Privy Council finds loss of profits under separate contract not too remote to be recoverable

On an appeal from the Court of Appeal of the British Virgin Islands, the Privy Council has considered the damages that should have been awarded to a contractor as a result of the BVI Government's breach of contract in failing to provide a prepared project site to enable the contractor to install a water reclamation treatment plant: Attorney General of the Virgin Islands v Global Water Associates Ltd [2020] UKPC 18.

The Privy Council held that the contractor was entitled to claim damages for the loss of profits it would have earned under a separate 12 year contract to operate the plant on behalf of the Government. The breach had resulted in the plant not being built, and therefore the contractor being unable to earn profits in operating the plant. That type of loss was not too remote to be recoverable, as it was within the reasonable contemplation of the parties when they entered into the construction contract. It fell within the second limb of the classic Hadley v Baxendale test for recoverability of damages in contract, based on special circumstances known to the parties, rather than losses arising naturally from the breach.

As well as illustrating that, in some circumstances, a loss of profits under one contract may be recoverable for breach of another contract, the decision is of interest as a relatively rare example of a higher court considering the principles of remoteness of damage in contract.

Background

The Government of the BVI entered into two contracts with Global Water Associates Ltd ("GWA") relating to a proposed water reclamation treatment plant at Paraquita Bay in Tortola:

• a Design Build Agreement (“the DBA”) under which GWA agreed to design and build a water reclamation treatment plant at the site; and
• a Management, Operation and Maintenance Agreement (“the MOMA”) under which the Government engaged GWA to manage, operate and maintain the plant for a period of 12 years.

The Government failed to provide a prepared project site to enable the installation of the plant, as it was required to do under the DBA, and so the plant was not built and GWA was not able to earn profits under the MOMA. GWA terminated the DBA and referred to arbitration its claim for breach of the DBA, seeking as damages the profits it would have earned under the MOMA.

The arbitrators found that the Government had breached the DBA in failing to provide a prepared site, but that the damages claimed were too remote to be recoverable.

On GWA's application, the High Court in the BVI accepted GWA's argument that the arbitrators had erred in finding that the damages claimed were too remote, and remitted the award to the arbitrators to assess damages. The BVI Court of Appeal allowed the Government's appeal. GWA appealed to the Privy Council.

Decision

The Privy Council allowed GWA's appeal, agreeing with the High Court that there was an error of law on the face of the award in relation to the claim for damages for breach of the DBA.

Lord Hodge, who gave the judgment of the Board, considered in some detail the classic cases which have established the general principles on remoteness of damage in contract, namely Hadley v Baxendale (1854) 9 Exch 341, Victoria Laundry (Windsor) Ltd v Newman Industries Ltd [1949] 2 KB 528 and Koufos v C Czarnikow Ltd (“The Heron II”) [1969] 1 AC 350.

Hadley v Baxendale established that damages will be recoverable if the loss falls within either of two limbs:

1. a loss that would arise naturally, according to the usual course of things, from the breach of contract itself; or
2. a loss that may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of a breach - ie where the loss arises from special circumstances communicated to the defendant at the time of contracting.

In Victoria Laundry, the claimant launderers and dyers sought damages from the defendant seller of a large second-hand boiler, where delivery was delayed due to the boiler having been damaged in transit. The Court of Appeal held that the claimant could recover damages for loss of profits in respect of contracts that could reasonably be expected, but not the loss of profits on particularly profitable dyeing contracts where the existence of those contracts had not been communicated to the defendant.

In The Heron II, the House of Lords in general endorsed the principles stated in Victoria Laundry, but considered in further detail the extent to which it must be foreseeable that the loss in question might result from the breach. The various Law Lords used a number of phrases including that the loss was “liable” to result, or that it was a “serious possibility” or a “real danger”. In the present case, Lord Hodge said what was important was to identify what they were trying to encapsulate in their choice of language, which in his view was:

"whether as a question of fact the parties to a contract, or at least the defendant, reasonably contemplated, if they applied their minds to the possibility of breach when formulating the terms of the contract, that breach might cause a particular type of loss".

That was not solely a question of the percentage chance of such an event occurring, although that was not irrelevant. Lord Hodge referred to a more recent statement of the principle by Professor Andrew Burrows (now Lord Burrows) in “A Restatement of the English Law of Contract” (2016), which used the phrase "serious possibility".

From his review of the main authorities, Lord Hodge derived five propositions which, he said, summarised the position:

1. First, in principle the purpose of damages for breach of contract is to put the party whose rights have been breached in the same position, so far as money can do so, as if his or her rights had been observed.
2. But secondly, the party in a breach of contract is entitled to recover only such part of the loss actually resulting as was, at the time the contract was made, reasonably contemplated as liable to result from the breach. To be recoverable, the type of loss must have been reasonably contemplated as a serious possibility.
3. Thirdly, what was reasonably contemplated depends upon the knowledge which the parties possessed at that time or, in any event, which the party who later commits the breach then possessed.
4. Fourthly, the test to be applied is an objective one. One asks what the defendant must be taken to have had in his or her contemplation rather than only what he or she actually contemplated. In other words, one assumes that the defendant at the time the contract was made had thought about the consequences of its breach.
5. Fifthly, the criterion for deciding what the defendant must be taken to have had in his or her contemplation as the result of a breach of their contract is a factual one.

Applying those principles to the facts of the present case, Lord Hodge said it was clear that the losses resulting from an inability to earn profits under the MOMA were within the reasonable contemplation of the parties to the DBA when they made that contract. This was for a number of reasons, including that the contracts were entered into between the same parties on the same day and they both related to the same plant on the same site, giving rise to special knowledge under the second limb of the rule in Hadley v Baxendale. Further, the Government knew and intended that the performance of each party’s obligations under the DBA would lead to the commencement of the MOMA.

The arbitrators had recognised the vital interconnection of the DBA and the MOMA, but found that loss of profits under the MOMA flowed only from the MOMA and not the DBA. This was untenable. Although they were separate contracts, it was clear that a failure to perform the DBA would prevent GWA from obtaining profit from its performance of the MOMA.

The arbitrators had sought to distinguish Victoria Laundry on the basis that the claimant in that case was to be the owner of the boiler which it had contracted to purchase whereas here the Government, not GWA, was to own the plant. This was not, however, a tenable distinction.