This case discusses the extent to which a contracting party can claim, as damages for breach of contract, expenditure incurred in preparation of a contract that has been wasted as a result of breach of that contract by the other party. The facts of this claim arose from a breach of a Charterparty by the Charterers.
The Owners of the vessel MAMOLA CHALLENGER (the 'Vessel') entered into a 5 year Charterparty with the defendant Charterers who were to sub-charter the Vessel to Shell Nigeria Exploration & Production Company Limited ("SNEPCO"). Under the terms of the Charterparty the Owners had to make modifications to the Vessel prior to delivery which included the installation of a new crane. As a result Owners incurred various expenses in preparation for these modifications including the cost of removing a crane from another Vessel which they intended to install on the MAMOLA CHALLENGER.
It became apparent that the Charterers would not be able to perform this fixture because SNEPCO would not be sub-chartering the Vessel from the Charterers. The Owners accepted this breach as bringing the Charter to an end, the result was that the expenditure incurred by the Owners had been wasted and had no residual benefit to the Owners.
Following the repudiation of the Charterparty the Owners concluded a number of short-term fixtures for the Vessel. However, since the date on which the Charterparty was concluded the market rate of hire had increased and as a result the Owners were able to trade the Vessel at the higher market rate. If the Charterparty had not been breached Owners would have been restricted to the lower contractual rate, which was $7,500 per day lower than the higher market rate post breach. The consequence of this was that the Owners did not suffer any net loss as a result of losing the Charterparty, in fact they had more than recuperated their loss and the initial wasted expenditure. The Owners nevertheless claimed $675,000 damages for the expenses they had incurred and arbitration proceedings were commenced.
The arbitral tribunal held as fact that the Owners had more than recuperated the losses they were claiming but they still awarded the Owners damages in the sum of $86,534. In finding that the Owners were entitled to damages for the wasted expenditure the tribunal followed the authority of C&P Haulage v Middleton [1983] 1 WLR 1461] and held that "[The expenses] were simply wasted as a result of the termination of the contract by the other party. The fact that the Vessel might have been occupied in more gainful employment as a result of the termination of the Charterparty by the Charterers is not a matter to be brought into account."
On appeal the Charterers submitted that the tribunal's decision was wrong in law on the basis that the Owners had not suffered any loss by reason of the Charterers' breach. The Charterers argued that because the market rate of hire was higher than in the Charterparty, the Owners had "more than recuperated the losses they [claimed in the] arbitration". In these circumstances it was argued that the tribunal had breached the principle that an award of damages for breach of contract are compensatory and are designed to put the innocent party in the position he would have been had the contract been performed rather than the position he would have been had no contract been made.
Arguing that the tribunal's decision was correct the Owners submitted that where the law protects a party's "reliance" interest, as where expenditure is claimed, the benefit flowing from the substitute employment cannot be taken into account to reduce or extinguish a claim for wasted expenditure.
These arguments discussed the theory that damages for breach of contract can be recovered on two bases; (1) on the 'expectancy basis' and (2) on the 'reliance basis'. The expectancy basis is where a party is entitled to recover the benefit that he would have gained had the contract been carried out and the reliance basis allowing a party to recover damages in the sum of the expenses incurred by him in reliance on the contract being performed (effectively putting him back into the position that he would have been had he not entered into the contract). It was argued in the present case that the Owners had abandoned their claim for damages on the expectancy basis and were claiming the wasted expenses incurred on reliance of the contract being performed.
Mr Justice Teare hearing the appeal began his discussion with the principle set out in Robinson v Harman (1848) 1 Exch.850 that states:
"The rule of the common law is, that 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."
It should be noted that in this case the claimant claimed both expenses incurred in reliance on the contract and damages for loss of bargain. The court then went on to consider cases in relation to both damages on the expectancy and reliance bases.
The court used the case of British Westinghouse v Undergrounds Railways [1912] AC 673 as authority that when assessing damages on the expectancy basis any benefit that the innocent party enjoys as a result of the breach of contract must be taken into account when assessing damages.
