Lost Profit Damages: A Paradise (Not Yet) Lost

  1. Introduction

This article explores recent progress in the  law of lost profit damages by analysing a landmark Privy Council case Attorney General of the Virgin Islands v. Global Water Associates Ltd.[1]. Lost profit damages for breach of a contract are available but their recovery is circumscribed by the conditions of parties’ contemplation and remoteness. Claims for lost profit damages have to overcome the barrier of remoteness.

 

Starting from Hadley v. Baxendale[2], many cases for lost profits have arisen in the context of services by logistics providers. Lost profit cases have also arisen in context of resale of goods, professional services and land transactions among others. They frequently occur in this pattern: A promised to B to supply goods or perform services, and B in turn further contracted with C to supply goods to be received from A or services to be performed by A under A’s contract with B (broadly called as “linked contracts”). This pattern of linked contracts is extremely common since the earliest trading days to the modern, global supply chains. The challenge has always been to prove parties’ contemplation at the time of contracting to foresee the risk of consequential loss from the breach of contract. Risks contemplated by the parties can lead to recovery of lost profits (also called “loss of profits” by many authors) that are not too remote.

 

2. Architecture of the Remedy of Damages

In India and few other former British colonies that adopted the Contract Act, 1872, damages under Section 73 are termed as “compensation”. Damages for breach of contract are payable by a party which broke the contract to a party that suffers the breach. Quantum of damages is defined by the loss or damage suffered by the party minus any allowed reductions like mitigation.

 

A party suffering from a breach of contract is entitled to recover damages that either:

  1. Naturally arose in the usual course of things; or
  2. Which the parties knew at the time of contracting to likely result from a breach.

The scope of damages that can be recovered is controlled by the requirement in Section 73 that the damages must not be from remote and indirect loss or damage.

 

Section 73’s language can be traced to Alderson B’s dictum in the celebrated 1854 English case Hadley v. Baxendale[3] 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. (emphasis supplied)

 

The core rule of damages seeks to place a contract party suffering the breach in a position she would be in if the contract had been performed. This has been aptly stated by Parke B in Robinson v. Harman[4] as:

… what damages is the plaintiff entitled to recover? The rule of the common law is, that where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed.

 

Damages are available when a breach of contract is a proximate, direct cause(s) of a loss arising from such a breach. Damages are not recoverable when a breach of contract is a remote, indirect cause(s) for a loss arising from such a breach. Consequential damages are recoverable only if they were in the contemplation of the parties (or at least the defendant), otherwise such damages would be remote and hence not recoverable.

 

Allowing damages when such losses were in contemplation of parties is not an exception to the core rule of granting damages that arise naturally, but where a defendant has a notice of special circumstances, that notice enlarges the scope of the natural consequences of the breach[5].

 

Mayne[6] illustrates a common demand for lost profits that would have been made if the defendant had performed her contract promises as:

One very common instance in which damages are held to be too remote arises where the plaintiff claims compensation for the profits which he would have made, if the defendant had carried out his contract. It is by no means true, however, that such profits can never form a ground of damage … Loss of profits is recoverable so far as it is the natural result of the breach of contract, but not when it is founded on a special contract for resale, unknown to the defendant, which is frustrated by that breach.

Knowledge of the parties has to be objectively ascertained as to whether they contemplated certain events or losses to be within the scope of a contractual bargain. But this is not always easy to ascertain. Knowledge possessed by the contracting parties is classified into two types: imputed and actual. Imputed knowledge refers to the knowledge that the contracting parties ought to have of the loss consequent to a breach in ordinary course. But a defendant may possess actual knowledge outside the ordinary course which if the contract is breached in special circumstances will make the defendant liable[7][8].

Hadley v. Baxendale case’s ratio is considered an “orthodox” or “standard” approach, while the reformulated approach in Achilleas[9] case by two-Judges of the Bench is described as, “… defendant is only to be held liable for loss which it was the intention of the parties that he should bear i.e. loss for which he has ‘assumed responsibility’, or which falls within the scope of his duty”[10]. But Treitel considers Achilleas[11] case’s ratio is not any definite departure from the rule in Hadley v. Baxendale case and may be thought of as a requirement that the defendant has accepted or assented to the risk of loss over and above the contemplation in the foresight of the parties[12].

