Before you take the plunge. Life after breach - Part 3. Great expectations?
What happens if one party to a contract fails to perform? Can the innocent party get all of its losses back? What happens if the losses are difficult to prove?
Here, we look at what you can claim and how to protect your position.
The general rule
Damages for breach of contract are usually intended to compensate the injured party for its losses arising naturally from the breach or which were within the parties' contemplation when the contract was made.
The general rule is to put the claimant in the position it would have been in had the contract been performed - 'expectation losses'. If A sells goods to B for resale and fails to deliver those goods, B is entitled to recover compensation for its loss of profit net of any expenses which B would have incurred. These losses work well if B had made a good bargain, but what if the nature of the contract is such that it is difficult to prove what B would have received had A performed its part of that bargain?
Alternative one: reliance
B may be able to claim damages to put it in the position that it would have been in as if the contract had never been entered into - 'reliance losses'. B is compensated for expenses incurred and losses suffered (wasted) in reliance on the contract.
Reliance losses are more appropriate where it is difficult to demonstrate what B would have received had the contract been performed. However, the courts won't allow claims for such losses if the only reason is to escape the consequences of a bad bargain and expectation losses are unlikely to lead to substantial recovery.
Alternative two: restitution
Exceptionally, it may be possible to recover restitutionary damages, which are intended to strip a defendant of any profit made as a result of its breach. For some time, the courts have been willing, in certain circumstances, to award damages based on a defendant's gain, for example, for breach of a proprietary interest or of a confidentiality obligation or in lieu of specific performance or an injunction.
These damages, also known as Wrotham Park damages, are often viewed as the notional sum the defendant would have paid the claimant to relinquish its rights following a hypothetical negotiation.
The case of Giedo van der Garde v Force India Formula One Team Ltd (2010) extended the ambit of this remedy. The claimant, an aspiring racing driver, entered into a contract to test drive a Formula One racing car for a minimum of 6,000 km, but was only allowed to drive 2,004 km. The court recognised the claimant's difficulty in proving his future loss of earnings. Having first said it was unable to award restitutionary damages, the court went on to achieve the same result by awarding damages representing the value of the contractual performance wrongfully withheld by the defendant - i.e. the amount it assessed as the 'cost' to the defendant of buying out the entitlement to a further 3,996 km of driving.
Alternative three - liquidated damages
Often, parties include a liquidated damages provision to make it easier to recover damages and avoid the need to prove actual loss. How do you avoid a court finding such a provision to be a penalty clause and unenforceable?
Generally, when dealing with commercial agreements negotiated by two legally represented parties of equal bargaining power, the courts exercise caution before striking out a clause which sets out a damages formula or figure. If the clause provides a reasonable estimate of the probable loss, it will generally be held to be valid. However, Azimut-Benetti Spa (Benetti Division) v Healey (2010) reinforced a recent trend toward courts adopting a more flexible and commercial approach. Rather than focus on whether the clause was a genuine pre-estimate of loss, the court considered whether there was commercial justification for the clause and found that there was. The courts are moving to look at the reasonableness of the concept of a pre-estimate of loss, away from the reasonableness of the amount of the pre-estimate.
If, however, the clause is purely intended to deter a party from breach, by imposing an inflated remedy, it will be a penalty and unenforceable.
Watch out! Termination for repudiatory breach
If your claim is for repudiatory breach, take legal advice before you make a decision on your response as this will have significant implications. Do not overly delay in either accepting the breach and terminating the contract or seeking performance of the contract. In either case, you are entitled to claim damages. Beware, however, as the damages available upon termination may depend upon how the termination notice is worded. Additionally, failure to act may result in either affirmation of the contract, or an inference of lack of intention to perform the contract which could bar any recovery.
Practical hints and tips
Consider what your damages are likely to be and how you would prove your loss in the event of a breach of contract. Retain documents that may help prove a loss in the event of a claim.
- Where it may be difficult to prove your loss, consider including a liquidated damages provision in the contract, specifying what types of loss will be recoverable and on what formula.
- Where a liquidated damages provision is included, limit this to certain types of breach (so that it is a focused clause, rather than applying to all and any breach). Ensure there is commercial justification for the clause and retain documents evidencing how liquidated damages, and their amount (or the formula), were calculated and negotiated.
- If you wish to rely on a liquidated damages provision, ensure you have complied with its terms, including any notice provisions or time periods.
- If a liquidated damages clause is not included, don't assume your claim will be restricted to loss of profits (expectation losses). Would it be better to claim reliance losses or restitution losses? To avoid double recovery, you must elect which basis to claim on, as you cannot recover on all!
This alert was written by Samantha Holland, director in Wragge & Co's Commercial Litigation team, firstname.lastname@example.org and Richard Smith, associate in Wragge & Co's Commercial, IT and Outsourcing team, email@example.com.
Wragge & Co's 60-lawyer Commercial Litigation team is part of one of the largest dispute resolution practices in the UK. The team completes a mix of domestic and international work for major private and public sector companies.
The team works closely with Wragge & Co's 35-lawyer Commercial, IT and Outsourcing team, where commercialism and creative thinking is central to the team's approach, and which achieved recognition at the 2010 British Legal Awards when it was crowned Commercial Team of the Year.
This alert is available in hard copy. To request a copy of this individual alert or to request a full bound copy of the entire series, please contact Jane Bates, firstname.lastname@example.org.
This analysis may contain information of general interest about current legal issues, but does not give legal advice.