Legal Briefing

Remoteness of damage: Supershield brings commercial background to the fore

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Corporate and commercial | 01 March 2010

Supershield Ltd v Siemens Building Technologies FE Ltd [2010] takes us back to the nuts and bolts of contract law – to the question of remoteness of damage.

A type of loss resulting from a breach of contract cannot be recovered if it is too remote. The law in this area has become unsettled in recent years, but the Court of Appeal’s new judgment helps clarify when a type of loss will be considered too remote to be recovered.

The commercial background of the contract has, as a result of Supershield, taken on greater significance in this area of the law.

Facts of Supershield

Supershield gave rise to an interesting and apparently unprecedented point on the remoteness of damage. The defendant (D), a subcontractor of the claimant (C) in the construction of an office building, breached its contract with C.

D had to install a ball float valve and lever arm (such as you might find in a domestic toilet cistern) so that the water storage tank of a sprinkler system would be refilled whenever the water level dropped. After D had installed the ball float valve and lever arm, the nut and bolt connection between them failed, and the bolt fell out. The judge at first instance found that D had not screwed the nut sufficiently tight. After the bolt fell out, the valve was left open so that water flowed into the tank, but the valve did not close as the tank filled up. The tank overflowed.

The design for the office building had incorporated several protection measures to ensure that an overflowing tank would not cause any damage. The tank room had built in drains that were designed to remove any leaking water and an alarm system to warn of any overflow.

As it was, the drains became blocked and the alarm system was not being monitored. Water flooded from the tank room into the office building basement and caused substantial damage to electrical equipment.

Multiple protection measures all fail

This was, apparently, an unprecedented point. D argued that the parties could not have foreseen that overflowing water would cause damage, as they would not have anticipated the drain being blocked and the alarm being unmonitored. The building was designed specially to avoid such damage. Did the unexpected failure of multiple protection mechanisms make the resulting damage too remote to be recovered?

To resolve this question, the Court of Appeal reviewed the law on the remoteness of damage. This has, in recent years, become rather uncertain as a result of the House of Lords judgment in Transfield Shipping Inc v Mercator Shipping Inc [2008]. But the Court of Appeal has now helped to clarify the law.

A loss reasonably contemplated or in the natural course of things?

The classic case of Hadley & anor v Baxendale & ors [1854] remains the starting point when considering whether a type of damage is too remote to be recovered.

Damages were held to be recoverable according to a two-limbed test:

  1. when the damages may be fairly and reasonably considered to arise naturally, ie according to the natural course of things; or
  2. when the damages may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.

On the facts, the defendant carriers had not been informed that late delivery of the crankshaft they were transporting would delay the operation of the mill and, as far as they were aware, the owner might have had another crankshaft. Therefore the mill owner could not recover the lost profits as this type of loss was too remote.

Applied to the facts of Supershield, it could be argued, on the one hand, that flooding would naturally be expected to result from the faulty installation of the tank valve. On the other hand, the overflowing water might have been expected to flow away down the drains or to have been prevented after activation of the alarms.

A sufficiently likely loss?

In C Czarnikow Ltd v Koufos (The Heron II)[1967], the House of Lords developed and restated the rule in Hadley. Whether a type of loss was recoverable depended on the likelihood, or the degree of foreseeability, that the type of loss would occur as a result of a breach.

Although no single formulation of the rule was agreed, the crucial question according to Lord Reid was:

Applied to the facts of Supershield, the question could be constructed as follows: did the multiple protection measures in place make the flooding sufficiently unlikely for this kind of damage to be too remote?

An assumed responsibility?

The House of Lords in Transfield brought significant uncertainty to this area of the law. In Transfield, ship owners had chartered out their ship and it was due to be redelivered to them by 2 May 2004. They also agreed a new hire to a new charterer at a lucrative rate, with the vessel to be delivered to the charterer by 8 May 2004 at the latest. The vessel was delayed and it was not redelivered to the owners by the earlier charterers until 11 May 2004. The new charterer still agreed to take the vessel, but only at a much reduced rate. Due to an unexpectedly volatile market, the difference between the lucrative rate and the much reduced rate was very large.

The majority of their Lordships introduced a novel dimension into their judgments in suggesting that losses would only be recoverable if the party who had breached the contract could be reasonably assumed to have undertaken responsibility for that kind of loss. Lord Hoffmann, in particular, emphasised that the extent of a party’s liability depended on the construction of the contract as a whole in its commercial setting. On this basis, the Lords held that the loss of the very lucrative charter rate, which was the central issue in the dispute, was too remote, as, even if it was perfectly foreseeable, the earlier charterer could not reasonably be seen as having undertaken responsibility for the whole period of the new charter.

Could this approach hold the key to the question in Supershield? Had D assumed responsibility for the losses caused by the overflowing water?

A loss within the scope of the contractual duty?

The Court of Appeal in Supershield reasoned that the very purpose of installing the ball float valve had been to control the flow of water and so D had undertaken responsibility for the consequences of the water overflowing. It would have been strange for the extra protection measures put in place to have diminished D’s responsibility, as the whole point of protection measures was for them to act as a backup, rather than to reduce the importance of the water not overflowing in the first place.

The losses caused by the overflow of water were within the scope of D’s contractual duty to C. As such, the losses would not have been too remote for C to recover, even if the parties could not have predicted them.

The Court of Appeal held that the rule in Hadley, as rationalised and restated in The Heron II, remains the ‘standard approach’, but that the reasonable expectations or intentions of the parties may cause the court to depart from this rule.

The Court held that ‘if, on the proper analysis of the contract against its commercial background, the loss was within the scope of the [contractual] duty’ the loss will not be too remote to be recovered, even if loss of that kind ‘would not have occurred in ordinary circumstances’.

Comment

The House of Lords in Chartbrook Ltd v Persimmon Homes Ltd & ors [2009] and the Supreme Court in Sigma Finance Corporation, Re [2009] have recently emphasised the importance of interpreting contracts against their commercial contexts.

The Court of Appeal in Supershield has now also cemented the reasonable intentions of the parties against the commercial background as a key element of the law of remoteness of damage. The scope of the contractual duty and the contractual assumption of responsibility will now always have to be considered when determining what type of loss can be recovered. It will be interesting to see how this area continues to develop in light of Transfield, as the law is still very unsettled.

Final key point

For practitioners, when drafting contracts, the Supershield judgment is a further reason to allocate responsibility for the consequences of breach clearly and in a way that signposts the underlying commercial rationale.