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Reliance basis for claiming damages still subject to compensatory principle

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Amy Edwards

Senior PSL - Litigation

London

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04 October 2010

Omak Maritime Ltd v Mamola Challenger Shipping Co[2010] EWHC 2026 (Comm), 4 September 2010

In the case of Omak Maritime Ltd v Mamola Challenger Shipping Co[2010] it was decided that all claims for damages for breach of contract are based on the compensatory principle, ie that the claimant should be placed in the same position as if the contract had been performed.

This is irrespective of whether a claim is framed on the "reliance" basis, namely a claim for expenses incurred in reliance on a contract being performed, or on the "expectation" basis (ie expected profits less expenses). Where a defendant charterer had repudiated a charterparty, and the owner sued for wasted expenditure on the "reliance" basis, the court was entitled to look at what the owner would have earned had the contract been performed, and also take into account benefits received on alternative, more profitable charterparties. The court rejected the owner’s argument that the "reliance" basis was totally separate and required the court to put it in the position had the contract not been entered into at all. The claimant was unable to claim for its wasted expenditure as it suffered no net loss. It had been able to arrange charterparties at more favourable rates than the original charterparty, and the higher earnings from the replacement charterparties would more than offset the wasted expenditure.

This important judgment by Teare J, on appeal from a Maritime Arbitrators Association arbitration tribunal, considers whether the law allows recovery of wasted expenditure incurred by a party who has, as a result of mitigation, suffered no net loss as a result of a counterparty’s repudiatory breach of contract. There was no previous English authority on this issue.

The issue arose in the context of a contract of charterparty for five years between the claimant owner and defendant charterers. Under the charterparty the owner was required to make certain costly modifications to the vessel, including the installation of a new crane. The charterers repudiated the contract before even taking control of the vessel.

The owner commenced arbitration proceedings and obtained an arbitral award for the wasted expenditure which it had incurred for the modifications. The arbitrators found that the wasted expenditure was recoverable on the "reliance" basis even though, in fact, the owner would suffer no net loss as it had been able to arrange replacement charterparties at a much higher rate.

On appeal, the charterers argued that the owner should not recover more than nominal damages because the wasted expenditure would be more than offset by the increased amount that the owner was able to charter out the vessel for on the open market. The market hire rate was $21,347 per day, whereas under the charterparty it had been $13,700 per day. In short, the charterers argued that the owner would not suffer any net loss because the owner would earn more from the alternative charters than the amount of the wasted expenditure. Any decision to award more than nominal damages to the owner would therefore offend against the principle that contractual damages are compensatory, ie are designed to compensate a party so that it is in the same position had the contract been performed, as ennunciated by Baron Parke J in Robinson v Harman [1843-60] All ER Rep 383. This normally takes into account the expected profits, less expenses incurred, and is often referred to as the "expectation basis" for quantifying loss.

The owner claimed its losses on the "reliance" basis, ie amounts incurred by it in relying on the contract being performed. The owner argued that the reliance basis was completely different and separate from the expectation basis, and the increased profits on the alternative charters should not be offset against the wasted expenditure claim, as it should be put into the position had the contract not been entered into at all.

Teare J observed that the law permits a party to claim damages on the reliance basis rather than the expectation basis. The reliance basis means that a party can claim for amounts spent in reliance on the contract being performed. The key question was how, if at all, the compensatory principle applies to the reliance basis so that the claimant is not put into a better position than if the contract had been performed.

Teare J held that reliance loss is just a species of expectation loss, and cannot put a claimant in a better position than it would have been in had the contract been performed. This was extrapolated from US, Australian and Canadian authorities, and from the Court of Appeal case of C&P Haulage v Middleton [1983] 3 All ER 94. The expenditure which was sought to be recovered was incurred in expectation that the contract would be performed. It was therefore rational to have regard to the position that the claimant would have been in had the contract been performed. If the contract was unwise from the claimant’s point of view, because for example it was a speculative venture and his expenses were likely to exceed any gross profit, it was difficult to understand why the defendant should pay damages in an amount equal to that expenditure. The breach had not caused that loss. The defendant did not underwrite a claimant’s decision to enter into a contract.

The claimant’s expenditure should only be recoverable where the likely gross profit would at least cover that expenditure. The burden was on the defendant to show that the likely profits would not at least equal the claimant’s expenditure. The arbitrators’ error was to regard a claim for wasted expenses and a claim for loss of profits as two separate and independent claims which could not be mixed. The weight of authority clearly showed that both claims were illustrations of, and governed by, the fundamental compensatory principle in Robinson v Harman. This requires the court to compare the claimant’s position with what it would have been had the contract been performed, and to ensure that damages do not put a claimant in a better position than it would have been in had the contract been performed.

Where steps had been taken to mitigate the loss (as here where alternative, more profitable charterparties had been arranged), the benefits obtained by mitigation should be set against the loss which would otherwise have been sustained. To fail to do so would put the owner in a better position than he would have been in had the contract been performed. The owner had suffered no net loss as a result of the charterer’s breach and the owner had been able to charter the vessel at a greater profit.

The tribunal’s award was set aside.

Comment: This is an important contract case that clarifies that the reliance basis for claiming damages for breach of contract is merely a species of expectation loss, and follows the same compensatory principle that the claimant cannot be put into a better position than had the contract been performed, and benefits obtained from mitigation must be taken into account.

Imagine the following scenario: A and B enter into a contract. A spends £1,000 in reliance on B performing the contract. B repudiates the contract. A can choose how to frame its claim for damages.

A may choose the expectation basis (ie a claim for profits expected to flow from the contract, less expenses that it would have incurred) or the reliance basis (ie a claim for the £1,000 wasted expenditure). It is now clear, from this case, that if A elects the reliance basis, a court will look to see what position A would have been in had the contract been performed. If A has made a bad bargain, such that it is unlikely that its profits under the contract would have exceeded £1,000, then A will not be able to recover its wasted expenditure. This is because, had the contract been performed properly, A still would not have been able to recoup its £1,000 expenditure. If A has made a good bargain and future profits would have been likely to exceed £1,000, then A would be able to recover its expenditure. The evidential burden would be on B to show that A had made a bad bargain.

Consider further that A manages successfully to mitigate its loss by entering into an alternative contract on more attractive terms than the contract with B. Teare J has made it clear that those benefits obtained by mitigation would be offset against A’s claim.

Richard Farnhill has written an article explaining how a claimant should choose to frame its claim for damages: See the May 2010 Litigation Review "Damages – any other choice?".

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.