An extract from The Global Damages Review, 3rd Edition

Quantification of financial loss

i Introduction

In English law, the purpose of an award of damages for breach of contract is to compensate the injured party for loss, rather than to punish the wrongdoer. The general rule is that damages should (so far as a monetary award can) place the claimant in the same position as if the contract had been performed. Therefore, damages are usually measured by the difference in value between the contemplated and actual performance of the contract.

To establish entitlement to damages, the claimant is also required to show that adequate steps have been taken to mitigate the damage resulting from the defendant's actions. Failure to take mitigating steps will likely result in the claimant's entitlement to damages being reduced.

In addition to mitigating factors, damages awarded under English law are also influenced by methods of calculation, application discount and interest rates and income tax or capital gains tax.

ii Evidence

If a claimant has suffered a loss, there are four key elements that are relevant to establishing a party's entitlement to damages and determining the amount of damages to be awarded: (1) the existence of a wrong; (2) reasonable foreseeability; (3) failure to mitigate the impact of the breach; and (4) chain of causation.

The first and most basic requirement is that, to establish an entitlement to damages, one must prove the existence of a 'wrong' – that is, a breach of contract. Second, a claimant must establish that the damage is not too remote and that the losses were reasonably foreseeable at the time the parties entered into the contract. The test of reasonable foreseeability was first outlined in Hadley v. Baxendale as:

Where two parties have made a contract, which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e. according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach of it.

For loss to have been foreseen, it must have been contemplated by the parties and 'not unlikely' at the date of entering into the contract. Loss is said to have been in contemplation of the parties (and therefore assumed) if, objectively assessed, it could be said to occur in the ordinary course of events, or, if subjectively assessed, there are special circumstances or knowledge attributable to the parties.

Third, any damages awarded are subject to deductions for any failure to mitigate (or contributory negligence in the case of breaches of duty of care). The defendant carries the burden of proof in relation to establishing the claimant's actions (or lack thereof) to mitigate damage as a result of the defendant's breach. Provided the steps taken by the claimant to minimise the loss incurred are reasonable, the cost of such steps is recoverable even if the steps taken have increased the loss. However, any profit accrued as a result of the claimant's mitigating actions is also credited to the defendant if causation is established, with the latter having the burden of proving the existence and amount of such profit.

Fourth, any damages awarded are also subject to any breaks in the chain of causation. Irrespective of factual causation, English law can treat some losses as not having been legally caused by the breach, on the basis that it is not fair to hold the defendant responsible for them because of a 'break in the chain' or novus actus interveniens. If the breach of contract was the 'effective' or 'dominant' cause of the loss, damages may be recoverable even if the breach was not the sole cause of the loss. Where there are competing causes, a balance of probabilities test applies.

iii Date of assessment

Under English law, damages are normally assessed at the date of breach of contract unless to do so would not be in the interests of justice.

However, the date of breach may not be appropriate as the starting point for calculation of damages. For example, a claimant's steps to mitigate the loss may impact the evaluation of the damages. Similarly, where the claimant has not in fact suffered any loss at the date that the actual breach occurred, but only began to suffer loss subsequently, the latter date may be the more appropriate starting point for calculation.

iv Financial projections

Under English law, a claimant must prove the fact of loss and the amount of the loss on the balance of probabilities, that is, 'If the evidence shows a balance in favour of it having happened, then it is proved that it did in fact happen.' However, different principles apply for future or projected loss.

Where it is difficult to prove the amount of loss with certainty, the wrongdoer should not be relieved of his or her responsibility to pay. Damages can be recovered for 'loss of a chance'. However, this is an inherently uncertain head of loss, and can raise difficult issues of causation and quantification.

The doctrine of 'loss of chance' was introduced in English law by the decision in Chaplin v. Hicks, but has since evolved considerably. In Mallett v. McMonagle, Lord Diplock opined:

Anything that is more probably than not [the court] treats as certain. But in assessing damages which depend on its view as to what will happen in the future or would have happened in the future if something had not happened in the past, the court must make an estimate as to what are the changes that a particular thing will or would have happened and reflect those chances, whether they are more or less than even, in the amount of damages it awards.

Establishing a loss of chance requires that there be both a real and a substantial chance – a chance that is negligible is not likely to support recovery of projected damages. Similarly, a chance to which only a speculative money value can be assigned is unlikely to succeed. However, where the realisation of a chance appears to be virtually certain, the court will consider it appropriate to award what would have been awarded against the defendant originally. The court recently held that where a claimant's recovery is dependent on the actions of a third party, then loss of chance principles must apply, rather than an assessment of the actions of the third party having taken place by reference to the balance of probabilities. If causation depends at least in part on the action of one or more third party, the claimant must demonstrate that there would have been a real or substantial chance that the third party would have acted in the respect relied upon by the claimant.

v Liquidated damages and penalties

Parties to a contract can agree between them the amount of damages payable for any breaches (stipulating different sums for different breaches). The long-standing common law rule is that a term in a contract, which constitutes a penalty, is unenforceable. Therefore, the court will have to determine whether the payment stipulated is a liquidated damage or a penalty. A penalty is a payment of money stipulated as in terrorem of the offending party and the liquidated damages are a genuine pre-estimate of damage. The Supreme Court in the 2016 conjoined appeals in Cavendish Square Holdings v. Makdessi and ParkingEye Ltd v. Beavis revisited and reinstated the above law on penalties and liquidated damages.

