Will damages be awarded where a breach of contract resulted in an inability to earn profits under a separate agreement?

The key takeaway

Where contractual obligations under one contract impact on related contracts (eg maintenance contracts), clear provisions setting out the full extent of each party’s liability in the event of termination of the contract and what losses are recoverable should be included.

The background

The Government of the British Virgin Islands (the Government) entered into two contracts with Global Water Associates Ltd (GWA). The first was a Design Build Agreement (DBA) related to the designing and building of a water treatment plant at Paraquita Bay, Tortola. The second contract, a Management, Operation and Maintenance Agreement (MOMA) for the water treatment plant for a period of 12 years.

The Government breached the DBA by failing to deliver a properly prepared project site on which the plant could be built. As a result of the breach, GWA gave the Government contractual notice to remedy its default. The Government failed to respond and GWA then terminated the DBA and claimed damages as GWA was unable to install the plant or subsequently, enter into the MOMA as there was no plant to manage, operate and maintain.

GWA initially referred the DBA damages claim to arbitration, claiming that there had also been a breach of an implied term of the MOMA, to the effect that the Government would perform its obligation to provide a prepared site as required under the DBA.

The arbitrator rejected GWA’s claim, finding that although there had been a breach (i) the profits which would have been earned under the MOMA were too remote to recover, and (ii) the MOMA did not contain an implied term that the Government would deliver a prepared site. GWA took the case to the High Court and won on both points. The Government appealed.

The Court of Appeal reversed the High Court’s decision and found in favour of the Government. That decision was then appealed to the Privy Council.

The decision

The Privy Council rejected the Court of Appeal’s decision as GWA’s lost profits under the MOMA were within the reasonable contemplation of the parties at the time both contracts were entered into.

The Privy Council summarised the position concerning remoteness of damage as follows:

  • Damages are intended to put the non-breaching party in the same position had its rights not been breached. However, a non-breaching party is only entitled to recover loss that was, at the time the parties entered into the contract, reasonably contemplated as a serious possibility in the event of a breach.
  • Both contracts were entered into on the same day and incorporated the same DBA documents. Further, the parties had each intended that their performance of the DBA would lead seamlessly into the commencement of the MOMA.
  • The fact that there were two separate contracts could not of itself support the view that the DBA contained an implicit contractual limitation of liability for breach. As the two contracts were so closely related, the loss of profit arising from an inability to enter the MOMA must have been reasonably contemplated as a “serious possibility” should the DBA fail.

Why is this important?

Many commercial arrangements which encompass distinct and separate phases (eg IT projects, affiliate programmes, construction/developments etc) often result in separate contracts between the same parties. This decision demonstrates that separate contracts are not enough in themselves to limit liability.

Any practical tips?

The relationship between contracts and the potential consequences if one or more is breached/not performed must be carefully considered. Cross-default termination provisions which automatically trigger default termination of related contracts may be appropriate, as well as including clearly defined heads of loss, compensation provisions, and exclusions of liability.