal rule. The difficult question, on which there is certainly not agreement, is when one should apply the breach date rule and when one should depart from it. It may, with the greatest respect, be doubted whether the answer to the question is any clearer now than it was before the decision of the House of Lords. One argument is that if the charterparty had still been subsisting the charterer would certainly have terminated in March 2003 on the outbreak of the war. The arbitrator held as a fact that the charterer would have done so if it had had the option of 18 For a discussion of the decision of the Court of Appeal, see G Treitel, ‘Assessment of Damages for Wrongful Repudiation’ [2007] 123 LQR 9.

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doing so. It is, however, hard to see how the charterer’s actual position can be relevant. By repudiating the charter and by the repudiation being accepted by the owner, the charterer’s right to cancel had come to an end. If the owners had rechartered the ship, then it would have been possible to enquire what the new charterer would have done or indeed did in March 2003. Since the owners had not rechartered the ship it is necessary to keep reminding ourselves that no one involved in the case inquired what the owner had actually done. What was considered was the notional loss suffered in the light of the notional rechartering. So perhaps the question should be, would the notional charterer have terminated in March 2003? This question was not put, but it is perhaps worth answering. It is believed that the effect of the outbreak of war in March 2003 was to drive freight rates sharply upwards. In such a situation, it is actually rather unlikely that a charterer would terminate since this would usually involve going into the market and rechartering at a higher rate.19 The truth is that the cancellation clause gave both the owner and the charterer the possibility of cancelling if war broke out. It is almost inconceivable that the outbreak of war would have no effect on the charter market and very probable, therefore, that in any normal situation one of the parties would be glad of the opportunity to cancel, as provided by the cancellation clause. In the circumstances in 2003, this would seem to be much more likely to be an owner’s option than a charterer’s option. There is certainly a conceivable argument that in March 2003 either the owner or the notional new charterer would have thought it expedient to use the cancellation clause, but this is not the way the case was put. Counsel for the owners was certainly not asked during argument in the House of Lords whether the owners would have cancelled the notional recharter in March 2003. He might perhaps have plausibly replied that the owners had never directed their minds to this question. If we assume that the owners would behave in a rational but opportunistic way, the answer must depend upon a sophisticated analysis viewed from March 2003 of likely moves in the market between March 2003 and the normal end of the notional recharter in December 2005. Presumably a similar analysis in December 2001 had led the owners not actually to recharter but to let the ship on the spot market. The most powerful argument for the owner’s position is that it would have been perfectly possible for an arbitrator to reach a decision in December 2001 as to the value of what the owners had lost. The balance of the charter clearly had a commercial value. One could have gone to a bank and borrowed against it or one could have sold it. It is perhaps worth stopping at this point and considering how the balance of the 19 Lord Brown stated, at [82], that it was to be ‘assumed’ that the notional charterer would have cancelled on the outbreak of war but it is hard to see any basis for this assumption since charterers do not usually cancel on rising markets.

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charter should have been valued in December 2001. Anyone buying or lending against it would surely have read the charter carefully or got a lawyer to do so for them. This would have involved a consideration of the cancellation clause. The arbitrator in fact considered the cancellation clause and, indeed, both sides called expert evidence on it. The arbitrator held that at 17 December 2001 [a reasonably well informed person] would have considered war or large scale hostilities between the United States or the United Kingdom and Iraq to be not inevitable or even probable but merely a possibility.

The speeches in the House of Lords revealed some puzzlement as to exactly what the arbitrator meant by his finding. It would obviously have been more precise, though also more likely wrong, if he had given it a numerical value and said that it was 10% chance or whatever. The arbitrator’s finding is obviously not open to challenge in the courts. The opinions which are being tested were probably those of people likely to lend against or buy the balance of the charter rather than well-placed observers in Washington with friends in the West Wing.20 One can perhaps test matters by asking whether the situation would have been different if the charterers had repudiated in the summer of 2002 rather than in December 2001. The answer is surely that in the summer of 2002 war was much more likely and therefore the value of a long-term charterparty with a war cancellation clause would have been significantly reduced compared with its value in December 2001. As a historical fact, the value of the charter in December 2001 was not altered by the outbreak of war. One might measure this by asking what the position would have been if, after the repudiation, the owners had in fact rechartered the ship and six months later the ship had been the subject of a nautical accident and had sunk. It is hard to see how this could affect the liability of the charterers for wrongful repudiation. There is clearly a more plausible case in relation to the cancellation because the cancellation clause was part of the charterparty. This would certainly justify taking the possibility of cancellation into account in valuing the charter in December 2001, but this does not necessarily mean that one should wait until March 2003 to do the sums or, indeed, that, because the process of litigation was taken to 2003 or later, the answer should be different. The argument put for the owners in the House of Lords seemed to come close to arguing that the cancellation clause could be disregarded. Such an argument cannot, it is thought, be right. It was appropriate to discount the 20 George Packer’s book on America and Iraq, The Assassins’ Gate: America in Iraq (New York, Farrar, Straus & Giroux, 2005), says that in July 2002 Sir Richard Dearlove, Britain’s Head of Foreign Intelligence, reported back to Tony Blair that ‘military action is now seen as inevitable’ (at 61).

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possibility of the charter lasting for 48 months but not, in the light of the arbitrator’s holding, by much. It is thought that the presence of the cancellation clause in the charterparty was an essential part of the reasoning of the majority. It cannot be the case that the measure of damages is at the mercy of events between the breach and the date of judgment. Suppose that S agrees to sell to B a racehorse, Atkin, to be delivered on 1 May 2007, at a price of $100,000. S fails to deliver. A few weeks later Atkin wins the Derby and is now worth $10 million. Surely B’s damages are determined by Atkin’s value at the date of breach and not at the date of judgment. Would those who disagree feel differently if, instead of winning, Atkin falls, breaks a leg and has to be destroyed? These are, of course, sale of goods cases, but not ones of notional values.

V

DA M AG E S A N D CH A N C E S

The discussion in the previous section assumes that it is permissible and proper to assess chances for the purposes of claims for breach of contract. This is in a sense completely orthodox law since this is what the Court of Appeal held in Chaplin v Hicks21 and the correctness of this decision has not, I think, been challenged in any later decision. In this case, the plaintiff was one of 50 people who had been shortlisted for consideration for 12 jobs and promised that she would be considered. The defendant in breach of contract failed to consider the plaintiff and the Court of Appeal upheld the award by the jury of £100 (a very substantial sum in 1910) as damages. It is perhaps worth noting that the leading judgment in the Court of Appeal was given by Fletcher Moulton LJ, probably the best mathematician to have graced the House of Lords22 and therefore unlikely not to have been familiar with probability theory. The jury did not, of course, have to explain how they reached their figure, as a modern judge would have to do. The amount awarded could only have been based on the jury’s view that the plaintiff had a substantial chance of being selected. Many contract cases have followed this lead. Perhaps the most obvious group is cases against solicitors who have negligently harmed their client’s case, for example, by failing to start proceedings within the limitation period. There will be very few such cases in which the client will have been certain of success, so in nearly all cases it is the chance of success which is the substance of the claim. Judges on the whole do not appear to have 21 [1911] 2 KB 786. It is clear that some other systems have much greater difficulty with loss of a chance. 22 Fletcher Moulton was the best undergraduate mathematician in his year at Cambridge, in itself proof of high mathematical skills. According to the DNB, he was recognised by his contemporaries as so good that other undergraduates did not enter for prizes when he had entered. While in practice at the bar doing, amongst other things, a substantial number of patent cases, he became an FRS.

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experienced enormous difficulty in deciding on the value of the claim and discounting it by the prospects of success. There are, of course, more difficult cases, of which Allied Maples v Simmons and Simmons23 is a good example, where the defendants had given the claimants bad advice but the effect of the bad advice was hard to assess because it impacted on the claimant’s position in negotiations with a third party and it was impossible to be sure how the third party would have reacted if the claimant had been given good advice. Nevertheless, it is clear that, even in such a difficult case, the claimant can maintain a claim based on loss of the chance of doing better if good advice had been given. The puzzle I have here is that a different line of reasoning appears to be applied in a group of medical negligence cases, a number of which have gone to the House of Lords.24 In the House of Lords decision Gregg v Scott the claimant, Mr Gregg, went to see his GP, Dr Scott, and drew attention to a lump in his armpit. Dr Scott, as it was held negligently, took the view that the lump was benign. The effect of this was to delay treatment of the lump, which turned out to be cancerous, for nine months. The House of Lords (Lords Nicholls and Hope dissenting) held that Mr Gregg could recover nothing. It is perhaps not unfair to say that many people who are neither doctors nor lawyers would find this conclusion surprising. It is hard to avoid the feeling that Mr Gregg was worse off the day after he had been to the surgery than he was the day before. It is impossible to state all the difficulties in a few words. Undoubtedly the speeches repay careful examination.25 It cannot, however, I think, be the case that there are different rules for loss of a chance in contract than in tort. The cases against solicitors are indifferently fought in contract and in tort and no one suggests that there should be a different result. In any case, although most of the reported cases involve actions where the patient has been treated within the NHS, there is a sizeable private sector for medical treatment and there is no hint in any of the cases that defendants in the private sector are to receive different treatment on exactly the same facts. There could be no rational reason for such a distinction since most doctors who are practising privately are also practising in the NHS and, in any case, in any normal situation the damages will be met either by the NHS or by medical insurance. A rather better argument may be that there 23 24

[1995] 4 All ER 907. Hotson v East Berkshire [1987] AC 750; Gregg v Scott [2005] 2 AC 176, [2005] 4 All ER

812. 25 The earlier decisions of the House of Lords in this group have been unanimous and it is noteworthy that this did not prevent powerful dissents in the present case. Despite decisions of the High Court of Australia apparently following the earlier English decisions, most recent intermediate Court of Appeal decisions in Australia go the other way. In Gregg v Scott, the actual decision may have been influenced by the fact that Mr Gregg was, fortunately, still alive at the date of judgment and by the way his case is put.

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should be special rules for personal injury. Those of us who think that there would be much to be said for taking the whole of personal injury law outside the law of negligence might welcome this development, but that is a matter for another day.

VI

CONCLUSIONS

It is clear that there are significant differences at least in the way the rules are formulated between English law, on the one hand, and both other domestic systems and the international conventions, on the other. How large these differences are in practice is less clear. English law has a rich case law in many parts of the area, but there are still many areas of uncertainty. This is particularly so in relation to when one moves from notional calculation to actual facts. The Golden Victory reflects these ambiguities. The basic calculation took no account of what the owners had actually done after the charterers’ repudiation but, in the view of the majority, the actual outbreak of war was of decisive importance.

18 The Market Rule of Damages Assessment THE MARKET RULE OF DAMAGES AS S ES S MENT

M IC H A E L BR ID G E * MI CHAEL BRI DGE

I

A

G E N E R A L C O N S I D E R AT I O N S

Introduction

A superficial comparison of the rules for the assessment of damages for breach of a sale of goods contract as laid down in international instruments, such as the UNIDROIT Principles of International Commercial Contracts (UPICC) and the United Nations Sale Convention (the CISG),1 with the English law rules exemplified in the Sale of Goods Act 1979 would not be a particularly interesting exercise. From such a comparison, we should learn that the Sale of Goods Act rules for non-delivery and non-acceptance, predicated upon the termination of the contract, direct the court’s attention to the state of the market prevailing on the due date of delivery.2 In contrast, the international instruments turn first to any replacement or substitute transaction entered into by the seller or the buyer; only in default of such transaction do they turn to a market or current price.3 We should also learn from our superficial survey that the two limbs of the remoteness of damage rule in Hadley v Baxendale4 are to be found, if one looks for them hard enough, in the Sale of Goods Act,5 but that the requisite degree of probability of loss has to be discovered from a careful reading of the case law. On its face, such a reading would require a higher degree of probability than is the case with the CISG, where the Professor of Commercial Law, London School of Economics. In this chapter, I shall confine my attention to these two instruments, referring also as necessary to the Principles of European Contract Law (PECL). 2 Sale of Goods Act 1979, ss 50–1 and 53. 3 CISG Arts 75–6; UPICC Arts 7.4.5–6. 4 (1854) 9 Ex 341, 156 ER 145. 5 Bence Graphics International Ltd v Fasson UK Ltd [1998] QB 87 (CA) (Otton LJ). * 1

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remoteness rule of reasonable foreseeability of loss is spread across Articles 74–6,6 but appears to be broadly comparable to the standard of probability laid down in the UPICC.7 Unless and until a sophisticated body of reasoned and reported case law emerges out of the international instruments, it will be impossible to carry out a meaningful comparison of the international instruments and English law. So far as the international instruments fail to penetrate commodities markets and are not applied in market conditions,8 the development of such a body of law is consequently bound to remain inhibited. The experience of English law has been that an understanding of damages is not to be found in a minute parsing of the remoteness of damage rule. Two short examples will suffice to make this point. First, there is Parsons (H) (Livestock) Ltd v Uttley Ingham & Co Ltd,9 where a hopper for the storage and dispensing of animal feed had been supplied with the ventilator flap closed, which resulted in the feed becoming mouldy and the subsequent deaths of animals from a rare bacterial illness. The buyer’s claim was based on a breach of the seller’s fitness for purpose obligation10 and at trial the judge ruled that the injury need not have been contemplated at the date of the contract. Lord Denning boldly asserted that, for physical injury, the tort rule governed both as to the degree of foreseeability and as to the date of foresight, namely, when the seller committed its breach of duty. The other members of the court were not prepared to countenance such a radical realignment of the rules of remoteness of damage in tort and contract.11 Nevertheless, with some manipulation of the contract remoteness rule, they were able to arrive at the same result in favour of the buyer as Lord Denning. The willingness of English law to accept overlapping liability in tort and contract12 produces pressure to align results so that no appreciable difference turns upon the selection of the claim as lying in contract or tort. However dramatic are the differences between the articulation of the tort and contract remoteness

6 See in particular Art 74 (loss foreseen or foreseeable at the contract date as a ‘possible consequence of the breach of contract’). 7 See Art 7.4.4 (such loss foreseen or foreseeable at the contract date as ‘likely to result’—a formulation that appears to draw heavily from the discussion in Czarnikow (C) Ltd v Koufos (The Heron II) [1969] 1 AC 350 (HL). 8 The CISG is invariably excluded by the standard form contracts promulgated by London-based trading associations, like the Refined Sugar Association and the Grain and Feed Trade Association (GAFTA), and also by oil majors such as BP and Royal Dutch Shell. 9 [1978] QB 71 (CA). 10 Sale of Goods Act 1979, s 14(3). 11 Many judges have observed, however, that the rules of remoteness in contract and tort are very different and that the latter are stricter: see, eg The Heron II, above n 7 (Lords Reid and Upjohn). 12 The buyer’s claim was laid in contract but, on these facts, it might equally have been laid in the tort of negligence.

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rules, they are unlikely, on a given set of facts, to produce different results.13 The second example is The Heron II.14 That case concerned a voyage charterparty where the shipowner, in admitted breach of duty, deviated in the course of a voyage to Basra. Consequently, the ship arrived in Basra some nine days later than it would otherwise have done. The ship was carrying a cargo of sugar. During that period of delay, the sugar market declined and the charterer, whose aim was to sell the sugar on the Basra sugar market on arrival, incurred financial loss. Counsel for the shipowner demonstrated with some skill that the loss of market was only one of a number of possibilities that the shipowner might have contemplated had it directed its mind to the consequences of delay at the time the contract was concluded. For example, the shipowner did not know whether it was the charterer’s intention to sell or warehouse the sugar, or whether the cargo had already been sold, and the fluctuating Basra sugar market might equally have risen during that nine-day period. The charterer’s loss of profits in The Heron II appears therefore to be of a relatively low order of probability and the outcome in its favour does not seem to satisfy the quite exacting requirements of the various statements of the remoteness rule in that case, even taking probability to mean something lower than 50%.15 If a statement of the remoteness rule fails to convey informed understanding of its application, nothing is to be gained from a simple, textual comparison of remoteness rules between the Sale of Goods Act and the international instruments. Problems of assessment of damages are manifold. The full implications of this subject cannot be encompassed in one short chapter, so I shall have to be selective. In this chapter, I shall focus on the market approach to damages in English law, with particular regard being paid to whether it is consistent with the rule that loss be proved as a matter of fact to have occurred before the remoteness of damage rule is applied to the claim for damages. In its purest, abstract application, the market damages rule pays no regard to the question of factual causation in the award of damages. This is because its concern lies with what might have been done and not 13 See, eg Lord Phillimore in Re Hall (R&H) and Pim (WH) (Junior) & Co’s Arbitration (1928) 30 Ll L Rep 159, 164 (HL): ‘Whether the action be one of tort or of contract, the defendant against whom judgment passes must pay all damages which naturally flow from his wrong action or his breach of contract.’ A further feature of the remoteness damages rule stems from a court’s selection of the point of reference from which the foresight exercise is conducted. In Parsons itself, the calculation must be influenced by whether that point of reference is the supply of a hopper with the ventilator flap closed or the supply of a hopper that is generally unfit for its purpose. 14 Above n 8. 15 Consider also Lord Pearce’s famous example in The Heron II, above n 8, of the one-in-ten chance of the ceiling in one of the law courts collapsing while the court is sitting. Despite the result in The Heron II, it is a likely hypothesis that the degree of probability required for personal injury will be of a lesser probability than that required for financial loss.

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with what was or should have been done. So far as the rule is ameliorated by staggering the date of complex and bulky hypothetical transactions in the market, as occurred to a limited extent in Shearson Lehman Hutton Inc v Maclaine Watson & Co Ltd (No 2),16 this signifies some movement away from a purely abstract measure of damages to one that is somewhat more concrete. Assessing damages by reference to the market is an abstract measure of damages, whereas an assessment based on a sub-sale price is a concrete measure.

B Speculative Questions In the background of the inquiry in this chapter lie two speculative themes that cannot be resolved here but that should nevertheless stimulate thought and inform understanding of the problems of damages assessment. The first speculative theme is whether the English approach to damages for breach of contract, disregarding as it does connected contracts, is influenced by the doctrine of privity of contract. If this is the case, then a shift away from the market rule and towards a reference to re-sales and sub-sales may be seen as a consequence of the same movement in legal thought that ultimately led to the passing of the Contracts (Rights of Third Parties) Act 1999. Related to this line of thought is the point that an approach to damages based on a reference to the market might be seen as particularly characteristic of the market-sensitive commodity markets. Yet, surprisingly perhaps, a reading of default rules in modern standard form contracts shows that the market rule does not play the dominant rule that it plays in the Sale of Goods Act. A tribunal or court first looks to any substitute or replacement transaction entered into by the claimant in consequence of terminating the contract.17 Perhaps it is no accident that these same forms recognise the connectedness of contracts entered into in string trading conditions for various other purposes, for example, in differentiating the persons of seller and shipper and in encouraging cash settlements when the existence of a contractual circle is established.18 The second speculative theme is whether the common law approach to probability in the remoteness of damage owes anything to strict liability in contract. Put simply, is there some reluctance, at whatever level of judicial consciousness, to impose liability for events of a relatively low order of probability given the common law rule that no fault, presumptive or otherwise, is needed for there to be liability in damages for a breach of [1990] 3 All ER 723 (‘limited fictitious assumptions’ at 731). Eg GAFTA 100, cl 23. For an example of a circle clause, where contracts in the circle are settled for cash on the basis of the lowest contract price in the circle, see, eg GAFTA 100, cl 24. 16 17 18

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contract?19 Although it is an orthodox proposition that fault or bad conduct does not inflate a damages award in a given case,20 the question here is whether liability in the absence of fault has had some inhibiting effect, expressed through the remoteness of damage rule, on the recovery of damages that represent the full extent of loss caused by a breach of contract. This is the other side of the coin to the more commonly posed question whether personal fault should inflate a damages award. An examination of the market damages rule in English law shows a judicial realisation, bordering on resignation, that perfect compensation is simply an impossible ideal.21 A clash of values of compensation and no-fault liability, if it does exist at some level in English law, is echoed by way the UPICC expressly assert and deny full compensation. Article 7.4.2 announces the principle of full or integral compensation: ‘The aggrieved party is entitled to full compensation for harm sustained as a result of the non-performance.’ This clear provision is then immediately compromised by the succeeding two articles requiring, first, that the harm be established with ‘a reasonable degree of certainty’,22 and secondly, that the harm be reasonably foreseeable at the contract date. As much as anything can, this stark antimony reveals the impossibility of finding the law on damages in the text of statutory rules.