The court considered a number of authorities in relation to reliance based damages, but in particular L. Albert & Son v Armstrong Rubber Co. (1948) 178 Fed. Rep. 182, a decision in the United States Court of Appeals, Second Circuit, presiding over the Federal Court was Chief Judge Learned Hand. In this case it was agreed that a "promissee could recover his outlay in necessary preparation for the performance of a contract, subject to several limitations, of which one was that the promisor may deduct whatever he can prove the promisee would have lost if the contract had been fully performed", in this decision he also noted the "very simple formula" suggested by Professor Fuller in an article written in the 1936 Yale Law Journal that:
"We will not in a suit for reimbursement for losses incurred in reliance on a contract knowingly put the plaintiff in a better position than he would have occupied had the contract been fully performed."
This approach was also followed by a Canadian Court in Bowlay Logging Limited v Domtar Limited [1978] 4 WWR 105 where the Judge concluded that:
"The law of contract compensates a plaintiff for damages resulting from the defendant's breach; it does not compensate the plaintiff resulting from his making a bad bargain. Where it can be seen that the plaintiff would have incurred a loss on the contract as a whole, the expenses that he has incurred are losses flowing from entering into contract, not losses flowing from the Defendant's breach"
All of the principles above were followed by the English Court of Appeal in the case of C&P Haulage v Middleton. In the present case the Judge reasoned that during the course of commercial dealings, parties enter into a contract with a view to recouping their expenditure initially and going on to then securing profit. For this reason damages for breach of contract, are often called 'loss of profits'. However, when assessing the total level of profits expected from a contract any expenditure must be subtracted from that figure, not to do so would put the Claimant in a better position than he would have been if the contract had been completed.
Mr Justice Teare concluded that both bases of damages are founded on the fundamental principle set out in Robinson v Harman and that expectation loss is the only basis on which damages should be awarded. Initial expenditure is always incurred in the expectation that the contract will be performed and as such the court must have regard to the claimant's actual position and what it would have been had the contract been performed. He affirmed the principle in C&P Haulage that the claimant should not be placed in a better position than if the contract had been performed. Also to award expenditure incurred without regard to what the position would have been had the contract been performed the defendant would in effect underwrite the claimant's decision to enter into the contract.
Finally the Judge concluded that any action in mitigation by the innocent party must be set against the loss which would otherwise have been sustained.
Comment
In this case the Judge decided that the arbitral tribunal were wrong in law to find that a claim for 'wasted expenditure' and 'loss of profits' were two different types of loss that should not be 'mixed'. On appeal the Judge held that when assessing the loss of profits the initial expenditure must be taken into account and set against the sum earned from performance of the contract. If the claimant was unlikely to have made back his initial expenditure had the contract been performed then the court is of the opinion that it is unreasonable to make the defendant pay damages for the claimant entering into a bad bargain. The effect would be to place the claimant in a better position than if the contract had been performed.
It was argued in the case that not every contract will be made to return a profit, e.g. in the case where purchases are made for a charitable purpose or for pleasure. In these cases the Owners argued that dismissing the reliance basis approach will deny recovery for wasted expenditure in these cases. The Judge disagreed on the basis that in this scenario the defendant would not be able to show that the expenditure outweighed the benefits. As a result the expenditure would be recoverable as damages, this highlights where the burden of proof lies in such a claim.
It appears that three principles can be derived from this case when assessing damages from a breach of contract:
- Damages are always assessed on the expectation basis and the court will take into account the claimant's position had the contract been performed;
- The claimant should not be placed in a better position than he would have been had the contract been performed; and
- Where the claimant has taken steps to mitigate his loss this must be set against the loss which would otherwise have been sustained.
It is clear that in this case the claimant took action to mitigate his loss and as a result suffered no overall net loss, a factor that the tribunal should have taken into account when awarding damages. Mr Justice Teare overturned the tribunal's award.
For further information please contact Ian Woods:
i.woods@bjm-co.com.
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