Money down the drain? How to avoid damages being sunk by remoteness.

Richard Farnhill

The fact that your contract has been breached and the breach has caused you losses is not enough for you to make a recovery. Remoteness is the often overlooked third leg of the damages stool. In AG of the Virgin Islands v Central Water Associates the Privy Council gave more guidance on how the rules in this area work.

The British Virgin Islands Government needed a water reclamation and treatment plant. It therefore engaged Central Water Associates (CWA) under two agreements: a design and build agreement (the DBA), under which the Government would provide a site prepared for construction and CWA would build the plant; and a management, operation and maintenance agreement (the MOMA), under which CWA would operate the plant. That, at least was the plan. The Government effectively pulled the plug when it failed to provide the site. CWA subsequently terminated the DBA; this meant that a condition precedent to the MOMA was not satisfied such that it, too, fell away.

Although the Government’s failure had ultimately brought down both the DBA and the MOMA it had done so in somewhat different ways. The Government had breached an express promissory condition of the DBA, which gave CWA a right to claim damages. However, most of CWA’s losses flowed from the profits it would have earned under the MOMA, and there had been no breach of any express term of the MOMA. True, a condition precedent had not been satisfied, but failure to satisfy a condition precedent is not in itself a breach (in a pure condition precedent a party does not promise that it will do something, it simply agrees what will happen if that something does not happen) and so does not give rise to a damages claim. So (the Government argued) the contract that had been breached did not give rise to the lost profits; and the contract that gave rise to the lost profits had not been breached.

CWA was not ready to see its claim flushed away in such a fashion. It advanced two arguments before the Privy Council:

  1. There was an implied term in the MOMA that had been breached. Unfortunately for CWA, it changed its position between the original arbitration and the appeal, so it was impossible for the Privy Council to find there had been an error of law in the original finding and it would be inappropriate on an appeal of a question of law to consider a factual assertion that had not been advanced before the arbitration tribunal.
  2. The parties had known about the MOMA when they signed the DBA; indeed, the agreements were signed on the same day and by the same people. So it was entirely foreseeable that a breach that resulted in termination of the DBA would also cause a loss of profits under the MOMA. Those profits were therefore properly recoverable for the breach of the DBA, even though they arose under another contract. This was the remoteness issue.

The Privy Council started its analysis with the frequently cited rule in Hadley v Baxendale. There, it was found that two types of losses were recoverable: (i) those losses that arise in the ordinary course from such a breach of contract; and (ii) losses that were specifically in the contemplation of the parties at the time of contracting, typically because one party tells the other that it is unusually exposed to loss in some way. In light of that decision and the subsequent case law, the Privy Council formulated five propositions:

  1. Damages for breach of contract are compensatory; they are intended to put the party whose rights have been breached in the financial position it would have been had the contract been performed.
  2. However, recovery is limited to 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. In applying this approach the Privy Council cautioned against a pure probabilistic approach. Probability was relevant but, as the Supreme Court had noted in The Achilleas: “If a manufacturer of lightning conductors sells a defective conductor and the customer’s house burns down as a result, the manufacturer will not escape liability by proving that only one in a hundred of his customers’ buildings had actually been struck by lightning.”
  3. The question of what was reasonably in the parties’ contemplation depends on what they knew at the time, or at the very least what the party subsequently in breach knew at the time.
  4. The test is objective – it is not what the defendant actually contemplated that matters, it is what they must be taken to have contemplated.
  5. The criterion for assessing what a party had in its contemplation is a factual one.

Applying those propositions the Privy Council found that the losses under the MOMA would have been in the reasonable contemplation of the Government at the time it entered into the DBA: as was plain from both the terms of the contracts and the way they were entered into, they were intended to operate together. The Government had the requisite knowledge to satisfy the second limb of Hadley v Baxendale, meaning its remoteness defence failed.

The decision does not change any of the rules on remoteness, but is a useful, if rather short, summary of the key principles. It will obviously be of interest to litigators (and litigants) considering damages claims. Keep in mind, however, that references to “indirect and consequential loss”, often used in exclusion clauses, have been held to refer to losses recoverable under the second limb of Hadley v Baxendale, making this a decision of wider application. It may be a case about sewers, but it is in no way limited to suing.