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Last edited 25 Jun 2013
Expectation interest and reliance expenditure
The rules as to measure of damages give rise to two broad categories of damage:
Expectation interest is the primary category of damage and represents the difference between the value to the promisee of a promise, which has been performed satisfactorily, and the value to the promisee of a promise, which has been performed defectively or incompletely. The loss of profits on the sale of the sugar in Koufos v Czarnikow Limited (The Herron II) (1996) is an example of expectation interest. Similarly where there are building defects the expectation interest will be the diminution in value, that is to say, the difference between the market value of the property without defects and the market value of the property with the defects.
Save for claims against building surveyors where the measure of damage is diminution in value (see Perry v Sidney Phillips & Son), the measure of damage in respect of building defects will often be based on reliance expenditure and not expectation interest. A reliance expenditure award of damages is payment of compensation for wasted expenditure incurred by the promisee in reliance on the promisor's promise to perform.
There are four broad categories of reliance expenditure:
- Expenditure incurred by the promisee in order to perform thier part of the contract, for example the cost of labour or materials.
- Expenditure incurred by the promisee prior to entering into the contract but which will be wasted if there is not a satisfactory performance of the contract, for example the taking on of additional laundry staff in Victoria Laundry (Windsor Limited) v Newman Industries Limited.
- Expenditure incurred prior to the breach of contract not related to the promisor's performance but which will be wasted if the promisee fails to fulfil their contractual obligations; for example in British Westinghouse Electric Company Limited v Underground electric Railways (1912) the plaintiffs incurred the costs of extra coal used by defective generators.
- Expenditure incurred after the breach of contract, for example the costs of repairs paid to a third party.
It is the fourth category of expenditure that is most commonly awarded in the construction industry as the measure of damage for defective buildings and is often referred to by lawyers as 'substituted performance'.
In East Ham Corporation v Bernard Sunley & Sons Ltd, B constructed a school for E under the then current RIBA Form of Contract. Several years after completion of the work stone panels fixed to the exterior walls fell off owing to defective fixing. The court held that the proper measure of damages was the cost of replacing the stone panels.
As a general rule the person entitled to damages for breach of contract may elect to recover expectation interest or reliance expenditure. However, where the damages arise from a breach of a construction contract, because of defective building works or incomplete building works, the courts appear to require the plaintiff to demonstrate an intention to carry out the works or an intention to continue to occupy the relevant building or premises. The proper measure of damage is more than an academic debate. It can have a profound effect on the damages recovered particularly when the costs of carrying out the remedial works or completing outstanding works can be substantially greater than the diminution in the market value of the property.
Such were the circumstances in Radford v De Froberville and Lange (1977). R was the owner of a large house in Holland Park, London, which was let into flats. The house had a large garden and R decided to sell for building purposes part of the garden which fronted on the highway. R obtained planning permission to build a new house on the proposed plot and he agreed to sell the undeveloped site to D. In the document of transfer D agreed to build a new house in accordance with the planning permission and also to construct a wall in accordance with the detailed specification along the boundary of R's retained land and the new plot, the wall to be situated on the new plot. These obligations had to be carried out within a certain time, which was subsequently extended.
However D eventually sold the plot to L and the proposed house and the dividing wall remained unbuilt. R sued D for breach of contract because of D's failure to construct the dividing wall. D admitted liability but denied that R had suffered any loss on the basis that the proper measure of damage was diminution in value and there was no diminution as the absence of a physical barrier on the boundary of the property was unlikely to bring about any significant diminution in letting value. The cost of erecting the wall was £3400. The court held that as R intended to make good D's breach by building a wall himself on his own property the proper measure of damages was the cost of carrying out the work on his own land.
