Mitigation of damage where there is no available market is a difficult area of law and can be challenging. As the Court of Appeal recognised recently in its judgment in The New Flamenco, “it is notoriously difficult to lay down principles of law in the realm of mitigation of loss”. This judgment provides helpful guidance on the complicated interplay between market conditions at the time of a breach, mitigation and causation. While the facts are squarely based in the shipping world, this key decision has a much wider effect on commercial contracts.

This client alert examines the key principles highlighted in that case and considers how it affects contracts for the sale of goods.

The facts

On 13 February 2004, The New Flamenco was chartered by her claimant owners to the defendant charterers on a time charterparty.2 In August 2005, the charterparty was extended to 28 October 2007 by mutual agreement. On 8 June 2007, the parties reached an oral agreement to extend the charter for another two years, to 2 November 2009.

The charterers alleged no such extension had been agreed and indicated an intention to redeliver the vessel at the end of October 2007, refusing to sign an addendum documenting the further extension. The owners declared the charterers in anticipatory repudiatory breach and accepted this breach as terminating the charterparty on 17 August 2007.

The vessel was redelivered by the charterers on 28 October 2007. However, the owners had been unable to find an alternative employment for the vessel as from October 2007, and shortly before redelivery they entered into a memorandum of agreement for sale of the vessel for the sum of US$23.765m.

The arbitration

Arbitration was commenced by the owners against the charterers for recovery of the net loss of profits the owners alleged they would have earned between October 2007 and November 2009. The charterers contended that the change in value of the vessel had to be taken into account: the vessel’s value between the time of actual redelivery in 2007 and the time the owners alleged she should have been redelivered in 2009 had dropped by US$16.765m to just US$7m. As a result, the charterers said that credit should be given to them for the ‘benefit’ the owners gained in having the vessel redelivered early (i.e. the avoided loss of value of the vessel).

The sole maritime arbitrator found that the sale of the vessel was reasonable mitigation of damage and held that the benefit accrued to the owners by such sale should be brought into account. On appeal to the High Court, Popplewell J reversed the arbitrator’s decision. The Court of Appeal then overturned Popplewell J’s decision and restored the arbitrator’s decision: i.e. the sale of the vessel had to be taken into account.

Guiding principles

There is no single case which sets out guiding principles relating to mitigation. In practice, where there is a renunciation of a contract and there is an available market, the relevant market price for the purposes of assessing damages will generally be determined by the principle of mitigation: the innocent party is normally required to mitigate its loss by going into the market for a substitute contract as soon as is reasonable after the original contract was terminated (usually subject to any express default/termination clause in the contract). The position is less straightforward when there is no available market. Helpfully, Popplewell J at first instance summarised the guiding principles in such cases.

In summary, in order for a benefit to be taken into account and reduce the damages payable by a breaching party, the benefit must be caused by the breach. There must be a clear, direct, causal link between the breach and the benefit obtained. All of the relevant circumstances must be taken into account, including the “nature and effects of the breach and the nature of the benefit and loss, the manner in which they occurred and any pre-existing, intervening or collateral factors which played a part in their occurrence”. Other important factors with a role to play are “considerations of justice, fairness and public policy”.

Application of these principles by the Court of Appeal

The Court of Appeal found that the principles laid down by Popplewell J at first instance were sound. However, it was the application of such principles which was wrong and led the Court of Appeal to overturn the decision. This was based on a number of considerations.

First, the Court of Appeal discussed that the compensatory principle was key. In this respect, the Court of Appeal made specific reference to the Supreme Court judgment in Bunge SA v Nidera BV, which had also emphasised the importance of the compensatory principle. It is clear that “he who has proved a breach of a bargain to supply what he contracted to get is to be placed, as far as money can do it, in as good a situation as if the contract had been performed”. Compensation for financial loss naturally arising from the breach is the fundamental purpose of awarding damages.