The court held that the penalties doctrine is applicable only when there is a breach of contract and no matter how extreme a party is penalised, it will amount to a penalty only when it is a result of breach. The courts have no power to regulate parties' primary regulations and the rule is applicable only in the case of secondary obligations. In this judgment, Lords Neuberger and Sumption stated that 'the true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation'. The court further observed that whether a clause operates as a primary obligation or secondary obligation is a question of substance and not form. More recently, the court considered the application of liquidated damages clauses and reiterated the importance of the precise wording of the clause in determining its application.

vi Discount rates

The calculation of compensatory damages often involves the determination of future losses or 'loss of chance'. When calculating future losses, the application of an appropriate discount rate is required to estimate the expected rate of return had the loss not occurred.

In a consultation by the Ministry of Justice in relation to the Damages Act 1996, the overriding aim behind discount rates was described as to set the rate as accurately as possible so that under-compensation or over-compensation by reason of the accelerated payment of the future losses is avoided as far as possible.

While this principle was articulated in the specific context of personal injury claims, the general presumption is helpful when considering the general application of discount rates to the calculation of compensatory damages. In the discounted cash flow analysis (discussed further below), if a breach of contract results in loss of profits over time, a discount rate is applied to estimate the current value of the cash flow. The discount rate in such instances would typically depend on the asset being valued. For example, while valuing equity, the relevant discount rate would be that most appropriately reflecting the cost of the equity. Discount rates are influenced by a variety of factors including political changes, future inflation, currency devaluation and fluctuating interest rates.

Experts use a variety of discount rate calculation methods when valuing assets including, for example, the capital asset pricing model (which considers a stock's rate of return, the market's rate of return and a risk-free rate) and the weighted average cost of capital (which is usually used to assess a company's value as a whole by estimating the weighted average of new debt and equity needed to operate the company).

vii Currency conversion

The currency contemplated by the contract generally determines the currency for damages to be awarded. Where the contract does not provide for a specific currency for the awarding of damages, the damages will be awarded in the currency in which the claimant suffered the loss.

In Miliangos Respondent v. George Frank (Textiles) Ltd, the House of Lords found that the English courts had the authority to give judgment in foreign currency where under a contract, payment obligations are in a foreign currency and the proper law is that of the foreign country, with payment to be made outside the United Kingdom. The courts will take into account commercial considerations and give judgments in foreign currency or its sterling equivalent at the date when the court authorises the claimant to enforce the judgment. This protects the claimants against any decrease in the external value of sterling in relation to their own currency, save for in instances where the value of sterling is rising.

The courts have also considered the issue of whether a court has the power to make a cost award to compensate for any exchange rate losses incurred in paying costs. In Elkamet Kunststofftechnik GmbH v. Saint-Gobain Glass France SA, the court held that 'order for costs is designed to compensate the successful party for its expenditure so that exchange rate losses can be compensated in the same way as it is entitled to be compensated by way of interest for being kept out of the money'.

viii Interest on damages

The court has the authority to award interest on damages for any period between the date when the cause of action arose and the date of judgment. If the claimant caused unwarrantable delay, interest on damages for such period will be reduced accordingly. A damages claim (including a claim for interest) should, therefore, be clearly particularised and supported by the necessary written and oral evidence required to prove the claimant's case.

The court has the discretion to award interest at different rates in respect of different periods; in contractual claims, the interest rate should reflect the current commercial rate. The Commercial Court and the Court of Appeal generally award 1 per cent above the base rate. However, if such calculation would put either party in an unfair position (smaller business pays higher interest rate, etc.), the court can adopt an appropriate interest rate to suit the parties.

Where the damages are calculated in a foreign currency, the commercial borrowing rate in the foreign currency in the relevant country is considered as the relevant interest rate.

ix Costs

As a general principle, legal costs incurred as a result of breach of contract can be recovered as damages, where they were incurred in actions against third parties or previous actions against the defendant. The costs of the dispute over the breach of contract itself, although caused by the breach usually cannot be claimed as damages as they fall within the exclusive jurisdiction of the courts' costs regime.

As a result of the mitigation principle, legal costs recoverable as contract damages are assessed in the same way as 'indemnity basis' of costs. That is, 'unreasonable' costs are not recoverable under common law principles, nor is proportionality always taken into account.

x Tax

There are two types of taxation that may apply in relation to an award for damages: income tax and capital gains tax.

Prior to 1956, the English courts did not reduce awards of damages to account for income tax. However, in British Transport Commission v. Gourley, the House of Lords ruled that when calculating damages for personal injuries resulting from a tort, the court will take into account the tax liability in respect of his loss of earnings (both past and prospective). This rule has been modified over the years in instances where the damages sought would have been taxed.

Capital gains tax differs from income tax in that it does not cause damages to be reduced. However, the impact of capital gains tax would need to be considered on a case-by-case basis where the application of capital gains tax affects the value of the asset that is said to have suffered the loss.