 

 3. Lost Profits (Loss of Profits) under the Contract Act, 1872

Lost profit (Loss of Profits) damages are available under Indian contract law. The only bar is remoteness. As noted above, the Indian contract law of damages tracks the English common law being firmly rooted in Hadley v. Baxendale rules that are enacted in statute’s Section 73.

 

There are illustrations to Section 73 that cover lost profits. For example, illustration (i) is a variation of Hadley v. Baxendale situation with damages being recoverable as lost profits in contemplation of the parties for normal operation but not for the loss of a remote government contract. Illustration (j) describes linked contracts where knowledge of a linked contract leads to lost profit damages. In Illustration (l), the builder has knowledge of the further linked contract and hence the builder is liable for lost profits. In illustrations (k, n, p, q and r), consequential damages are not being recoverable as being too remote. In all illustrations to Section 73 where parties had mutual knowledge of purpose of the contract liability for lost profits is shown to exist.

 

In a road construction project, when the Government breached the contract by improperly rescinding it, Supreme Court of India upheld grant of lost profits on the unfinished work[13]. But at times, the High Courts have rejected lost profits, because they were not proved[14][15]. Then there have been the courier related cases where if the defendant did not have knowledge of plaintiff’s special purpose or circumstances, lost profit damages have been disallowed[16][17]. Lost profits have had a long history in Indian contract law cases. But there is a dearth of lost profit judgments post-independence similar to the reduced count of contract damages decisions too. Hence, it is necessary to consider English law decisions on this point where the issue of contemplation has been refined over the years.

 

4. A Milestone: Attorney General of Virgin Islands v. Global Water Associates Ltd.

In a landmark recent decision Attorney General of the Virgin Islands v. Global Water Associates Ltd.[18] (2020), the Privy Council restated the law on lost profit (loss of profit) damages and remoteness of damages. In a decision that traces the law from Hadley v. Baxendale onwards,  the Privy Council undertook a comprehensive review of English law precedents on loss of  profit damages and remoteness of damages. The following discussion refers to the same case Attorney General of the Virgin Islands v. Global Water Associates Ltd. (2020).

 

D.1 The Two Contracts

The facts of the case involved two contracts that were to be operational in sequence: to build and then to operate a water plant. First contract was a design and build agreement (DBA). Second contract was a management operation and maintenance agreement (MOMA). Parties were Government of British Virgin Island (Government) and global water associates (GWA). The parties to the two contracts, DBA and MOMA, and the designated signatories were the same.  Both the DBA and MOMA were signed on the same day. Hence, the DBA was to be followed by MOMA with the same parties. The DBA and MOMA incorporated the common “design build documents”, which included the GWA’s proposal, Government’s approval and letter from a company pure stream stating that GWA were their authorised agents and their support for executing the project.

 

Government executed the DBA with GWA to build a water reclamation treatment plant. It also executed a MOMA with GWA to operate the same water plant from the commencement date, which was to be the first date on which the water plant produced specified quantity of water.

 

D.2 Breach of Contract

GWA claimed that the Government failed to provide a prepared site for the water plant, a requirement under the DBA. Hence, GWA could not build the water plant. GWA then issued a contractual remedy notice, which the Government failed to respond. Thereafter, GWA terminated the DBA. Due to this breach of DBA  by the Government, GWA claimed it had lost profits it could have earned from managing and operating the plant for 12 years under the MOMA. Hence, GWA claimed damages for the breach of an implied term under the MOMA that the Government would provide a prepared site under its DBA obligations.

 

D.3 Litigation

GWA initiated an arbitration for its claims for damages arising from the breach of the DBA and also the breach of an implied term of MOMA. The Arbitral Tribunal rejected GWA’s claim because there was no implied term in MOMA to provide a prepared site. Further, the damages claimed for lost profits to be earned under MOMA were too remote to be recoverable.

 

GWA’s challenged the award in the High Court for errors of law. A Single Judge Bench held in favour of GWA and remitted the award back to the arbitrators for assessment of damages.