Second, where a breach has occurred, a claimant is required to take all reasonable steps to mitigate the loss consequent on the breach. Any loss which could have been avoided but failed to be, due to a lack of action, cannot be recovered.

Third is the natural corollary of the obligation to mitigate, which is that where action has been taken which diminishes the loss, such diminution is to be taken into account when awarding compensation. This is so even where such action did not have to be taken as a ‘reasonable step’ in mitigation, but was taken in any event.

Application of the principles of mitigation

(i) Available market The principles of mitigation are relatively straightforward to apply where there is an available market. In sale of goods cases, the statutory obligation contained in the Sale of Goods Act 1979 is that, where there is an available market, damages are prima facie assessed by comparing the contract price of the goods with the market price at the time of default. If the innocent party opts to go into the market and buys or sells against the breaching party, it has mitigated its loss by taking this reasonable step. If the innocent party opts not to go into the market, its damages are still limited to the difference between the contract and the market price of the goods. The duty to mitigate is therefore built into this statutory formula and, where there is an available market, the actual decisions and actions of the innocent party should not – save for in exceptional circumstances – affect this calculation. Interestingly, the UK Supreme Court recently considered the principle of mitigation in the context of the GAFTA default clause in its judgment in the Bunge SA v Nidera BV case, where the court rejected the argument that the GAFTA default clause precludes the operation of the principle of mitigation of loss. As the Supreme Court held in that case, although the GAFTA default clause deals with the innocent party’s duty to mitigate by going into the market to buy or sell against the defaulter, it does not deal with any other aspect of mitigation3.

(ii) No available market More complex are cases where there is no available market at the time of the breach. In this situation, the innocent party is required to consider much more carefully what “reasonable steps” in mitigation would be. In The New Flamenco, there was no available market for the re-charter of the vessel. The owners therefore opted to sell the vessel, a decision which was accepted as a reasonable step in mitigation.

The Court of Appeal stated that, where there is no available market, an innocent party will need to consider what steps it may take to mitigate its loss. If steps are taken, “he may make additional losses or additional profits but, in either event, they should be taken into account,” as “he is just bringing into account the consequences of his decision to mitigate his loss and those consequences will ‘arise, generally speaking’, from the consequences of the breach of contract”.

The Court of Appeal also stated that “one just has to decide whether the sale of the vessel arose ‘out of the consequences of the breach and in the ordinary course of business’.” It does not matter that the benefit obtained was of a different type to the loss – “there is no requirement that a benefit which is to be brought into account must be of the same kind as the loss being claimed or mitigated”.

In this particular case, the Court of Appeal held that the arbitrator had “made his own ‘common sense overall judgment’” and had not, therefore, made an error of law in doing so. The arbitrator had been persuaded that the benefit arose from the consequences of the breach and so should be taken into account. Furthermore, considerations of fairness and justice were important, as these “persuaded the arbitrator that, when he looked at the case as a whole, the owners had made a considerable profit from the action they took by way of mitigating what would otherwise have been an undoubted loss”.

What next for mitigation?

This case serves to bring to the fore the importance of mitigation. When faced with a breach of contract, the innocent party’s focus is often solely on determining whether a breach has indeed been committed and how to extricate itself from the contract. However, it is clear that the actions of the innocent party immediately after the breach can and will have significant effects on the damages it is then able to recover from the breaching party.

In a sale of goods contract where there is an available market, there is generally no need to consider beyond whether the innocent party wishes to buy or sell against the breaching party at that point. The prima facie measure of damages means that speculation on the market is done entirely at the risk of the innocent party.

However, where there is no available market, the innocent party must consider and document much more carefully what appropriate mitigating steps may be available to it to take and what impact these may have on the overall claim. Options might include cleaning, blending to upgrade, storage, sale to a different geographic market or type of market (e.g. food to fuel). In such case, if the innocent party obtains a benefit by taking a specific step in mitigation, such as the owners of The New Flamenco, that benefit will most likely have to be brought into account in assessing any loss claimed against the defaulting party.