Legal Briefing

Damages for repudiatory breach of contract: don’t assume the worst

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Corporate and commercial | 01 May 2014

When a party with which you have contracted informs you that they no longer intend to perform their obligations, this will amount to a repudiatory breach entitling you to terminate the agreement and seek damages. In such a case, you should be entitled to recover the amount that would put you in the same position financially that you would have been in had the contract been properly performed. In other words, contractual damages should represent the net loss suffered as a result of being unable to enforce the agreement.

Calculating loss can be problematic in situations where the defaulting party’s obligations are not definite, perhaps because they depend upon something else happening. Specifically, the extent of the defaulting party’s obligations may depend on some hypothetical action of the innocent party, such as where the innocent party is able to elect if and how often it will require the defaulting party to provide services.

In understanding how the courts will assess the level of damages due for breach of contract in such circumstances, it is necessary first to consider whether the innocent party would have acted in a certain way. Doing so will determine whether the breach has caused any loss – if the innocent party would not have requested the defaulting party to provide it with any services, it cannot be said to have suffered any loss by the defaulting party’s repudiation.

If it can be established, on the balance of probabilities, that the innocent party would have acted in such a way that the breach caused it loss, then it will also be necessary to consider the nature and extent of the defaulting party’s obligation to determine whether it had any leeway to minimise the cost in performing the contract. This is because damages will only be assessed on the basis that the defaulting party would have performed its obligations in the way which would have been least onerous to it.

These issues came to the fore in the recent decision of the Court of Appeal in SC Compania Nationala de Transporturi Aeriene Romane Tarom SA v Jet2.com Ltd [2014], which provides us with an opportunity to see how the courts will deal with the calculation of contractual damages in such circumstances.

TAROM V JET2

Background

In July 2004, Jet2 entered into a maintenance agreement whereby Tarom, the Romanian state airline, would provide base maintenance services to certain of Jet2’s aircraft. Jet2 was under no obligation to send any aircraft to Tarom under the agreement: it was purely within its discretion whether or not it did so. Under this agreement, Tarom would carry out extensive checks, the C-Checks, and any related work on Jet2’s aircraft pursuant to Jet2 providing Tarom with a ‘request for service’ and indicating the date upon which such work should commence. The request 
for service was to be issued to Tarom by 
1 December for ‘work commencement slots’ within the 12-month period from 1 September the following year. This requirement could be altered up to 1 June of the following year, after which Jet2 had to provide a maintenance plan and pay the appropriate deposit. The agreement was to last for an initial period of three years, although it could be (and was) extended for a further period of three years at Jet2’s discretion.

The payments due to Tarom under the agreement were calculated by using a fixed hourly rate of $26 per hour multiplied by the number of man hours that would be required to undertake specified types of work. Tarom offered the services at very competitive prices and, due to the fixed nature of the hourly rate, the prices would become increasingly attractive to Jet2 as the agreement continued. However, Jet2’s aircraft had to be taken out of service while they were sent to Romania and serviced and it was therefore very much in Jet2’s interests to have the work carried out punctually.

The agreement operated relatively smoothly until November 2006 when Tarom’s work began to be plagued by serious delays due to its difficulty in recruiting and retaining competent labour given the fixed rate of $26 contained in the agreement. Tarom then sought to renegotiate the terms of the agreement.

Jet2 elected to extend the agreement for a further three-year period in December 2006 and shortly thereafter provided Tarom with notice that it wanted to reserve two maintenance bays for the whole of the winter period the following year. Jet2 insisted it would only agree to renegotiate the agreement if Tarom continued to perform in accordance with the agreement’s original terms in the interim; Tarom indicated in July 2007 that it would not carry out further work unless the agreement was amended. At this time, Jet2 entered into discussions with a third party for the provision of maintenance services so that it had an alternative option to using Tarom.

On 10 September 2007, Tarom informed Jet2 that it was terminating the agreement on the basis that Jet2 had failed to make payment of fees due under the agreement. Although Jet2 agreed that the agreement had come to an end, it said that the agreement had been terminated in April 2007 when Tarom had made it clear it would be unable to continue to perform the agreement on the original terms.

Decision at first instance

It was found at first instance that the agreement had come to an end in September 2007. However, the judge 
found that Tarom did not have grounds 
to terminate for lack of payment, time 
not having been of the essence. Rather, 
the judge found that Tarom’s letter of 
10 September constituted a renunciation which was accepted by Jet2. Consequently, Jet2 was entitled to recover damages for Tarom’s repudiatory breach of the agreement.

The judge approached the issue of damages on the basis of an assumption that Tarom would have performed its obligations under the agreement when called upon to do so. This entailed treating Tarom as if it would have properly complied with its obligations from September 2007 onwards. On that basis, the judge found that aircraft would have continued to be sent to Tarom, notwithstanding that at the time the agreement was repudiated, alternative arrangements had been made. Judgment was entered for just over $3,800,000 (less $360,000 that Jet2 owed to Tarom). Tarom appealed the decision.

