Contractual damages

The judgment of the House of Lords in Transfield Shipping Inc v Mercator Shipping Inc (The Achilleas) [2008] UKHL 48 considered the law on recoverable damages following a breach of contract. Although all members of the House were in agreement as to the outcome of the appeal on the facts, there were differences in the reasoning. The way in which the case is interpreted going forwards and, in particular, the reasoning that is adopted, will play an important role in the law of contractual damages.

The Facts

By a time charter dated 22 January 2003, the appellant, Transfield Shipping Inc ("Transfield") chartered a vessel from Mercator Shipping Inc ("Mercator") at a daily rate of US$13,500 for a period of five to seven months. By an addendum dated 12 September 2003, the vessel was chartered for a further five to seven months at a daily rate of US$16,750 with the latest date for redelivery set at 2 May 2004.

On 20 April 2004, Transfield gave notice of redelivery between 30 April and 2 May 2004. Mercator fixed a new four to six month charter with a third party which, due to prevailing market conditions, was at a daily rate of US$39,500. The latest date for delivery to the third party charterer was 8 May 2004.

Less than two weeks before 2 May 2004, Transfield sub-chartered the vessel. Due to delays outside of the control of Transfield, the vessel was not redelivered until 11 May 2004. By that time, charter market rates had fallen and Mercator agreed with the third party charterer to reduce the daily rate in the new charter to US$31,500 in return for the third party charterer agreeing to extend the cancellation date to 11 May 2004.

Mercator claimed from Transfield the US$8,000 per day difference between the daily rate it originally agreed with the third party charterer and the amended daily rate it agreed due to the late redelivery of the vessel. The sum claimed totalled US$1,364,584.37. Transfield submitted that the claim should be limited to the difference between the market rate and the charter rate for the nine day period during which Mercator could not use the vessel. The alternative sum totalled US$158,301.17.

Decision of Arbitrator, High Court and Court of Appeal

The claim went first to arbitration where by a two to one majority, the tribunal allowed Mercator's claim in full. First Mr Justice Christopher Clarke and then a Court of Appeal composed of Lord Justice Ward, Lord Justice Tuckey and Lord Justice Rix upheld the majority arbitral award.

The Issue on Appeal

The question before the House of Lords is summarised in the judgment of Lord Hoffmann as follows:

"is the rule that a party may recover losses which were foreseeable ("not unlikely") an external rule of law, imposed upon the parties to every contract in default of express provision to the contrary, or is it a prima facie assumption about what the parties may be taken to have intended, no doubt applicable in the great majority of cases but capable of rebuttal in cases in which the context, surrounding circumstances or general understanding in the relevant market shows that a party would not reasonably have been regarded as assuming responsibility for such losses?"

In short, could the House of Lords move beyond the Hadley v Baxendale (1854) 9 Exch 341 and The Heron II [1969] 1 AC 350 line of authority based on foreseeability and consider any limitations on recoverable damages?

Judgment of the House of Lords

The House of Lords unanimously allowed the appeal and Mercator were restricted in its recovery to the difference between the market rate and the charter rate for the period during which it was prevented from using the vessel by the delay in its redelivery. All five of the Appellate Committee gave a reasoned judgment, and different schools of thought can be detected in the judgments as regards the reasons for allowing the appeal.

Assumed Responsibility - Lord Hoffmann and Lord Hope

Lord Hoffman and Lord Hope opined that the appropriate test was not simply to determine whether the loss was one which was not unlikely. Rather, it was to ascertain the scope of the obligations for which the contractor could reasonably be expected to have assumed responsibility for. Although the charter of the vessel to a third party charterer and the fluctuation of market values were "not unlikely", these were not losses for which Transfield assumed responsibility. Lord Hoffmann and Lord Hope gave several reasons for that conclusion:

1. Although it would be considered likely that Mercator would enter into a future charter, the risk was unquantifiable as, at the time of the charter to Transfield, neither party would have any idea about when the further charter would be entered into, its length or other terms.
2. Mercator could have rejected Transfield's orders for the final charter had it been clear to the Mercator that the last charter was bound to overrun. It did not do so and the final charter was a legitimate use of the vessel which, but for circumstances beyond the control of Transfield, would not have resulted in late delivery.
3. The charter market has proceeded for a number years on the basis that the correct damages calculation for late redelivery of a vessel was the difference between the market rate and the charter rate for the period of late delivery. Lord Hoffmann referred to several authorities in support of that point.
4. If Transfield had intended to and been aware of an obligation to assume a liability for the type of damages claimed by Mercator, Transfield could have negotiated with Mercator a discount for assuming that risk.

