56 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #117 NOVEMBER/DECEMBER 2007

DAMAGES FOR LOST PROFITS—A qUESTION OF REMOTENESSSTUART PTY LTD V CONDOR COMMERCIAL INSULATION PTY LTD [2006] NSWCA 334Scott Alden, Partner

Alyson Eather, Solicitor

TressCox Lawyers, Sydney

When a contract is breached the question often arises as to the extent of damages that may be recovered by the aggrieved party. Damages that naturally arise are generally recoverable but compensation for the more remote and less foreseeable damages will depend very much on the facts of each individual case. A recent decision of the Court of Appeal regarding a claim for loss of profits went through the relevant factors to consider in relation to the recovery of remote damages.

The assessment of contractual damages in Australia relies on the well established doctrine set out in Hadley v Baxendale1 an old but still very relevant English case. This case set out the two limbs of contractual damages being those:

1. arising naturally, i.e. according to the usual course of things; or

2. such as 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.

It is the second limb which was relevant in this case which considered the situation where a contractor sought damages from its subcontractor for loss of profits in a potentially lucrative contract where that contract was terminated due to the subcontractor’s faulty workmanship.

Stuart (the contractor) entered into a contract with the Commonwealth of Australia to replace wool insulation in residential properties as part of the Sydney Aircraft Noise Insulation Program. Relevant to this case, the work to be carried out on each property was its own discrete contract, and whilst it was expected that the government would enter into a number of such contracts with

The assessment of contractual damages in Australia relies on the well established doctrine set out in Hadley v Baxendale (1854) 9 Ex 341, an old but still very relevant English case.

CASE NOTE

AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #117 NOVEMBER/DECEMBER 2007 57

Stuart, due to past experience and other factors, this was not certain.

Stuart subcontracted the work to Condor (the subcontractor) which failed to properly box some downlights prior to installing the insulation leading to a fire at five of the properties. Following a quality audit the Commonwealth terminated the contract with Stuart for faulty workmanship and Stuart brought an action against Condor for loss of profits resulting from the loss of this contract and also the potential profits in the expected large number of future, but now lost, contracts. At first instance the trial judge found that the faulty workmanship by the subcontractor was the reason for the termination of the contract between Stuart and the government but that the claim for lost profits for future contracts was too remote. Stuart appealed this decision to the Court of Appeal.

The Court of Appeal, in this case, confirmed that when considering contractual damages the two limbs of Hadley v Baxendale set out the relevant tests and then proceeded to consider a number of subsequent decisions which have applied and clarified these tests on their particular facts. These subsequent cases have established the following:

(a) Not every type of damage reasonably foreseeable by the parties when the contract is made can be considered as arising naturally or in the contemplation of the parties.2

(b) It is not enough that, in fact, the plaintiff’s loss was directly caused by the defendant’s breach.3

(c) The crucial question is whether the loss of the particular kind was within the defendant’s contemplation.4

(d) Damages are not necessarily too remote merely because

their likelihood is less than an even chance, the relevant test is whether they are ‘not unlikely to occur’. It is clear that ‘a great many extremely unlikely results are reasonably foreseeable’.5

(e) It is clear that a general loss of profits is recoverable but loss of profits from a specially lucrative contract of which a defendant is unaware is not. The parties must contemplate both the general nature of the loss or damage and the general manner of its occurrence.6

(f ) The law is conscious of the injustice of visiting the party in breach with the consequence of a loss that is not within that party’s reasonable contemplation when contracting.7

In this case the court found that the subcontractor was not liable for these damages as they were outside of the second limb in Hadley v Baxendale. In finding this the court focussed on the disparity between the price payable to the subcontractor for the work and the very large and disproportionate claim for damages for lost profits. As a result of this disparity it was seen that the presumption of acceptance by the defendant of the risk, due to actual knowledge of the potential damage at the time of contract, had been rebutted.

It is highlighted in the judgement that one solution to this potential problem of uncertainty in relation to the recoverability of damages following a breach is the inclusion of an express clause in the contract which clearly allocates the risk in the event of the breach occurring as well as identifying the damage which may flow and responsibility for that damage. Of course parties are often unwilling to clearly identify and allocate all potential risks and damage at the start of a project, particularly the higher value risks, as this

may lead to agreement not being reached on the contract or to difficult risk discussions at the commencement of a project when the parties are more interested in focussing on the positive aspects of the project.

Notwithstanding this difficulty it is advisable for parties to engage in a risk identification and allocation process in relation to performance and non–performance of their contracts. This ensures that the parties are fully aware of their position at the outset and are then able to make informed decisions about proceeding to contract and pricing for potential risks and damage.

REFERENCES 1. (1854) 9 Ex 341

2. C Czarnikow Ltd v koufos [1969] 1 AC 350

3. ibid

4. ibid

5. R&H Hall Ltd v WH Pim (Junior) & Co Ltd (1928JJ) 33 Com Ca 324; [1928] All ER 763 at 388

6. Alexander v Cambridge Credit Corporation Limited (1987) 9 NSWLR 310

7. Castle Construction Pty Limited v Fekala Pty Limited [2006] NSWCA 133