Performance and compensation: An analysis of contract damages and contractual obligation

Oxford Journal of Legal Studies

Volumn 26, Issue 1, 2006, Pages 41-71

  Webb, Charlie ^a  

^a UNIVERSITY OF OXFORD   (United Kingdom)

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EID: 33645749050     PISSN: 01436503     EISSN: 14643820     Source Type: Journal    
DOI: 10.1093/ojls/gqi044     Document Type: Article

References (108)

1. See P. Cane, The Anatomy of Tort Law (1997) for an analysis of those interests protected by the law of torts.
2. J. Austin, Lectures on Jurisprudence (3rd edn 1869), Lecture XLV.
3. English law does on occasion admit other responses to a breach of primary duty, notably a right to disgorgement of the profits acquired by the defendant as a result of his breach and punitive damages. The former has now been recognized as an available response to (some) breaches of contract: See Attorney-General v Blake [2001] 1 AC 268. It is questionable whether it is accurate to say that these other responses reflect a secondary interest of the claimant. The justifications of permitting these other responses may lie in more general public policy considerations, such as the need to deter such conduct, not in any entitlement or interest of the particular claimant (although, of course, the consequence of giving effect to the policy is the creation of rights in the claimant). Consideration of these other responses is beyond the scope of this essay.
4. On this point see now N McBride, 'Duties of Care - Do they Really Exist?' (2004) 24 OJLS 417.
5. On which point see below, text to n 24.
6. A similar point comes out of a more general exploration of the instabilities of the term 'remedy' in P. Birks, 'Rights, Wrongs, and Remedies' (2000) 20 OJLS 1.
7. Such an argument is made in R. Nolan, 'Remedies for Breach of Contract: Specific Enforcement and Restitution' in F. Rose (ed.), Failure of Contracts: Contractual, Restitutionary, and Proprietary Consequences (1997) 35 at 37-8.
8. Birks, above n 6.
9. One of the advantages of the term 'remedy' is that it implies some such connection.
10. This terminology is borrowed from D. Friedmann, 'The Performance Interest in Contract Damages' (1995) 111 LQR 628.
11. Friedmann, ibid at 629 and 632, argues that the performance interest is 'the only pure contractual interest'. However, Friedmann views compensatory damages as a 'substitutional remedy' which protects the performance interest, thus leaving no scope for a secondary (compensatory) interest. For the reasons given in the text, this conflation of the primary and secondary interests cannot be maintained. A second challenge to the view that the compensatory interest can be regarded as a contractual interest comes from Professor Birks. Birks' taxonomy of legal rights (developed perhaps most fully in P. Birks, 'Property and Unjust Enrichment: Categorical Truths' [1997] NZ Law Review 623) classes rights by the events which lead to their creation. More specifically, this results in a distinction between rights arising in response to consent and rights arising in response to wrongs. On this basis, a contracting party's primary right, arising from the formation of the contract, falls into the former class, while his secondary right, arising from the wrong of breach of contract, falls into the latter group. However, it seems clear that the event of contract formation is equally central to both rights. One can say that, from the moment of entering into a contract, each contracting party has a right that the other party should compensate him for any losses which may result should that other breach the contract. It may be that the claim can only be made once the breach is committed, but the right to claim damages in respect of losses caused by breach is a right held by all contracting parties and arises by virtue of the contract they have entered into.
12. On this point see also Photo Production Ltd v Securicor Transport Ltd [1980] AC 827 at 849, per Lord Diplock. In any case, the question ultimately turns on what me mean by saying a right is 'contractual' and, significantly, Birks' analysis supports the point that these are distinct interests and rights.
13. Friedmann, above n 10 at 629.
14. See, for instance, Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 at 360, per Lord Mustill.
15. This would entail that the claim for damages would not be regarded as founded upon a breach of duty by the defendant. This is in effect the substance of Holmes' 'right to break a contract' theory, see further below, text to n 24.
16. Thus the position is taken in C. Mitchell, 'Remedial Inadequacy in Contract and the Role of Restitutionary Damages' (1999) 15 JCL 133 that contracts only confer a performance interest on a claimant if specific performance or, possibly, an award of damages measured as the cost of obtaining a substitute performance are available to him.