C

Contingencies

Comparisons may be drawn between the market damages rule and the discounting of damages to take account of future contingencies as apprehended at the date of breach. The recent decision of the House of Lords in The Golden Victory23 poses in a very direct form the question whether hindsight should be employed when assessing those contingencies. The market approach to damages, when applied in its purest form, treats the claimant as having an established right at the breach date and is insensitive to any inquiry based upon an actual loss suffered by the claimant. This approach might be prayed in aid to oppose any reduction of damages to 19 Randall v Newson (1877) 2 QBD 102 might suggest otherwise. In holding the intermediate seller of manufactured goods liable for consequential damages arising out of a hidden defect in the goods, which it could not have detected, the court treated the issue as a simple matter of applying the rule in Hadley v Baxendale, above n 4. 20 In any case, the formulation of the rule in terms of contemplation at the contract date repels any such gloss on the rule. As for whether fault might play a subliminal role, Re Hall and Pim, above n 13, offers an instructive example (see particularly the speech of Lord Blanesburgh). 21 See, eg Scrutton LJ’s realistic reference to ‘one of the many instances in English law where the measure of damage did not give the real loss suffered by the party’ in James Finlay & Co Ltd v NV Kwik Hoo Tong Handel Maatschappij [1929] 1 KB 400, 411 (CA). 22 A notion that has a long history in American contract law but no clear pedigree in English law. 23 [2007] UKHL 12.

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take account of future contingencies that have not crystallised by the time of contractual termination. On the other hand, Lord Blackburn has most authoritatively stated the purpose of the award of damages in terms that firmly repel any award placing the claimant in a world that it did not occupy and never could have occupied. Damages are awarded to place the claimant in the position it had been in before the breach occurred.24 It does not take an unkind critic of the English law of damages to say that its philosophy of compensatory principle is not as clear as it might be. A full commitment to legal certainty favours a clear rule that is not compromised by immediate fact. If the dissentients in the House of Lords in The Golden Victory had had their way, no account would have been taken of the war that would have allowed the charterer to withdraw from a long-term charterparty in assessing damages against that charterer, who had unlawfully repudiated the charterparty before the war occurred. When termination occurred, war was only a possibility. Lord Bingham was particularly insistent on the need for certainty. Again, putting aside the limited concrete incursion made into the market rule by Webster J in Shearson Lehman Hutton Inc v Maclaine Watson & Co Ltd (No 2),25 if a purely abstract approach were made to the award of damages based on the market, the market rule would be applied evenly and consistently, more or less regardless of the actual position of a particular claimant. Taken to its logical extreme, the effect of a market rule applied without exceptions is that a party to a forward contract of sale is not buying or selling goods but purchasing a market position. The contract of sale of goods is thus recharacterised as a financial differences contract.

D

Countervailing Policies

Standing back from particular problems in the assessment of damages, there are two fundamental policies pulling in different directions. First of all, there is a practical need for a simple rule that can be administered in a clear, expeditious and certain way. The market rule of damages is an important expression of this policy. Another was the old rule in The Parana that, in the case of late delivery of a cargo under a voyage charter, the charterers’ damages should be limited to interest on the invoice value of the cargo for the period of delay.26 Secondly, there is the need to calculate Livingstone v Rawyards Coal Co (1880) 5 App Cas 25. [1990] 3 All ER 723. (1876) 2 PD 118 (reinstating to this effect the registrar’s decision at (1875) 1 PD 452, 456). It is a feature of shipping cases that a conventional view of recoverable damages stands in for the application of remoteness rules on a case-by-case basis until the received wisdom is eventually challenged. Another example is the belief that damages recoverable for an overrunning time charter were limited to the difference between the charter rate and the market rate during the 24 25 26

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damages in a way that expresses the real loss of the claimant. Hence, the rule in The Parana was abandoned in The Heron II,27 when charterers were entitled to damages for missing their market for sugar in Basra as a result of the shipowner failing to prosecute the voyage with all convenient speed. In reaching this conclusion, the House of Lords had to deal with a burden of factual inquiry and legal argument far in excess of anything it would have had to face had it simply applied The Parana. Similarly, in an important case concerning defective goods, the Court of Appeal in Bence Graphics28 declined to apply the market rule when assessing damages for the supply of non-conforming goods, but looked instead at the fate of sub-sales concluded by the buyer when selling on the contract goods in a processed form. The very development of the rule in Hadley v Baxendale29 heralded a movement away from factual conclusions reached by a jury on unpublished grounds to a legal rule administered by the court. Modern developments, moving away from simple rules and guided by judicial discretion, herald a reversion to the old system, but with that discretion in the hands of the judge rather than a civil jury. In so approaching the assessment of damages, courts are in fact behaving like arbitrators. Although the evidence so far is scant, it may be predicted that this same tendency will emerge under the international instruments.

II

A

THE M ARKET APPROACH TO DAMAGES

General

The rule in Hadley v Baxendale30 is widely understood as encouraging the pre-contractual disclosure of information. So far as a claimant might be vulnerable to particular losses arising out of a future breach, the claimant is encouraged to disclose its position to the other party so as to engage the application of the second limb of the rule. That other party may take due note of the claimant’s position, or it might instead decline to contract or period of the overrun. The Court of Appeal, on an orthodox application of remoteness rules, has now sanctioned damages for the loss of a subsequent fixture caused by the late redelivery of a vessel on charter. See Transfield Shipping Inc v Mercator Shipping Inc [2007] 1 Lloyd’s Rep 19, affirmed [2007] EWCA Civ 901 (CA) (where, on the facts, the owner did not lose the fixture but was compelled to renegotiate it at the lower market rate prevailing at the time of late redelivery). 27 28 29 30

Above n 7. Above n 5. Above n 4. Ibid.

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contract only in return for a higher premium that matches the greater risk exposure brought about by the disclosure.31 All of this presupposes a period of contractual negotiation. This is far removed from the world of shipping and commodity sales, where transactions are often concluded between substitutes, brokers and ship’s agents for example, on an expedited and informal basis. There is little room or time for negotiation apart from quantity, price and delivery dates in a sale of goods contract and their equivalent in a voyage or time charter. It is no accident that simple rules of damages assessment, removed from the particular pre- or post-contractual circumstances of the parties, are most in evidence in these areas of contractual activity. The parties are treated like interchangeable players in a market. A market for present purposes is a community of suppliers and acquirers of goods or services, where the level of demand at a given time drives prices up or down. This is the way that the expression ‘the market’ is understood, for example, in sale of goods cases,32 though the abandonment of a fixed physical location as defining the market has not been an altogether straightforward matter.33 It need scarcely be said that any attempt in modern conditions to define market in terms of a physical location would be highly anachronistic.

B Examples The impersonal character of the market rule in the assessment of damages is best understood with the aid of references to resale and sub-sale transactions. Using sale of goods as an example, by a resale transaction, I mean the substitute sale arranged by the seller when the seller has to terminate the contract for the buyer’s breach. The counterpart transaction for the buyer is the repurchase arranged when the seller defaults. A sub-sale, on the other hand, is not a substitute transaction but is instead the transaction concluded prior to the seller’s breach, and possibly prior to the conclusion of the contract of sale, that the buyer expected to fulfil with goods supplied by the seller that now, because the contract has been terminated by the 31 In C Czarnikow Ltd v Koufos [1966] 2 QB 695, 731 (CA), Diplock LJ explains the limitation on the recovery of damages by a non-disclosing claimant in terms similar to estoppel: ‘by his own conduct in entering into a contract without communicating such special circumstances to the non-performer the other party reasonably induces the non-performing party to believe that he, the other party, is not asserting any legal right to claim reparation for any exceptional kind on loss resulting from non-performance of a primary obligation’. Lord Diplock’s contribution to the law of damages is invariably thoughtful but not always convincing. See Lord Reid in the same case on the significance of pre-contractual communication (‘I need not stop to consider in what circumstances the other party will then be considered to have accepted responsibility . . .’): above n 7, 386. 32 Shearson Lehman Hutton Inc v Maclaine Watson & Co Ltd (No 2) [1990] 3 All ER 723. 33 Dunkirk Colliery Co v Lever (1878) 9 Ch D 20 (CA).

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buyer for the seller’s breach, will no longer be delivered to the buyer. These two transactions throw separate shafts of light on the market rule. Taking sub-sales as the first example, suppose that S contracts to sell to B1 on CIF (cost, insurance and freight) Rotterdam terms 30,000 tonnes of red winter wheat for June shipment at Great Lakes ports at a price of $230 per tonne. The contract is concluded on 1 February. On a rising market, S defaults and B1 terminates the contract when S fails to deliver. For reasons connected with the technicalities of CIF contracts, it is a difficult matter to establish the date of delivery for the purpose of the market rule.34 Suppose that the date is 15 July, when S, deemed to avail itself of the right to ship at the end of June, should have transferred the bill of lading to B1. On 15 July, the market stands at $250 per tonne. According to the market rule as expressed in section 51(3) of the Sale of Goods Act 1979, S would have to pay B1 damages in the amount of $600,000 (30,000 × $20). This would be regardless of any intention on the part of B1 to go into the market on 15 July to purchase a replacement cargo. Suppose now that B1 had contracted to sell the same cargo of wheat to B2 at a price of $240. On its immediate face, the market rule overcompensates B1, who receives $20 per tonne instead of the $10 per tonne that it would have made if S had performed and the sub-sale in turn had been performed. This, however, is far from being the case, for it ignores the vulnerability of B1 to a similar claim for damages brought by B2 calculated at the rate of $10 per tonne. The market rule, seen in this light, is a simple rule that diminishes the length of trials by avoiding multi-party complexity and encouraging bilateral settlement. This is consistent with the characterisation of delivery terms in commodity sales as conditions35 and has a strong appeal for those who relish commercial certainty. If consideration were given to the sub-sale contract, then a number of issues of daunting difficulty, currently concealed beneath the surface of the market rule, would present themselves. These will be considered below. If the problem had not been one of a non-delivering seller on a rising market, but rather a non-accepting buyer on a falling market, and the question had been whether account should be taken of any resale price achieved by the seller, then a court would not as such be dealing with the significance of a collateral transaction. The resale is entered into as a result of the buyer’s default. Instead, it would be presented with the selection of a date for the assessment of damages.36 The counterpart of this problem of the non-accepting buyer is the problem of the non-delivering seller whose buyer has not yet entered into a sub-sale contract. So far as any court 34 See MG Bridge, International Sale of Goods (Oxford University Press, 2nd edn, 2007), 479–83. 35 Bunge NV v Tradax Export SA [1981] 1 WLR 711 (HL). 36 See S Waddams, ‘The Date of Assessment of Damages’ (1981) 97 Law Quarterly Review 445.

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might insist on a realistic date for entry into the market, it would have to depart from the present rule, which looks to the market on the agreed delivery date or on the last date of an agreed delivery range. And if the court were persuaded to take an extra step in pursuit of its realistic goal, what could be more natural than to look at an actual, concrete transaction if that were entered into with sufficient dispatch and in a reasonable manner? Lord Wilberforce’s observation in Johnson v Agnew37 leads the way to this approach: a court need not abide by the delivery date in a contract of sale but might instead ‘fix such other date as might be appropriate in the circumstances’. Lord Wilberforce’s statement was directed to the particular case of a party striving to have a contract performed,38 but it should by no means be limited to that case.

C

Sub-sales and Non-delivery

The cases that throw the brightest light on the market rule, on what it reveals and what it conceals, are not resale or repurchase cases, but cases where the buyer has entered into a sub-sale contract prior to the breach of the contract of sale. These cases present the market rule in its challenging aspect. The balance of this chapter will be devoted to these cases. The first case, not a sub-sale as such but a sub-charter, raising the same issues, is Rodocanachi Sons & Co v Milburn Bros,39 which was an action for non-delivery under a voyage charter of a cargo of cotton seed shipped at Alexandria on account of the charterer and bound for the UK. Owing to the master’s negligence, the cargo was lost. The charterer had in turn sold the cargo on a ‘to arrive’ basis, at a price below the market rate prevailing when the goods should have arrived in the UK. The Court of Appeal held that, in assessing damages, account should not be taken of the charterer’s sale price and that, as a self-evident matter, ‘the value is to be taken independently of any circumstances peculiar to the plaintiff’ charterer, since its relations with the buyer was an ‘accidental’ matter.40 Had the charterer sold the goods for more than the market rate prevailing at the due date of arrival, this gain would not have been taken into account in calculating the damages owed by the shipowner. In the view of the court, the market rule was therefore even-handed. A rule that is even-handed between charterers and shipowners in gross, [1980] AC 367. See the consequences of this worked out in Carbopego-Abastecimento de Combustiveis SA v Amci Export Corp [2006] 1 Lloyd’s Rep 736. If correct, which is to be doubted, this case would allow a party unilaterally granting indulgence to extend the date of assessment of damages. 39 (1887) 18 QBD 67 (CA). 40 Ibid, 76–7. 37 38

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however, is not necessarily even-handed when applied to a particular contract between one charterer and one shipowner. One of the issues in a case of this kind is whether the rule of remoteness should be put to work to determine whether a sale at more or less than the market price prevailing at the due date of delivery was within the reasonable contemplation of the parties at the contract date as not unlikely to happen. Another issue was factual causation. The operation of the market rule in this case meant that the charterer apparently made a windfall gain. Had the goods arrived in due course, it would have had to hand the goods over to the buyer for a below-market price. In Williams Bros v Agius (ET) Ltd,41 which concerned the sale of a November cargo of coal on CIF Genoa terms, A agreed to sell to W at 16.25 shillings per ton. W in turn agreed to sell coal of the same quantity and description to G for 19 shillings and, according to the finding of the umpire, intended to use A’s goods in fulfilment of that contract—and indeed appropriated the cargo to that contract.42 The contract between W and G was initially evidenced by a broker’s note that contained a war clause, but otherwise there was no provision excusing W from liability in the event that A did not fulfil its delivery obligation to W. At a later date, formal sold and bought notes passed between W and G, stipulating that W had ‘no obligation to deliver this cargo unless they get delivery of a similar cargo due to them’ by A. This ‘no obligation’ clause complicated proceedings from the umpire up to the House of Lords. The umpire’s finding was that the ‘no obligation’ clause did not form part of the W-G contract but the House of Lords, despite certain misgivings about the correctness of this finding, reached its conclusions without having to decide whether the umpire was correct on this point.43 Towards the end of November, G in turn sold goods of the same quantity and description to A for 20 shillings and also assigned to A his rights under the contract with W.44 As found by the umpire, the market [1914] AC 510 (HL). Since no coal was ever shipped by A, this finding is clearly incorrect, whether ‘appropriated’ is understood in a proprietary sense or even in a contractual sense. See Viscount Haldane’s reference on this point to Hamilton LJ in the Court of Appeal: ibid, 518–19. See also Lord Atkinson, ibid, 526–7. 43 Lord Atkinson appears to have concluded that the bought and sold notes evidenced the contract between W and G and that, moreover, the umpire treated as a question of fact a matter that was a question of law: ibid, 527. Lord Moulton clearly viewed the contract as being found in the bought and sold note (ibid, 531–2), as did Viscount Haldane (ibid, 518). Lord Dunedin was prepared, despite his own misgivings, to assume that the umpire was correct (ibid, 518). This was the most favourable assumption for the seller, A, who nevertheless remained unsuccessful in having its damages measured by the sub-sale price between W and G. Further, inconclusive discussion in the House of Lords centred on the meaning of a clause in the W-G contract, by which W ‘ceded’ its rights under the contract with A to G. See, eg Lord Dunedin, ibid, 521. 44 The price must have been below the market prevailing at that time but was surely discounted because of doubts about G’s prospects of recovering damages from W. 41 42

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stood at 23.50 shillings when A breached the contract by failing to ship November coal.45 The motivation that led to A buying back the contract from G, though somewhat transparent, did not attract comment in the House of Lords. Moreover, Viscount Haldane and Lord Dunedin were both at pains to say that the present case stated did not concern G’s assigned claim for non-delivery and that they were not expressing an opinion on whether W would have had a defence on the basis that the contract was to be satisfied out of the coal that A failed to deliver to W. The umpire did not have jurisdiction to deal with any counterclaim that A might have had against W. The real question, however, was whether A’s failed case on the umpire’s jurisdiction could succeed in different terms as an argument that W’s damages should be based on the difference between the sale prices of the A–W and W–G contracts (2.75 shillings per ton) instead of, in accordance with the market rule, the difference between the A–W price and the market price prevailing on the breach date (7.25 shillings per ton). Viscount Haldane saw no reason to depart from the approach taken in Rodocanachi and, indeed, saw it as consonant with the recent decision of the House of Lords in British Westinghouse Co Ltd v Underground Electric Railways Co Ltd46 that, if a transaction is to be treated as mitigating in fact the loss arising out of the contract breached, then it must be ‘naturally attributable to the consequence of the breach, and must not be of an independent character’.47 Such reasoning would necessarily preclude any reference to sub-sales where these are concluded before the seller’s breach or even before the contract of sale itself. The market rule thus represents only a partial departure from the law’s commitment to the principles of factual causation in the assessment of damages. Furthermore, the distinction between cases where the sub-sale was or was not concluded before the breach is the product of the mitigation in fact rule and not of any inconsistency in the application of the market rule. In the usual case, the sub-sale is a conventional onward transaction and not something stemming from the consequences of a particular breach of contract.48 In Williams, Lord Dunedin was equally firm on the correctness of Rodocanachi49 when saying that, ‘barring special circumstances’, the market rule ensured that

No explanation or date is given for the date of breach. [1912] AC 673 (HL). At 520. Cf Pagnan (R) & Fratelli v Corbisa Industrial Agropacuaria Lda [1970] 1 WLR 1306 (CA), where the particular transaction, the repurchase at a distress sale of the very goods previously (and lawfully) rejected by the buyer, could not possibly have taken place without the seller’s previous breach of contract. 49 Above n 41; so too Lord Atkinson at 529 and Lord Moulton at 530. 45 46 47 48

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the defaulting seller is neither mulct in damages for the extra profit which the buyer would have got owing to a forward resale at over the market price . . . nor can he take benefit of the fact that the buyer has made a forward resale at under the market price.50

The common law rule of remoteness does not require the amount of loss to be reasonably contemplable, only the type of loss,51 but the market rule spares the court the harder consequences of the common law rule. Lord Dunedin thought it best to have the consequences of each contract breached to be worked out in its own terms.52 That makes for a simpler rule to apply.53 The application of the market rule respects the integrity of individual contracts: if parties had wanted to enter into multilateral contracts, then they could have done so. One highly beneficial outcome of the application of the market rule in this case was that any claim that A might later make against W on the assigned W–G contract, which the umpire had no jurisdiction to entertain, would be against a party who had recovered full market damages, not against a party whose damages had in effect already been reduced to take account of that claim. This is because the application of the market rule leaves the successful buyer with a surplus in hand if the seller’s breach of contract triggers a breach by the buyer of the sub-sale contract leading to an award of damages against the buyer. If the buyer is limited to its profit, and if the arbitral reference is confined as it usually will be to only one contract in a sales string, then the buyer’s legitimate profit is diminished or eliminated in the subsequent sub-sale proceedings. The market rule lends itself to bilateral proceedings of the kind observed in arbitration proceedings, which is the conventional way to settle commodity disputes. A final point for the present, however, is the somewhat unreal conviction that surfaces from time to time in market damages cases that the claimant buyer is looking for a sum of money to permit it to enter the market to acquire substitute goods. This conviction appears in the following words of Lord Moulton: [The buyer] is entitled to recover the expense of putting himself into the position of having those goods, and this he can do by going into the market and purchasing them at the market price. To do so he must pay a sum which is larger than that which he would have had to pay under the contract by the difference between the two prices. This difference is, therefore, the true measure Ibid, 522–3. Horne v Midland Railway Co (1873) LR 8 CP 131. At 523. In cases involving the non-delivery of shares, the market rule as laid down in Rodocanachi and Williams was applied: Bear Stearns Bank Plc v Forum Global Equity Ltd [2007] EWHC 1576 (Comm); Oxus Gold v Templeton Insurance Ltd [2007] EWHC 770 (Comm) (where Langley J applied the rule with a significant measure of reluctance). 50 51 52 53

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of his loss from the breach, for it is that which it will cost him to put himself in the same position as if the contract had been fulfilled.54

It is already far too late for the buyer to enter the same market for performance of the sub-sale on the same date. Moreover, the buyer in so many cases has no intention of acquiring substitute goods and is not being required to do so. For intermediate traders, unperformed contracts are water under the bridge.

