Supreme Court clarifies when damages for breach of contract need to be reduced for benefits obtained after the breach

Written on 24 Jul 2017

The Supreme Court has clarified the legal test for when actions taken after a breach of contract can be taken into account as mitigation of loss, thereby reducing the damages that the innocent party is entitled to. In this case, although the actions taken were a commercially reasonable response to the situation, they were not legally caused by the breach.  As a result, the benefit obtained as a result of those actions could not be taken into account to reduce the amount of damages owed.

What was the dispute about?

We have previously discussed the High Court, and then Court of Appeal, decisions in the case of Globalia Business Travel v Fulton Shipping.  The case concerned a cruise ship called New Flamenco. Fulton chartered the vessel for two years, from 2005 to 2007.  The parties subsequently negotiated an extension of the charter by another two years, to 2009.  However, Fulton denied that a binding agreement was reached, and maintained an entitlement to redeliver it in 2007.  The owner treated that as an anticipatory, repudiatory breach of contract, and terminated the charter contract.

At the time of redelivery, there was no alternative demand for a charter of the vessel, so the owner instead sold it, for approximately US$23.7m.  The 2008 financial crisis meant that, had the owner instead waited until 2009 to sell the vessel, its value would have dropped to just US$7m.

During the arbitration that followed, Fulton argued, and the arbitrator agreed, that the benefit that the owner received in selling the vessel in 2007, rather than 2009, should be taken into account to reduce (or extinguish) the damages it owed. That decision was ultimately appealed up to the Supreme Court.

What did the Supreme Court decide?

The Supreme Court found in favour of the owner: that the benefit it received in selling the vessel early should not be taken into account in quantifying the damages they were due.

The key issue, which was successively reversed at each stage up to and including the Supreme Court, was whether the owner’s actions were sufficiently linked to the breach of contract to constitute a mitigation of loss. Considering the link between the breach of contract and the benefit obtained, Lord Clarke, giving the Supreme Court’s judgment, held that:

“The essential question is whether there is a sufficiently close link between the two and whether they are similar in nature. The relevant link is causation. The benefit to be brought into account must have been caused either by the breach… or by a successful act of mitigation.”

In this case, an important factor was that, when Fulton terminated the charter, there was no market for alternative long-term charters, so the owner could not simply find an alternative charterparty. It could have found short-term charterparties, but this would not have given it the same income stream as under the agreement with Fulton.

The Court of Appeal found that, in those circumstances, selling the vessel amounted to an alternative way of mitigating the owner’s loss. The Supreme Court disagreed, finding that the termination by Fulton did not make it necessary to sell the vessel.  It could have simply chartered it for short periods, when there was demand.  The decision instead to sell the vessel was a commercial decision made at the owner’s risk – they could have equally sold the vessel at any time during the charter, or conversely, could have retained it after the end of the charter.  The premature termination was, the court found, “the occasion for selling the vessel. It is not the legal cause of it.

Practice points

Attempting to assist the understanding of what is often a difficult factual and legal area, the judge in the High Court laid out 11 principles to determine whether a benefit should be taken into account to reduce the damages owed for breach of contract. Those 11 principles were rejected by the Court of Appeal and although the Supreme Court disagreed with the Court of Appeal, it did not express a clear view as to whether or not those principles should be followed.  It remains to be seen, therefore, whether subsequent courts will refer to those principles to help them answer the simpler test set out by the Supreme Court:

  • Is there a “sufficiently close” link between the breach and the benefit – in the sense that the benefit was caused either by the breach or by an act of mitigation; and
  • Are the breach and the benefit similar in nature (although they do not necessarily need to be of the same kind)?

What this judgment highlights is that when faced with a breach of contract, a party will need to make a commercial decision about what actions it should take. That will not necessarily mean that the actions that it takes were legally caused by the breach. Accordingly, it will not necessarily follow that any benefit, or loss, derived from those actions will be taken into account when assessing the damages that party is owed as a result of the breach.