The risk of a pyrrhic victory for claimants relying on damages clauses for the calculation of compensation in the absence of actual loss

The Supreme Court has handed down a unanimous decision which confirms that clauses which provide a contractual mechanism for the calculation of damages remain subject to standard rules of construction.

Absent any express stipulation, such clauses will not operate to the exclusion of common law compensatory principles.  The decision also confirmed that the compensatory principle established in The Golden Victory [2007] 2 AC 353 is not restricted to contracts for delivery by instalments, but can apply to delivery of a single cargo.

The seller of goods was found to have repudiated the contract by giving premature notice of cancellation.  The contract contained a mechanism for calculation of damages which would have resulted in damages of around US$3 million being payable to the buyer.  However, the legislative embargo which prompted the seller to give notice of cancellation remained in force and a barrier to performance of the contract by the time that shipment would have been due.  The Supreme Court held that the contractual provision for the computation of damages did not operate to the exclusion of common law principles and, in the absence of any real loss (on the basis that the contract would have been cancelled in any event) it awarded only nominal damages of US$5 to the buyer.

Facts

The parties had entered into a standard form of contract, which incorporated the Grain and Feed Trade Association ("GAFTA") Form 49.   Pursuant to the contract, Bunge SA was to sell 25,000 metric tonnes (+/- 10% at the buyer's option) of Russian milling wheat crop 2010 to Nidera BV. The terms provided that the sale was FOB Novorossiysk (a Russian port), and ultimately it was agreed that shipment was due between 23 to 30 August 2010.

On 5 August 2010, Russia introduced a legislative embargo on exports of wheat from its territory, which was to run from 15 August to 31 December 2010.  On 9 August 2010, Bunge SA purported to give notice to the buyer to cancel the contract in accordance with clause 13, which provided:

"13. PROHIBITION - In case of prohibition of export, blockade or hostilities or in case of any executive or legislative act done by or on behalf of the government of the country of origin of the goods, or of the country from which the goods are to be shipped, restricting export, whether partially or otherwise, any such restriction shall be deemed by both parties to apply to this contract and to the extent of such total or partial restriction to prevent fulfilment whether by shipment or by any other means whatsoever and to that extent this contract or any unfulfilled portion thereof shall be cancelled. Sellers shall advise Buyers without delay with the reasons therefor and, if required, Sellers must produce proof to justify the cancellation."

The buyer did not accept that the seller was entitled to cancel the contract at that stage.  It treated the purported cancellation as a repudiation, which it accepted on 11 August 2010.  The following day, the seller offered to reinstate the contract on the same terms, but the buyer did not agree.  The buyer commenced arbitration proceedings under the GAFTA rules, claiming damages of US$3,062,500, calculated by reference to clause 20 of the contract (the Default Clause), sub-clause (c) of which provided:

"20.  DEFAULT – In default of fulfilment of the contract by either party, the following provisions shall apply:

(c)     The damages payable shall be based on, but not limited to, the difference between the contractual price and… the actual or estimated value of goods on the date of default…"

GAFTA's first tier tribunal held that the seller had repudiated the contract because the cancellation notice was premature.  This was on the basis that the embargo may still have been lifted in time to permit shipment within the contractual period, and it had therefore not been possible to say, at the time when the seller purported to cancel the contract, that shipment would necessarily be prevented by the embargo.  However, the tribunal also held, in agreement with the seller, that in fact no loss had been suffered because the embargo was not lifted, and it therefore followed that the contract would have been cancelled in any event by the time that delivery was required.

Both parties appealed to the GAFTA Appeal Board.  The Appeal Board agreed that the seller had repudiated the contract by cancelling too early.  It also accepted, on the basis that the embargo had not been lifted by the date due for shipment, that if the contract had not been repudiated on 9 August 2010 it would have been cancelled prior to shipment in any event.  However, it awarded damages of US$3,062,500 to the buyers, on the basis that it said that such an award was required by clause 20(c) of GAFTA 49.

