Profiting from breach: when must an innocent party give credit?

Globalia Business Travel S.A.U (Globalia) chartered a ship from Fulton Shipping Inc of Panama (Fulton).  The charter was later extended for two years by oral agreement.  Globalia denied that the charter had been extended and said it was entitled to end the charter on the original date.  Fulton treated this as a repudiatory breach of contract, which it accepted.  Because Fulton could not recharter the ship, it sold it in a very favourable market in October 2007, for USD 23,756,000. 

The redelivery date under the extended charter was November 2009, and the world financial crisis happened between the actual date of sale and the contractual redelivery date.  If the ship had been redelivered at the extended contractual date, its value would have only been USD 7,000,000. 

Fulton claimed damages for loss of USD 7,558,375 profits that it would have earned in the two years by which the charter had been cut short.  In response, Globalia said it should be given credit for the difference between the price (USD 23,756,000) Fulton received when it sold the ship in October 2007 and the much lower amount (USD 7,000,000) it would have received if Fulton had sold it in the depressed market in November 2009 (which is when the charter should have expired but for the breach).  Globalia thus claimed Fulton had actually made a profit from Globalia’s breach of contract.  Fulton said this “profit” was legally irrelevant and should be ignored in any calculation of damages.

High Court – profit was not relevant as it was not caused by Globalia’s breach

The claim went to arbitration and then (relying on s69 Arbitration Act 1996) to the High Court.  In the High Court, Popplewell J agreed with Fulton that the benefit it had received from the early sale should be disregarded “because it was not a benefit which was legally caused by the breach”.   He found in Fulton’s favour by analysing what had caused the beneficial sale price.  It was not caused by Globalia’s breach of contract but “by the fall in the market which occurred irrespective of such breach”.  Movement in the market after Fulton’s decision to sell was irrelevant, and “The breach merely provided the context or occasion for the owners to realise the capital value”.  It was the trigger not the cause.

Court of Appeal disagrees

Longmore LJ found for Globalia that “if a claimant adopts by way of mitigation a measure which arises out of the consequences of the breach and is in the ordinary course of business and such measure benefits the claimant, that benefit is normally to be brought into account in assessing the claimant’s loss unless the measure is wholly independent of the relationship of the claimant and the defendant”.   He also noted that, if Fulton had reacted to the breach by spot-chartering at a higher rate, that higher rate would have been taken into account when assessing any losses caused by the breach.  Longmore LJ did not see a good reason to treat the consequences of a sale any differently.  The other members of the Court of Appeal reached the same conclusion.

Supreme Court – agrees with High Court

The Supreme Court agreed with Popplewell J.  In particular: “the increase in value of the vessel was… irrelevant because the owners’ interest in the capital value of the vessel had nothing to do with the interest injured by the charterers’ repudiation of the charterparty”.

Lord Clarke agreed with Popplewell J in that, as a general rule, there is no requirement that a benefit caused by a breach has to be of the same kind as the loss caused by such a breach in order for it to be taken into account in assessing a loss – a difference in kind would be “too vague and potentially too arbitrary a test” to apply. 

Test – causation

The essential question is whether there is a sufficiently close link between the benefit and the loss, not 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 of the counterparty or by a successful act of mitigation.

What was lacking in this case was a causal link.  The benefit Fulton received had to be one caused either by the breach, or by Fulton’s mitigation. “The analysis is the same even if the owners’ commercial reason for selling is that there is no work for the vessel.  At the most, that means that the premature termination is the occasion for selling the vessel.  It is not the legal cause of it.”

Sale of ship was a commercial decision

Not caused by breach

The loss caused by the breach was a loss of two years’ income from chartering the ship.  However, there was nothing in the nature of the breach that made it necessary for the owners to respond by selling the vessel, either when the breach happened, or at all.  Fulton could have sold the ship at any time, even whilst the charter existed (so long as it did so subject to the terms of the charter).  “If the owners decide to sell the vessel, whether before or after termination of the charterparty, they are making a commercial decision at their own risk about the disposal of an interest in the vessel which was no part of the subject matter of the charterparty and had nothing to do with the charterers.”

Not caused by act of mitigation

The sale had not been an act of mitigation.  The relevant mitigation in context would have been the acquisition of an income stream alternative to the income stream under the original charterparty.  Where there is no available market, the measure of the loss is the difference between the contract rate and what was or ought reasonably to have been earned from employment of the vessel under shorter charterparties.  The sale of the vessel was not an act of mitigation because it was incapable of mitigating the loss of the income stream.

Comment

This is a difficult case, as suggested by the fact that an arbitrator and the Court of Appeal found in favour of Globalia, and the High Court and Supreme Court found in favour of Fulton. 

Damages in English law reflect an underlying principle that an innocent party should be left in the same economic position as it would have been in if the relevant contract had been fulfilled.  In this case, if the contract had been fulfilled, Fulton would have received two more years of charter income and, presumably, still have owned the ship and had it available to charter out to earn more income.  However, and crucially, Fulton might have decided to sell the ship at any time, during, or after, the charter period with Globalia.  On this basis, Lord Clarke held that the sale, which happened to have occurred when Globalia wrongly repudiated, was effectively an independent event.  As Popplewell J had said, any gain from the timing of the sale should be disregarded “because it was not a benefit which was legally caused by the breach”.   A causal link thus remains key.

However, this remains potentially problematic, or at least highly fact-dependant.  It might be that the sale was caused by the breach.  Thus Lord Clarke addresses what should happen if there is no relevant alternative market in which the particular asset could be used, and suggests that the income available from short charterparties could have been used to measure any loss.  It is less clear what should happen when there is no sufficiently comparable alternative income stream, or the asset could not be used to generate such income streams.  In such cases, a sale might be the only option.  This suggests that causation between the breach and the sale might be found in such cases.  If so, the court might find that credit for a higher sale price should be given.

Separately, Lord Clarke’s judgment includes a useful summary of Popplewell J’s account of the general principles “which determines when a wrongdoer obtains credit for a benefit received following his breach of contract or duty”.  Popplewell J says that “the search for a single rule… is elusive”.  Nonetheless, Popplewell J and Lord Clarke provided a handy starting point for any analysis of this.

Although this case arises in the shipping context, its impact is broader, for example on questions of mitigation involving any type of asset leasing.

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication. For more information please contact Amy Edwards at amy.edwards@allenovery.com.

 

This case was also covered on Compact Contract, a blog where experts from Allen & Overy analyse the latest contract law themes and developments, and what they mean for your business.​