17. Similar arguments are also made in B. Coote, 'Contract Damages, Ruxley, and the Performance Interest' [1997] CLJ 537 at 541,
18. and E. McKendrick, 'Breach of Contract and the Meaning of Loss' (1999) 52 CLP 37 at 38.
19. (1848) 1 Exch 383 at 385.
20. This is recognized by Lord Clyde in Panatown Ltd v Alfred McAlpine Construction Ltd [2000] 4 All ER 97 at 111, where he states, 'a failure in the obligation to perform does not destroy the asset [the bargained for contractual rights]. On the contrary it remains the necessary legal basis for a remedy'.
21. See above, n 9.
22. L. Fuller and W. Perdue, 'The Reliance Interest in Contract Damages' (1936) 46 Yale LJ 52 and 373.
23. Ibid at 54.
24. See Coote, above n 15 at 540. Coote also argues that there is such an ambiguity in the Robinson v Harman formulation. However, for the reasons given in the text below, the reference to 'loss' makes it clear that this is a definition of the secondary (compensatory) interest, to the exclusion of the performance interest. Coote's position also differs from that taken here in that he regards the performance and compensation 'principles' as essentially competitive, contract law being able to give effect to one or the other, but not both. The position taken here is that is that the two interests are capable of co-existing and indeed do so in English law.
25. See above, n 16.
26. See below, n 44.
27. This is equivalent to the theory of contractual obligation put forward by Holmes: See O. W. Holmes Jr., The Common Law (1881). Holmes stated, at 301, 'the only universal consequence of a legally binding promise is, that the law makes the promisor pay damages if the promised event does not come to pass. In every case it leaves him free from interference until the time for fulfilment has gone by, and therefore free to break his contract if he chooses'. This argument is self-defeating for a similar reason to those mentioned above, at n 15 and accompanying text. The very fact that the promise is legally binding means that the promisor is not free at law to breach his contract, notwithstanding that the courts may, on occasion, be powerless to prevent his breach.
28. This also shows that an attempt to conflate the primary and secondary interests is in substance a denial of a primary performance interest.
29. A similar point is made by Birks, above n 6 at 27, although his distinction is founded on the events which generate the claims rather than the interests these claims protect. See also G. Treitel, Remedies for Breach of Contract (1988) at 42 and 75.
30. Indeed, so far as specific performance and injunctions are concerned, it may well be that the court would refuse to allow such a claim unless satisfied that a breach had been or would be committed on the basis that it is the breach of contract, actual or anticipatory, that makes it 'equitable' to grant the decree: See A. Burrows, Remedies for Torts and Breach of Contract (3rd edn, 2004) at 456. This does not change the fact that the claimant is asserting his primary right.
31. See below, n 12 et seq.
32. See, e.g. Co-operative Insurance Society Ltd v Argyll Stores (Holdings) Ltd [1998] AC 1 at 11, per Lord Hoffmann.
33. Above n 15 at 47.
34. See above, n 9.
35. e.g. Attorney-General v Blake [2001] 1 AC 268.
36. e.g. Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798. A performance interest claim may, perhaps, be brought in respect of such a breach where it is possible to return the land to its prior state. Although the claimant could not enforce the obligation not to develop, the end result of such performance, namely that the land remains undeveloped, could still be achieved: See below, nn 58-67.
37. It is for this reason that the dictum of Lord Diplock in Photo Production Ltd v Securicor Transport Ltd [1980] AC 827 at 848 that 'breaches of primary obligations give rise to substituted secondary obligations on the part of the party in default' may be called into question. For criticism of the view that secondary rights are 'substitutes' for primary rights see above, n 11 and accompanying text.
38. An analogy can be drawn with the cases dealing with the availability of injunctions to prevent the commission of the tort of nuisance. In such instances the courts have refused to allow considerations of public policy to limit the claimant to enforcement of his secondary rights: See Shelfer v City of London Electric Lighting Co [1895] 1 Ch 287 and Kennaway v Thompson [1981] QB 88.
39. Tang Man Sit v Capacious Investments Ltd [1996] 1 AC 514.
40. United Australia Ltd v Barclays Bank Ltd [1941] AC 1. Nothing turns on whether the restitutionary claim lies in the field of autonomous unjust enrichment or is an example of restitution for wrongs.
