Justin Lucas looks at what best to do where parties reach an impasse on agreed damages clauses and finds that, according to the High Court, the answer may lie in a “congeries1 of provisions”.
In the negotiation of complex agreements, clauses providing for agreed damages on termination can become a sticking point. This is particularly the case where a formulation for the calculation of a loss of bargain is sought to be agreed. The response of negotiators wanting to conclude a deal can be to say “forget it, delete the agreed damages clause and, if it comes to termination, we will just sue them for all the loss and damage”. But does this approach work?
On termination, an innocent party will often want loss of bargain damages (i.e. the benefit of the contract being performed) rather than merely damages for the particular breach that gives rise to the exercise of the right to terminate.
The first point to recognise is that, on exercise of a contractual right of termination, absent expressed contractual rights or rights at law, the innocent party will not receive loss of bargain damages2.
The rationale is that the loss of bargain, in that situation, stems from the act of termination rather than the breach. The election of the innocent party to terminate puts it beyond their power to insist on performance of the contract. The best that the innocent party can expect to recover is loss or damage caused by the breach.
The right to terminate and the right to recover loss of bargain damages do not automatically go together. So, a right of termination alone is not an adequate solution.
Repudiation and fundamental breach
Where a contract is terminated for repudiation or fundamental breach, there is a presumption that loss of bargain damages can be recovered. Fundamental breach has been defined as the breach of an essential term, a term which is so serious it goes to the heart of the contract, or a sufficiently serious breach of a non-essential term.3
So, all is not lost where an agreed damages provision is not included. In the right circumstances, loss of bargain damages can still be recovered in the absence of express provision. But, those circumstances are likely to be more limited and the exercise of rights will carry greater risk.
Agreeing essential terms
Significant improvements can be achieved by conferring the characteristic of an essential terms on particular obligations. Where the breach that gives rise to termination includes breach of such an essential term, there is a presumption that the innocent party can then recover loss of bargain damages.
Provisions specifying terms of the contract that are essential are, in the writers experience, often less controversial to resolve than agreeing the formulation for the damages that will be payable on termination. But, thought and care are required in drawing such provisions. It is not enough to specify that all provisions of the contract are essential.
It is also not enough to simply agree a list of provisions that constitute essential terms. Whether a term is an essential term is a matter of the true construction of the agreement (a matter of substance rather than purely form).
In Gumland4, the High Court found that an obligation to pay rent punctually was an essential term of a lease. In a joint judgment, Gleeson CJ, Kirby, Heydon, Crennan and Kiefel JJ held that “it is possible by express provision in the contract to make a term a condition, even if it would not be so in the absence of such a provision – not only in order to support a power to terminate the contract…but also to support a power to recover loss of bargain damages.”
But this possibility is not easily realised. In Gumland, the lease was said to reveal a “preoccupation” with the obligation to punctually pay rent which pointed overwhelmingly to the conclusion that, on the true construction of the Lease, the covenant was an essential term. There, the essentiality was found not to depend on a single provision. It was reinforced by several provisions; a “congeries of provisions” that revealed the obligation to pay rent as having the characteristic of essentiality.
That level of significance will be difficult to attribute to a broad range of obligations, particularly obligations that would otherwise be regarded as non-essential or trivial. But this might be achieved by a rag-bag of provisions, addressing the point from different directions with each pointing to the essentiality of the selected provisions.
The Court in Gumland held that it was unnecessary to decide whether or not the mere description of a covenant in a lease as essential can make it essential.
So, while a broad range of breaches might give rise to a right of termination, only more limited breaches will sound in loss of bargain either by making out a claim for repudiation or a claim based on breach of an essential term.
What best can be done?
Where the best way forward in negotiations is to abandon attempts to settle on an approach to agreed damages, it should not simply be assumed that the innocent party can, following the exercise a contractual right to terminate, recover loss of bargain in all circumstances.
Instead, extra effort should be focussed on the nomination of essential terms. It is not enough to agree a list of terms. Some greater preoccupation, by a congeries of provision, should be included to demonstrate that terms that are said to be essential are conferred the characteristic of essentiality.