The Supreme Court recently overturned the Court of Appeal in a judgment which considered the proper measure of damages in a situation where the party suffering loss had avoided a greater loss as a result of the breach by the other party. The case involved the early termination of a charterparty by the charterers (Globalia). The point arose because the owners (Fulton) sold the ship following the early termination and as a result avoided a hypothetical capital loss which it would have suffered had it retained ownership until the end of the charterparty.
Fulton claimed damages following acceptance of the repudiatory breach and Globalia argued that Fulton should give credit for the avoidance of a fall in the capital value of the ship against the loss of income that it suffered as a result of wrongful early termination.(1)
The dispute was referred to arbitration in London and the arbitrator held that the sale of the ship was a reasonable act of mitigation by Fulton. The arbitrator went on to find that the value of the ship in November 2009 (when the ship had been due to be returned) would have been $7 million (a reduction due in large part to the effects of the intervening financial crisis), as opposed to the actual sale value achieved in the region of $21 million in October 2007 following Globalia's breach. In light of that finding, the arbitrator found that Fulton was obliged to give credit by way of mitigation of its losses of nearly $17 million on the basis that it had 'saved' that amount by selling the ship in October 2007, rather than when the ship had been due to be returned in November 2009.
At first-instance the High Court found that the arbitrator had made an error in law; the sale of the ship was not a step taken to mitigate the loss, but was rather an independent business decision. Fulton was not obliged to give credit for any benefit in realising the capital value of the ship following early termination in October 2007, by reference to its capital value when the ship had been due to be returned, "because it was not a benefit which was legally caused by the breach". The repudiation merely provided an opportunity for that independent business decision to sell the ship to be taken, rather than directly caused the decision to be taken.
The Court of Appeal reversed the first-instance decision, instead finding that Fulton was obliged to give credit for the hypothetical loss that it had avoided by selling in 2007. In a key section of the leading judgment, it was held that "The search for legal principle in this area is undoubtedly elusive", but that the longstanding fundamental principle is:
"that a claimant who sustains loss is, so far as money can do it, to be placed in the same situation as if the contract had been performed. It was, in the end, considerations of fairness and justice that 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. That profit arose from the consequences of the breach and should therefore be brought into account."
The Supreme Court preferred the reasoning of the High Court and provided a summary of relevant legal principles identified in the first-instance decision:
- In order for a benefit to be taken into account in reducing the loss recoverable by the innocent party for a breach of contract, it is generally speaking a necessary condition that the benefit is caused by the breach (Bradburn, British Westinghouse, The Elena D'Amico).
- The causation test involves taking into account all of the circumstances, 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 (The Fanis).
- The test is whether the breach has caused the benefit; it is not sufficient if the breach has merely provided the occasion or context for the innocent party to obtain the benefit or merely triggered its doing so (The Elena D'Amico). Nor is it sufficient merely that the benefit would not have been obtained but for the breach (Bradburn, Lavarack v Woods, Needler v Taber).
- In this respect, it should make no difference whether the question is approached as one of mitigation of loss or measure of damage; although they are logically distinct approaches, the factual and legal inquiry and conclusion should be the same (Hussey v Eels).
- The fact that a mitigating step, by way of action or inaction, may be a reasonable and sensible business decision with a view to reducing the impact of the breach does not of itself render it one which is sufficiently caused by the breach. A step taken by the innocent party which is a reasonable response to the breach and designed to reduce losses caused thereby may be triggered by a breach but not legally caused by the breach (The Elena D'Amico).
- While a mitigation analysis requires a sufficient causal connection between the breach and the mitigating step, it is not sufficient merely to show in two stages that there is a causative nexus between breach and mitigating step, and a causative nexus between mitigating step and benefit. The inquiry is also for a direct causative connection between breach and benefit (Palatine), in cases approached by a mitigation analysis no less than in cases adopting a measure of loss approach (Hussey v Eels, The Fanis). Accordingly, benefits flowing from a step taken in reasonable mitigation of loss are to be taken into account only if and to the extent that they are caused by the breach.
- Where, and to the extent that, the benefit arises from a transaction of a kind which the innocent party would have been able to undertake for its own account irrespective of the breach, that is suggestive that the breach is not sufficiently causative of the benefit (Lavarack v Woods, The Elena D'Amico).
