In a claim for loss of profits, when there has been a breach of contract that has been pleaded as a claim for expectation damages, there are no clearly defined principles as to what expenses should be deducted. Each expense is to be determined individually, irrespective of whether it is a direct cost or overhead.

In our September 2010 edition of Project Insights, we reported that in a claim for expectation damages, fixed overhead costs should be taken into account in determining net profit (North Sydney Leagues' Club Ltd v Synergy Protection Agency Pty Ltd [2010] NSWSC 256).

In the more recent decision of North Sydney Leagues' Club Ltd v Synergy Protection Agency Pty Ltd (formerly Joseph Merhi Industries Pty Ltd) t/as Sydney Protection Agency [2011] NSWSC 286, the Court was asked to assess the damages payable to Synergy in respect of North's breach of contract.

The Court did so under a well recognised principle that expectation damages ensures 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 (see Robinson v Harman (1848) 1 Exch 850 at 855).

In this case, the parties agreed that Synergy was entitled to an award for expectation damages but were in dispute as to how the principle should be applied, in particular, whether the Court should deduct from Synergy's entitlement to damages a proportionate share of indirect or overhead costs.

It was held that there is no established and clearly defined principle in determining what expenses should and should not be deducted from the expected revenue stream. The Court distinguished building cases where contractors claimed damages for a proportion of overheads, where they show they have suffered loss by being unable to deploy overheads elsewhere on other building contract work to produce income. There was no evidence to show this applied to this case.

The Court considered the best way to place Synergy in the position if the contract had not been breached was to deduct from forecast revenue which expenses would have increased when the contract was being performed and would have diminished when it ended. It ultimately supported Synergy's approach in assessing its expectation damages, that being to consider each expense individually, irrespective of whether it is a direct cost or overhead, and determined what cost was saved as a result of the loss of the contract. The approach which apportioned fixed and variable overheads on a pro-rata basis was rejected and the Court stated that "fixed costs should not be factored in at all while variable costs, whatever their nature, should be included only to the extent they are saved by the breach of contract".

The preferred approach in assessing damages came down to applying a basic principle of ascertaining how the breach of contract caused loss to the particular party. In doing so, one should not be distracted in classifications such as direct and indirect costs or net and gross profit.

Thanks to Saloni Kantaria for her help in writing this article