 

In the Government’s appeal, the court of appeal rejected GWA’s claim on the ground that the damages were too remote to recover. The court of appeal reasoned that even if Government had breached the DBA, which led to GWA terminating the DBA, for the purpose of MOMA, Government could have got the plant built by some other contractor. GWA in such case could then have operated the plant for 12 years under the MOMA. Hence, the court of appeal held that the parties could not have reasonably foreseen that breach of DBA would lead to MOMA being non-operational. Further, the court of appeal also rejected the argument that MOMA had an implied term that DBA obligations would be fulfilled. The court of appeal based its decision on the implied term being that the Government will make a water plant available to operate at the commencement of MOMA. GWA appealed to the Privy Council.

 

D.4 Privy Council’s Analysis

Analysing the remoteness of damages issue, the Privy Council noted Hadley v. Baxendale’s formulation were apt for an age when juries decided such questions. But now when Judges give reasons, the formulations are subjected to “closer scrutiny and some expansion”. (emphasis supplied)

 

Considering Victoria Laundry (Windsor) v. Newman Industries Ltd.[19] decision, the Privy Council chose to focus on its later review in Heron II[20] case. The Privy Council said that unusual market volatility or understanding of market which were the focus of  Achilleas[21] case were not at issue here. The Privy Council favoured Lord Walker of Gesting Thorpe’s preference in Achilleas[22] case because:

78.… arguably a vague expression (such as “real possibility”) … because it is more flexible once it is understood that what is most important is the common expectation, objectively assessed, on the basis of which the parties are entering into their contract.

He preferred the “real possibility” expression over various probabilities of the parties contemplating the event of breach being considered in Heron II[23] case because, “In the context of contractual liability, the Court is not solely concerned with percentage chance of such an event occurring, although that is not irrelevant.”

 

The Privy Council also considered Lord Burrow’s formulation in his book[24] that a loss is too remote if such loss could not reasonably have been in defendant’s contemplation as “a serious possibility”.

 (emphasis supplied)

The Privy Council also agreed with the Single Judge Bench’s determination of inapplicability of Singapore Court of Appeal’s Burgundy[25] case on facts where parties had entered into an escrow and a drilling contract. The Singapore Court of Appeal in that case had held that damage caused by failure to fund the escrow account was only loss of security and driller could still have performed the contract. But here, the Government’s failure to perform DBA had prevented GWA from making profits under the MOMA.

 

The Privy Council[26] summarised the legal position of remoteness of damages as:

  1. First, in principle the purpose of damages for breach of contract is to put the party whose rights have been breached in the same position, so far as money can do so, as if his or her rights had been observed.

 

  1. But secondly, the party in a breach of contract is entitled to recover only such part of the loss actually resulting as was, at the time the contract was made, reasonably contemplated as liable to result from the breach. To be recoverable, the type of loss must have been reasonably contemplated as a serious possibility, in the sense discussed in paras 27 and 28 above.

 

  1. Thirdly, what was reasonably contemplated depends upon the knowledge which the parties possessed at that time or, in any event, which the party, who later commits the breach, then possessed.

 

  1. Fourthly, the test to be applied is an objective one. One asks what the defendant must be taken to have had in his or her contemplation rather than only what he or she actually contemplated. In other words, one assumes that the defendant at the time the contract was made had thought about the consequences of its breach.

 

  1. Fifthly, the criterion for deciding what the defendant must be taken to have had in his or her contemplation as the result of a breach of their contract is a factual one.

(emphasis supplied)

D.5 Application of the Law to Facts

Returning to the facts at hand, the Privy Council noted four facts: (i) contract parties were identical, and the contracts were executed simultaneously; (ii) government knew and intended that DBA’s performance would lead to MOMA; (iii) design build documents incorporated into the DBA were the same as the ones incorporated into the MOMA; and (iv) absence of an express or implied term in the DBA limiting the government’s liability for loss of earnings. Further Privy Council rejected the contention that he existence of two contracts itself is an, “implicit limitation on liability for breach of contract”, in the DBA because there could be several reasons why the contracts were separated.

 

The Privy Council rejected the court of appeal’s reasoning that the Government could have got the water plant built by another contractor and yet met its obligations under the MOMA. It did so because of: (i) incorporation of same design build documents into both DBA and MOMA; (ii) same entity GWA was contracted to build the plant under DBA and operate it under MOMA too; and (iii) definition of commencement date in both contracts indicates a “completion of DBA to lead seamlessly into the operation of the MOMA”. Hence, arbitrators were correct in their finding on fact that MOMA could commence only after the DBA was completed.