41. See Co-operative Insurance Society Ltd v Argyll Stores (Holdings) Ltd [1998] AC 1 at 15, per Lord Hoffmann, and Burrows, above n 27 at 456.
42. Co-operative Insurance Society Ltd v Argyll Stores (Holdings) Ltd [1998] AC 1 at 12 and 16, per Lord Hoffmann.
43. Particularly with regard to the 'consumer surplus': See below n 46.
44. Panatown Ltd v Alfred McAlpine Construction Ltd [2000] 4 All ER 97 at 154.
45. See also McKendrick, above n 15
46. and the dictum of Lord Mustill in Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 at 360.
47. This distinction between direct and consequential losses will tend to be clearer in relation to tort claims. For example, where the claimant's leg has been broken through the negligence of the defendant, the claimant's direct loss is the physical injury, the broken leg, while the cost of medical treatment, loss of future earnings and the like are examples of his consequential losses. The distinction is made in a contractual context by Lord Scott in Farley v Skinner [2001] 3 WLR 899. While this distinction may be relevant in English law in relation to the rules of remoteness and other principles restricting the recovery of certain types of loss, there is no reason why the full extent of a claimant's direct loss should necessarily be recoverable, especially if the award is to take account of the 'consumer surplus', on which see below n 46.
48. For a detailed analysis of the different types of loss, or heads of damage, which may form the basis of a claim for compensatory damages for breach of contract, see chs 9-13 of Burrows, above n 27.
49. Attorney-General v Blake [2001] 1 AC 268 at 282.
50. See further above, n 21.
51. In other words, by greater reference to the 'consumer surplus': See D. Harris, A. Ogus and J. Philips, 'Contract Remedies and the Consumer Surplus' (1979) 95 LQR 581. That the courts are beginning to pay heed to the fact that the claimant's valuation of the benefit derived from the defendant's performance may differ from the value placed upon it by the market is clear from Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344, in particular the speech of Lord Mustill, and Farley v Skinner [2001] 3 WLR 899, in particular the speeches of Lord Scott and Lord Hutton. It is important to note that the vindication of the performance interest and the proper recognition of the consumer surplus are distinct issues, the latter going to the compensation interest.
52. This can be obscured by the various dicta to the effect that the fact that the claimant contracted for the defendant's performance indicates that it must be of value to him, and hence, where the claimant then fails to receive this performance, he suffers a loss which is measured by the cost of obtaining that performance from another source: See, e.g. Woodar Investment Development Ltd v Wimpey Construction UK Ltd [1980] 1 WLR at 300-01, per Lord Scarman;
53. Panatown Ltd v Alfred McAlpine Construction Ltd [2000] 4 All ER 97 at 160, per Lord Millett, and at 151, per Lord Browne-Wilkinson. This involves a non-sequitur. While it is true that the fact that the claimant contracted for the performance indicates that it was of value to him, even if it has no positive market value, it does not follow that the loss entailed by its non-receipt will equate to the cost of cure.
54. Nor the term 'damages': See below, n 55.
55. [1994] 1 AC 85.
56. Ibid at 97.
57. This is the interpretation favoured by Lord Goff in Panatown Ltd v Alfred McAlpine Construction Ltd [2000] 4 All ER 97.
58. See also the confusing dictum of Lord Millett ibid at 160, which seems to attempt to conflate a compensatory interpretation with a performance interest analysis.
59. Ibid at 151.
60. See above n 46.
61. Panatown Ltd v Alfred McAlpine Construction Ltd [2000] 4 All ER 97 at 111.
62. See also Lord Clyde's statement in Farley v Skinner [2001] 3 WLR 899 at 915: 'The mere fact of a loss of a bargain should not be the subject of compensation'.
63. It may be said that the term 'damages' implies a compensatory approach: see H. McGregor, 'Restitutionary Damages' in P. Birks (ed.) Wrongs and Remedies in the Twenty-first Century (1988) 203. This may well be true and, moreover, could be an obstacle to appreciating that the performance interest, unlike the compensation interest, is not concerned with the claimant's loss. Nonetheless, the term 'damages' will be used here when referring to a monetary award designed to give effect to the performance interest as this is the terminology used by the courts and there are already other examples of damages assessed on a non-compensatory basis, for instance, nominal, punitive and restitutionary damages.