D

A Special Case

This prompts the question whether the buyer’s ability or inclination to make a replacement transaction is at all relevant in determining the limits of the market rule. Suppose the buyer is manifestly incapable of entering the contract to acquire the goods and suppose this is due to the conduct of the seller. The House of Lords, in Re Hall and Pim,55 departed from its own previous decision in Williams Bros v Agius (ET) Ltd on facts that were not so very different from those in Williams. On 3 November, Pim, acting as del credere agents for an unnamed principal, agreed to sell to Hall on CIF terms a UK ports cargo of Australian wheat at 51.75 shillings per quarter. On 21 November, Hall agreed to sell a similar cargo to Williams at 56.75 shillings. Williams sold on a similar cargo to Pim on 25 November at 59.25 shillings, this time acting for different principals (Suzuki). Towards the end of January, when the market was in decline but still stood high relative to November, Pim bought a cargo on board the Indianic at 60 shillings from Rank and immediately resold it to Rank at 59.975 shillings. This device permitted Pim to appropriate an Indianic cargo to the contract with Hall and in due course receive that same appropriation from Williams, secure in the knowledge that that cargo could not be delivered.56 Seeking to postpone its default as the market was in decline, Pim in late January sent to Hall, as required by the contract, a provisional invoice for the Indianic At 531. Above n 13. Discussed in Transfield Shipping, above n 26, [72]–[81]. Transfield Shipping was a case where a time charterer was late in redelivering a ship, the consequence of which was that the owner was obliged to renegotiate the charter rate under the fixture that was due to follow it. The owner could not substitute another ship, and so was in broadly the same position as the plaintiff in Re Hall and Pim. When Transfield Shipping was affirmed by the Court of Appeal, the court accepted this reasoning: above n 26, [109]–[110] (‘a follow on fixture made by a shipowner is rather like the resale of goods of a merchant buyer’: Rix LJ). The court added that the owner’s conduct was also in line with the behaviour of a buyer going into the market for substitute goods. By renegotiating the charter rate with the next charterer, the owner had mitigated its losses flowing from the late redelivery under the earlier charter: ibid, [108]. The court otherwise approved the general application of the market rule: ibid, [102]–[103]. 56 In the documentary sense: CIF cargoes are not physically delivered by the seller. 54 55

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cargo.57 At the time of eventual default, the market stood at 53.75 shillings. The consequence of Pim’s actions was that it minimised the damages that its first principals had to pay for non-delivery (assuming that the market rule applied), at the same time making it impossible for Williams to deliver to Pim’s other principals on a falling market. The arbitration was a purely bilateral one, between Pim and Hall, though Lord Phillimore was at pains to say that ‘the whole question of the relations between the parties’ was open to the arbitrator. For variously stated reasons, the House of Lords, overturning the Court of Appeal, was unanimous in holding that Hall’s recoverable damages were the difference between the price it agreed to pay Pim and the price that it had agreed to receive from Williams. This came to 5 shillings per quarter (56.75 – 51.75) and was 3 shillings more than the difference between the contract price and the market price on the date of default (53.75 – 51.75). Nothing was said in the case about Hall’s exposure to a damages claim from Williams and nothing needed to be said: Williams had been liberated from a losing contract as a result of Hall’s enforced breach and was free to enter a lower market. The circumstances of the market rising and then falling meant that the court was free to direct an award of damages based on the sub-sale price from Hall to Williams without having to consider the consequences of damages actions rolling back up the string to Hall in its capacity as non-performing sub-seller. Putting aside the market approach in this exceptional case58 was justified because of the way the market behaved over the relevant period. Moreover, the result was readily justifiable by an application of the remoteness rule without invoking the second limb of the rule,59 even though Hall’s contract with Williams was concluded after its contract with Pim. As Lord Shaw demonstrated at length, the standard form contract at numerous points contemplated string transactions. Modern GAFTA forms preclude the award of damages based on the sub-sale price unless there are ‘special circumstances’ and the arbitrator wishes to exercise a discretion to award damages on this basis. The most obvious special circumstance is where a circle exists with the same party appearing more than once and manipulating the transactions within the circle. Modern contract forms, 57 Lord Blanesburgh referred to ‘the entirely unreal provisional invoice’: Re Hall and Pim, above n 13, 167. 58 It was ‘justified on its special facts’ according to Lords Blanesburgh and Phillimore: ibid, 168 (HL). The court relied heavily on Hammond & Co v Bussey (1888) 20 QBD 79 (CA), a case dealing with the recovery as damages by the buyer of costs incurred by that buyer when defending a claim brought by the sub-buyer. That was a case, however, of damages for consequential loss brought under the second limb of the rule in Hadley v Baxendale, above n 4. 59 As Viscount Haldane did. See also Christopher Clarke J in Transfield Shipping, above n 26: ‘Hall v Pim was an application of Hadley v Baxendale. The case plainly decides that loss of profits on a sub sale can be recovered if the contract itself contemplates that the buyers will sub sell the very same cargo without possibility of substitution and, at the time of breach, the sub contract price exceeds the contract and sub contract price.’

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however, invariably make particular provision for circle settlements, though it should be noted that Re Hall and Pim is technically not a circle case at all because Pim was an agent and moreover was acting for different principals on the two occasions it appeared in the string. It is important to note the limits of the exception in Re Hall and Pim. As Devlin J once observed, the fact that a sub-sale is within the contemplation of the parties is no reason for departing from the market rule of assessment of damages.60 Something more is needed, like the special facts of Re Hall and Pim, where the buyer in a series of string contracts is locked into the supply of ‘specific goods’61 and consequently is unable to go into the market to mitigate its loss.62 It may be, too, that a departure from the market rule might be justified where at the contract date the contracting parties have a particular sub-sale in mind.63 The abiding lesson to be drawn from Re Hall and Pim and Williams Bros v Agius (ET) Ltd is that one cannot be an absolutist in accepting or denying the market damages rule in cases of non-delivery. Indeed, that is what a plain reading of the Sale of Goods Act tells us. A perfect sense of justice in the application of rules of damages assessment is at odds with the efficient administration of justice, which is shaped overwhelmingly on bilateral lines. The limits of the market damages rule in cases of non-delivery are also exposed in other ways. It was noted above that markets were bounded by time though not by place. The time factor presents particular difficulties of assessment in the case of contracts where delivery is dated according to shipment, rather than the arrival of the goods at the destination. A September shipment market for goods, to take one example, may no longer be extant by the time of the seller’s default. This leaves the buyer looking for equivalent goods on a spot market in the port or country of destination,64 and the goods may be too thinly traded65 60 Kwei Tek Chao v British Traders and Shippers Ltd [1954] 2 QB 459, 489. See also Bear Stearns, above n 53, at [206]. Contrast Devlin J’s statement above with his much looser statement in Biggin & Co Ltd v Permanite Ltd [1951] 1 KB 422, 435: ‘It has often been held . . . that the profit actually made on a subsale which is outside the contemplation of the parties cannot be used to reduce the damages measured by a notional loss in market value. If, however, a subsale is within the contemplation of the parties, I think that the damages must be assessed by reference to it, whether the plaintiff likes it or not.’ 61 Kwei Tek Chao, ibid. The goods in such a case are technically not specific goods, since goods of this character must be identified and agreed upon at the contract date and not at some later time when an appropriation notice is sent. See also Louis Dreyfus Trading Inc v Reliance Trading Ltd [2004] 2 Lloyd’s Rep 243 at [19]. 62 Transfield Shipping, above n 26, [81]. 63 Louis Dreyfus, above n 61. 64 See Ströms Bruks Aktiebolag v Hutchison [1905] AC 515 (HL) (charterparty); Esteve Trading Corp v Agropec International (The Golden Rio) [1990] 2 Lloyd’s Rep 273 (default clause). 65 Goods may be too thinly traded at any time for there to be a market: see Coastal International Trading Ltd v Maroil AG [1988] 1 Lloyd’s Rep 92; Harlow and Jones Ltd v Panex (International) Ltd [1967] 2 Lloyd’s Rep 509.

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in such conditions to be procured in such circumstances, leaving the court looking for an alternative measure,66 such as the buyer’s lost profits.67

E Late Delivery The limits of the market rule need also to be considered in other cases of breach, namely, late delivery and the delivery of defective goods. In Rodocanachi, damages for non-delivery were carefully distinguished from damages for late delivery,68 hence the damages rule laid down in The Parana69 for late delivery under a charterparty should have no application to sale of goods. Of course, the rule in The Parana could not sensibly be applied to a sale of goods case unless, most unusually, the buyer had already paid for the goods before delivery. In the common run of cases, it is not the buyer’s assets that are locked out of the market and the buyer, meanwhile, can still earn interest on the price not yet paid to the seller. The decision of the House of Lords in The Heron II not to apply The Parana opened the way to the application of the market damages rule for delay in a charterparty case. Prior to the case of Williams, the Privy Council in Wertheim v Chicoutimi Pulp Co70 declined to apply the market damages rule to the case of a seller’s delay in making an FOB (free on board) shipment. The question is whether the Privy Council was correct to do so. In reaching its decision, the Privy Council was applying the law of Quebec, which does not have the Sale of Goods Act, but even if the Sale of Goods Act had been applicable, there is nothing in the Act dealing with the particular problem of late delivery. The contract in Wertheim was for the sale of 3,000 tons of Canadian moist pulpwood FOB Chicoutimi, delivery no later than 1 November.71 The buyers had already contracted to sell 2,000 tons of pulpwood in the home English market at the contract date and made later contracts that in gross accounted for the full FOB quantity. The pulpwood was not in fact shipped until the following June. The buyers did not terminate the contract and, in the meantime, persuaded their domestic sub-buyers to wait for eventual delivery in the home market, which duly occurred. The FOB contract price was 27.5 shillings per ton and reference was made to the English market for the purpose of damages assessment in the absence of a Chicoutimi market. The market price prevailing had the goods been Hinde v Liddell (1875) LR 10 QB 265. Lesters Leather & Skin Co Ltd v Home and Overseas Brokers Ltd [1948] WN 437. (1886) 18 QBD 67, 80 (CA) (Lopes LJ). (1876) 2 PD 118. [1911] AC 301 (PC). See also Transfield Shipping, above n 26, [90]–[94]. Chicoutimi is on the River Saguenay, a tributary of the St Lawrence. The port is ice-bound in winter so, if goods miss the last clear water, they face months of delay. 66 67 68 69 70 71

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delivered on time was 70 shillings, but it had fallen back to 42.5 shillings by the time delivery was belatedly made.72 The buyers claimed market damages based on the difference between the market at the due delivery date and the market when the goods were in fact delivered. The principal obstacle to success was the fact that the sellers’ breach had caused them no loss at all. Although the market rule does not compel the claimant to go to market to crystallise its damages claim, it does suppose a claimant who has the option to do so to replace goods that were not delivered. These goods were in fact delivered. The sellers ‘must have known that the goods were required for resale’, since the buyers were not manufacturers. Had they contemplated those sub-sales, they might or might not have contemplated the loss of those sub-sales as a result of the delay. But to contemplate a loss that might have occurred but did not was no reason for awarding damages. As Devlin J incisively put it in Kwei Tek Chao:73 In this case the buyer has received the goods, and a calculation which supposes, incorrectly and notionally, that he should go out and buy another quantity of the same goods, has nothing to do with the reality of the matter.

The Privy Council in Wertheim was not prepared to take the ‘unjust and anomalous’ step of awarding substantial market damages to buyers who had already made a very substantial profit from the supply under sub-sales of the very goods for which damages were being claimed. The purpose of contract damages was to put the claimant in the position it would have been in if the contract had been performed, and not in a ‘much better position’.74 The argument against the result in Wertheim is that, if the goods had been delivered on time, the buyers might have sold them at the high point in the market and then have bought in at a later date, when the market fell, to perform the various delayed sub-contracts.75 This is ingenious and highly speculative, and there was no shred of evidence in the case that this is what the buyers would or even might have done, or that, in these new circumstances, the sub-buyers would have tolerated such behaviour by the buyers. The buyers made no such claim in any event. The Privy Council did, however, uphold the decision of the court below to award damages based on the difference between the market price prevailing at the due date of delivery (70 shillings) and the sub-sale prices (65 shillings). This seems like a wholly irrelevant measure of damages. If it suggests that out-of-pocket expenses were incurred in going into the 72 Some of the difference between the contract price and the market price prevailing in England is accounted for by the cost of freight (13 shillings) from Chicoutimi to England. 73 Above n 60, 497–8. 74 See also the discussion of late delivery in Transfield Shipping, above n 26, [90]–[94]; Louis Dreyfus, above n 61. 75 S Waddams, The Law of Damages (Toronto, Canada Law Book Inc, 4th edn, 2004), para 1.1930.

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market to cover the sub-sales to arrive at a break-even position, the proper response is that the buyers did not do this. If, nevertheless, they had done this, then in principle they should have been able to recover market damages for delay according to the basis on which they made their claim. In cases where buyers do miss their market because of delay, then there is every reason to award market damages for the delay so long as the loss of market was within the contemplation of the parties at the contract date, in line with the position laid down by the House of Lords in The Heron II.

F

Defective Goods

Lord Justice Scrutton was a particularly firm advocate of the market damages rule, though the conduct of Pim in Re Hall and Pim stretched his commitment to the rule almost to breaking point.76 As a member of the Court of Appeal in Slater v Hoyle & Smith,77 he was responsible for the application of the rule in the case of defective goods that were sold on after undergoing a manufacturing process. Defective goods retained by the buyer78 have this in common with goods delivered late: the contract is not terminated and the buyer retains and uses or disposes of those goods. So an entry into the market, notional or actual, cannot be made to replace those goods. The question therefore is whether a market reference is appropriate and, if so, what function it plays.79 The contract in Slater was for the sale of a quantity of unbleached cotton cloth. Goods of an inferior quantity were delivered and accepted by the buyers. A portion of this cloth was bleached by the buyers and used in fulfilment of a sub-sale contract concluded before the contract of sale. The price under this sub-sale contract was paid in full; the sub-buyers made oral complaints but did not reject the goods. No proceedings had yet been taken by the sub-buyers, but they had not abandoned their complaints. At trial, the judge awarded damages based upon the difference in market 76 Re Hall (R&H) and Pim (WH) (Junior) & Co’s Arbitration (1927) 27 Ll L Rep 253, 258: ‘I do not understand the conduct of Messrs. Pim and I do not like it; it is quite possible that I do not like it because I do not understand it; it may be that I do not understand it because I do not understand commercial transactions; but Messrs. Pim have given me no help to understand it; they have been implored by a very leading man in their own trade to come and state why they deliberately broke their contract and they have deliberately resisted his invitation and preferred to say nothing and not submit themselves to any test of cross-examination on the subject. Messrs. Pim not having helped me to understand what they have done, I say at once that I do not like it, and I should have liked to have affirmed the judgment of Rowlatt, J.; but I have to administer the English law, and on the principles of English law I do not think the judgment of Rowlatt, J., can be supported.’ 77 [1920] 2 KB 11 (CA). 78 If defective goods are delivered and are lawfully rejected by the buyer, this is treated as a case of non-delivery. 79 For a statement of the difficulty of finding a market in defective goods, see Biggin & Co Ltd v Permanite Ltd [1951] 1 KB 422, 438 (Devlin J).

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value between the goods in their defective state and the goods if they had conformed to the quality requirements of the contract. It was the sellers’ contention that their liability should take account of the fact that the buyers were paid in full under the sub-sale, even though they had not been informed of the existence of this transaction at the date of their own contract with the buyers. The Court of Appeal nevertheless upheld the trial judge’s assessment. Since the goods had in fact been delivered to the sub-buyers, the court had to distinguish Wertheim, where delivery had occurred in a case of late delivery. Bankes LJ contented himself with saying that the rule in that case concerned only the sub-sale of the identical goods. These goods had been bleached by the buyers. He also referred, interestingly, to the idea that Wertheim could be applied in a case like the present one only where the sub-sale was concluded ‘in mitigation of damages’. This requirement could not of course be satisfied where the sub-sale preceded the breach or the sale contract.80 Warrington LJ repeated the point about identicality in distinguishing Wertheim but, in treating the sub-sale as an unconnected transaction, made the illogical point that, if the contract goods had been up to the quality standard required by the sale contract, the buyers might have been able to obtain an even higher price for the sub-sale goods than was the case. The fact is that they bargained for the sale goods in the light of their pre-existing sub-sale requirements. The most interesting judgment is that of Scrutton LJ. He went to the heart of the matter in noting that the delivery of sub-standard goods to the buyers improved their financial position in that they had recovered market damages whilst also being paid in full by the sub-buyers. The buyers, nevertheless, were under no obligation to deliver these goods to their sub-buyers. Scrutton LJ then made an interesting point about market damages in a conventional case of non-delivery, where the sub-sale price might have been above or below the market price prevailing at the due date of delivery. The buyer could, if not bound to deliver the same goods as under the sale contract, go into the market to buy substitute goods. If the market stood higher than the sub-sale price, then the buyer would at a cost avoid a claim for non-performance under the sub-sale. If the market stood lower than the sub-sale price, then the buyer could make a profit additional to the profit on the sale, itself realised in the form of market damages recovery. This reasoning, in Scrutton LJ’s view, was equally applicable to cases of defective delivery and, indeed, to late delivery. It may also be added that this reasoning is entirely consistent with the view that a buyer of goods traded in a market is bargaining for a market position. In addition, this reasoning treats market opportunities as excluded from any rule of factual mitigation. It would be decidedly odd if market damages 80

See text accompanying nn 45–7.

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were payable to a claimant who in fact did not enter the market but those same damages were reduced in cases where the claimant did. Scrutton LJ had to confess his difficulty in seeing how Wertheim fitted in with the principles he stated above. The buyers in that case might equally have entered into the market at its low point in order to perform their sub-sale contracts, though they did not in fact do this. He plainly thought the decision was wrong and candidly confessed that the English law of damages commonly under- and overcompensated. His concern was therefore with workable and consistent rules, not with the impossible attempt to achieve a perfect indemnity in every case. Slater v Hoyle & Smith was not followed in Bence Graphics International Ltd v Fasson UK Ltd.81 In this case, a quantity of vinyl film was sold to the buyers, who used it to make decals for the shipping industry to identify bulk containers. In breach of contract, the sellers supplied sub-standard vinyl which did not survive five years’ use in the industry in a legible condition. Most of the vinyl was used to make decals and the buyers received extensive complaints from shipping lines which had attached the decals to the containers long-leased to them by the buyers’ sub-sale customer.82 A complaint had also been made by that customer but, to date, had not been pursued. The trial judge awarded damages on the market basis, but his decision was reversed by the Court of Appeal by a 2–1 majority. In the majority, Otton LJ distinguished Slater on the narrow and untenable ground that the same goods were being sold on after bleaching, without in any way engaging with the reasons for the market rule given in that case or even with the market rule in general.83 The sub-sale of manufactured decals was plainly within the contemplation of the parties, so that damages should be assessed by reference to the sub-sales. Had there been a chain of transactions thus contemplated, the award of damages coupled with costs would, by a process of indemnity, have reached back up the chain to the sellers.84 Auld LJ was in general agreement with Otton LJ but went further in his analysis of Slater, which in his view was ripe for reappraisal and whose facts could not be distinguished from those in the present case on the basis adopted by Otton LJ.85 Auld LJ did engage with the market authorities and took considerable comfort from Wertheim, together with the reasoning employed by Lord Dunedin in Williams when distinguishing Wertheim. The principle in section 53(2) of the Sale of Goods Act, which has a counterpart in the sections dealing with non-acceptance and non-delivery, and which states 81 82 83 84 85

Above n 5. One complaint was directly satisfied by the buyers. [1998] QB 87, 98 (CA). See Kasler and Cohen v Slavouski [1928] 1 KB 78. [1998] QB 87, 102 (CA).

