Contractual or tortious damages: what is the difference (and when does it matter)?

Mr Karim purchased a solicitor’s practice from Mr Wemyss in March 2008. In pre-contractual negotiations in December 2007, Mr Wemyss told Mr Karim in an email that the practice’s turnover and net income were “on course” for GBP 640,000 and GBP 120,000 respectively. The Sale and Purchase Agreement (SPA) contained a warranty: “… all other information relating to the Business given by … the Seller to the Buyer … are true accurate and complete in every respect and are not misleading”.

After the purchase, it became apparent to Mr Karim that the practice would not hit the turnover or net income figures for 2008 that Mr Wemyss had indicated.

Forecast figures were not true, and seller did not believe them to be true

The court found that, in December 2007 when Mr Wemyss made the statements regarding turnover and profit, they were not true and he did not believe them to be true. When the parties entered the SPA a few months later in March 2008, the statements were still not true and Mr Wemyss “must have known the true position if he had looked at it”. The court also found that the information was not only not true at the date of the contract, it was also incomplete and misleading. Accordingly, Mr Wemyss was liable to Mr Karim on tortious grounds for misrepresentation and for breach of contract.

Tortious and contractual claims – how to choose

The Court of Appeal provides helpful guidance in this area.

Entitlement to choose measure of damages

Where a party is entitled to damages on both the tortious and the contractual measure, as in this case, the party is free to select whichever measure produces the better outcome.

Contractual versus tortious measure of damages

The manner in which tortious and contractual damages are calculated is different and, although in some cases the same outcome will result, in others the difference can be significant.

The measure of contractual damages is the difference between “the true value of the asset and its value with the quality as warranted”, whereas the measure of tortious damages is the difference between “the true value of the asset and the price paid”.

Lord Justice Lewison demonstrated the consequence of the difference: A buys a painting from B for GBP 8,000 because B told A that it was painted by a famous artist. This was not true and the painting was therefore only worth GBP 100; if it had been true, however, it would have been worth GBP 10,000.

If B’s claim constituted a contractual warranty, A could recover the difference between what the painting would have been worth if the quality was as warranted (GBP 10,000) and its true value (GBP 100), so GBP 9,900. However, if B’s statement only constitutes an actionable misrepresentation, then A would be entitled to the difference between the price paid (GBP 8,000) and the true value (GBP 100), so GBP 7,900.

When damages are difficult to calculate

As Mr Wemyss was liable on both a contractual and tortious basis, Mr Karim could choose between:

• the difference between the price he paid and the true value of the business (ie the tortious measure); and
• the difference between the value of the business if the information regarding turnover and net income had complied with the warranty and the business’s true value (ie the contractual measure).

However, the parties had not provided the court with a valuation of either the business’s true value at the contract date or what its value would have been if the warranted information had been true, complete and not misleading.

Absence of expert evidence does not preclude assessment of damages

The court quoted from a number of judgments in support of the principle that the fact that it may be difficult to calculate damages does not disentitle the injured party from receiving compensation for its loss. In such circumstances, the court must assess damages as best it can, even if this involves a degree of speculation. In this instance, the profit earning capacity of the business, which had been warranted to be GBP 120,000, was in fact only GBP 92,000. The usual way in which a business’s profit-earning capacity is reflected in the sale price of the business is through goodwill. The value of goodwill is ordinarily calculated by the application of an agreed multiplier to the value of the business’s annual profit. The court observed that this was a point on which it would have benefited from expert evidence regarding what that multiplier would have generally been agreed to be between sellers and buyers in the market.

In the absence of expert evidence, the court calculated the multiplier itself. It concluded that damages of GBP 15,000 were owed as reflecting the difference in the value of the price that Mr Karim paid for goodwill for the profit earning capacity as warranted and the price it could be assumed that he would have paid for goodwill for the actual profit earning capacity of the business (ie the difference between the value as warranted and the actual value).

COMMENT

If a party is able to claim on both a contractual and a tortious basis, how should it go about choosing which will produce the better outcome? One approach is to look whether the claimant made a good bargain in the first place, compared to what the value of the asset had been warranted to be.

• If the claimant’s bargain would have been a bad one, even on the assumption that the representation was true, the tortious measure is best. 
• If, on the assumption that the representation was true, the claimant’s bargain would have been a good one, the contractual measure (under which he may recover something even if the actual value of what he has recovered is greater than the price) is best.¹

The reason why the tortious measure will be better in the case of a bad bargain is because the purpose of damages under this measure is to put the party, so far as is possible, in the position it would have been in had it not been induced by the representation to enter the contract, which means the party may be able to rescind the contract and recover its money. Contractual damages will only operate to put the party in the position it would have been in if the representation had been true. If it is the case that, had the representation been true, the party would have made a good bargain, then the contractual measure will effectively give the party the benefit it would have received if that representation had been true.

It is important to remember that the loss for which Mr Karim was claiming damages arose as the result of Mr Wemyss’s misrepresentation and breach of warranty as to the business’s profit earning capacity. Accordingly, it was not a case in which questions of remoteness arose.

Equally, as the court stated, it was not a case in which damages were to be calculated on the “no transaction” basis. If a party finds itself in either of those scenarios it should have regard to the specific rules which come into play in those instances in order to determine which measure will produce the better outcome.

Footnote:

1 See also Prof Treitel in “Damages for Deceit” (1969) 32 MLR 556, 558-559, which the court cited with approval (and which had previously been approved by Lord Steyn in Smith New Court Ltd v Citibank NA [1997] AC 254, 282). 

Further information

For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 20 3088 3710.