64. Though the claimant may be happy to accept that sum of money in lieu of the performance to which he is entitled under the contract, in which case his acceptance of that sum could give rise to an agreement to discharge, or at least to vary the terms of, the existing contract.
65. See Coote, above n 15 at 541-2
66. and McKendrick, above n 15 at 39.
67. See C. Fried, Contract as Promise (1981) ch 5.
68. This is another instance of the attitude to contractual obligation embodied in the theory of absolute liability: See Paradine v Jane (1647) Aleyn 26.
69. See Fried, above n 58 at 58-63.
70. Exemplified by the 'officious bystander' test set down by MacKinnon LJ in Shirlaw v Southern Foundries (1926) Ltd [1939] 2 KB 206 at 227.
71. See also Liverpool City Council v Irwin [1977] AC 239.
72. See Associated Japanese Bank (International) Ltd v Credit du Nord SA [1989] 1 WLR 255 at 268, per Steyn J and
73. Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696 at 728, per Lord Radcliffe.
74. As demonstrated by the tests set down in Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696 and Bell v Lever Brothers Ltd [1932] AC 161.
75. Such an approach to the implication of terms, while clearly not orthodox, does have some support in the cases. For instance, Nicholls LJ in Javad v Aqil [1991] 1 WLR 1007 at 1012: 'As with other consensually-based arrangements, parties frequently proceed with an arrangement whereby one person takes possession of another's land for payment without having agreed or directed their minds to one or more fundamental aspects of their transaction. In such cases the law, where appropriate, has to step in and fill the gaps in a way which is sensible and reasonable. The law will imply, from what was agreed and all the surrounding circumstances, the terms the parties are to be taken to have intended to apply'. This was made in the context of a dispute as to a purported lease, but there is no reason for restricting the principle to that context and it is clear that Nicholls LJ would not have so restricted it.
76. It should be noted that such an implied obligation would be a primary obligation, in the same way that an exclusion clause or liquidated damages clause also creates primary rights and obligations. Nor does such an obligation entail that the defendant is free to choose between providing the end product himself or paying a cost of cure sum.
77. Treitel, above n 26 at 1.
78. The position would be different if the obligation to deliver was conditional upon delivery being made by the due date.
79. Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 at 359.
80. Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85 at 98, per Lord Griffiths;
81. Darlington Borough Council v Wiltshier Northern Ltd [1995] 1 WLR 68 at 80, per Steyn LJ.
82. See above, n 21.
83. Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 at 357.
84. The same point has recently been made in S. A. Smith, Contract Theory (2004) at 422. To the extent that the claimant does not so use his award, he has no entitlement to it, and the defendant should be allowed to demand its return. This could plausibly be effected by a restitutionary claim founded on failure of basis (or consideration). The claimant is only entitled to that sum on the basis that it will be used to cure the defendant's defective performance, and so, to the extent that it is not so used, the basis of the payment fails.
85. Ibid at 369.
86. Ibid at 360.
87. However, it should be borne in mind when drawing this analogy that the issue in the frustration cases is whether the parties are discharged from all their contractual obligations, primary and secondary, whereas the issue here is whether the claimant should be restricted to his secondary rights.
88. Tennants (Lancashire) Ltd v C. S. Wilson & Co Ltd [1917] AC 485 at 510, per Earl Loreburn; Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696.
89. J. Lauritzen AS v Wijsmuller BV, The Super Servant Two [1990] 1 Lloyd's Rep 1.
90. An argument similar to that presented in the text also applies to another of the limits placed on the claimant's right to compensation, rules of remoteness.
91. G. Treitel, The Law of Contract (11th edn, 2003) at 977.
92. Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 is an excellent example of this.
93. It may appear odd to be arguing that incurring the cost of curing defects in performance is unreasonable (for the purposes of the mitigation rules) in the context of the broader argument that cost of cure awards should be more widely available. However, the point is that it is only the existence of the performance interest which can justify (at least in the usual case) a cost of cure award; compensatory principles alone will not. Accordingly, if a claim to recover the costs of curing such defects is to be successful, it must in the end involve an assertion of the claimant's right to performance.