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the first limb of the rule in Hadley v Baxendale, came into play on these facts so as to displace the market rule in section 53(3). He was not prepared ‘to award a buyer more than the evidence clearly showed he had lost’.86 Thorpe LJ, oddly, rested his dissent on a finding of fact at trial that the parties did not in fact contemplate the displacement of the market damages rule in section 53(3).87 This approach to the matter was firmly and correctly dismissed as wrong by Otton LJ.88 Despite the confidence displayed by the majority judgments in Bence, the decision leaves the authorities in some state of disarray.89 As a matter of practical surgery, it might be said that Bence draws a line between cases of non-delivery and non-acceptance, on the one hand, and defective and late delivery on the other hand,90 or, to put the matter in different terms, between cases where the contract is terminated and where it is not. In the former cases, whilst a reference to the market is not precluded, the market rule is displaced when sub-sales are within the reasonable contemplation of the parties at the contract date. The difficulty with this reasoning is that, if the category of sub-sales includes cases where the goods have been transformed in the hands of the buyer, then a reference to sub-sales will constitute in practice the norm rather than the exceptional case. There was nothing particularly unusual about the sellers’ knowledge of sub-sale activities in Bence. Furthermore, such reasoning could just as easily be applied to the other cases dealing with non-delivery and non-acceptance. Bence therefore poses a challenge to the market rule that goes beyond cases of defective delivery. In the process, it effects a rehabilitation of Wertheim, which has tended in the past to be dismissed as a problem case. The challenge arises because Bence presents such a strong commitment to factual causation and the compensation principle: if no loss has in fact been caused by the defendant’s breach, then the defendant should not have to pay damages for an imaginary loss. The same idea is presented by Wertheim too, though in quite different circumstances. Before turning to any defence of the market rule as the general rule, it is worth considering whether the buyers in Bence did in fact suffer no loss. It is arguable that they did. First, though their sub-buyers may well have been out of time in starting proceedings against the buyer, the case by no means establishes this as a fact. In any event, the sub-buyers were a large corporation who might have been in a position even out of time to extract Ibid, 103–7. Ibid, 109. Ibid, 101. In Bear Stearns, above n 53, [204], Andrew Smith J found it difficult to reconcile the two cases, both of which were binding on him. He also stated, at [208], that Bence could not be treated as restricting the prima facie market rule in cases of non-delivery. Similarly, this was the conclusion to which Langley J felt driven in Oxus Gold, above n 53, paras [66]–[83]. 90 The line in fact taken in Bear Stearns, ibid. See also Oxus Gold Plc, ibid, [82]. 86 87 88 89

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a settlement. This introduces another matter that was present in the mind of the trial judge91 but does not seem to have been considered by the Court of Appeal in Bence, namely the possible loss of repeat business and damage to reputation. It has in the past been notoriously difficult to prove and recover damages for such items of loss.92 The market rule may lead to an award of damages that in fact serves to abate such losses, though its application is not justified on that basis. So far as modern courts are less hostile to the recovery of consequential damages of this kind,93 this change of attitude could be seen as complementary to a willingness to depart from an unyielding application of the market rule. Yet there will always be difficult cases—and Bence itself may be one such case—where the evidence may not be sufficient for an award of consequential damages to be made. Moreover, at a time when the high cost of legal services and litigation in London is a matter of some concern, there is considerable merit in the retention of a market rule that discourages lengthy proceedings and renders it comparatively straightforward to calculate the claimant’s damages. The second matter relating to real loss in Bence concerns what has come to be regarded as the claimant’s performance interest in the contract.94 Consider the following case. Under a contract for the supply to a spaghetti manufacturer of 1,000 tons of number 1 hard durum amber wheat at £200 per ton, the seller supplies instead number 2 wheat, which has a lower protein content and therefore commands a lower price in the market (£150 per ton). The buyer consumes the wheat in its manufacturing business by eking out the inferior wheat and mixing it with supplies in store of number 1 wheat.95 The consequence is that the customers of the buyer make no complaints. If the decision in Bence is correct, the buyer’s damages should be nominal. Yet the seller has delivered to the buyer wheat at a price of £200,000 when it should have charged £150,000. The buyer has paid too much and is out of pocket to the extent of £50,000. This in and of itself is a form of loss, even if it is not a direct loss flowing from the breach of contract. In Bence itself, there may not have been a market at all for the defective vinyl film supplied, since it was manufactured as a result of a mistake made by the sellers’ Dutch affiliate, but there is no reason [1998] QB 89, 94. Simon v Pawsons and Leafs Ltd (1932) 28 Com Cas 151 (CA). The opposition to such claims displayed by Scrutton LJ in that case might be seen as balanced by his willingness to apply the market rule even if the buyer appeared to suffer no losses on the sub-sale contract itself. 93 See GKN Centrax Gears Ltd v Matbro Ltd [1976] 2 Lloyd’s Rep 555. 94 See D Friedmann, ‘The Performance Interest in Contract Damages’ (1995) 111 LQR 628; C Webb, ‘Performance and Compensation: An Analysis of Contract Damages and Contractual Performance’ (2006) 26 OJLS 41; Alfred MacAlpine Construction Ltd v Panatown Ltd (No 1) [2001] 1 AC 518 (HL). 95 Cf the buyer of the citrus pulp pellets in Cehave NV v Bremer Handelsgesellschaft mbH [1976] QB 44 (CA). 91 92

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why the principle should be any different. The buyers in Bence paid too much and suffered loss to the extent of that overpayment.96 Another point in relation to Bence concerns the buyer receiving defective goods who sells them on to a sub-buyer. That buyer is subsequently sued by the sub-buyer and sustains loss in the form of costs when unsuccessfully defending the sub-buyer’s claim. The courts have not showed themselves willing to write a blank cheque for this buyer but have, within the discipline of the second limb of the rule in Hadley v Baxendale, been prepared to allow recovery of these costs against the seller if the sub-sale was within the contemplation of the parties and the buyer’s conduct was reasonable.97 The award of such consequential damages, however, is compatible with the market rule. This damages claim supplements any claim for direct loss brought under the first limb of the rule in Hadley v Baxendale, and the debate about market damages is a debate about the scope of that first limb. A difficulty, nevertheless, arises if the buyer rolls up with that claim with a further claim for damages for defective goods based on the sum of damages that it had to pay its sub-buyer. One response to this is to say that if the circumstances of this sub-sale satisfy the test laid down in the second limb, there is no reason why the buyer may not elect to claim this sum rather than the sum, whether greater or less, produced by the market rule. The decision in Bence is wrong insofar as it refuses to allow the buyer claiming market damages to recover market damages.

G

In Defence of the Market Rule

Perhaps the most important benefit provided by the market rule lies in the way that it simplifies trials and leaves collateral issues and disputes to be worked out on their own terms. It thus avoids uninformed speculation about whether sub-buyers will bring claims or act in other ways injurious to their buyers. The market rule also avoids the difficulty of attaching particular contracts of sale to particular sub-sales in those cases where the buyer trades on a wide front, as in the commodities trades. If it were said that the market rule does not encourage pre-contract disclosure, one response is to say that the virtues of such disclosure are overrated. A buyer might say that its business is its own concern: it should not have to inform the seller of the identity of its sub-buyers or disclose in such a way as to give the seller a competitive edge. In the nature of things, a de facto 96 Waddams cites the example of a buyer receiving defective goods who either gives them away or sells them at an undervalue by way of part gift: Waddams, above n 75, para 1.2580. If the Court of Appeal in Bence is correct, this buyer recovers nothing in damages. 97 Hammond & Co v Bussey (1888) 20 QBD 79 (goods (‘steam coal’) resold under the same description as in the sale contract) (CA); Biggin & Co Ltd v Permanite Ltd [1951] 1 KB 422.

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requirement of disclosure would bear more heavily on buyers than on sellers, so that any such requirement would not be even-handed. A renewed commitment to the market rule should nevertheless take account of the decisions in Re Hall and Pim and Wertheim. Were these cases correctly decided? This is not at all an easy question to answer. It is submitted that Wertheim was probably correctly decided. The case is uninformative on the question whether the delay injured the buyers in their relations with their sub-buyers. In the absence of any such evidence, the buyers could not be said to have suffered any loss at all. At the contract date, there could not have been said to be a price difference between goods delivered on time and goods delivered late, so on that account the case is distinguishable from cases of defective delivery. Markets rise as well as fall. As for Re Hall and Pim, the actions of Pim prevented their buyers, Williams, from taking market action to rescue their position under the sub-sale contract. It would therefore have been unjust to measure their damages according to the market. The market rule is based on the idea that a buyer need not go to market, which is not the same thing as a buyer who cannot go to market. In conclusion, prior to Bence, the cases would appear to have been correctly decided. No dramatic lessons can be learnt from the market and sub-sales cases. The market rule generally works well, despite the ‘superficial tension’ between it and the rule of remoteness of damage,98 and should be departed from only in exceptional cases. Damages rules cannot sensibly be tailor-made for the particularities of each and every dispute if the assessment of damages is to be treated as a matter of law and not factual discretion.

III

T H E I N T E R N AT I O N A L I N S T RU M E N T S

English law has had long experience of dealing with market-based transactions and a depth of experience of dealing with items of fluctuating value. The new international instruments lack that same length of experience and have shown little evidence so far of penetrating the world of international commodity sales. It is nevertheless instructive to turn to them to see how they might deal with the sorts of issues presented by the English cases. First of all, in ordinary resale or repurchase cases, they eschew a reference to the state of the market at the delivery date but look instead to the substitute contracts actually carried out by the seller or buyer, as the case may be. This may not be so large a departure from the market rule as might be thought. The substitute transaction rule, also present in Article 2 of the Uniform Commercial Code99 and in the standard commodity 98 99

Transfield Shipping, above n 26, [93]. Arts 2-706 and 712.

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trading forms,100 is wide enough to embrace market and non-market conditions alike. In addition, the substitute transaction in market conditions might be seen as a concrete manifestation of the state of the market at the time it was concluded. Admittedly, it departs from the pure market rule in English law in that it is based on the market rate prevailing at the date of entry and not at the earlier date of delivery, but that is a difference which the approach of Lord Wilberforce in Johnson v Agnew101 can accommodate within a market rule. As stated above, the debate in these cases is really about the date of assessment. The sub-sale cases, on the other hand, pose more profound questions about the assessment of damages for non-delivery. Are damages so designed to compensate that the court should strive to arrive at a correct figure disregarding other purposes that might be served by a clear rule of assessment? There is no explicit treatment of the sub-sale problem on the face of the rules themselves. Article 75 of the CISG plainly countenances a substitute transaction concluded after the avoidance of the contract by the buyer, whereas the sub-sale issue concerns contracts made by the buyer before avoidance for the seller’s non-performance. Article 76, applicable in those cases where Article 75 does not apply, refers the tribunal to the ‘current price for the goods’, which is measured at the time of avoidance, unless the buyer has taken over the goods, in which case it is the current price at the time of taking over that applies. This suggests a less than complete commitment to the compensation principle in the CISG, in that a buyer may take time to examine the goods and give notice of rejection before being able to avoid the contract. Moreover, even if the buyer avoids the contract before taking over the goods, it may take some little time to organise a substitute transaction. In both cases, there is a need for the buyer to move with some dispatch, and the rule as expressed encourages the buyer to do precisely that or suffer any adverse consequences from market movement. The compensation principle is thus qualified by another policy. This departure from the compensation principle might be indicative of assisting the resolution of the sub-sale problem: values taken from the Convention as a whole might be of assistance in determining the outcome of issues not dealt with explicitly in the Convention.102 Article 74 expresses the principle of factual causation and might be interpreted as making this a necessary requirement of a damages action. The buyer’s damages may not exceed the loss that the seller might have foreseen ‘as a possible consequence of the breach’ but can include a loss of profit. On close inspection, Article 74 does not as such lay down a requirement of factual causation but rather puts a cap on recovery in accordance with ordinary remoteness principles. 100 101 102

Eg GAFTA 100, cl 23. Above n 37. Under Art 7(2).

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Taken as a whole, the damages rules in the CISG on their face do not rule out pragmatic considerations of the sort underlying the application of the market rule in sub-sale cases, but the express reference to loss of profit in Article 74 will probably steer tribunals to an award of damages calculated by reference to a sub-sale price rather than the market. The UPICC, on the other hand, show a clearer commitment to factual causation. Article 7.4.2 lays down a rule of full compensation ‘for harm sustained as a result of the non-performance’103 and Article 7.4.3(1) allows damages only for ‘harm . . . that is established with a reasonable degree of certainty’. Article 7.4.3(3) then relents to a degree by giving the court a discretion to assess damages ‘[w]here the amount of damages cannot be established with a sufficient degree of certainty’. The whole article reeks of a carefully worked out compromise reconciling irreconcilable positions. It does not in the comments or illustrations provide any concrete assistance with the sorts of problems raised in the English sub-sale cases. In other respects, the provisions of the UPICC are compatible with those of the CISG.104 This leaves the case law decided under the CISG. There is little helpful case law dealing with the sub-sale problem and nothing that would dictate a reference to the market price where the sub-sale was concluded before non-performance took place under the contract of sale. In a Russian arbitration decision,105 the tribunal was willing in principle to award damages to a buyer of CIF goods measured according to the terms of a sub-sale entered into after the contract of sale but before the seller’s default. In the event, however, it did not do so. The buyer’s claim for loss of profit on the sub-sale was for an amount equal to 50% of the price in the contract of sale, but the tribunal, applying Article 74, concluded that the buyer had not supplied the seller with sufficient information about the sub-sale for such a large loss to be foreseeable. Moreover, it had not mitigated its loss under Article 77106 and had not complied with the current price provisions of Article 76 when making out its claim. An award of 10% of the contract price was made instead, somewhat eccentrically based on the insurance requirement in the contract of sale that the buyer insure the goods to the value of 110% of the contract price. A more conventional German case involving the supply of a car to a car dealer allowed the recovery of damages based upon the sub-sale price further to Article 74. The amount claimed, apparently, was not so excep103 Article 9:501(1) of the PECL allows for the recovery of damages for ‘loss caused by the other party’s non-performance’. 104 See also to similar effect Arts 9.506–7 of the PECL. 105 Case No 406 of 1998 (6 June 2000) Tribunal of International Commercial Arbitration at the Russian Federation Chamber of Commerce and Industry, available at http:// cisgw3.law.pace.edu/cases/000606r1.html (accessed 27 June 2007). 106 Because the buyer had neither cancelled the sub-sale nor entered into an alternative contract to supply that sub-sale.

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tionally high as to preclude recovery.107 In Hamburg arbitration proceedings108 concerning a Hong Kong seller’s non-delivery to a German buyer, loss of sub-sale profits was recoverable in terms of the price difference between the two contracts. These were foreseeable at the contract date. The tribunal referred to this concrete measure prevailing over the abstract measure based on the market in Article 76, but Article 76 on its terms would not be applicable to a pre-avoidance sub-sale transaction in any event. The cases therefore do not establish a decisive position. It remains to be seen if tribunals applying the CISG will relive the English experience with sub-sales. On the balance of probabilities, they will not, if only because the CISG demonstrates as a general matter a preference for concrete over abstract transactions. It should not be forgotten that the CISG is an instrument designed for both courts and arbitral tribunals. Arbitrators have no responsibility, when making awards, for the future, orderly development of the law. They are not as likely as courts to see the merits of a rule, the market rule of damages assessment, which creates certainty for future players in market transactions to conduct their dealings. The long tradition of commercial judges in England, however, is one of responsiveness to precisely these considerations. This is not to deny, however, that the fluctuating relationship between law and fact may be leading them to behave more like arbitrators than as judges and to show less partiality for rules of law that are not fully responsive to immediate fact.

107 Case No 22 U 4/96, 21 May 1996, Oberlandesgericht Köln (Provincial Court of Appeal, Köln, Germany), available at http://cisgw3.law.pace.edu/cases/960521g1.html (accessed 27 June 2007). 108 Case before Schiedsgericht der Handelskammer Hamburg (Arbitral Tribunal, Hamburg, Germany) of 21 March 1996, available at http://cisgw3.law.pace.edu/cases/960321g1.html (accessed 27 June 2007).

19 Changes in Monetary Values and the Assessment of Damages CHANGES I N MONETARY VALUES AND THE AS S ES S MENT OF DAMAGES

CHARLES PROCTOR* CHARLES PROCTOR

I

I NTRO DUCTION

This chapter seeks to explain the impact of changes in the value of money on the assessment of damages. It seeks to do so in the context of both domestic and foreign currency obligations and, as the reader may readily imagine, this is a somewhat esoteric subject which is not entirely free of complexity.1 With this cautionary note in mind, it is necessary to recall that the assessment of damages—whilst frequently a hazardous and imprecise process in practice—is nevertheless based upon established principles. It is also necessary to recall that an assessment may fall to be made in different types of claim and—as the discussion will demonstrate—cases dealing with exchange rate fluctuations tend to be highly fact sensitive. Different considerations may apply and the calculation must fit the particular circumstances of the case.2 It is thus necessary to step back and examine the objectives which a court seeks to achieve when assessing damages. In an effort to provide some form of logical progression, it is proposed at the outset to consider some of the weaknesses of money as a form of compensation, even in cases concerned only with the domestic currency. This will provide a backdrop Partner, Bird & Bird; Honorary Professor of Law, University of Birmingham. In terms of the available source materials, one can only agree with the comment of Lord Phillips when he noted that ‘The English courts proceeded to develop a substantial body of jurisprudence dealing with the principles that governed the power of the court or arbitrator . . . to award in a foreign currency and the dates at which the foreign currency obligations should be converted, when conversion was appropriate. The development of this jurisprudence is well set out in ch 16 of the 17th edn (2003) of McGregor on Damages’: see Lesotho Highland Development Authority v Impregilio SpA [2005] UKHL 43 (HL) [47], [2006] 1 AC 221, 241–2. That chapter provides the starting point for anyone who seeks an understanding of this subject. 2 It should perhaps be emphasised that the present chapter is principally concerned with the recovery of debts and the assessment of damages in claims of a contractual character (although some reference will be made to tort cases for illustrative and comparative purposes). *

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against which to consider cases involving multiple currencies and the added complexities to which they may give rise.

A

Subject Matter of this Chapter

Against that brief introductory background, it is proposed to examine the following topics: 1. the objective of an award of damages; 2. the value of domestic money and its impact in relation to the recovery of debts, the assessment of damages and the date with reference to which the assessment is made; 3. liquidated claims and the recovery of foreign currency debts, including a brief review of the well-known decision in Miliangos and an explanation of the corresponding position in the US; 4. contract claims and unliquidated damages, including the identification of the currency in which an award should be made; 5. the availability of an award for late payment and the extent to which the creditor may be compensated for resultant exchange losses; 6. the particular difficulties which can arise in relation to foreign exchange contracts; and 7. finally, a few general comments and conclusions will be stated.

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THE O BJECTIVE OF AN AWARD O F DAMAG ES

Overview

It is unnecessary to dwell on the objectives which a court should have in mind when making an assessment of damages, since broader issues of this kind have been considered in earlier chapters, but a brief overview may help to set the scene. It is well known that, in making an award of damages—whether in contract or in tort—the court seeks to place the claimant in the position he would have been in had the actionable wrong not occurred. Damages are thus intended to constitute a form of restoration. But how does the court arrive at the figure which represents proper restoration? The House of Lords has recently decided two cases in this field. In The Golden Victory,3 the House decided that an assessment of damages could be made with reference to the circumstances subsisting as at the date of the hearing, if that would provide the most accurate reflection of the claimant’s loss. 3

[2007] UKHL 12 (HL).

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Likewise, in Sempra Metals v Her Majesty’s Commissioners of Inland Revenue,4 the House overcame its former antipathy towards compound interest, on the grounds that such an award would more closely reflect the losses which the claimant suffers in consequence of the non-payment5 or, on the particular facts of that case, as a result of meeting a tax demand which ought not to have been made. It will be necessary to return to these decisions at a later stage. In a contractual claim it might be thought that the application of the restitutionary principle would require the claimant to be placed in the position he would have been in had the contract never been made. Yet this would be unrealistic. The parties made the contract for a commercial purpose in the expectation that it would be performed. As a result, the award must be designed to place the claimant in the position he would have been in had the contract been performed.6 The claimant is thus entitled to recover the value of any profits or benefits which he might legitimately have expected to derive from the full performance of the contract. It would not be difficult to list an impressive body of case law which stands as authority for this proposition. But there are relatively few cases which deal with the inherent weakness of an award of damages, namely that an award can only be made in money and that, as a result, the adequacy of the award rests in large measure upon the value and effectiveness of money as the medium of that award. It is perhaps unsurprising that this rather abstract point has received limited judicial consideration; the court has no other means of remedy available to it in any event,7 and a philosophical discussion may therefore be out of place. Yet the subject merits review if only because questions touching the value of money may be very much to the fore where the court has to assess damages by reference to cases involving different currencies.8 4 [2007] UKHL 34 (HL). It should be added that this judgment was published shortly before this chapter was completed. The full implications of the decision therefore remain to be worked out. 5 Although not referred to in the judgments, the decision of the Supreme Court of Canada in Bank of America Canada v Mutual Trust Co [2002] SCR 601 (SCC) contains a discussion of the whole subject and justifies the award of compound interest in commercial and financial cases. As the Supreme Court noted, an award of simple interest overlooks the fact that the creditor must fund his own interest costs for so long as the debtor remains in default. In similar vein, the High Court of Australia observed in Hungerfords v Walker (1989) 171 CLR 125 (HCA), para 41, that an award of simple interest will almost invariably understate the claimant’s true loss. 6 Robinson v Harman (1848) 154 ER 363 (Exch); Wertheim v Chicoutimi Pulp Co [1911] AC 301 (HL); H McGregor, McGregor on Damages (London, Sweet & Maxwell, 17th edn, 2003) para 1-023 and cases there noted. 7 Equitable remedies such as specific performance will only rarely be appropriate in commercial cases, since damages will normally be an adequate remedy. Such remedies may therefore be ignored for present purposes. 8 The point is dramatically illustrated by the decision in The Texaco Melbourne, which is discussed later in this chapter.

