Legal Briefing

Are limited damages adequate?

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Corporate & Commercial | 01 April 2014

In AB v CD [2014] the High Court held, with a degree of uncertainty, that the fact that contractual damages are subject to a limitation clause does not mean that those damages are not adequate, as required for the granting of an injunction under the American Cyanamid1 guidelines.

APPLICATION

The claimant had applied for an injunction to restrain the defendant from terminating a contract, pending resolution of an arbitration.

The defendant owned the intellectual property in an electronic platform for the sale and purchase of goods and services by entities involved in the mining, metals and other natural resources businesses (the eMarketplace). Under the terms of a licensing agreement (the Agreement), the claimant was licensed to market the eMarketplace to potential participants in the Middle East and to supply them with training and support.

Following the initial five-year term, the Agreement was automatically to renew annually subject to the defendant’s entitlement to terminate. After the initial period, the defendant was entitled to terminate on notice in the event that (i) the claimant failed to meet in material respects an agreed sales and marketing plan or (ii) the claimant’s business had developed in a different direction to the defendant’s (the Termination Requirements).

The defendant served notice that it would terminate the Agreement on 31 December 2013 on the basis the Termination Requirements had been met. The claimant issued an application for injunctive relief and (in accordance with the arbitration clause in the Agreement) made a request for arbitration.

Under the terms of the Agreement, neither party would be liable to the other party for lost profits or any indirect, special, consequential or incidental damages and damages would be limited to certain entitlements arising during the six months prior to breach.

AMERICAN CYANAMID

The questions to be answered when considering the grant of injunctive relief 
as set out in American Cyanamid are 
well known:

  1. Is there a serious issue to be tried?
  2. Are damages an adequate remedy for the applicant (if the injunction is not granted) or the respondent (if the injunction is granted)?
  3. If not, in which direction does the balance of convenience lean?
Serious issue

Having been presented with no serious argument to the contrary, Mr Justice 
Stuart-Smith held that there was a serious issue to be tried.

Adequacy of damages

While the claimant put forward a number of alternative arguments as to why damages would not be adequate (all rejected), the argument that received the most judicial consideration was that the damages to which the claimant would be entitled in the event that it successfully proved wrongful termination were limited by the Agreement, that the damage that would be suffered by the claimant as a result of the breach would be significantly more than the recoverable damages, and therefore that damages would not be adequate. Stuart-Smith J saw this argument as going to the heart of the meaning of the phrase ‘adequacy of damages’ and exposing a latent ambiguity in Lord Diplock’s exposition of the principle in American Cyanamid: does adequate remedy mean a remedy that provides (so far as money can) full compensation for what has been lost or does it mean a remedy that is regarded as adequate by the law, even though it may fall short of providing full compensation?

Having noted the surprising lack of authority on the point and the fact that the Court’s approach to the adequacy of damages question ‘is not bound by inflexible rules’, Stuart-Smith J proceeded briefly to consider three authorities: Bath and North East Somerset DC v Mowlem plc [2004]; Vertex Data Science Ltd v Powergen Retail Ltd [2006]; and Ericsson AB v Eads Defence and Security Systems Ltd [2009].

In Bath, the defendant contractor was denying another contractor entry to a construction site, the effect of which was to leave a high-profile construction project ‘sterilised in some sort of limbo’. The High Court held that the effect of a liquidated and ascertained damages clause between the claimant council and the defendant was that the council would sustain damage that would not be adequately compensated by an award of damages unless the injuction was granted.

The Court of Appeal upheld the injunction. Stuart-Smith J quoted the substantive judgment of Lord Justice Mance at some length. The quoted passage starts with 
an assumption that the damages ‘are viewed as an attempted measure of 
the full loss likely to be suffered or recoverable at common law by the 
Council’ and goes on:

‘… [the defendant’s] case treats the parties’ quantification of such loss as conclusive not merely in the context 
of a claim to recover damages, but also in the context of a claim to an injunction which is designed to avoid any further financial loss and any cause for a claim to such damages’.

Mance LJ reasoned that the defendant was not entitled to breach its contract, that the agreement on liquidated and ascertained damages is not an agreed price to permit the defendant to do so and that it does not preclude the court granting any other relief that may be appropriate. Mance LJ concluded that:

‘… it is open to the Council, despite the liquidated and ascertained damages clause, to rely on the probably higher level of the actual loss that it would suffer without an injunction, in order to show that it would not be adequately compensated if it were left to a claim 
in damages.’

In contrast to Bath, Vertex involved consideration not of a liquidated damages clause but a limitation clause. Having first referenced Lord Justice Millett’s observation that ‘the equitable jurisdiction should not be exercised in a manner which would defeat the commercial expectations of the parties at the time when they entered into their contractual obligations’2, Mr Justice Tomlinson stated that, in circumstances where sophisticated parties excluded liability for certain heads of loss and imposed a cap on liability:

‘… it is not immediately obvious to me that it would be unjust for [the claimant] to be confined to such remedy in damages as is determined to be the extent of the bargain which it struck’.