Matters in Contemplation of the Parties - Lord Rodger and Baroness Hale

Although both Lord Rodger and Baroness Hale allowed the appeal, both, and in particular Baroness Hale, did so on a slightly narrower ground. In a steady or rising charter party market, the claim by Mercator would never have arisen. It is assumed in the market that there will usually be adequate demand for chartered vessels and that, should a late redelivery take place, the owner will be able to fix a charter with a third party without loss, even if it loses a pre-arranged charter due to the late redelivery. Therefore, the only loss would be the difference between the market rate and the charter rate for the period of redelivery.

In the current case, it was only because the market was extremely volatile, with the value of the charter daily rate falling US$8,000 (or approximately 20%) over a very short period. That volatility created the additional loss in relation to a third party contract that Transfield knew nothing about. The loss was not one for which Lord Rodger and Baroness Hale would hold Transfield to be liable. As Baroness Hale stated, "It is one thing to say… that missing dates for a subsequent fixture was within the parties' contemplation as "not unlikely". It is another thing to say that the "extremely volatile" conditions which brought about this particular loss were "not unlikely"." That reasoning, therefore, would continue the foreseeability test of Hadley v Baxendale and The Heron II.

The difference in the judgments of Lord Rodger and Baroness Hale is that, although Lord Rodger states that he does not find it necessary to explore the question of assumption of responsibility considered by Lord Hoffman, he does state that he is "otherwise in substantial agreement with [Lord Hoffman's] reasons". By contrast, Baroness Hale expressed her hesitance to follow the assumption of responsibility reasoning, preferring to leave such considerations for future cases.

Nature and Object of the Contract – Lord Walker

Lord Walker considers the assumption of responsibility test, but neither endorses nor rejects it explicitly. The test Lord Walker appears to prefer is the "question of what the contracting parties must be taken to have had in mind, having regard to the nature and object of the business transaction". Although, perhaps, a slight development on the existing line of case law, such a test would not seem to go as far as that expounded by Lord Hoffmann. Having said that, Lord Walker concludes his judgment with "For these reasons, and for the further reasons given by my noble and learned friend Lord Hoffmann, Lord Hope and Lord Rodger…I would allow this appeal".

Comment

On one reading, the case continues Lord Hoffman's reformulation of recoverable damages commenced with the seminal SAAMCO case (South Australia Asset Management Corp v Young Montague Ltd [1997] AC 191). In SAAMCO, Lord Hoffmann, giving the only judgment, with which there was unanimous agreement in the House, held that in the professional negligence context, a Claimant could only recover from a Defendant damages that fall within the scope of the duty owed by the Defendant to the Claimant. The agreement must be construed as a whole in its commercial setting. If that reasoning is adopted, Transfield v Mercator may extend that principle into a wider contractual field.

On an alternative reading, the effect of the case is not nearly as dramatic. There were only two Law Lords that specifically adopted the assumption of responsibility test (although Lord Walker's "nature and objects" test could be seen as similar to the SAAMCO construction test) with Baroness Hale fiercely critical of any such principle. Further, the facts of the case were very specific. It is customary in the charter party market that the only damages that are recoverable are calculated by reference to the difference between the market rate and the charter rate for the period of late delivery; the final sub-charter that led to the late delivery was a legitimate contract for which there was adequate time and about which Mercator could have objected if it felt there was not adequate time; the late delivery was due to circumstances outside of Transfield's control; and the only reason there was a claim (or at least a claim of such magnitude) was because of the volatility of the charter party market at that time.

Even Lord Hoffmann made clear that the traditional test for recoverable damages of Hadley v Baxendale and The Heron II would be the starting point and that the assumption of responsibility test should only be used where the circumstances require it. It remains to be seen, therefore, whether Transfield v Mercator has any significant practical impact on the law of recoverable contractual damages.

The law on contractual damages is, of course, subject to the express agreement of the contracting parties. It would have been open to the charter parties to agree that the charterer would be liable to the owner for loss of profit on future fixtures as a result of late delivery. Indeed, Lord Hoffmann's test is concerned to discover the intention of the parties in that regard. Therefore, if there is a particular head of loss about which a party is concerned to pass on potential liability to a counterparty, there is no impediment to making specific agreement to that effect.