The seller had argued that at common law it was necessary to take into account the events occurring after the breach, which showed that the same loss would have been suffered even without the repudiation.  The seller relied on The Mihalis Angelos[1] and The Golden Victory [2] in support of this position.  The key questions were (i) whether the position at common law was, as the seller advanced, that it is necessary to take events post breach into account for the assessment of damages, and (ii) whether the common law principle continued to have any application to a contract containing a Default Clause in the terms set out in clause 20.   The Appeal Board doubted whether at common law subsequent events would be relevant to the assessment of damages under a contract for the sale of a single cargo (in contrast to a contract for delivery by instalments).  The Appeal Board held that the question of damages turned wholly on the effect of the Default Clause, which was said to be widely used and "commonly understood in the trade", and that the contract provided an "easily understood and readily applied" formula for calculating damages, which, by agreement of the parties, should be applied, and that it should be expected that this calculation may achieve more or less than the actual loss.

In October 2012, the Court gave permission to appeal against the award under section 69 of the Arbitration Act 1996.  The seller's appeal was heard by the High Court, and subsequently by the Court of Appeal, and in both instances was dismissed.  The seller's appeal to the Supreme Court was heard in April 2015.

On appeal

The Supreme Court provided a useful overview of the common law principles for the assessment of damages in cases of repudiatory breach.  The judgment notes that the fundamental compensatory principle which requires the injured party to be "placed in the same situation with respect to damages as if the contract had been performed"[3] is particularly problematic in the context of anticipatory breaches of contract.   While noting some of the criticisms advanced by commentators in relation to the decision in The Golden Victory, the Supreme Court affirmed the view that the compensatory principle would be offended by disregarding subsequent events which served to reduce or eliminate the parties' loss resulting from an anticipatory breach.  It also confirmed that there is no reason to limit the application of this principle to instalment contracts, and that it would apply equally to contracts for a sale of single cargo, as in this case. 

As to the application or exclusion of such common law principles in circumstances where parties have included a Default Clause in their agreement, the Supreme Court noted that damages clauses are commonly intended to avoid disputes about the quantum of damages, by either prescribing a fixed measure of loss, or providing a mechanism or formula for the calculation of damages.  In either case, the parties may have preferred to opt for a certainty and to accept "the rough with the smooth", recognising that they may have done better, or worse, if common law principles for the assessment of damages had applied.  However, damages clauses are assumed, in the absence of clear words, not to have been intended to operate arbitrarily, for example by producing an outcome which bears no resemblance to the parties' real loss.

It was held that damages clauses are subject to the standard rules of construction, and to treat damages clauses as dealing exhaustively with the principles which should be applied to an assessment for damages is to "tax the foresight of the draftsman in a way which is rarely appropriate".  The Supreme Court held that the Default Clause in this case could not be viewed as a complete code for every aspect of the assessment of damages, to the exclusion of considering the subsequent events which would have been considered at common law, which resulted in the original contract being cancelled in any event.  The Supreme Court found in favour of the decision by the first tier tribunal, and awarded only nominal damages of US$5 to the buyer.

Commentary

The Supreme Court's judgment provides a useful overview of the applicable principles for the assessment of damages in cases of non-delivery or repudiation under contracts for the sale of goods. It is also serves as a clear warning to parties to commercial contracts, not to treat a contractual damages provision as providing a complete answer to the issue of calculation of damages where they would not otherwise satisfy the relevant common law principles such as the relevance of actual loss to the assessment of quantum.  Parties must also not underestimate their duty to mitigate following a repudiatory breach, and should consider carefully what their damages claim might in reality be to balance this against any available alternative to accepting a repudiatory breach, or indeed a counterparty offer to reinstate a contract following any such acceptance.

[1]  Maredelanto Compania Naviera SA v Bergbau-Handel GmbH [1971] 1 QB 164

[2]  Golden Strait Corporation v Nippon Yusen Kubishika Kaisha [2007] AC 353

[3]  Robinson v Harman (1848) Exch. 850; [1848] EngR 135