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The value of money can thus be important in two, broad senses: 1. first of all, in a domestic context, the value of money within the UK has, on occasion, fallen quite dramatically in terms of its purchasing power. It may be necessary to take this factor into account in appropriate cases; and 2. secondly, in an international context, the currencies of several different countries may be relevant to the assessment. These currencies may fluctuate against each other both during the life of the contract and following the breach. Apart from the obvious complexities to which these factors may give rise, the award will only achieve its restitutionary objectives if it is made in the currency which most closely reflects the claimant’s loss.

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T H E VA L U E O F D O M E S T I C M O N E Y

The Principle of Nominalism

If a court can only award damages in money, then what will be the ‘value’ of that money to the successful claimant? In a purely domestic context, money itself has no monetary value.9 This may appear to be a curious statement but, for example, sterling in the UK merely serves as a medium of exchange10 for the purchase of assets or benefits, such as goods or services. The pound is a ‘measuring stick’ for the value of goods and services—not the other way round. No one will ‘buy’ a pound for a domestic monetary consideration, for a pound can have no greater or lesser value than one pound. This effective insulation of a currency within its own borders was succinctly stated by Scrutton LJ with reference to the demise of the gold standard: ‘a pound in England is a pound, whatever its international value’.11 Characteristically, Lord Denning expressed the point more elegantly: in England we have always looked upon a pound as a pound, whatever its international value . . . we have dealt in pounds for more than a thousand years—long before there were gold coins or paper notes. In all our dealings we have disregarded alike the debasement of the currency by kings and rulers or the depreciation of it by the march of time or events . . . Creditors and debtors have arranged for payment in our sterling currency in the sure knowledge that the sum they fix will be upheld by the law. A man who stipulates for a pound must take a pound when payment is made, whatever the pound is worth at the time. Sterling is the constant unit of value by which in the eye of the law everything 9 This may be contrasted with the position where multiple currencies are involved, and the existence of a rate of exchange gives each currency a monetary value in terms of the other currencies. 10 Money also serves as a store of value. On the whole subject see C Proctor, Mann on the Legal Aspect of Money (Oxford University Press, 6th edn, 2005) ch 1. 11 The Baarn [1933] P 251, 265 (CA), emphasis added.

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else is measured. Prices of commodities may go up or down, other currencies may go up or down, but sterling remains the same.12

This strict adherence to the unit of currency as a measure of value reflects the ‘principle of nominalism’, as developed by Dr FA Mann and others.13 The leading textbook on private international law neatly formulates the rule as follows: A debt expressed in the currency of another country involves an obligation to pay the nominal amount of the debt in whatever is the legal tender at the time of payment according to the law of the country in whose currency the debt is expressed (lex monetae), irrespective of any fluctuations which may have occurred in that currency in terms of sterling or any other currency, or gold or any other commodities, between the date when the debt was incurred and the time of payment.14

It will be apparent from this formulation that the ‘pound for pound’ principle of nominalism applies to debt obligations. The effect is that the creditor can only claim the amount stated in the contract. He cannot ask for the amount of the debt to be revalued (or ‘revalorised’) merely because the purchasing power of the pound has fallen between the date of the contract and the date on which payment falls due.15 Despite the limited scope of its application, the principle of nominalism does illustrate the inherent weakness of money as the medium of an award; its declining value may work injustice to creditor and claimant alike. It cannot be doubted that the internal purchasing power of sterling has declined over the years. It continues to decline, albeit perhaps not at the speed of the 1960s and 1970s. What have been the legal consequences of this state of affairs and how has it affected the court’s approach to the awards which it is called upon to make? At this point, it becomes necessary to differentiate between different types of claim.

B Debt Claims An action to recover a debt—whether arising under a contract or pursuant to a statutory obligation—is not an action for damages as such. It is simply a claim for money which is due as owing. Nevertheless, it is pertinent to examine the court’s approach to longer-term obligations which have lost their value over a period. It is in this field that inflation has its greatest Treseder-Griffin v Co-operative Insurance Society [1956] 2 QB 127 (CA). See generally Proctor, above n 10, chs 9–13. AV Dicey, JHC Morris and L Collins, The Conflict of Laws (London, Sweet &Maxwell, 14th edn, 2006), r 206. Given its context, the formulation produced in the text is aimed at foreign currencies, but it would apply equally to the domestic currency. 15 If, however, payment is made after the due date, then an award in respect of the loss of purchasing power during the period of default may be available: see section VI below. 12 13 14

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impact by eroding the value of the bargain which the parties originally made. In the context of a debt claim, the courts must enforce the contract in accordance with the actual or the presumed intention of the parties. In line with the principle of nominalism, which has been noted above, it is presumed that the parties intend their obligations to be discharged on a ‘pound for pound’ (or ‘unit for unit’) basis. Thus, in the case of long-term leases, ground rents which originally had some real value may become effectively worthless with the passage of time.16 The court has thus found itself unable to assist creditors who suffer hardship as a result of the erosion of monetary value. The Court of Appeal—led by Lord Denning MR—on one occasion implied a term allowing for the unilateral termination of a fixed-price water supply agreement on the service of reasonable notice,17 but it is noteworthy that he did not imply a term providing for reasonable price increases over the contractual period. In other words, whilst the Court sought to alleviate the harsh effect of the principle of nominalism, it did not seek to question or undermine the principle itself.

C

Assessment of Damages

Given that the principle of nominalism rests upon the presumed intention of the parties, it can apply only to debt or similar claims for a fixed and pre-determined sum of money. It can have no place in the assessment of damages in tort or for breach of contract. In such cases, reference to presumed intention would not be relevant; the victim of a road accident cannot be taken to have had any intention—presumed or otherwise—in relation to either the occurrence of the accident or its consequences. Likewise, the innocent contracting party had not intended that the contract should be broken. It is true that the leading textbook on private international law contains a statement which is directly contrary to this proposition,18 but it implies that the principle of nominalism only comes into play once the court has determined the date by reference to which damages are to be calculated, so that currency fluctuations occurring after that date must be disregarded. That may well be so, but nominalism applies 16 For a well-known example, see Treseder-Griffin, above n 12, where it may be said that the Court of Appeal refused to give effect to a ‘gold clause’ designed to protect the creditor against the consequences of inflation. See also Re Smith & Stott (1883) 29 Ch D 1009n, where an annual rent of three shillings under a 1,000 year lease granted in 1607 was found to remain a valid obligation which could not be increased on account of inflation. For an interesting application of these principles in a taxation context, see Cusack v Federal Commissioner of Taxation [2002] FCA 1012 (FCA). 17 See South Staffordshire Area Health Authority v South Staffordshire Waterworks [1978] 1 WLR 1387 (CA). 18 See Dicey et al, above n 14, para 36-013.

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at that point because the claim for damages has been crystallised into a liquidated sum. But however that may be, it is plain that the courts have in practice taken into account the declining value of money in making assessments of damages.19 Yet the ever-present effects of inflation are only infrequently the subject of express judicial comment. This is perhaps partly because inflation is difficult to define, at least in any meaningful legal sense. But it follows perhaps from the fact that the court will not generally indulge in a discussion on the declining value of money. It will instead focus on the other side of the coin—namely that the cost of goods or services has increased. Factors of this kind can readily be demonstrated by objective evidence, and this approach has the merit of avoiding discussion of potentially difficult issues of monetary law. It is also consistent with the view that—so far as English law is concerned—sterling is a constant measure of value, whilst the value of goods and services themselves fluctuate in terms of sterling. (i)

The Date of Assessment

The date by reference to which damages are assessed may clearly have an impact on the amount of the award, given that the monetary cost of goods and services may fluctuate over time. In claims for breach of contract and in tort, the courts formerly adhered rigidly to the rule that damages are to be assessed as at the date of the breach (the ‘breach date rule’). Rigid rules have the merit of convenience and certainty, but they also have a habit of producing injustice. Lord Wilberforce was clearly conscious of this difficulty when he observed that, whilst the breach date rule is the starting point, it is for the courts, or for arbitrators, to work out a solution in each case best adapted to giving the injured plaintiff that amount in damages which will most fairly compensate him for the wrong which he has suffered.20

This position was repeated by the House of Lords in Johnson v Agnew: The general principle for the assessment of damages is compensatory, that is, the innocent party is to be placed, so far as money can do so, in the same position as if the contract had been performed. Where the contract is one of sale, this principle normally leads to assessment of damages as at the date of the breach—a principle recognised and embodied in section 51 of the Sale of Goods 19 Although not germane to the present chapter, judicial recognition of the problems posed by inflation is most clearly demonstrated by the so-called ‘conventional sum’, which used to be awarded for loss of life expectancy in personal injury cases. The sum was fixed at £200 in 1941 but had increased to £1,750 by 1980. For cases which track this gradual increase, see McGregor, above n 6, para 16-011. 20 Miliangos v George Frank (Textiles) Ltd [1976] AC 443 (HL) 468.

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Act 1893. But this is not an absolute rule; if to follow it would give rise to injustice, the court has power to fix such other date as may be appropriate in the circumstances.21

It is submitted that this approach is plainly right.22 The breach date rule is appropriate where the innocent purchaser of goods can readily acquire replacement goods in the market,23 or where there are ready buyers for the goods which were to be provided by the innocent seller. Otherwise, the assessment may have to be made as at a later time or as at the date of the judgment. Indeed, the House of Lords, in its recent decision in The Golden Victory,24 upheld the assessment of damages for repudiation of a charterparty as at the date of the award itself, as opposed to the date of the breach or repudiation. By the date of the award, war with Iraq had broken out and the charterer could have validly terminated the charter in any event, with the result that the arrangement had a lesser value from the owner’s perspective. One is left with the impression that the supposed breach date rule is firmly in retreat.25 Plainly, inflation may affect the calculation of damages as the date of assessment is postponed, although: (i) in a contractual case, inflation may be taken into account only insofar as it affects the subject matter of the particular contract concerned;26 and (ii) interest on a judgment or award should only run from the date of assessment where that date has been postponed and inflation has been taken into account up to that date; otherwise, the claimant would achieve a double recovery.27 Assessment as at the date of judgment has been held to exclude any award in respect of future or prospective inflation, perhaps—according to Lord Diplock—because higher rates of inflation will be reflected by higher rates of interest available on the proceeds of the award.28 The High Court of Australia has adopted the same line; in one case, Barwick CJ noted that

[1979] 2 WLR 487 (HL) 499. Courts in other Commonwealth jurisdictions have likewise claimed the same flexibility: see, eg Brown & Root v Aerotech [2004] MBCA 63 (Manitoba CA). 23 Even then, however, some flexibility may be required, eg where the buyer has paid for the goods in advance and does not have readily available resources for a substitute purchase. 24 Above n 3. 25 As will be noted below, the rigid application of the breach date rule in The Texaco Melbourne [1994] 1 Lloyd’s Rep 473 (HL) would perhaps merit reconsideration on this basis. The decision in The Golden Victory has already been discussed by David McLauchlan, ‘Expectation Damages: Avoided Loss, Offsetting Gains and Subsequent Events’, this volume. 26 Ie no addition can be made for any general rise in the cost of living. However, in terms of the first limb of the test in Hadley v Baxendale (1854) 9 Exch 341, inflation in relation to the price of the goods may be taken into account as part of the damages calculation because it is a reasonably foreseeable consequence of the breach: H Parsons (Livestock) Ltd v Uttley Ingham & Co Ltd [1978] QB 791 (CA). 27 Dodd Properties Ltd v Canterbury City Council [1980] 1 All ER 928 (CA) 936 (Megaw LJ). 28 Cookson v Knowles [1979] AC 556 (HL) 571. 21 22

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‘the date of verdict is, in my opinion, the proper date as at which to make the assessment’ and that therefore the assessment will in general be made in relation to the purchasing power of the currency at the date of the assessment of the damages.29

The High Court of South Africa has likewise refused to take into account the possibility of future inflation in personal injury cases.30 The Supreme Court of Canada, however, described Lord Diplock’s approach as ‘unrealistic’, and may allow for an element in respect of future inflation.31 The practice of the US courts is mixed; some have avoided an element to account for inflation on the basis that it is too ‘speculative’, whilst others have said that a ‘common sense’ assessment will clearly take inflation into account.32

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L I QUI DAT E D C L A I M S A N D T H E R E C OV E RY O F F O R E I G N CUR R E N CY D E B T S

The Havana Railways Case

An understanding of the attitude of the English courts to foreign currency obligations must begin with a review of the rules adopted in the context of claims for the recovery of commercial debts. Cases of this kind first opened the door to foreign currency judgments in a much wider variety of cases. In 1961, in the Havana Railways case,33 the House of Lords was confronted with a proof of debt for US dollar rental payments owing by an English company and which had originally fallen due in the 1930s. The matter was complex and arose at a long distance in time34 because the 29 O’Brien v McKean (1968) 119 CLR 540, followed in Barrell Insurance Pty Ltd v Pennant Hills Restaurants Pty Ltd (1981) 34 ALR 102 (HCA) and Todorovic v Walker (1981) 150 CLR 402 (HCA); see also the decision of the High Court of Australia in Johnson v Perez (1988) 166 CLR 351. English cases also confirm that an award for non-pecuniary loss must be assessed with reference to ‘the value of the pound sterling as at the date of the award’: Mitchell v Mulholland (No 2) [1972] 1 QB 65 (CA) (departing form the earlier decision in Bishop v Cunard White Star Line [1950] P 242 (P), where a claim heard in 1950 was assessed by reference to the purchasing power of sterling in 1942, when the loss occurred). 30 Ambrosi v Bane and others (15 June 2006). 31 Andrews v Grand Toy Alberta Ltd [1978] 2 SCR 229 (SCC) 254; see also Re Asamera Oil Corp [1978] 89 DLR 3d 1 (SCC). 32 The cases referred to in this paragraph are personal injury decisions, rather than contractual cases. Nevertheless, they illustrate the difficulties which inflation can pose in making an award. It may be noted in passing that, whilst inflation may be seen as an economic and social evil, there is no consideration of public policy which prevents a court from making an award which takes account of the increasing cost of living, for the court’s duty is to ensure that the claimant receives adequate compensation: see Walker v John McLean & Sons Ltd [1979] 1 WLR 760 (CA) 766. 33 Re United Railways of Havana and Regla Warehouse Limited [1961] AC 1007 (HL). 34 The rental payments had been in default for many years, as a result of a moratorium imposed by Cuba in 1934.

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debtor company was to be wound up following the acquisition of its assets by the Cuban government in 1954. The House reaffirmed the long-standing rule that it could only give judgment in sterling.35 It further held that: 1. the claim for the lease rental payments had to be framed as a claim in damages and not in debt.36 This position perhaps appears quaint to the modern eye, but some of its consequences had not been thought through. If the claim sounds in damages (rather than debt), then the claimant is generally under a duty to mitigate his loss, although this issue was not really addressed in the decision itself;37 and 2. the breach date rule applied, so that the US dollar/sterling exchange rate to be used was that in effect on the dates on which the rental payments were originally due. The decision piled anomaly upon anomaly. A debt claim was potentially subjected to the rules on mitigation for the sole reason that the parties had been so misguided as to express an international financing transaction for a Cuban railway in US dollars (the natural and obvious currency) instead of sterling. In addition, the court used the dollar/sterling rate of exchange as at the date of the breach, that is, many years before the judgment was ultimately given. The outcome therefore bore only the faintest resemblance to the transaction originally agreed between the parties. At all events, the sterling damages rule was unanimously reaffirmed. Lord Denning—in a statement he may later have regretted—said ‘and if there is one thing clear in our law, it is that the claim must be made in sterling and the judgment given in sterling’.38 The origin of the requirement for the English court to grant judgment in sterling dated from the late Victorian era, when Lord Lindley MR felt himself unable to deliver a judgment expressed in Mexican dollars.39 There may, at different times, have been other factors which influenced the position. Although it should not really have been an obstacle in most cases involving international trade, the Exchange Control Act 1947 may 35 Insofar as this rule related to claims in contract, the leading authority was Di Fernando v Simon Smits & Co [1920] 3 KB 409 (CA). The corresponding authority in tort was The Volturno [1921] 2 AC 544 (HL). 36 As Lord Denning noted in Havana Railways (at 1069): ‘If the trust company had sought to recover judgment in the US, it would, I presume, have been able to sue there for a debt in dollars. But it cannot sue here in debt. There is no sterling debt. Its claim here must be in damages. It must claim damages for breach of the contract because of the non-payment of dollars in the US.’ The attitude of the English courts to foreign money obligations was in many respects coloured by the so-called ‘commodity theory’ of foreign money. This theory is now largely discredited: see Camdex International Ltd v Bank of Zambia (No 3) (1997) CLC 714 (CA) and n 133. 37 As to whether a claimant is required to take steps to contain his loss in this way, see section VI.E below. 38 [1961] AC 1007 (HL) 1068–9. 39 Manners v Pearson [1898] Ch 581 (CA).

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have engendered the mentality that the courts should adopt sterling as their sole medium of an award. Furthermore, the fixed exchange rate regime supposedly enforced by the post-war Bretton Woods Agreement may have left an impression that differences between currencies were not so great as to require judicial attention.40 That system finally collapsed in 1971 when the US suspended the convertibility of the dollar into gold, and there is no doubt that this provided the catalyst for a revolution in the English courts’ approach to foreign currency obligations. It should be appreciated that insistence on the use of sterling as the money of judgment was not only distortive as regards exchange rates, which could create artificial and unwarranted gains and losses; it could also distort the interest rate awarded by the court. For example, the Japanese yen and the Swiss franc for many years attracted virtually negligible interest rates. If claimants were compelled to accept sterling judgments, then they may well lose out on the exchange rate but they might gain on the interest rate attributable to a sterling judgment. It should be emphasised that this was not necessarily so,41 given the court’s discretion to fix a suitable interest rate, but it would be difficult for a court to insist that a creditor must content himself with a sterling judgment accompanied by a yen interest rate! This illustration emphasises that the ‘sterling only’ rule could mean that the adequacy or appropriateness of the award of damages could be reduced to something of a lottery. The sterling judgment rule could therefore run counter to the objective of proper compensation.

B The Miliangos Decision The security of the ‘sterling only’ rule suffered its first breach when, in Jugoslavenska Oceanska Plovidba v Castle Investment Co Inc,42 the Court of Appeal confirmed the power of an arbitrator to issue an award expressed in a foreign currency. The Court made the point—which should perhaps have been obvious all along—that the claimants 40 Although devaluations of sterling in 1949 and 1968 should perhaps have put an end to such complacency. For a brief description of the Bretton Woods system and its eventual collapse in 1971, see Proctor, above n 10, paras 2.07–2.13. 41 In Helmsing Schiffahrts GmbH v Malta Docks Corporation [1977] 2 Lloyd’s Rep 444 (Comm) the court held that interest should be awarded at the rate at which the claimant had himself had to borrow, even if he had to borrow abroad and in a different currency. However, a claimant is entitled to interest even if he did not have to borrow, and the starting point is that the interest rate should be the rate applicable to the currency in which the award is expressed: see The Pacific Colocotronis [1981] 2 Lloyd’s Rep 40 (CA) 46 (Waller LJ); Barings plc v Coopers & Lybrand [2003] EWHC 2371 (Ch). For Australian decisions to similar effect, see State Bank of New South Wales Ltd v Swiss Bank Corporation (1995) NSWLR 350 (NSW CA), followed in Westpac Banking Corporation v ‘Stone Gemini’ [1999] FCA 917 (FCA). 42 [1974] QB 292 (CA).

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will want an award which will enable them to recover the same amount as they ought in the first instance to have received. They do not want that recovery to be exposed, if that can be avoided, to exchange fluctuations between the currency in which they ought to have received the amount initially and the pound sterling, especially since the latter was allowed to float.

