In a recent case arising out of a vendor’s breach of warranty on a sale of a business, the High Court has reinstated an award of damages for breach of contractual warranties in the amount of approximately $1.2 million, in the circumstances where the purchase price for the business was less than $400,000.

In Clark v Macourt [2013] HCA 56, a five judge bench of the High Court was called upon to consider the competing approaches to the assessment of damages for breach of contract by the primary judge and the New South Wales Court of Appeal.

In a majority decision (with Gageler J in dissent), the primary judge’s findings were upheld.

Facts

Clark had contracted to buy the assets of a fertility company controlled by Macourt for a price less than $400,000.  The sale included a stock of frozen donated sperm, which the vendor warranted was compliant with relevant regulations.

Macourt guaranteed the vendor’s obligations, including the warranties, under the contract.

Upon delivery it became apparent that the stock was not compliant as warranted and was unusable.

Clark was subsequently required to buy replacement stock from the United States at a cost of approximately $1 million. Judgment was entered against the vendor for the breach of warranty, and against Macourt as guarantor, with damages to be assessed. The finding of liability was not the subject of appeal.

The primary judge awarded damages for breach of contract in the amount of $1,246,025.01, being the amount that it cost Clark to buy the replacement stock, such award being set aside by the Court of Appeal.

The key issues for determination by the High Court were:

  1. the value of the loss, if any, suffered by Clark; and
  2. whether the loss had been mitigated.

Valuing the loss

The primary judge valued the loss by calculating what it would have cost the appellant to purchase warranty compliant stock as at the date of the breach of contract.

On the basis that the contract was for the sale of a business and not the sale of goods, the Court of Appeal did not consider it appropriate to apply the measure of damages found by the primary judge.

The Court of Appeal held that it was extremely difficult “if not impossible” to determine what portion of the purchase price could be attributable to the unuseable stock. The Court of Appeal held that it could not be demonstrated that anything had in fact been paid for the stock and accordingly the appellant had suffered no loss.

The High Court embarked on an identification of what the loss entailed in the particular circumstances of this case, starting with the principle governing the assessment of damages for breach of a contractual warranty, that a successful plaintiff is to be awarded damages to put them, so far as money can do, in the same situation as if the contract had been performed as promised[1].

In the primary judgment by Keane J (with Hayne, Crennan and Bell JJ’s generally agreeing), his Honour held that the ruling principle (set out above) governs the assessment of damage not only in a case of a failure to supply goods but also where the goods are supplied as an aspect of the sale of the assets of a business.  The value is to be assessed as at the time of the breach of the contract.

In response to the Court of Appeal’s reasoning, Keane J stated that: “Because the ruling principle is concerned to provide the purchaser with compensation for the loss of the benefit of the bargain, it does not require an apportionment of the components of the bargain.” 

The loss was measured not by what Clark had originally outlaid to obtain the unusable stock but the value of what the vendor had promised to deliver but did not.

The High Court agreed with the primary judge that this was best evidenced by what Clark had in fact been required to pay for the replacement stock.

Mitigation

On appeal, Macourt argued that regardless of the characterisation of the contract, the loss claimed had been fully mitigated, as the cost of the replacement stock had been recouped from patients.

The majority of the High Court found that this failed to address the claim Clark actually made as Clark’s loss could not be confined to the expense that she had to incur (but was able to recoup) in acquiring the replacement stock.

The High Court stated that “mitigation” embraced two separate ideas.  First, a plaintiff cannot recover damages for a loss which he or she ought to have avoided and second, a plaintiff cannot recover damage for a loss which he or she did avoid.  The Court of Appeal’s analysis engaged the second of these propositions.

The High Court, however, determined that the transaction (acquiring the replacement stock) neither mitigated nor aggravated the loss suffered by Clark from the vendor not supplying in accordance with the contract.

The evidence of what Clark had charged or could charge third parties was irrelevant to decide the value of what the vendor should have supplied.  Clark had been required to purchase the replacement stock to put herself in the position she would have been had the contract been performed.  Whatever transactions she then chose to make was irrelevant in determining the value of what was not provided under the contract.

In his dissenting judgment, Gageler J held that the measure adopted by the Court of Appeal was appropriate as it yielded an amount which placed the appellant in the same position as if the contract had been performed.

Conclusion

As a result of the decision, Macourt is liable for the damages award as the vendor has subsequently gone into liquidation.

Careful consideration should be given to the drafting of contractual warranties in a sale of business context, particularly where, as in this case, the value of damages could be significantly higher than the purchase price of the stock.  Particular consideration should be given to:

  1. drafting caps on liability for different types of warranties; and
  2. putting into place procedures for managing disputes during the “earn out” period, for example, dispute resolution or mediation processes which apply prior to the “earn out” period coming to an end.

It also highlights the risk to a guarantor of warranties where there is a risk that the vendor will be unable to meet a claim for damages in the event of breach.