When Might the English Court Claw Back an Innocent Party’s Post-Breach Windfall?

The Facts

The Arbitration Act 1996 sets out the very limited situations in which a party to an arbitration may seek to challenge or appeal, in the English Court, the award of the arbitral tribunal. The case of Fulton Shipping v Globalia Business Travel [2014] EWHC 1547 (Comm), (Fulton) involved one such appeal, which was heard by the Commercial Court in May 2014. The appeal was made pursuant to section 69 of the Arbitration Act, the Claimant alleging that, in reaching his award, the sole arbitrator had made an error of law.

Since March 2005, the Claimant had owned a small cruise ship, the "New Flamenco", which was chartered to the Defendant, a division of a large Spanish tourist group. In August 2005, the parties agreed to extend the charter for two years, until October 2007. In June 2007, a further two-year extension was agreed in writing. The Defendant subsequently denied agreeing to the terms of the second extension, and maintained its right to deliver up the vessel in October 2007. The Claimant treated this as a repudiation, accepting the breach as terminating the contract in August 2007. Shortly before the vessel was redelivered in October, the Claimants entered into an agreement to sell her to a third party for around $24 million.

Following the repudiation, the Claimants commenced an arbitration in London, pursuant to the terms of the charterparty. The hearing took place in May 2013. As a result of the financial crisis, the value of the vessel had vastly decreased between the date of the sale in October 2007 and November 2009, the date when the charterer would have delivered it up, but for its repudiation. In the latter scenario, it was estimated that the vessel would be worth just $7 million.

In the arbitration, the Claimant argued that it was entitled to damages, estimated at around €7.5 million, for loss of profits for the additional two-year extension until November 2009. In response, the Defendant argued the Claimant was required to give credit for the difference in the profit it had made selling the vessel in 2007, compared to the profit it would have made, had the vessel been sold two years later. The arbitrator agreed with the Defendant, and found that a credit of €11 million, representing this difference, should be applied to any damages awarded to the Claimant. While the precise quantum remained to be calculated, it was clear that the loss of profits would be significantly lower than the credit owed to the Defendant. This meant the Claimant would not recover any damages for losses resulting from the Defendant's repudiation.

The Claimant appealed this award to the High Court, arguing that, in taking into account the discrepancy in the value of the vessel, the arbitrator had made an error of law.

The Issues

The legal issue at the core of the case can be put simply: if a breach of contract by one party leads to a benefit for the other party, does this innocent party have to give credit for this benefit when calculating its damages. While simple to formulate, Fulton demonstrates that a conclusive resolution has proven somewhat more difficult to reach.

As any law student can tell you, damages for breach of contract are intended to put the innocent party into the position they would have been, but for the breach. This is known as the "compensatory principle" of damages, which "has been enunciated and applied times without number and is not in doubt," per Lord Bingham in Golden Strait Corp v Nippon Kubisha Kaisha (The Golden Victory) [2007] UKHL 12. 

The principle does not always lead to a clear result when, as here, both parties claim it supports their own case. The Claimant argued the arbitrator's award offended the compensatory principle, because correctly applied to the charterparty, the principle required the Claimant be placed in the same position as if it had received hire payments under the breached contract. The Defendant argued that this position, itself, offends the compensatory principle, because it would leave the Claimant better off as a result of the breach.

In his analysis, the Mr Justice Popplewell considered these conflicting submissions, concluding at paragraph 17 of his judgment that: "[t]he answer to the question whether a claimant is bound to bring a benefit into account in calculating his damages is not to be found in a simple application of the compensatory principle. [The Parties' submissions] do not therefore offer a solution to the problem in this case."

Finding little help in the submissions, the judge, therefore, was required to conduct a detailed review of relevant caselaw.

The Decision

Mr. Justice Popplewell disagreed with the arbitrator, finding he had made an error of law, and granted the appeal. 
While there was conflicting caselaw on the point, the judge was able to discern, in the case of Parry v Cleaver [1970] AC 1, a broad principle:

"…rooted in policy, that benefits do not fall to be taken into account, even where caused by the breach, where it would be contrary to fairness and justice for the defendant wrongdoer to be allowed to appropriate them for his benefit because they are the fruits of something the innocent party has done or acquired for his own benefit."

Of course, while instructive, this principle is perhaps too general to prove helpful to contracting parties. In his review of the caselaw, the judge did, however, provide more concrete statements of principle. The most significant of these were:

1. For a benefit to be taken into account in reducing the innocent party's loss, the benefit must be caused by the breach. It is not sufficient that the breach merely provided the occasion or context for the innocent party to obtain the benefit, nor that the benefit would not have been obtained but for the breach.
2. A step taken by the innocent party which is a reasonable response to the breach and designed to reduce losses caused by it may be triggered by a breach but not legally caused by it. The question of legal causation must be answered by considering all the relevant circumstances in order to form a common sense overall judgment on the sufficiency of the causal nexus between breach and benefit.
3. However, although causation between breach and benefit is generally required, it is not always enough. Consideration of justice, fairness and public policy have a role to play which may preclude a defendant from reducing his liability by reference to benefits obtained by the claimant.

Reflecting on these principles, Mr Justice Popplewell noted that, as her owner, the Claimant had a pre-existing right to sell the vessel. The exercise of this right was independent of the charterer's breach of the charterparty. Therefore, the benefit obtained by the Claimant in selling the vessel could not be said to be legally caused by the breach: "The breach merely provided the context or occasion for the Owner to realise the capital value of the Vessel. It was the trigger not the cause."

In addition, the vessel was an investment by the Claimant, with all the attending risk. To require the Claimant to account to the Defendant for the benefit of its investment "would be to allow the Charterers to appropriate the fruits of the Owners' investment in a way which would be unfair and unjust."

Commentary

The decision of Mr Justice Popplewell provides helpful insight into the principles which the English Court will apply in determining whether an innocent party, faced with a repudiatory breach of contract, will have to account for any benefit it obtains thereafter.

The first question is: can the act which resulted in the benefit, accurately be characterised as a step to mitigate? If not, and the act is better described as the exercise of a right obtained before the breach, it is unlikely a party will be required to account for the benefit.  If the act was one of mitigation, the analysis is slightly more complex, although the judgment makes clear that: "[a] broader rule that the exercise after breach of rights obtained prior to breach can never be treated as mitigation is not supported by the [case law]." 

For those acts which relate to mitigation, the current test is, at its most simple, a two-stage inquiry into (i) the proximity of the benefit obtained to the breach suffered; and then (ii) broad principles of fairness.

So, on the facts of Fulton, the Claimant did not have to account for the benefit it acquired in selling the vessel. However, had it sought purely to mitigate its loss, for example by taking out a further charter, it is more likely that, in assessing damages, the Court would have taken into account any income from the new charterparty.

Contracting parties should be aware that this test may be applied to any benefit they achieve as part of their efforts to mitigate losses suffered following a repudiatory breach of contract. This will be a concern for those sophisticated commercial parties whose profits can be at the mercy of market fluctuations. For such parties, an attempt to mitigate could result in potential benefits being achieved after a breach, which could significantly outweigh the losses emerging from it. Such a party could suddenly find this windfall wasn't quite all it seemed.