 

The Privy Council hence advised Her Majesty to allow the GWA’s appeal.

 

Conclusion

The Privy Council decision in Attorney General of the Virgin Islands v. Global Water Associates Ltd.,[27] (2020) case discussed above further strengthens the law of lost profit damages and remoteness of damages. In particular, the decision crystalises the standard of contemplation of parties to be objectively determined that either both or at least the defendant “reasonably contemplated as a serious possibility” the type of loss arising from the breach of the contract. This is also the standard mentioned in Professor Andrew Burrows’s  (now Lord Burrows) book referred above.

Lost profits (loss of profits) damages would be recoverable and not considered too remote if the parties or at least the defendant had contemplated as a serious possibility the type of loss arising from the breach of contract.

Milton said in his poem Paradise Lost:

Our torments also may in length of time

Become our elements

Similarly, may each step in the development of law of damages for the loss of profits and remoteness lead us to ever more precise standards to determine the contemplation of parties.

 

Advocate, practices as an independent counsel in the Bombay High Court and in arbitrations

[1] Attorney General of the Virgin Islands v. Global Water Associates Ltd., 2021 AC 23 : (2020) 3 WLR 584 : 2020 UKPC 18.

[2] Hadley v. Baxendale, 1854 EWHC Exch J70, [1854] 9 Ex. 341.

[3] Id. (Further citations to Hadley v. Baxendale are not repeated for brevity).

[4] Robinson v. Harman, (1848) 1 Exch 850, 855.

[5] William B. Hale, Handbook on the Law of Damages 78 (Roger W. Cooley, 2nd edn., 1912).

[6] John D. Mayne and Lumley Smith, A Treatise on the the Law of Damages: Comprising their Meausre, the Mode in Which they are Assessed and Reviewed, the Practice of Granting New Trials, and the Law of Set-off  55 (6th edn., 1899).

[7] Frederick Pollock and Dinshah Mulla, Indian Contract & Specific Relief Acts 1535 (13th edn., 2006).

[8] Victoria Laundry (Windsor) v. Newman Industries Ltd (1949) 2 KB 528.

[9] Transfield Shipping Inc.v Mercator Shipping Inc, 2009 AC 61 : 2008 UKHL 48.

[10] Treitel, The Law of Contract, §§ 20-109 (Edward Peel, 14th edn., 2015).

[11] Transfield Shipping Inc., (2009) 1 AC 61 : (2008) 3 WLR 345 : 2008 UKHL 48.

[12] Treitel, supra note 10,§§ 20-110.

[13] A.T. Brij Paul Singh  v. State of Gujarat, (1984) 4 SCC 59, 65.

[14] NTPC Ltd. v. Sri Avantika Contractors (I) Ltd., Delhi High Court, OMP (COMM) 428/2017, decided on 12-5-2020.

[15] National Highways Authority of India v. Ijm-Gayatri Joint Venture, Delhi High Court, OMP (COMM) 428/2017, decided on 12-5-2020.

[16] Madras Railway Company v. Govinda Rau, 1898 SCC OnLine Mad 4 : ILR (1898) 21 Mad 172.

[17] Dominion of India v. All India Reporter Ltd., 1951 SCC OnLine MP 35 : AIR 1952 Nag 32.

[18] Attorney General of the Virgin Islands, 2021 AC 23 : (2020) 3 WLR 584 : 2020 UKPC 18.

[19]Victoria Laundry (Windsor), (1949) 2 KB 528.

[20] Koufos v. C. Czarnikow Ltd., (1969) 1 AC 350 : (1967) 3 WLR 1491.

[21] Transfield Shipping Inc., (2009) 1 AC 61 : (2008) 3 WLR 345 : 2008 UKHL 48.

[22] Id.

[23] Koufos, (1969) 1 AC 350 : (1967) 3 WLR 1491.

[24] Andrew Burrows, A Restatement of the English Law of Contract 20 (2016).

[25] Burgundy Global Exploration Corpn v. v Transocean Offshore International Ventures Ltd., 2014 SGCA 24.

[26] Attorney General of the Virgin Islands, 2021 AC 23, 35-36.

[27] Id.

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