In the Radford case the defendant had failed to carry out or complete the works. In Harbutts Plasticine Ltd v Wayne Tank & Pump Co Ltd (over-ruled by Photo Productions v Securicor Transport on a different point), the defendants W were responsible for defective work. W entered into a contract with H to design and install equipment for storing and dispensing stearine in a molten state (at temperatures of between 120°F and 160°F) at H's factory, which was an old building. W specified Durapipe, a form of plastic pipe, which was to be heated by electrical tapes wound round the pipe controlled by a thermostat. In fact, Durapipe was wholly unsuitable for this purpose because it was liable to distort at temperatures of about 187°F and had a low thermal conductivity. The installation was completed on 5 February 1963 and both parties intended to test it the next day. As it was very cold, to ensure that the stearine would be molten for the test, an employee of W switched on the heating tapes on the night of 5 February and the installation was left unattended during that night. In the early hours of 6 February there was a fire, which destroyed the factory. H rebuilt the factory but because of planning restrictions they had to replace their old five-storey mill with a new two-storey factory. The cost of building the new factory was £67,973 compared with the diminution in value of the old mill before and after the fire of £42,538. The court held that the proper measure of damage was the cost of reinstating the factory not the difference in its value before and after the fire. Widgery LJ stated:
'The distinction between those cases in which the measure of damage is the cost of repair of the damaged article, and those in which it is the diminution in value of the article, is not clearly defined. In my opinion each case depends on its own facts... If the article damaged is a motorcar of popular make, the plaintiff cannot charge the defendant with the cost of repair when it is cheaper to buy a similar car on the market. On the other hand, if no substitute for the damaged article is available and no reasonable alternative can be provided, the plaintiff should be entitled to the costs of repair. It was clear in the present case that it was reasonable for the plaintiffs to rebuild their factory, because there was no other way in which they could carry on their business and retain their labour force.’
The question of the correct measure of damages was considered by the House of Lords in Ruxley Electronics and Construction Ltd v. Forsyth. The defendant had contracted for an enclosed swimming pool to be constructed in his garden. The contract expressly provided that the maximum depth of the pool should be 7 ft 6 in. After completion, the defendant discovered that the maximum depth was only 6 ft 9 in and only 6 ft at the point where people would dive into the pool. The defendant refused to pay the balance of the price due under the contract and counterclaimed for damages for breach of contract. The breach was admitted, but the damages claimed as a consequence of the breach were disputed. The trial judge awarded the defendant £2500 on his counterclaim on the basis that the shortfall in depth had not decreased the value of the pool. The £2500 was awarded for general damage for loss of amenity. The defendant had claimed £21,500, the cost of reconstructing the pool to the contractual specification. The Court of Appeal allowed the defendant's appeal finding that it was not unreasonable to award as damages the cost of replacing the swimming pool in order to make good the breach of contract, even though the shortfall in the depth of the pool had not decreased its value. The House of Lords reversed the decision and held:
- In assessing damages for breach of contract for defective building works, if the court took the view that it would be unreasonable for the plaintiff to insist on reinstatement because the expense of the work involved would be out of all proportion to the benefit to be obtained, then the plaintiff was confined to the difference in value.
- The plaintiffs intention, or lack of it, to reinstate was relevant to reasonableness and hence to the extent of the loss which was sustained, since, if the plaintiff did not intend to rebuild he had lost nothing except the difference in value, if any.
- Where the diminution in value caused by the breach was nil, it was not correct to award the cost of reinstatement as an alternative to the difference in value.
- The cost of reinstatement and diminution in value were not the only available measures of recovery for breach of contract for defective building works and the court was not confined to option for one or the other. Where there had been a breach of performance resulting in loss of expectation of performance, satisfaction of a personal preference or a pleasurable amenity but there had been no diminution in value, the court would award modest damages to compensate the plaintiff.
In Tito and Others v Waddell and Others No. 2, (The Ocean Island case) (1977), the court held that a plaintiff can establish that their loss consisted of or included the costs of doing the work if they could show that they had done the work, or intended to do it, even though there was no certainty that they would.
To what extent can a party claim both expectation interest and wasted reliance expenditure? The Court of Appeal has held that a party cannot claim both heads of damage; they must seek either expectation interest or wasted reliance expenditure.
The case of Cullinane v British 'Rema' Manufacturing Co Ltd. may be distinguished on the basis that in that case the plaintiff claimed an expectation interest based on his gross profits and not net profits; if the claim is limited to net profits there is no duplication of damages. Similarly where there is a claim for damages for building defects it would appear arguable that a claim for the costs of repairs together with a claim that the property had suffered a diminution in its market value because of the fact that it is a repaired structure, are not overlapping claims for damages and both heads of damage should be recoverable. Indeed both costs of repairs and diminution in market value were recovered in the case of Thomas and Others v T. A. Phillips (Builders) Ltd and Taff Ely Borough Council. This case involved negligence and not breach of contract. However the decision on measure of damages should also be relevant to a breach of contract case.
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