94. Above nn 22-4.
95. A similar point arises in respect of Lord Lloyd's statement in Ruxley Electronics and Construction Ltd v Forsyth [1996] 1 AC 344 at 373, that, by undertaking to have the defective performance cured, a claimant 'cannot be allowed to create a loss which does not exist in order to punish the defendants for their breach of contract. The basic rule of damages...is that they are compensatory not punitive'. In the context of a compensatory claim, this is a standard application of mitigation principles. The party should not act unreasonably so as to increase his loss. But in the context of a performance interest claim, this statement makes little sense. The claimant's right that the defendant render the stipulated performance is unaffected by the subsequent conduct of the claimant. Any performance interest award which the court may order, and hence the defendant's potential liability in respect of such an award, remains the same regardless of the claimant's conduct after breach.
96. It should not be thought that the success of the argument put forward in the text would always enable a claimant to avoid mitigation. Even where the claimant brings a performance interest claim, the mitigation rules will apply to any compensation claim he may make for consequential losses which will subsist even if his performance interest claim succeeds. Furthermore, it may be that no performance interest claim is available (see below, text to nn 89-91) and so the claimant is limited to his claim for compensation, to which the mitigation rules apply.
97. This would see mitigation as having a similar rationale to the defence of contributory negligence.
98. Although it should be noted that the courts at present do allow claimants to avoid policy based limits (eg limitation or remoteness rules) placed on one claim by bringing an available concurrent claim to which no such limit exists or it is located elsewhere: See Henderson v Merrett Syndicates Ltd [1995] 2 AC 145.
99. The same issues must likewise be confronted by those who maintain that the availability of other performance interest claims should be limited so as not to circumvent the mitigation requirement: See, e.g., Burrows, above n 27 at 350-53.
100. It may be thought that there is a middle position whereby the economic waste policy would not prevent the right to performance arising but would merely preclude the claimant from then being able to enforce this right. But the policy question is surely the same at both stages (ie when deciding to what rights the contract gives rise and when deciding to what award the claimant is entitled), and so should receive the same answer at both points. So, if the policy against the wasteful application of resources requires us to conclude, at the outset, that the claimant should not be allowed to enforce his performance interest, and hence should be limited to an award ensuring that he is left no worse off by reason of not receiving that performance, it should likewise lead us to conclude that the claimant does not become entitled to, acquires no right to, that performance upon entry into the contract. There may be exceptional cases where, though at the time of contract formation the economic waste argument is not so strong as to preclude the claimant acquiring a right to the promised performance which the court would enforce, subsequent events, including the conduct of the defendant which constituted the breach, have greatly increased the economic waste involved in enforcing the performance interest such that such a claim should be refused. Wrotham Park Estate Co Ltd v Parkside Homes Ltd, above, n 32 may be an example of such a case.
101. See the examples given above, at nn 32 and 33 and accompanying text.
102. The question whether the property has been sold on at full value is irrelevant to such a claim because we are not concerned with the issue of compensation for loss. Cf. McKendrick, above n 15 at 66-8.
103. McKendrick, above, n 15 at 39. McKendrick's position is explicable on the basis that he sees the performance interest merely as giving rise to a broader notion of the loss to be made good by an award of compensatory damages, rather than identifying the performance interest as a different interest to the compensation interest.
104. Though the argument concerning the filling of gaps in contracts developed above, text to nn 58-65, may make such an interpretation of the parties' contractual obligations possible.
105. Tang Man Sit v Capacious Investments Ltd [1996] 1 AC 514
106. Burrows, above, n 27 at 14-16. The language of double recovery is avoided here as this implies recovery twice over in respect of the same loss. Where only one of the claims is compensatory, and hence loss related, this language is inapposite.
107. The possibility of combining performance interest and compensatory claims is already recognized by s 49 of the Supreme Court Act 1981, which allows a claim for compensatory damages to be combined with an action for specific performance. See Burrows, above n 27 at 506, giving the example of Jaques v Millar (1877) 6 Ch D 153.
108. An action for an agreed sum can also be combined with an action for damages; see Treitel, above, n 79 at 1014, citing Overstone Ltd v. Shipway [1962] 1 WLR 117.