The last few words serve to emphasise the influence of the Bretton Woods Agreement in this sphere.43 This was shortly followed by the decision in Schorsch Meier GmbH v Hennin,44 where the Court of Appeal gave judgment in Deutschmarks. Lord Denning reflected on the fact that sterling was no longer a reserve currency. He summed up the situation characteristically, saying Why have we in England insisted on a judgment in sterling, and nothing else? It is, I think, because of our faith in sterling. It was a stable currency which had no equal. Things are different now. Sterling floats in the wind. It changes like a weathercock with every gust that blows. So do other currencies.

It is no longer necessary to dwell on the fact that the Court of Appeal’s decision in Schorsch Meier was irreconcilable with the precedent set by the House of Lords, for the House itself shortly took the opportunity to overrule Havana Railways. In Miliangos v George Frank (Textiles) Ltd,45 the House was confronted with a contractual debt expressed in Swiss francs and governed by Swiss law. The House found that changing monetary conditions required that the relatively recent ruling in Havana Railways should be discarded. Once again, this was found to flow from the breakdown of the Bretton Woods arrangements. In justifying departure from that ruling, Lord Wilberforce noted that: The situation as regards currency stability has changed even since 1961. Instead of the main world currencies being fixed and fairly stable in value, subject to the risk of periodic re- or de-valuations, many of them are now ‘floating’, ie, they have no fixed exchange value even from day to day. This means that, instead of a situation in which changes of relative value between the ‘breach date’ and the date of judgment or payment being the exception, so that a rule which did not provide for this case could be generally fair, this situation is now the rule. So the search for a formula to deal with it becomes urgent in the interests of justice. 46

Lord Wilberforce went on to say that the remedy was achieved by ‘awarding delivery in specie, rather than by giving damages’. In other 43 The power of an arbitrator to express his award in any currency was subsequently confirmed by s 48(4) of the Arbitration Act 1996, but the arbitrator must identify the appropriate currency in accordance with the relevant case law. The provision does not allow him a broad discretion to award whatever currency he may identify in his discretion: see Lesotho Highland Development Authority v Impregilio SpA [2005] UKHL 43 (HL). 44 [1975] 1 All ER 152 (CA). 45 [1976] AC 443 (HL). 46 Ibid, 463.

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words, treat a debt as a debt,47 and order the debtor to perform his obligation as he originally promised to do.48 It is perhaps regrettable that such an obvious principle did not commend itself to the House of Lords in the Havana Railways case itself,49 but perhaps hindsight is an easy form of wisdom. The effect of the Miliangos judgment is that the creditor only takes the risk of depreciation of the currency in which the contractual debt is expressed. But this is an inevitable consequence of the principle of nominalism; every business has to take the risk of the currency in which it chooses to denominate its contracts.50 As noted above, the contract in Miliangos was governed by Swiss law. The House of Lords specifically confined their judgment to cases in which the contract was governed by a foreign system of law. Yet it is perhaps unfortunate that they were so cautious; the ability to deliver judgment in a particular form must surely be a matter of procedure, which applies regardless of the law applicable to the contract or dispute in question. In any event, it was soon established that the Miliangos principle applied equally to contracts governed by English law51 and—importantly, from the perspective of the present chapter—to claims for liquidated damages.52 47 In this sense, the House of Lords departed from the rule—also stated in Havana Railways—that an action in England on a foreign currency debt was to be treated as an action for damages: see the comments of Lord Denning, above n 36. 48 If the debtor fails to meet the judgment and it has to be enforced in England, then the foreign currency obligation is converted into sterling as at the date on which the court authorises the enforcement proceedings. It may be that the court could now dispense with this restriction and provide for conversion as at the date of actual payment. The point is discussed in section V.E. 49 As noted earlier, it is sometimes said that the provisions of the Exchange Control Act 1947 may have led to a reluctance on the part of the court to given judgments in foreign currencies. Yet this should not have been an impediment, for the 1947 Act did not prevent a foreign debtor from making payment in his own currency. A creditor who fell within the scope of the UK’s exchange control regime could then retain that currency with the consent of the Treasury—see s 1 of the 1947 Act. Even failing such consent, the foreign currency would have to be sold to an authorised dealer for sterling, but the creditor would then at least receive the rate at the date of payment, rather than the date of breach. Furthermore, at around the same time as Miliangos, the court held that the proceeds of a mortgagee sale of a vessel could be received in US dollars and invested by the court in that currency in accordance with the proviso to s 6(1) of the 1947 Act: The Halcyon the Great [1975] 1 All ER 882. 50 Even then, if currency depreciation is a source of concern to the creditor, he may seek to negotiate some form of “value maintenance” clause by reference to some independent index. There is no general consideration of public policy which restricts the enforcement of such provisions: Multiservice Bookbinding Ltd v Marden [1979] Ch 84 (Ch). See also Rochis Ltd v Chambers [2006] NZHC 524, see n 119. 51 Barclays Bank International v Levin Brothers (Bradford) Ltd [1977] QB 270 (QB). 52 Federal Commerce and Navigation Co v Tradax Export [1977] QB 324 (CA), a claim for damages expressed in US dollars. Note, however, that some charterparties provide for damages to be calculated in US dollars (the money of account) but to be paid in sterling (the money of payment) at a fixed exchange rate. In such a case, the claimant would have expected to receive payment in sterling, and the court should give effect to that expectation: The Agenor [1985] 1 Lloyd’s Rep 155 (Comm).

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The same rules are now applied in most Commonwealth countries, and many civil law countries adopt the same approach.53

C

Position in the US

It is pertinent to note that courts in the US have likewise had to wrestle with the problem of changing international monetary conditions attributable to the collapse of the Bretton Woods system of fixed exchange rates. Notwithstanding developments in England, the New York courts for a time continued to insist that judgments had to be expressed in US dollars, even if a conversion from a foreign currency was involved. A prominent example is offered by the 1988 decision of the New York court in Teca-Print AG v Amacoil Machinery Inc.54 This approach is not necessarily consistent with two judgments of the Supreme Court, to which it is now necessary to turn. As will be seen, the approach to be adopted differs according to the place in which the foreign currency debt is payable. In Hicks v Guinness,55 a German debtor owed a Deutschmark sum to a creditor within the US, and the debt was payable there. According to the court’s decision, the creditor in such a case has the option to require either: (i) the payment of the foreign currency sum in specie; or (ii) payment in US dollars by reference to the exchange rate as at the date of breach (that is, the original due date of the debt). From the creditor’s perspective, this may well be an ideal position, although it is not obvious why the court should allow him an option which may significantly affect the quantum of the debtor’s obligation. In contrast, the decision in Deutsche Bank Filiale Nuremburg v Humphreys56 involved the failure by a German bank to repay a deposit placed with it in Berlin, with the result that Germany was the place of payment. In such a case, conversion was to be effected by reference to the exchange rate as at the date of judgment, apparently on the basis that, until judgment was given by a US court, there was no obligation which was recognised by US law, and hence no sum to which a conversion rate could be applied. This, in turn, flows from the rule that—so far as the US courts were concerned—they were not giving judgment for the foreign 53 See, eg the decision of the Kammergericht (Appellate Court), Berlin of 24 January 1992 (Case No 2-U-7418192) holding that an Italian supplier of wine had to claim the price in the contractual currency (Italian lire) and had no right to substitute a claim in Deutschmarks merely on the ground that he occasionally had to use marks in the course of his business. 54 525 NYS 2d 523 (1988), applied by the US Court of Appeals for the Seventh Circuit in Agfa-Gevaert AG v AB Dick Co (No 88-2729). For a decision involving a collision in New York harbour, where sterling repair costs were converted into US dollars for the purposes of the award, see The Verdi 268 Fed 908 (1920, SDNY). 55 269 US 71 (1925). 56 272 US 517 (1925), followed in Zimmerman v Sutherland 247 US 257 (1927).

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currency debt itself.57 Rather, they were awarding damages for the breach of the agreement. As noted elsewhere in this chapter, assessment as at the date of judgment may well be the best approach, but the reasoning offered by the Supreme Court does not seem to provide a logical basis for this result. Apart from other considerations, it overlooks the fact that obligations may be validly contracted under a foreign system of law and that these should be recognised by reference to the ordinary principles of private international law; such obligations do not rely on a judgment of a US court or any rule of US domestic law for their existence or validity. To put matters another way, a judgment of a US court may recognise the obligation, but it does not create it. It is submitted that the distinctions drawn in Hicks v Guinness and the Deutsche Bank case produce artificialities which are insupportable58 and that, if conversion is to be effected at all, this should be achieved by reference to the exchange rate as at the date of the judgment, on the simple ground that such an award will most closely achieve full compensation for the creditor. Nevertheless, and in spite of the apparent anomalies, courts within the US have continued to adhere to this distinction in more recent times. In Reliastar Life Insurance Co v IOA Re and Swiss Re Life Canada,59 the court found that a reinsurer’s reimbursement obligation expressed in Canadian dollars was payable in Minnesota, where the primary insurer was located. Since the place of payment was within the US, it followed that conversion fell to be effected as at the breach date, rather than the judgment date. In New York, section 27(b) of the Judiciary Law (1988) now formalises the Teca-Print decision and provides that: In any case in which the cause of action is based upon an obligation denominated in a currency other than the currency of the US, a court shall render or enter a judgment or decree in the foreign currency of the underlying obligation. Such judgment or decree shall be converted into currency of the US at the rate of exchange prevailing on the date of entry of the judgment or decree.

Finally, reference should be made to the Uniform Foreign-Money Claims Act. The underlying philosophy is that the approach to the difficulties posed by foreign money obligations must be solved by reference to the 57 The English courts have, at times, adopted the same view of this matter. The point has already been noted in the context of the Havana Railways decision: see text accompanying n 33 et seq. 58 The position has nevertheless been defended by the High Court of Australia on the basis that ‘this would appear to allow Courts to select the rule that in any particular case, will prevent the loss due to fluctuating exchange rates being borne by the injured party or the party not in breach’: Re Griffiths [2004] FCAFC 102, para 51. It is, however, submitted that the decisions of the Supreme Court simply provide different rules which apply in different situations; they do not allow the court a discretion as to the appropriate conversion date. 59 Court of Appeals for the Eighth Circuit, 13 June 2002. See also Re Good Hope Chemical Corporation 747 F 2d 806 (First Circuit, 1984), cert, denied 471 US 1102 (1985).

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compensation principle. Section 4 of the Act expressly allows the parties to select the currency which is to be used to meet any claim arising out of their transaction. In the absence of such a stipulation, judgments may be given in foreign currency but the debtor has the option to settle in US dollars by reference to the rate of exchange as at the date of payment.60 If the creditor is to be compelled to accept local currency, then this is by far the best conversion date. Unfortunately, the Act has not won wide acceptance.

V

A

CO N T RACT CLA I M S A N D UN L I QU I DAT E D DA M AG E S — T H E CURRENCY O F T HE AWARD

Awards in Foreign Currencies

In light of the developments described above, the courts only had to go a short distance in order to hold that an award of unliquidated damages could likewise be made in a foreign currency.61 Whilst this is perhaps a logical extension of Miliangos as a matter of principle, there are some practical difficulties. For example, there is no necessary connection between the currency in which the contract is expressed and the currency in which damage may be suffered.62 Whilst there may be indications in the contract that the parties intended that compensation or damages should be settled in a specific currency,63 this will only rarely be the case.64 In negotiating their contract, the parties will tend to focus on the objective of performance—not the consequences of a breach. Furthermore, in the nature of things, determination of the currency in which the loss is suffered may be affected by a number of factors, including the nature of the breach, the place in which it occurs and the currency in which the claimant manages its business. It is perhaps unsurprising that this type of problem has arisen, in its most acute form, in maritime cases. Nevertheless, the point could equally arise in cases involving the carriage of goods by air or the cross-border 60 S 7(f) of the Act. The debtor enjoys a similar sterling option where a foreign currency debt is due to be paid in England: see, eg Libyan Arab Foreign Bank v Bankers Trust Co [1989] QB 728 (Comm). This option does not affect the quantum of the debtor’s obligation, since he is merely required to effect an exchange transaction on the date of payment. However, the option can be valuable to the creditor if, as happened in the Libyan Arab case itself, payment in the foreign currency has become unlawful for some reason. 61 See Jean Kraut v Albany Fabrics [1977] QB 182 (QB), subsequently confirmed by the House of Lords in The Folias [1979] AC 685. 62 The point is made by McGregor, above n 6, para 16-036. 63 Ie what Lord Wilberforce referred to as the ‘currency of the contract’ in The Folias, above n 61. 64 Although, as will be argued below in relation to the decision in The Texaco Melbourne, the courts should be willing to imply a term to that effect where the market for a commodity is invariably priced in a particular currency.

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transport of goods by rail or by road. It is therefore important to bear in mind that the normal measure of damages for non-delivery of goods is the market value of the goods at the contractual place and time of delivery, less the cost of getting the goods to that place.65 The same principle applies to the delivery of damaged goods, except that one obviously looks to the diminished market value at the place of delivery.66 But this still leaves the question—in what currency is the loss to be assessed? If the market value at the place of delivery is relevant, then it may often be assumed that the value of the goods must likewise be expressed in the currency of that place, since that will be the currency which the claimant will need to acquire substitute goods in that place. Yet this rule may be of doubtful value, because the claimant may need to use his own trading currency in order to purchase the money of the place of delivery, and restitution would demand that he receives the amount which he was actually obliged to expend, in his own trading currency, for that purpose. (i)

The Folias

The ground-breaking decision in this field is The Folias.67 French charterers of a vessel were delivering a cargo of onions to Brazil, but the refrigeration equipment failed and the cargo was damaged. The consignees claimed for the loss and the French charterers used some of their French franc resources to purchase the Brazilian cruzeiros to which the consignees were entitled. The charterers then sought to recover their loss from the Swedish owners on the basis that—in breach of a standard warranty—the vessel was not seaworthy.68 The hire was payable in US dollars, but this was held not to be relevant to the damages claim.69 Having discarded US dollars as a candidate, the choice lay between French francs and Brazilian cruzeiros. The simplest approach and—in some respects—the most convenient would be to express the award in cruzeiros. That was the currency paid to the consignees; and the inconvenience of currency conversion would be avoided. This would—perhaps—have been the outcome if the charterer’s claim had been for an indemnity. But it was not—the claim was for damages for breach of contract. Thus, as Lord Wilberforce put it: the essential question is what was the loss suffered by the charterers. I do not find this to be identical with that suffered by the cargo receivers . . . their [the 65 McGregor, above n 6, para 27-003; The Texaco Melbourne, above n 25; The Freja Scandic [2002] EWHC (Comm) 79. 66 The Ocean Dynamic [1982] 2 Lloyd’s Rep 88 (Comm); The Good Friend [1984] 2 Lloyd’s Rep 586 (Comm); The Sanix Ace [1987] 1 Lloyd’s Rep 465 (Comm). 67 Above n 61. 68 The claim was accordingly framed in contract, rather than in tort. 69 The fact that the hire and other contractual payments were expressed in a particular currency does not necessarily lead to the conclusion that damages must likewise be paid in that currency.

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claimant’s] loss, which they claim as damages, was the discharge of the receivers’ claim, together with the legal and other expenses which they incurred. They discharged all these by providing francs; until they provided the francs to meet the receivers’ claims, they suffered no loss . . .70

Of course, if an award was to be made in francs, then, in accordance with accepted principles, the possibility of a loss suffered in francs had to be a reasonably foreseeable consequence of the owner’s breach of warranty.71 As to this, Lord Wilberforce remarked: was this loss the kind of loss which, under the contract, they were entitled to recover against the owners? The answer to this is provided by the arbitrators finding that it was reasonable to contemplate that the charterers, being a French corporation and having their place of business in Paris, would have to use French francs to purchase other currencies to settle cargo claims arising under the bills of lending. So, in my opinion the charterers’ recoverable loss was, according to normal principle, the sum of French francs which they paid.72

The core principles that flow from The Folias are: 1. damages should be calculated and awarded ‘in the currency in which the loss was felt by the plaintiff or which most truly expresses his loss’.73 2. in order to identify the relevant currency ‘the court must ask what is the currency, payment in which will as nearly as possible compensate the plaintiff in accordance with the principle of restitution and whether the parties must be taken reasonably to have had this in contemplation’.74 Although not directly relevant to the present chapter, it is important to note the House of Lords decision in The Despina R,75 which was heard at the same time as The Folias. Predictably, the House decided that damages in tort (in this case, a maritime collision) could likewise be awarded in an appropriate foreign currency. No doubt they were mindful of the need for consistency, given that damages in contract and tort serve the same objective and are assessed on essentially the same basis. But even if the result is the same, the process of reasoning which leads to it must be different. In a tort claim, the parties will frequently have had no contact before the incident concerned. When the tort is committed, the defendant may not even know the identity of the claimant, still less will he know the currency in which the claimant operates its business. Consequently, whilst The Folias, above n 61. It is apparent from The Folias that the defendant can only be made liable for damages in a foreign currency if a loss in that currency was a foreseeable consequence of the breach. See further the discussion of the decision in Metaalhandel Magnus BV v Ardfields Transport Ltd [1988] 1 Lloyd’s Rep 197 (Comm), text accompanying n 97 et seq. 72 The Folias, above n 61, 702. 73 Ibid, 701 (Lord Wilberforce). 74 Ibid. 75 [1979] AC 685 (HL). 70 71

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the losses which flow from the breach may well be foreseeable, the currency in which those losses are incurred may not. But the tortfeasor must take his victim as he finds him,76 and this must extend to the currency in which the claimant runs his business. In The Despina R itself, two Greek-registered ships collided off Shanghai. The claimant’s vessel required repairs which were carried out in China, Japan and the US, and the costs were met in the respective national currencies. However, the vessel was managed from New York and the various currencies were purchased from a US dollar account. The House accordingly held that the entire award should be made in US dollars, because that was the currency in which the losses were ultimately incurred.77

B The Currency of the Claim—The Federal Huron It will be obvious that the currency in which the loss is felt will usually be the ‘normal trading currency’ of the claimant,78 although even then the identification of that currency may pose difficulty where the claimant is a multinational business. The decision in The Federal Huron79 offers an interesting basis for comparison with The Folias and demonstrates the fact-sensitivity of this type of case. Once again, the claimants—in this case, the consignees—were a French corporation. They had arranged for the shipment of a cargo of soya beans from the US to Bordeaux. On arrival, the goods were found to be damaged, but the consignees managed to sell them locally (at a reduced price) for a price expressed in francs. Expenses associated with the sale were also paid in that currency. The consignees thus sued for the loss of a part of the price, and for the reimbursement of the expenses. One might instinctively feel that the natural currency of the award—or currency in which the loss is ‘felt’—would be the French franc,80 for the claimant was a French corporation carrying on business in that country. It was true that both hire and demurrage were expressed in US dollars, but it Smith v Leech Brain [1962] 2 QB 405 (QB). Whilst the principle is thus clear, its application to the particular facts is in some respects doubtful. It is not the currency paid by the agent which represents the loss, for the agent is not the claimant. The question is, what currency did the principal ultimately use to reimburse the agent? Similar confusion may have given rise to the differing opinions in The Lash Atlantico [1987] 2 Lloyd’s Rep 114 (CA). For a case which involved an assessment of the competing claims of the US dollar and the Italian lira to represent the currency in which the loss was felt, see The Mosconici [2001] 2 Lloyds Rep 313 (Comm). 78 This terminology was employed in The Folias. It is, however, submitted that this will not always be the case and that a loss may be felt by reference to the value of that currency in terms of its relationship with another monetary unit: see the discussion of The Texaco Melbourne, see text accompanying n 89 et seq. 79 [1985] 2 Lloyd’s Rep 189 (Comm). 80 Or, of course, in more recent years, the euro. 76 77

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Charles Proctor

was impossible to infer from those provisions any agreement that damages were likewise to be paid in US dollars.81 The defendants argued that damages should be calculated in French francs, since: (i) damages should be calculated by reference to the diminution in value of the goods at the place of delivery;82 and (ii) the presumption should be that the value of the goods—and any diminution in their value—should be measured by reference to the currency in use in that place. As noted earlier, this may well offer a starting point, but the court’s prime concern is to determine: (i) the loss actually suffered by the particular claimant; and (ii) the extent to which that loss was reasonably foreseeable or was within the contemplation of the parties, so as to constitute a recoverable loss. On the facts, the court found that the French claimants traded in US dollars. They had paid for the soya beans in US dollars; when they were on-sold, the buyer paid in his local currency, but the proceeds were immediately converted into US dollars. If soya beans were sold for delivery and payment at a future date, the claimants sold forward the local currency proceeds—even if expressed in French francs—for US dollars. The claimants were not thereby entering into a reasonable device to avoid the use of their own national currency. Their financial activities simply reflected the fact that the soya bean market operated in US dollars, and the claimants conducted their operations in the same currency so as to minimise the risk of exchange losses.83 Perhaps the most useful passage from the judgment reads as follows: the evidence is overwhelming that the cargo receivers treated soya bean as a dollar commodity. In purchases of raw soya beans the dollar was always the money of account. How the cargo receivers would have disposed of the damaged cargo had it not been damaged cannot now be determined, partly because it was damaged and partly because supplies of raw beans became intermingled in their silo. But the evidence was clear that if the currency of any onward sale were not dollars, the proceeds of sale would be immediately converted into dollars and, if it were a forward sale, the cargo receivers would buy dollars forward as a hedge against depreciation of the foreign currency against the dollar. To give judgment in francs in these circumstances would, in my opinion, offend in an obvious way against the principles I have summarised. It would mean that the shipowner’s breach and the intervention of the court had imposed on the receivers an exchange loss which they would not otherwise have suffered and against which, as a matter of routine commercial practice, they took careful measures to protect themselves.84 81 Ie the US dollar was not ‘the currency of the contract’, to use the expression adopted by Lord Wilberforce in The Folias. 82 The point has already been noted during earlier discussion. 83 The claimants did, of course, effectively take the risk that the US dollar would depreciate against the currencies in which their buyers paid for goods. But, in any form of international trade, one must take that risk in one way or another, and it is clear that the claimant’s ‘currency of account’ was the US dollar. 84 The Federal Huron, above n 79, 192 (Bingham J).