- There is no requirement that the benefit be of the same kind as the loss being claimed or mitigated (Bellingham v Dhillon, Nadreph v Willmett, Hussey v Eels, The Elbrus, cf The Yasin); but such a difference in kind may be indicative that the benefit is not legally caused by the breach (Palatine).
- Subject to these principles, whether a benefit is caused by a breach is a question of fact and degree which must be answered by considering all of the relevant circumstances in order to form a common-sense overall judgment on the sufficiency of the causal nexus between breach and benefit (Hussey v Eels, Needler v Taber, The Fanis).
- Although causation between breach and benefit is generally a necessary requirement, it is not always sufficient. Considerations of justice, fairness and public policy have a role to play and may preclude a defendant from reducing its liability by reference to some types of benefit or in some circumstances even where the causation test is satisfied (Palatine, Parry v Cleaver).
- In particular, benefits do not fall to be taken into account, even where caused by the breach, where it would be contrary to fairness and justice for the defendant wrongdoer to be allowed to appropriate them for its benefit because they are the fruits of something the innocent party has done or acquired for its own benefit (Shearman v Folland, Parry v Cleaver and Smoker).
On the facts of this case (notably, the English courts were limited to considering whether the arbitrator had erred in law; the courts had no authority to review or set aside findings of fact), the Supreme Court found that the fall in value of the ship was irrelevant because Fulton's interest in the capital value of the ship had nothing to do with the interest that had been injured by Globalia's repudiation. This was not because the benefit must be of the same kind as the loss caused by the wrongdoer. The essential question is whether there is a sufficiently close link between the two, not whether they are similar in nature.
The benefit to be brought into account must have been caused by either the breach or a successful act of mitigation. While Globalia's repudiation resulted in a prospective loss of income for a period of around two years, there was nothing about the premature termination of the charterparty which made it necessary to sell the ship, either at all or at any particular time.
The Supreme Court noted, as the High Court had done, that the ship could have been sold during the term of the charterparty. If Fulton had decided to sell the ship – whether before or after termination of the charterparty – it was making a commercial decision at its own risk about the disposal of an interest in the ship which was no part of the subject matter of the charterparty and had nothing to do with Globalia. In the absence of a relevant causal link, Fulton could not be required to bring into account the benefit gained by avoiding the fall in value.
For the same reasons, the Supreme Court considered that the sale of the ship was not, on the face of it, an act of successful mitigation. If there had been an available charter market, the loss would have been the difference between the actual charterparty rate and the assumed substitute contract rate. The sale of the ship would have been irrelevant. In the absence of an available market, the measure of loss would be the difference between the contract rate and what was or ought reasonably to have been earned from employment of the ship under shorter charterparties. The relevant mitigation in that context would be the acquisition of an income stream alternative to the income stream under the original charterparty. The sale of the ship was not itself an act of mitigation because it was incapable of mitigating the loss of the income stream. It would simply be the exercise of Fulton's proprietary right as owner, which it enjoyed independent of the charterparty and independent of its termination.
The Supreme Court therefore restored the judgment of the High Court and found that Fulton was not obliged to give credit for the losses that it had 'saved' by selling the ship after Globalia's early wrongful termination.
This decision highlights the issues that parties can encounter following repudiatory breach and disputes that arise regarding alleged acts of mitigation. However, the facts were unusual and the court was limited to considering whether the arbitrator had erred in law; its remit did not extend to reviewing or setting aside the arbitrator's findings of fact.
The Court of Appeal acknowledged that:
"It is notoriously difficult to lay down principles of law in the realm of mitigation of loss particularly when it is said that a benefit received by a claimant is to be brought into account as avoiding the loss… hard and fast principles are difficult to enunciate."
While the Supreme Court's decision does not contain much by way of statements of general principle regarding loss, it does set out the principles to be considered on causation and provides an endorsement of the legal reasoning and principles identified in the first-instance decision in a difficult area.
For further information on this topic please contact Laura Martin or Tim Brown at RPC by telephone (+44 20 3060 6000) or email (firstname.lastname@example.org or email@example.com). The RPC website can be accessed at www.rpc.co.uk.
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