Court of Appeal decision

The Court of Appeal found that Jet2 was entitled to recover the value of the contractual benefits which it had lost as a result of Tarom renouncing the agreement. However, because Jet2 was not bound to send any aircraft to Tarom, working out what its losses were depended on assessing how many aircraft Jet2 would have sent to Tarom for the remainder of the term of the agreement. The Court of Appeal concluded that the result of that assessment itself depended upon what assessments were to be made about Tarom’s performance had the agreement continued.

Lord Justice Christopher Clarke, with whom the Master of the Rolls and Lord Justice Briggs agreed, decided that for the purpose of determining damages he was entitled to assume that Tarom would have been ready, willing and able to perform the services in accordance with the agreement, as such an assumption was necessary to give Jet2 the benefit of the agreement. Crucially, Clarke LJ was also willing to assume that Tarom’s ability and willingness to perform would have been apparent to Jet2 as it would make no sense to say that Tarom would have performed but this would have been kept a secret from Jet2.

The Court of Appeal agreed with the finding at first instance that, if it could be assumed Tarom would perform and Jet2 would be aware of this, Jet2 would have sent aircraft to Tarom for servicing. The judge had made a finding of fact that Jet2 had not, by September 2007, decided never to use Tarom again, and given the very favourable rates at which Tarom were obliged to perform the services, Jet2 would have wished to take advantage of them.

Tarom argued that a distinction should be made between the way the Court approached the issue of causation, which it said should only take into account the actual facts, and the question of assessment, where the Court should be entitled to assume performance in accordance with the agreement. It followed that if the Court was only able to look at the actual facts to determine what would have happened, it would have found that Jet2 would not have sent any further aircraft to Tarom and would therefore have suffered no loss. However, Clarke LJ described the distinction as fallacious and found that these issues could not be looked at in isolation: it was not possible to consider whether Jet2 would have sent any aircraft to Tarom without assuming that Tarom would have been ready and willing to perform in accordance with the agreement.

Clarke LJ found support for his approach in the dicta of Lord Justice Patten in the Court of Appeal decision in Durham Tees Valley Airport Ltd v bmibaby Ltd [2010], in which Patten LJ concluded that in circumstances where the defaulting party had a single obligation to perform it will be necessary to conduct an inquiry as to how the contract would have been performed had it not been repudiated. He added that:

‘[The contract’s] performance is the only counter-factual assumption in the exercise… the court has to look at the relevant economic and other surrounding circumstances to decide on the level of performance which the defendant would have adopted. The judge conducting the assessment must assume that the defendant would not have acted outside the terms of the contract and would have performed it in his own interests having regard to the relevant factors prevailing at the time. But the court is not required to make assumptions that the defaulting party would have acted uncommercially merely in order to spite the claimant. To that extent, the parties are to be assumed to have acted in good faith although with their own commercial interests very much in mind.’

Clarke LJ found that these remarks were not confined only to assessment of damages (as opposed to determining causation). Although in Jet2 the situation was slightly different, as the question was whether Jet2, the innocent party, would have sent further aircraft to Tarom after September 2007, the same principles can be applied. Accordingly, Tarom can be assumed to have acted in good faith and in compliance with its obligations, which would have been to service any aircraft sent to it. On that basis, the factual inquiry can be performed to determine how many aircraft Jet2 would have been likely to send to Tarom.

COMMENT

The approach adopted by the Court of Appeal in Jet2 is logical and makes sense from a commercial perspective. It gives effect to the principle that damages for breach of contract should put the innocent party in the position they would have been in had the contract been properly performed. To that end, the courts will not only assume that the defaulting party would have complied with its obligations, but will also assume that the other party would have been aware of the defaulting party’s willingness and ability to comply. While those assumptions may well be fictitious, they provide the courts with the necessary background to determine what benefits would likely have gone to the innocent party and therefore what loss it suffered as a result of the repudiation.

It is apparent that where there is more 
than one method of undertaking an obligation, the courts will adopt a 
‘minimal approach’ whereby they hold the defaulting party to the least onerous method of performance. That presents 
its own difficulty in determining whether the courts should calculate damages on 
the basis of the method least onerous to 
the defaulting party, or that least 
beneficial to the innocent party. The two will often be the same, but in some instances they may differ, and what is 
least onerous to the defaulting party in practice may perversely be more beneficial to the innocent party and thus result in a larger damages award.

It is apparent however, that when 
dealing with the extent of performance, 
the courts will not shy away from attempting to determine what would 
have happened on the basis of the assumptions mentioned above, which will allow them to estimate (relatively accurately) what losses the innocent 
party has actually suffered.