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Moving on to deal with the foreseeability issue, Bingham J continued: A dollar loss is what the cargo receivers would have foreseen as a result of cargo damage. I have no direct evidence of what the ship owners contemplated but have no reason to doubt that they would also have foreseen a loss in dollars if a commodity bought in and shipped from the US were damaged.85

In other words, the French claimants had ‘felt’ their loss in US dollars. That they would suffer their loss in that currency was entirely foreseeable in the context of a US dollar commodity, and it was thus appropriate to give judgment and damages in that currency.86 The justice of the outcome can be judged by analysing the final paragraph of the judgement: I accordingly conclude that the cargo receivers should have judgment for US$49,887.44 and interest from November 1981 until today [14 March 1985] at 13.4312 per cent.87

The claimants had suffered that loss in that currency in 1981, and would have had to fund their loss at that time. There is hence no injustice in holding them to that figure regardless of any subsequent exchange rate fluctuations which might have afflicted the US dollar during the interim period. The award of interest adequately compensates the claimants for their cost of funding during that period. So the ability to award contractual damages in the currency in which the loss is actually felt88 both simplifies matters (by avoiding unnecessary conversion into sterling) and provides a more accurate assessment of the actual loss. The application of the ‘breach date’ rule in a case of this kind probably leads to a just and commercially reasonable solution, largely because no currency conversion is required.

Ibid. The claim for expenses suffered in Bordeaux was also allowed in US dollars on the basis that the claimant quantified and incurred all of its expenditure in US dollars. For another case in which payment of repairs and expenses was made in Argentinian pesos but the award was made in US dollars because the claimants had debited a dollar account in remitting the necessary funds to Buenos Aires, see The Dione [1980] 2 Lloyd’s Rep 577 (Comm). A very similar outcome is to be found in the more recent Court of Appeal decision in Virani Ltd v Marcel Revert y Cia SA [2003] EWCA (Civ) 1651. Revert refused to accept delivery of a quantity of cloth priced in Spanish pesetas. However, damages were assessed in US dollars because the market generally traded this material in dollars and Revert would have been aware of that fact. 87 The Federal Huron, above n 79, 193 (Bingham J). 88 As previously noted, the currency must have been in the contemplation of the parties in order for it to form the subject matter of the award. In a case of this kind, it is quite likely that the parties would have contemplated losses in either US dollars or French francs, or a combination of the two. In principle, therefore, it was open to the court to make an award in either dollars or francs, subject to identification of the currency in which the losses were actually felt. 85 86

480 C

Charles Proctor The Texaco Melbourne

This view of the apparently fair and just approach to foreign currency losses may not be shared by the Ministry of Fuel and Energy of the Republic of Ghana in the light of the House of Lords decision in The Texaco Melbourne.89 The claimants employed a Texaco company to transport a cargo of oil across part of the coast of Ghana. The oil never arrived. There could be no serious question about the breach of contract or about the carrier’s liability for it. The question was: should damages be awarded in US dollars or in Ghanaian cedi? As may be imagined, parties never litigate over purely theoretical issues; in all of these cases, exchange rate fluctuations mean that real money is involved. This point, however, assumed a dramatic importance in The Texaco Melbourne for the difference between the two solutions was almost US$3 million. It is necessary to explain how this situation arose. Briefly, the breach of the contract to deliver the oil occurred in 1982, when one US dollar was equivalent to 2.75 cedis. By the time judgment was given at first instance the cedi had collapsed, and 375 cedis were required to purchase a single US dollar. Working on the basis that the damages fell to be assessed by reference to the date of breach, the claimants would receive a mere pittance if their loss was calculated in the cedi—apparently the total cedi figure would have been worth about US$20,000 by the date of judgment. On the other hand, if one took the damages to be the buying price of similar oil in the nearest available market, the recovery would have been some US$3 million, for oil is internationally priced in US dollars. It is perhaps fair to say that this is a case which satisfies the first test for a foreign currency award, which is that the claimants ‘felt’ the loss in cedis, but it probably fails the second test, in that the parties probably would not have had a cedi denominated loss in mind. If—before the contract fell into difficulty—one had asked the Ministry and Texaco about the currency in which damages should be expressed, then they would probably both have replied in terms of the US dollar.90 Texaco itself no doubt runs its accounts in dollars and, as already noted, that is the currency of the oil market. The ‘available market’ point which would have supported the argument for US dollars was fraught with difficulty, not least because the Ghanaian government did not seek to replace the lost oil. But, in any event, the House of Lords held that the claimants had felt their loss in cedis because: Above n 25. It is true that Lord Goff (at p 481) asserted that ‘it was within the reasonable contemplation of the shipowners that the department would feel its loss in cedis’ but, for the reasons given in the text, this seems to be a doubtful conclusion. 89 90

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1. the claimants conducted their business in cedi and their local accounts were maintained in that currency; 2. had the cargo arrived, it would have been sold to Ghanaian entities for a price in cedis; 3. even if the claimants had sought to replace the oil from the nearest available market, the loss would still have been felt in cedis because the necessary US dollars would have had to be purchased with cedis. This conclusion was reinforced by the fact that Ghanaian exchange control laws precluded the holding of US dollar balances by local companies.91 Although the disparity between the two figures was very significant, Lord Goff appears to have thought that there was no basis for departing from the rule that damages must be assessed as at the time of the breach. This may be so, but there appears to have been an insufficient consideration of the flexibility which the House of Lords itself had introduced in this area in Johnson v Agnew.92 Indeed, there seems to be little doubt that the application of the breach date rule operated unfairly in The Texaco Melbourne. Yet how could the court have fixed a more appropriate assessment date? It is submitted that the matter should have been approached as follows: 1. had the oil been delivered on the contracted date, it would have been on-sold to Ghanaian buyers for a price in cedis; 2. the cedi proceeds—or at least, the profit element—would then have been converted into US dollars and used to purchase further cargoes of oil, which would in turn have been re-sold; 3. this process would have continued indefinitely, with the result that the cedi proceeds received by the Ministry would always have been referable to the US dollar value of oil; and 4. if damages must be awarded in cedis, then the correct cedi amount would be the countervalue of the relevant US dollar amount at the time when the oil should have been delivered, since continuous trading based on the sale proceeds of that oil would effectively have insulated the Ministry against the continuing fall in the external value of the cedi. 91 As noted earlier, it must be said that the existence of exchange controls in particular jurisdictions has frequently had an impact of the court’s approach to the currency in which the award should be made. Restricted access to foreign currencies has led to the conclusion that the loss must have been felt in the domestic currency. In The Transoceanica Francesca [1987] 2 Lloyd’s Rep 155 (Adm) an Italian claimant had funded certain payments from a US dollar account but received an award in Italian lira on the ground that the US dollar funds would have been acquired with the local currency . 92 Above n 21. This decision has already been discussed. Subsequent case law has reinforced the view that a later assessment date may be used where appropriate: see, eg Alcoa Minerals of Jamaica plc v Broderick [2001] 1 AC 371 (PC), discussed by McGregor, above n 6, para 34-017 and The Golden Victory, above n 3, where the assessment was made by reference to the factual background as at the date of the hearing.

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This process might not have accounted fully for the depreciation of the cedi, but it would clearly have gone part of the way. As it is, one is very much left with the impression that the carrier (or its insurers) ‘got away with’ the breach. It is especially unfortunate that the defendants made a significant saving as a result of the delay in offering compensation for a plain breach of the contract.93 It would, however, have been preferable for the House to avoid these difficulties altogether by holding that oil is a dollar commodity94 and that the loss suffered by the claimant was thus very closely linked to the US dollar, regardless of the fate of Ghana’s own currency. If the loss was not actually felt in US dollars, it was nevertheless felt by reference to that currency,95 and this should be sufficient to justify an award expressed in dollars. There is, however, an alternative approach to the matter. In my view, it should have been possible to imply into the contract of carriage a term to the effect that the US dollar was the ‘currency of the contract’. It would be obvious to both parties that, if the oil were lost, the Ministry would need a supply of US dollars to acquire a substitute. The loss would not be ‘felt’ in cedis because the Ministry should not have had to have recourse to the central bank via Ghana’s system of exchange control. The dollars should have been supplied by Texaco, which had lost the cargo in the first place. For these reasons, there would be strong ‘business efficacy’ grounds for implying a clause requiring that all matters arising from the contract should be settled in US dollars. This approach to the matter would have secured a measure of justice for the Ministry without any obvious unfairness for the carrier. It is therefore suggested that the analysis adopted in The Texaco Melbourne should be reconsidered if the opportunity arises.

D

Other Cases

Nevertheless, and however valid these criticisms may be, the fact remains that The Texaco Melbourne is a decision of the House of Lords and will remain binding until (and if) it is overturned. It is thus necessary to work with it and to try to discern the principles which may be drawn from it. It is tempting to suggest that one merely has to look at the currency in which 93 It was not possible for the claimants to seek to recover the currency losses on the basis that compensation was paid long after the event, for English law does not allow for an award of damages in respect of the late payment of damages: see the discussion of the decision in Lips Maritime in the text to nn 120 and 121. See also Michael Furmston’s discussion of the decision in The Golden Victory in ‘Actual Damages, Notional Damages and Loss of a Chance’, this volume. 94 Compare the decision in The Federal Huron (see n 79 and text thereto), where the fact that soya beans were priced in US dollars was a significant factor. 95 The process described in 1–4 above would tend to support this line of argument.

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the claimant runs its business and that will be a sufficient pointer to the currency in which damages should be expressed—the claimant will have ‘felt’ the loss in that currency.96 Yet justice is not only for the claimant but also for the defendant. Consequently, and as previously noted, it must also be shown that the relevant currency was within the contemplation of the parties (or at least, it would have been within their contemplation had the parties turned their minds to the possibility of breach). This latter test was not met in Metaalhandel Magnus BV v Ardfields Transport Ltd.97 In that case, a metal trading company based in Holland purchased a consignment of tungsten rods from English sellers. However, the goods were stolen due to the seller’s lack of care in ensuring proper storage in accordance with the terms of the contract—they were apparently released ‘to some unidentified rogue on the strength of a bogus document’. The claimants unquestionably ran their finances in Dutch guilders, but damages were awarded in sterling partly (it seems) because the storage contract was expressed in sterling and partly because in my judgment, the parties to this contract cannot be said to have had in contemplation that damages payable by the first defendants to the plaintiffs . . . should be measured in Dutch guilders.98

Whilst the reasoning which underlies that view is not set out in any detail, the conclusion nevertheless appears to be appropriate in the circumstances. The tungsten rods had been purchased in Brighton. Ardfields had collected the goods from a facility in that town, and had transported them to their warehouse in St Albans, where they were stolen. From Ardfields’s perspective, this was therefore essentially a domestic job and the possibility of losses in Dutch guilders would never have crossed their minds. To express the matter in terms of Hadley v Baxendale, a loss in guilders did not flow naturally from the breach, nor did the parties specifically have that type of loss in contemplation.99 It may therefore be that the ‘currency of the loss’ principle can properly be applied only to transactions which have a genuine and sufficient international element.100 96 It appears that the German courts adopt the same line: see the decision of the Oberlandesgericht (Regional Court of Appeal) dated 14 July 1994 (Case No 17-U-146/93). An Italian shoe supplier delivered goods to a German buyer but the price remained unpaid. The price was expressed in Italian lire and the supplier operated in that currency. He was thus not entitled to damages reflecting the depreciation of the lira (as compared to the Deutschmark) during the period of non-payment. 97 [1988] 1 Lloyd’s Rep 197 (Comm). 98 Ibid, 205 (Gatehouse J). 99 In view of the quotation from the decision, it is clear that the judge was relying on the second limb of the rule. The decision in Metaalhandel may be seen as an illustration of the presumption that it is the value of the goods at the place of loss which must be made good, since that is the place in which replacement materials must be obtained. As noted elsewhere, however, the currency of the place of delivery may be displaced if it does not reflect the claimant’s loss. 100 It hardly needs to be stated that the application of this test would itself generate debate in particular cases. But the factual situation in Metaalhandel suggests that a case would not have

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The discussion in this section has proceeded on the basis that it is possible to identify the currency in which the claimant ‘feels’ his loss. This may be unrealistic where the claimant is an international bank which deals in numerous different currencies on a daily basis. In Westpac Banking Corporation v ‘Stone Gemini’,101 an Australian bank had made a US dollar loan which was repaid after the due date. It sought to argue that it would have funded the unpaid sums locally and that it should accordingly receive an Australian dollar interest rate. This argument was rejected because the bank’s operations and the fungibility of money made it impossible to identify how or in which currency the unpaid amount had been funded. The court thus fell back on the presumption that a US dollar judgment should attract a US dollar interest rate.102 By way of conclusion, it may be noted that claimants have frequently sought to increase the value of the award by reference to the currency in which the loss has allegedly been felt, but as the decision in The Texaco Melbourne dramatically illustrates, this rule can cut both ways.

E Enforcement Issues Although the Miliangos line of cases has greatly simplified the task of the claimant who has suffered foreign currency losses, there does remain one ‘sterling conversion’ issue. Whilst the claimant may gain a judgment in a foreign currency, he may not receive payment for a very significant time after judgment. Indeed, he may have to go back to court seeking remedies by way of enforcement. This gives rise to difficulties because—so the argument goes—it is necessary for the sheriff to enforce the judgment by selling assets within England and Wales, and this will result in a fund expressed in sterling.103 In order to deal with this supposed problem, the court in Miliangos held that the foreign currency claim must be converted into sterling as at the date on which the court authorises execution. There are two difficulties with this approach. First of all, there may be a significant lapse of time between the date on which execution is authorised and the date on which proceeds are received. Thus, in Carnegie v Giessen104 the necessary international element by reason only that one of the contracting parties is incorporated outside the UK. Of course, most of the cases discussed in this chapter involve the carriage of goods between different countries, so that the necessary international element is plainly present. [1999] FCA 917 (FCA). This approach to the matter would tend to be reinforced by various provisions found in standard loan documents (eg the obligation to pay interest on overdue amounts by reference to the currency in which the loan was made). 103 This assumption may not be well founded in shipping or aviation cases—see The Halcyon the Great, above n 49. 104 [2004] EWHC 1782 (Ch). 101 102

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dollar claims were converted into sterling at the date of a charging order, but further steps could not be taken at that point because other parties had an interest in the charged property. Nevertheless, based on Miliangos, the Court refused to amend the charging orders to refer to the sterling equivalent as at the date of receipt of the proceeds. There thus remains a significant exchange rate exposure during the interim period. This rule should now be discarded; exchange rates are published daily by independent sources and there is no reason why the sheriff could not refer to them on the date of actual enforcement. In other words, we should accept the logic of section 4 of the US Uniform Foreign-Money Claims Act to the effect that any necessary conversion should be effected as at the date of payment.105 It is true that an approach of this kind would not work where the judgment debtor has, in the meantime, become insolvent. But in such a case, the fund for division among creditors comes into being on the date of the winding up order and the judgment could thus be converted with reference to the exchange rate on that day.106

VI

A

DAM AG E S F O R L AT E PAY M E N T

Exchange Losses Flowing from a Breach

Thus far, this chapter has considered whether judgments can be given in foreign currencies and the factors which may lead the court to select one currency in preference to another. However, it has not so far considered whether exchange rate losses can themselves form an independent head of claim in a case involving a breach of contract. For example, suppose that a UK company runs its accounts in sterling. For competitive reasons, it may nevertheless enter into a contract with a US buyer expressed in US dollars on the (implied) understanding that it will accept the risk of currency fluctuations up to the date on which payment is due. But what happens if payment is made late and, during the period of default, sterling weakens relative to the US dollar? Can the UK supplier recover the loss by way of damages for the buyer’s breach? In this context, it is fair to observe that English law was, until very recently, burdened by a particular curiosity, in that it had long been held that interest could not be recovered by way of damages for late payment of a debt; this odd rule flowed from the 1893 decision of the House of Lords The Act has already been discussed: see n 60 and text thereto. See Re Lines Bros Ltd [1983] Ch 1 (CA); Re Dynamics Corporation of America [1976] 2 All ER 669 (Ch). The same rule is adopted in Australia: Re Griffiths [2004] FCAFC 102 (FCA). The logic is that a uniform conversion rate is likely to provide the most just solution where creditors are competing for a fund which will be insufficient to meet all of their claims. 105 106

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in London Chatham & Dover Rly Co v South Eastern Rly Co.107 It is true that the courts chipped away at this rule; in particular, it was decided that the rule only prohibited an award of general damages for late payment, but it did not prevent the award of interest by way of special damages if the loss of interest was specifically within the contemplation of the parties.108 But however that may be, the basic rule was obviously unsatisfactory and frequent pleas had been made for its reconsideration.109 Nevertheless, the rule remained essentially intact until July 2007, when the House of Lords in Sempra Metals110 recognised that the rule had no rational basis, and effectively overruled the London Chatham & Dover decision.111 It thus now appears that the rules applicable to the recovery of both exchange rate losses and interest costs flow from the breach under either limb of Hadley v Baxendale, provided that the necessary conditions are met. This must be regarded as a logical and satisfactory development. The House of Lords had in any event already held that the artificialities of the London Chatham & Dover decision did not restrict the recovery of exchange rate losses. In President of India v Lips Maritime Co,112 Lord Brandon remarked it appears to me that claims to recover currency exchange losses as damages for breach of contract, whether the breach relied on is the late payment of a debt or any other breach, are subject to the same rules as apply for breach of contract generally.

Nevertheless, in that particular case, no exchange losses were recoverable because the charterer was late in paying demurrage. Demurrage is a form of 107 [1893] AC 429 (HL). This decision can best be described as bizarre; if money is paid late, then a loss to the claimant is obviously foreseeable for the purposes of the first limb of the rule in Hadley v Baxendale. The claimant plainly loses the interest which he could have received on the funds or (alternatively) he loses the benefit of a reduced overdraft balance. These obvious points were noted by the High Court of Australia in Hungerfords v Walker (1989) 171 CLR 125, para 25. 108 In other words, interest could be awarded by way of damages under the second limb of Hadley v Baxendale in an appropriate case: see Trans Trust Sarl v Danubian Trading Co Ltd[ 1952] 2 QB 297 (CA) and Wadsworth v Lydall [1981] 1 WLR 598 (CA), approved by the House of Lords in President of India v La Pintada Compania Navigacion [1985] AC 104. However, this analysis appears to be redundant in the light of the decision in Sempra Metals. 109 In La Pintada, the House of Lords had declined to overrule London Chatham & Dover Rly on the basis that Parliament had subsequently intervened to allow the court to award interest in particular cases. This does not seem to be a particularly cogent reason for the preservation of a common law rule which lacks any coherence or commercial common sense. It is unsurprising that the High Court of Australia declined to follow this authority in Hungerfords v Walker (1989) 171 CLR 125, and the essence of its criticism was accepted by the House in Sempra Metals. 110 Above n 4. 111 This statement is subject to various detailed reservations. For example, it will remain incumbent on the claimant to prove his loss: see ibid, [96] (Lord Nicholls). 112 [1988] AC 395 (HL). The decision in the Court of Appeal had proceeded on the assumption that exchange losses could not be awarded by way of general damages.

