Assessing damages for contract breaches in a Covid-19 world
01 JUN 2020
With most of the world currently under restrictions put in place to combat the Covid-19 pandemic, this new ‘lockdown’ reality has also made it more difficult for businesses to properly perform their contractual obligations owed to other parties.
Although we have already explained (Terminating a contract – the importance of getting it right) how Covid-19 restrictions may enable parties to avoid liability for contract breaches, in this article we outline what happens when liability is in fact established. We look at how the pandemic impacts the assessment of damages (i.e., a monetary sum) that can be claimed following the breach of a contract term.
What can the innocent party recover if a right to claim damages arises?
According to the so-called compensatory principle, the main objective of awarding damages is to place the innocent party in the position it would have been in had the contract been properly performed.
If a term is breached and the innocent party suffers loss, it will be able to recover all losses which are the usual consequence of such a breach or which the parties, when entering into the contract, knew to be a possible result of a breach. An innocent party cannot, therefore, recover the types of loss that the parties could not have anticipated as a result of the breach – such losses would be considered too remote.
For instance, a supplier agrees to deliver wheat to a bakery by May 2020 for £30,000. Early in May, the supplier informs the bakery that it will not be able to make the delivery due to shortages of staff related to Covid-19. The market value of the same amount of wheat at this point is £40,000. The baker will, therefore, replace the wheat by paying £40,000 and claim damages of £10,000 from the original supplier for his loss of bargain. This is a usual consequence of a contract breach (non-delivery) and is recoverable.
Imagine, alternatively, that the baker had also secured a lucrative £80,000 contract with a supermarket chain for the supply of bread to its stores, which he had failed to tell the wheat supplier about. If, in this case, no wheat was available to buy in the market at all, the baker would breach his obligations to the supermarket. Would he be able to recover the £80,000 from the wheat supplier as a loss resulting from its non-delivery? Probably not, since the lucrative contract would be unusual, and he failed to inform the supplier about it.
The amount of damages that a business can claim will depend on the facts of each situation. This is particularly true where, as the above example illustrates, Covid-19 restrictions have made goods or services impossible to replace. Nevertheless, case law suggests that where goods or services have become much more expensive to replace, unusual market conditions and higher prices will not prevent damages being awarded in full.
What must the innocent party do to mitigate its losses following a breach by the other party?
Damages are assessed on the assumption that the innocent party took reasonable steps to mitigate its losses caused by the other party’s breach. For instance, it is reasonable for parties to obtain replacement goods or services if there is a market for them. However, the innocent party is not expected to do what is not commercially sensible and act speculatively. In the context of Covid-19 economic uncertainty, courts will be slow to rule that parties acted unreasonably.
For instance, the abovementioned baker waits until June 2020 and only then looks for alternative wheat suppliers, at which point the same amount of wheat costs £50,000. The baker had to reasonably mitigate its losses by searching for alternative wheat in May 2020 shortly after the breach occurred. He will, therefore, only be able to claim the abovementioned £10,000 in damages instead of £20,000.
But what if the breach actually benefitted the party claiming damages? It is easy to imagine that, had some of the transactions which were halted due to Covid-19 actually been performed, they would have caused losses to the innocent party (for instance, if the transactions would have been loss-making, or if the prices for goods or services had suddenly fallen because of the lockdown restrictions). Such benefits will only reduce the amount of damages claimed by the party where the breach factually and legally caused the benefit to occur.
For instance, a retailer actually benefited from a supplier’s non-delivery because it did not have to accept the supplied goods and then worry about selling them in a market with no customer demand. The retailer’s benefit, in this case, is caused by the wider collapse in the market rather than the supplier’s breach. The retailer will, therefore, be able to claim damages pursuant to the standard measures, without taking into account the broader benefits it obtained.
How will damages for pre-pandemic breaches be assessed?
The Covid-19 restrictions will also impact the assessment of damages for breaches that occurred prior to the pandemic.
The traditional measure of damages according to the compensatory principle is to put the innocent party into the position it would have been in had the breach not occurred. This is generally calculated at the time of the breach by reference to forecasts of how much profit the party would have made.
For instance, a clothes manufacturer agrees to deliver clothes to a retailer in March 2020 for £50,000. If the manufacturer fails to deliver last minute and the retailer has no time to find a replacement, the latter will claim damages for the loss of profits it could have made on these clothes. This would be assessed by calculating how much profit the retailer could reasonably have made had the clothes been delivered – for example, £70,000.
However, Covid-19 clearly impacts the innocent party’s actual profits (which may now be far lower, given the sharp decrease in consumer demand) and losses (which may now be far higher, given, say, the need to purchase additional safety equipment).
The impact of Covid-19 also means that if, after the breach occurred, the contract would have been ended (by termination or discharge by frustration Covid-19, impact on commercial contracts) anyways, this must be taken into account when assessing damages. Damages only compensate for the performance which the innocent would have actually been able to provide.
For instance, the abovementioned retailer is forced to close its shops in April 2020 due to Government restrictions. Even if the manufacturer did deliver the clothes on time in March 2020, the retailer would not have been able to sell them in April 2020 anyway. The retailer does not suffer any loss because of the manufacturer’s breach. He will therefore likely not be able to claim the loss of profit from the manufacturer.
In general, the ability to factor the impact of Covid-19 in assessing damages will be helpful for parties that were in breach of contract before the pandemic occurred. This will ensure that the innocent party is only compensated for its true loss suffered during the pandemic.
Overall, the assessment of damages is a complex issue that is sensitive to the facts of your situation. If you need additional guidance and support with your contracts (Covid-19 related or otherwise), we are open for business as usual and are happy to advise. Please get in touch with our team at email@example.com.
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