Having emphasised the ‘extraordinary’ factual background to Bath, he nevertheless acknowledged the possibility that the approach of the Court of Appeal in Bath may preclude the court from concluding that it is not unjust that the claimant should be confined to its remedy in damages. However, having previously concluded that injunctive relief would be inappropriate for other reasons, Tomlinson J was not required to reach a conclusion on the point.

Finally, Stuart-Smith J considered the Technology and Construction Court’s decision in Ericsson. Again, this was concerned with a limitation of liability clause that prevented the parties from recovering most types of economic loss (such as loss of profit or production) and capped the amount of recoverable damages. Mr Justice Akenhead emphasised that ‘both parties are in commercial terms very substantial entities’ and concluded that:

‘I cannot see that it is unjust that a party is confined to the recovery of such damages as the contract, which it has entered into freely, permits it to recover.’

Following his review of the authorities, Stuart-Smith J explained that the claimant had submitted that the Court should follow Bath and ‘by implication’ that the claimant had submitted that the reasoning of Akenhead J in Ericsson was wrong. While he finds the argument that the court should look behind an agreement to the substance of whether or not damages are an adequate remedy ‘attractive’ at first sight, he concludes that it was wrong: the Bath and Ericsson cases can be distinguished on the basis that the former is concerned with a liquidation damages clause, the purpose of which was to estimate what the damages would be in order that the damaged party be fully compensated; the latter is concerned with a clause the purpose of which was that the relevant heads of damage should not be compensated. The Court was entitled to take into account that purpose when deciding whether it was unjust for the party to be confined to its recoverable damages even though they fell short of full compensation.

Stuart-Smith J held that, in light of the parties’ intention to limit damages and exclude heads of damages, it was not unjust to exclude the effect of the limitation clause when considering whether or not it should be left to its remedy in damages. In the absence of any further sustainable argument, Stuart-Smith J dismissed the application.

Stuart-Smith J admitted to ‘a degree of unease at the result’ stemming from a tension between the American Cyanamid approach as applied in Bath and that suggested by Tomlinson J in Vertexand adopted by Akenhead J in Ericsson. He noted in particular that Mance LJ’s judgment in Bath ‘hints that the equitable jurisdiction has a more fundamental objective, namely “to avoid any further financial loss and any cause for a claim to such damages”’ and that it was evident that the Court of Appeal in Bath objected to treating the contract freely entered into by the parties as setting a price for a party’s breach of contract. As a result of this unease, the claimant was given permission to appeal.

COMMENT

Reading the judgment, one might assume that the Court in Ericsson considered the conflict between its conclusion and the Court of Appeal’s judgment in Bath, however this was not the case: in its judgment, the Court did not specifically address the argument that the limitation of damages would mean that damages were not adequate. The claimant’s argument in 
that case appears to have been that, if it was refused an injunction, termination would have a serious effect on its business, that it would entail the redundancy of a number of staff and that it would be muzzled by the confidentiality clauses in the agreement. It was presumably for that reason that the Court in Ericsson did not even consider the Bath judgment. Given that Ericsson did not therefore represent authority for an alternative approach to the issue, it would appear that the question asked by Tomlinson J remains: does the Court of Appeal’s approach in Bath preclude a lower court from concluding that it is not unjust that the claimant should be confined to its remedy in damages?

The result in AB v CD certainly holds some attraction. One can see that Stuart-Smith J was seeking to marry up the equitable result reached in Bath, whereby a wrongdoer is not entitled to see liquidated damages as the price at which it can walk away from a contract regardless of the damage, with the contractual certainty secured by the approach taken in Ericsson. Further, taking into account the nature of the clause restricting damages (namely whether it is a limitation clause or a liquidated damages clause) is certainly in line with the purposive approach to contractual interpretation. However, it is not entirely clear that this approach is in fact right (following Bath) or indeed necessary on the basis that the contractual certainty argument is not as strong as it may first appear: the court is not creating contractual uncertainty as the contractual provision remains intact and the wrongdoer is not being required to pay more than the agreed amount. With that in mind, there would appear to be a very good argument for the court to retain a discretion to consider the practical implications of limitation clauses in this context, particularly in exceptional circumstances where not to do so would have serious financial consequences for one of the parties.

By Alexandra Radcliffe, associate, 
Edwards Wildman Palmer UK LLP.

E-mail: ARadcliffe@edwardswildman.com

Notes


  1. See American Cyanamid v Ethicon Ltd [1975].
  2. See Co-operative Insurance v Argyll Stores Ltd [1996] at 305G.