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liquidated damages, and the House of Lords held that one could not recover damages for the late payment of damages. In strict terms, therefore, the recovery of exchange rate losses did not arise in that case. Nevertheless, it will be necessary to return to this decision at a later stage. To return to the main point, however, the non-application of the principle in the London Chatham & Dover Rly case means that damages for foreign exchange losses have always been recoverable under either limb of the rule in Hadley v Baxendale if the circumstances justify such an award and the losses are not too remote. There have been a few cases in which damages for late payment of debts have been considered. These have frequently been concerned with debts which should have been paid shortly before a devaluation113 but which were paid late.

B Impact of a Currency Devaluation In Mehmet Dogan Bey v Abdeni & Co Ltd,114 freight in sterling was due to be paid to a Turkish shipowner on 6 September 1949. The sterling payment was in fact made on 14 September and, by the time exchange control approval had been obtained for the remittance of the funds, sterling had been devalued. The Turkish owner was thus left with a significant shortfall in terms of his own currency. These losses were held to be irrecoverable by way of general damages on the ground that they were not foreseeable. This was so because—despite feverish speculation that devaluation was on the cards—the Chancellor of the Exchequer had repeatedly denied any intention to devalue sterling. To the modern eye, the decision may appear to be slightly naïve. In Aruna Mills Ltd v Dhanrajmal Gobindram,115 goods were to be shipped from India and the contract expressly stated that the buyers would take the risk of any devaluation of the rupee. The rupee was devalued and the price payable by the buyers was increased accordingly. However, a portion of that increase arose as a result of late shipment by the sellers, and it was held that the resultant loss could be recovered by the buyers. The ‘devaluation’ clause demonstrated that the parties had turned their minds to the impact of exchange losses. This decision accordingly rests on the second limb of Hadley v Baxendale.

113 In strict terms, a ‘devaluation’ of a currency generally referred to the adjustment of the par value of a currency within the Bretton Woods system of fixed exchange rates. The expression has no real meaning since the collapse of that system in 1971. 114 [1951] 2 KB 405 (KB). 115 [1968] 1 All ER 113 (Comm).

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In the modern era, of course, we are not concerned with official and very occasional devaluations but with the constant fluctuations in the comparative value of currencies. Nevertheless, it is submitted that the essential principles remain the same and that the rule in Hadley v Baxendale should be applied in the usual way. The point is well illustrated by the decision in Ozalid Group (Export) Ltd v African Continental Bank.116 Ozalid agreed to export machinery and equipment to a Nigerian buyer for a price expressed in US dollars. The defendant bank opened a letter of credit to cover the purchase price. Payment was made some three months late and sterling had fallen in relation to the US dollar during the intervening period. The bank knew that Ozalid ran its business in sterling,117 and it was thus foreseeable that the claimant would suffer an exchange loss in the event of late payment under the credit. Ozalid thus obtained an award in sterling representing the decline in the sterling value of the dollar during the period of default. Case law of this kind is by no means confined to the English courts. For example, in Isaac Naylor & Sons Ltd v New Zealand Co-operative Wool Marketing Association Ltd118 the New Zealand Court of Appeal likewise held that a debtor who paid a sterling debt to his creditor after the due date was liable to the creditor for an amount represented by the decline in the countervalue of sterling between the due date and the actual date of payment. As the New Zealand case law has rightly pointed out, the exchange losses flowing from late payment will be recoverable if they are not too remote or, to express matters in another way, if they are a foreseeable consequence of the breach. Exchange losses may therefore be recoverable even if the relevant payment was due to be made in the local currency, provided that these tests are met.119 [1979] 2 Lloyd’s Rep 231 (Comm). This had to be the case because exchange controls were still in force in the UK when the case arose, and any foreign currency earned by Ozalid would thus have to be surrendered in exchange for the sterling countervalue. The defendant bank would plainly have been aware of this situation. In this sense, therefore, it may be argued that a company based in a country which imposes a system of exchange control will always ‘feel’ its loss by reference to the domestic currency. However, it is suggested that this approach is too simplistic—see the discussion of The Texaco Melbourne, see accompanying text to n 89 et seq. 118 [1981] 1 NZLR 361 (NZ CA). On this case, see C Rickett, ‘Contract Damages for Exchange Losses—a New Zealand Development’ [1982] Lloyd’s Maritime and Commercial Law Quarterly 566. 119 See Volk v Hirstlens (NZ) Ltd [1987] 1 NZLR 385 (NZ HC) 400, where the question was whether a US dollar/NZ dollar exchange loss was ‘predictably incurred’ as a result of late payment of an NZ dollar debt owing to a US resident. See also Rochis Ltd v Chambers [2006] NZHC 524 (NZ HC), involving a purely domestic transaction for the sale of land in New Zealand and expressed in the local currency, but with a provision stipulating that the NZ dollar price had to be at least equal to a US dollar ‘floor’. It was thus clear from the contract that the parties had exchange rate questions in mind and the losses (in terms of the US dollar equivalent value) flowing from late payment were thus recoverable by way of damages. 116 117

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Matters took a slightly different turn in President of India v Lips Maritime Corporation.120 Under the charterparty at issue in that case, freight and demurrage were calculated in US dollars at the exchange rate in force on the date of the bill of lading. A claim for demurrage was disputed and, between the date on which payment would have been made in the ordinary course and the date on which payment was actually made following the umpire’s award, sterling had fallen by approximately 40% in terms of its US dollar countervalue. Could the umpire award the exchange loss by way of damages for late payment? The House of Lords held that he could not, on the basis that: (i) demurrage is a form of liquidated damages; (ii) English law does not allow for an action for damages flowing from the late payment of damages; and (iii) the only form of compensation available for the late payment was thus an award of interest in the usual way. This decision may well be intellectually justifiable, but it is perhaps unfortunate that damages may be awarded for late payment of freight but not for late payment of demurrage, in spite of the fact that they will both be expressed as liquidated amounts which are payable under the same contract.121 A much more recent analysis is offered by the decision of the Commercial Court in Travellers Casualty and Surety Co of Canada v Sun Life Assurance Co of Canada (UK) Ltd.122 Sun Life suffered claims made by policy holders in the UK in connection with the sale of their investment and other products. It accordingly sought an indemnity from its professional liability insurers. Given the nature of the claims, Sun Life had naturally made payments in sterling to the claimant policy holders, but clause VII of its professional indemnity policy stated that: All premiums, limits and other amounts under this policy are expressed and payable in the currency of the United States of America . . . If judgment is rendered [or] settlement is denominated in a currency other than [that of] the United States of America, payment under this policy shall be made in US dollars at the rate of exchange published in the Globe and Mail on the date the final judgment is reached.

The insurers argued that this referred to the rate as at the date on which judgment was given against the insurers themselves, and not any earlier date on which the corresponding claims were settled with the policy holders.123 The court rightly rejected that argument. The contract was one of indemnity, and it was plainly within the contemplation of the parties [1988] AC 395 (HL). Whilst the decision in Lips Maritime was discussed extensively in Sempra Metals, the issue noted in the text did not fall directly for consideration. The prospects for a review of Lips Maritime are perhaps limited by the comments of Lord Mance (at [214]), where he noted that the claim had failed ‘on the straightforward basis that demurrage is liquidated damages, and the law knows no such thing as a claim for damages for failing to pay damages’. 122 [2006] EWHC 2716 (Comm). 123 Needless to say, the exchange rate had moved significantly in favour of the insurers during the intervening period. 120 121

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that the insured would suffer an exchange loss if it was compelled to settle with its own policyholders before a corresponding payment was received from its own insurer. The court thus held that the insured was entitled to a balancing payment in sterling to cover the loss incurred during the period of non-payment. From a commercial angle, this seems to be plain common sense, but it overlooks an important point which the judge himself noted but does not seem to have followed through. The obligation of the insurer is to indemnify the insured; that is to say, the insurer must make payment on behalf of the insured, at the point of time at which the insured would himself otherwise have been obliged to make that payment. If the insurer disputes his liability so that the insured has to take proceedings in order to obtain reimbursement, then the insured may sue the insurer for breach of the policy, but that is an action in damages for breach of the contract of indemnity.124 Given that the decision in Lips Maritime would bar any award of damages for late payment of damages, the claim for exchange losses during the interim period should have been rejected. Despite its much lower status, it is submitted that the decision in the Canada Life case is to be preferred. As the judge pointed out, a refusal to award the exchange losses would have deprived the insured of the full indemnity to which it was entitled; it would also have allowed the insurer to benefit from its own breach of contract.125 Whilst there is perhaps a certain logic to the Lips Maritime decision, it is submitted that it adopts an unduly technical approach to the essence of a commercial contract and that it might accordingly benefit from reconsideration should the occasion arise. Although this would raise broader issues which go far beyond the scope of this chapter, there is no obvious reason why the obligation to pay liquidated damages on a set date should be treated differently from a simple debt obligation, especially where the payment is universally accepted to constitute liquidated damages rather than a penalty.126

D

Awards in Multiple Currencies

It should be noted that the availability of damages for the late payment of a foreign currency debt may lead to an overall award expressed in several 124 The judge made this point himself, on the authority of Chandris v Argo Insurance [1963] 2 Lloyd’s Rep 65 (Comm). There is much other case law to similar effect: see, eg Reynolds v Phoenix Assurance Co Ltd [1978] 2 Lloyd’s Rep 440 (QB) and Odyssey Re v Australian Reinsurance [2001] NSWC 266 (NSW SC). 125 It must be said that the obligor benefited from its own breach and delay in offering prompt compensation in cases such as The Texaco Melbourne, above n 89, and Lips Maritime itself. It is perhaps this unattractive feature of these cases which leaves one with a sense of unease about the justice of the outcomes in these cases. 126 This is certainly so in the case of demurrage, which is calculated on a daily basis and is thus proportionate to the breach: see McGregor, above n 6, para 13-058.

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different currencies. In line with the Miliangos principle, judgment for the debt itself will be given in the currency in which it was expressed. However, where exchange losses are recoverable, these will be assessed in the currency in which ‘the loss is felt’ in accordance with rules discussed elsewhere in this article. An illustration of this position is offered by the decision in International Minerals & Chemical Corporation v Karl O Helm AG.127 In that case, the claimant was entitled to a payment of 12,000,000 Belgian francs in 1981 pursuant to an agreement for the sale of a subsidiary. The assets were essentially US dollar assets, and it seems that payment in Belgian francs was agreed for the convenience of the purchaser. The price was not paid, and the seller was entitled to judgment: 1. for the 12,000,000 Belgian francs; and 2. since the parties contemplated conversion of the price into US dollars, the seller was also entitled to recover exchange losses representing the devaluation of the Belgian franc during the period of non-payment. Since the claimant operated in US dollars it was found to have felt the loss in that currency. Damages under this heading were thus expressed in US dollars.

E Mitigation Let it now be assumed that the claimant is able to establish that he is entitled to compensation for exchange losses flowing from the late payment of the debt. Since the claim sounds in damages, the claimant will be under a duty to mitigate his loss.128 How would the duty to mitigate apply in relation to a claim for exchange losses? The question is by no means straightforward, but the suggested answers can perhaps best be illustrated by reference to an example. Suppose that a French seller has delivered goods on credit to a buyer in the UK. The seller operates and maintains its accounts in euros, but it has nevertheless agreed to accept payment in sterling. The due date for payment arrives, but the payment does not. The seller finally receives the sterling amount some three months later, at which point the amount of euros which can be purchased is significantly less than the amount which could have been purchased on the contractual due date. In practical terms, questions of mitigation may arise at two points, namely: [1986] 1 Lloyd’s Rep 81 (Comm). This well-recognised terminology is used for convenience, although, of course, the claimant does not owe the defendant any ‘duty’ as such. A failure to mitigate may merely mean that the claimant may have suffered losses which he is unable to recover, but he is not otherwise liable for any breach of the duty: The Solholt [1983] 1 Lloyd’s Rep 605 (CA); Hyundai Merchant Marine Co Ltd v Dartbrook Coal (Sales) Pty Ltd [2006] FCA 1324 (FCA). 127 128

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1. on or shortly after the due date, when the French seller realises that payment has not been received in accordance with the terms of the contract; and 2. upon actual receipt of the sterling payment. These two situations must be considered in turn. First of all, when he discovers that payment has not been made, the French seller may realise that, in terms of the euro exchange rate, sterling is falling in value. The French creditor may elect to stem those losses by using other sterling funds to purchase euros. If he elects to do so, then he will have mitigated his loss and may claim by way of damages the additional amount of sterling required to purchase the euro amount which could have been acquired had the sterling purchase price been paid on the due date. However, these steps would require the seller to take additional exchange risks with his own funds, and it appears that the court will not require him to take unwarranted risks with his own assets in order to mitigate his loss.129 Accordingly, if the seller in fact mitigates his loss in this way, then the savings would be taken into account in calculating the award. But the seller would not be required to take these steps by way of mitigation, nor would the award of damages be reduced if he failed to do so. It seems to follow that, in the ordinary case, the creditor will not be required to take any steps in mitigation at the point of the buyer’s default. The position does, of course, change on the date of actual payment, because the French seller will have come into possession of monetary resources in sterling. If the seller immediately converts the proceeds into euros, then this will operate to mitigate his loss by avoiding the consequences of any further slide in the value of sterling. The seller will usually have acted reasonably in taking this step and cannot be held responsible if, in the events which happen, the foreign exchange markets move in the opposite direction and sterling recovers ground. The seller will thus be able to recover the differential in the euro equivalent between the due date of payment and the date of actual conversion into euros. Matters become significantly more difficult if the seller retains the funds in sterling for a period before converting them into euros. He seems to lose both ways. If sterling continues to decline, then he cannot hold the buyer responsible for the increased losses because he will have failed to mitigate his loss. On the other hand, he must give the buyer credit for any appreciation in the value of sterling, for the seller cannot recover a loss which he has not suffered.130 Jewelowski v Propp [1944] KB 510 (KB). As a general rule, any form of financial advantage accruing to the claimant in the process of mitigation must be taken into account in assessing the damages: British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways of London Ltd [1912] AC 673 (HL). This case is discussed in more depth by David McLauchlan in ‘Some 129 130

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If, however, the French seller retained the sterling funds for an extended period, then he may be able to show that any exchange profit which is ultimately realised represents the proceeds of his own speculation (as opposed to gains realised in the course of mitigating his losses). In the absence of a nexus between the exchange gain and the duty to mitigate, it would be inappropriate for the gain to be brought into account in the calculation of damages; the creditor retains both the risks and the rewards associated with his own speculation.131 Under these circumstances, it would seem appropriate for damages to be calculated by reference to the euro/sterling exchange rate as at the date on which the sterling amount is actually received.

VII

F O R E I G N E XC H A N G E C O N T R AC T S

The foregoing parts of this chapter have examined foreign currency questions in a fairly broad and general manner.132 But it seems appropriate to consider those contracts in which the question of exchange losses will most obviously arise—namely, contracts to exchange one currency for another. Contracts of this kind are very familiar to the tourist or business traveller who needs to equip himself with the currency of his destination. This exchange is normally completed over the counter and no real difficulties arise in practice. But in a commercial or financial context, matters may be more complex. Very large sums of money will frequently be involved, and settlement will often be required some time after the contract itself is made. For example, a UK buyer may have agreed to purchase equipment for a price expressed in US dollars. The equipment has to be specially manufactured to order, and the delivery and payment dates are 12 months away. The buyer does not wish to take the risk that the sterling equivalent of the purchase price will increase as a result of exchange rate fluctuations against the dollar. He therefore enters into a forward contract with his bank under which he will, in 12 months time, pay a pre-set amount of sterling in exchange for the required US dollar amount—thus insulating Issues in the Assessment of Expectation Damages’, this volume. The whole subject is also considered by Harvey McGregor in ‘The Role of Mitigation in the Assessment of Damages’, this volume. 131 See, eg Jebsen v East and West India Dock Co (1874) LR 10 CP 300 (CCP); Campbell Mostyn (Provisions) Ltd v Barnett Trading Co [1954] 1 Lloyd’s Rep 65 (CA); Hussey v Eels [1990] 2 QB 227 (CA) (profit made on resale of defective property not to be taken into account unless resale could be said to be part of a continuous transaction commencing with the original purchase of the property); Needler Financial Services Ltd v Taber [2002] 2 All ER 501 (Ch). 132 This is so even though most of the cases which have called for comment have arisen in the fields of shipping and/or international trade.

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himself from further exchange rate fluctuations during that period. He makes it clear to the bank that the funds are required to make payment under a contract with a US supplier, that the timely receipt of the equipment is critical to his business and that payment of the dollar purchase price is a condition to delivery. Suppose that the worst happens and, whilst the customer transfers the necessary sterling amount to the bank, the bank itself fails to pay over the US dollar amount on the due date. Given that the customer has made payment, the corresponding US dollar obligation of the bank would constitute a monetary debt which would be recoverable in the usual way.133 In addition, however, and in line with principles discussed earlier in this chapter, the customer could also recover: 1. the net cost of obtaining the necessary US dollar funds from another source. This cost arises naturally from the bank’s breach and would thus be recoverable under the first limb of Hadley v Baxendale;134 and 2. if, as a result of the bank’s default, the supplier cancels the contract, then the cost of organising replacement equipment and loss of profit during the relevant period may also be recoverable under the second limb of Hadley v Baxendale because the underlying commercial purpose of the foreign exchange contract was specifically disclosed to the bank. This serves to demonstrate that, in addition to its potential liability for exchange losses in the event of delayed settlement of a currency contract, the bank could also be responsible for a wider range of losses incurred by the customer if the objective of the exchange has been made known to the bank. In other words, whilst exchange rate losses may constitute a recoverable head of damage in respect of a breach of a commercial contract, it should not be overlooked that, likewise, commercial losses may be recoverable following a breach of a foreign exchange contract in appropriate circumstances. In line with the decision in The Folias and other authorities discussed earlier, the award of damages would usually be made in the currency in which the customer runs its business and prepares its financial statements.

133 It was formerly thought that a contract of this kind gave rise to an obligation to deliver the US dollars as a commodity, rather than to pay a debt. However, this distinction can no longer be maintained in the light of the Court of Appeal decision in Camdex International Ltd v Bank of Zambia (No 3) [1997] CLC 714. In truth, there was always limited support for the commodity theory. Even in a leading case such as Re United Railways of Havana and Regla Warehouses Ltd [1961] AC 1007 (HL), only Lord Simonds relied heavily on the theory (at 1043); Lord Radcliffe rejected it (at 1059) and the other members of the House relied on procedural or other issues. The commodity theory was also rejected by the Supreme Court of New South Wales in Daewoo v Suncorp-Metway [2000] NSWR 35. 134 For a comparable New York decision, see Richard v American Union Bank 253 NY 166, 170 NE 532 (1930).

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495

CONCLUSIONS

On the whole, there is no question that the development of the law on foreign currency obligations has been positive in helping to ensure that English law remains one of the systems of choice for international commercial and financial contracts—even where the transaction has no other nexus with this country. Nevertheless, there are a few areas in which matters may have developed a little unsatisfactorily. In particular: 1. it should no longer be necessary to insist that any conversion into sterling should take place on the date of the judgment. It would be perfectly feasible to state that the conversion should be effected on the date of payment (whether voluntarily or as a result of execution proceedings). This will produce the most accurate assessment of compensation so far as the creditor is concerned; 2. the ability (and the requirement) to recover losses in the currency in which the loss is felt is to be welcomed. Nevertheless, the House of Lords in The Texaco Melbourne erred in two respects: first, by adhering too rigidly to the date of breach as the assessment date; and, secondly, by failing to appreciate that a loss in one currency can be felt by reference to the value of that money in relation to another currency. A more flexible approach would therefore be desirable, but the recent House of Lords decision in The Golden Victory suggests that the formulation of a broader set of principles in this area is already judicial work-in-progress; 3. the recovery of exchange rate losses incurred as a result of late payment is permissible under either limb of the rule in Hadley v Baxendale, provided that the necessary criteria are fulfilled. It is satisfactory that, following the decision in Sempra Metals, the rules applicable to the recovery of exchange losses and the recovery of interest have been placed on the same footing; and 4. the rigid characterisation of demurrage as liquidated damages operates to deprive the owners of any right to compensation for exchange losses for late payment, under circumstances where such compensation would be entirely appropriate. As shown by the discussion of the Sun Life case, the potential difficulties are not limited to admiralty cases. The approach to the subject of liquidated damages in Lips Maritime could thus usefully be reconsidered, although it is accepted that this would involve a significant departure from principle.