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Last edited 19 Feb 2018
Measure of damages for construction contracts
The term 'measure of damages' can be used either in a wider sense to include both categories of damage and the calculation or quantification of damage, or in a more restricted sense, namely the principles of law which define the categories or heads of damage which will be recoverable when there has been a breach of contract, commonly referred to by lawyers as the 'rules of remoteness of damage'. It is the latter restricted meaning which is adopted for the purposes of this article.
The basic rule as to measure of damages is often referred to as the rule in Hadley v Baxendale. This was a case heard in 1854 involving a claim for breach of contract by a mill owner against a carrier and arising from the carrier's failure to deliver a crankshaft within the time specified by the contract of carriage. Unbeknown to the carrier, the crankshaft was critical to the whole of the output of the mill.
The plaintiffs brought a claim against the defendants claiming a loss of profit for the whole of their production between the dates when the crankshaft should have been delivered and the date when it was actually delivered. In rejecting their claim for loss of profits, Alderson B stated:
'Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either as arising naturally, i.e. according to the usual course of things, from such breach of contract itself, or 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.’
The judgment in Hadley v Baxendale was explained and indeed developed in two leading cases in the twentieth century: Victoria Laundry (Windsor) Ltd v Newman Industries Ltd and Koufos v Czarnikow Ltd (The Heron II).
In the Victoria Laundry case, the rule was explained with reference to three main propositions:
- ‘In cases of breach of contract the aggrieved party is only entitled to recover such part of the loss actually resulting as was at the time of the contract reasonably foreseeable as liable to result from the breach.
- What was at that time reasonably foreseeable depends on the knowledge then possessed by the parties or, at all events, by the party who later commits the breach.
- For this purpose, knowledge 'possessed' is of two kinds; one imputed, the other actual. Everyone, as a reasonable person, is taken to know the "ordinary course of things" and consequently what loss is liable to result from a breach of contract in the ordinary course... But to this knowledge, which a contract breaker is assumed to possess whether he actually possesses it or not, there may have to be added in a particular case knowledge which he actually possesses, of special circumstances outside the "ordinary course of things" of such a kind that breach in those special circumstances would be liable to cause more loss’
The wording of the judgment in Hadley v Baxendale caused much lively debate on the issue of whether there were two branches to the rule, the first branch being damages arising naturally and the second branch being damages in the reasonable contemplation of the parties.
This issue was not purely semantic for it will be appreciated that if the first branch of the rule was unqualified by the parties' reasonable contemplation, or, to put it another way, by the particular bargain struck between the parties, then the first branch of the rule would tend towards the reasonable foreseeability test applicable to the measure of damages in tort, that is to say damage which should have been foreseen by a reasonable person as being something of which there was a real risk (see The Wagon Mound (No. 2)).
However, the judgments in Victoria Laundry and Koufos support the view that there is really only one rule in Hadley and Baxendale, and that damages which may reasonably be supposed to have been contemplated by the contracting parties are damages which arise naturally from a breach of contract. What was in the reasonable contemplation of the parties is decided on both an objective basis and a subjective basis
The objective test turns upon the contemplation of a reasonable person - that is to say, it is imputed knowledge - whereas the subjective test turns upon the actual knowledge of the parties, or the particular party, who is in breach of contract.
The application of the rule in Hadley v Baxendale can be usefully illustrated by reference to the facts of the Victoria Laundry case and the Koufos case.
V entered into a contract to purchase from N, an engineering firm, a boiler, which was installed on N's premises. V, who were a firm of launderers and dyers, required the boiler to extend their business to increase their general turnover and also they had in mind the prospect of certain profitable dyeing contracts being obtained from the Government.
V and N agreed that the boiler should be delivered to V's premises on 5 June 1946. The boiler was damaged whilst it was being dismantled on N's premises and delivery to V was delayed until 8 November 1946. It was found as a matter of evidence that N were aware of both the nature of V's business and that V intended to put the boiler into use as quickly as possible. V sued N for breach of contract, and their claim for damages included their loss of business profits.
At trial the judge disallowed the claim for loss of profits on the ground that it was based upon special knowledge, which had not been drawn to the attention of N. V appealed and the Court of Appeal, reversing the trial judge's decision, held that N, an engineering company with knowledge of the nature of the plaintiffs business, having promised delivery by a particular date of a large and expensive plant, could not reasonably contend that they could not foresee that loss of business profit would be liable to result to the purchaser from a long delay in delivery; and that although N had no knowledge of the dyeing contracts which V had in prospect, it did not follow that V was precluded from recovering some general and perhaps conjectural sum for loss of business in respect of the contracts to be reasonably expected.
The Court of Appeal was applying the objective test of reasonable contemplations as regards the general business profits of the launderers. However the specific profits, which would have been earned from the prospective dyeing contracts with the Government, were not claimable as N did not have actual knowledge of those contracts.
C was the owner of the SS Heron II. C entered into a charterparty with K for the consignment of sugar from Constanza to Basrah. At the time of making the contract, the ship was docked in Piraeus and the shipowners anticipated that it would be ready to load in Constanza by about 25 to 27 October 1960 after which date it would proceed at all convenient speed to Basrah.
The ship arrived at Constanza on 27 October, was loaded with sugar and departed from that port on 1 November. A reasonably accurate prediction of the length of the voyage between Constanza and Basrah was 20 days. C knew that K were sugar merchants and that there was a sugar market in Basrah but C had no actual knowledge that K intended to sell the sugar promptly after its arrival. In breach of the charterparty contract, the SS Heron II deviated from the voyage by calling at Berbera, Bahrain and Abadan, delaying the voyage by some ten days, the ship arriving at Basrah on 2 December and not 22 November.
The prices on the sugar market at Basrah tended to fall in October and November to a low point in December. Between 22 and 28 November the price of sugar in the Basrah market was £32.10s per tonne and the price between 2 and 4 December was £31.2s 9d per tonne. K brought a claim against C for breach of contract claiming damages based upon a loss of profit by reason of the price differential.
The House of Lords held that, since prices in a commodity market were liable to fluctuate, shipowners should reasonably contemplate that it was not unlikely that, if their ships delayed their voyage, the value of marketable goods on board their ships would decline, and that therefore, where there was wrongful delay in the delivery of marketable goods under a contract of carriage by sea, the measure of damages was a difference between the price of the goods at their destination when they should have been delivered and the price when they were in fact delivered.
Again, the court was applying the objective test and did not feel it necessary to consider the actual knowledge of the contract breaker (See the decision of the Court of Appeal in Hotel Services Ltd v Hilton International Hotels (UK) Ltd for a rationale of Hadley v Baxendale and the dichotomy between direct and consequential damages.
In Brown v KMR Services the Court of Appeal reaffirmed the test of remoteness of damage stated by the Master of the Rolls, Sir Thomas Bingham, in Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd:
'The test is whether, at the date of the contract or tort, damage of the kind for which the plaintiff claims compensation was a reasonably foreseeable consequence of the breach of contract or tortious conduct of which the plaintiff complains. If the kind of damage was reasonably foreseeable it is immaterial that the extent of the damage was not.’
On the facts of Brown, the Court of Appeal rejected the defendant's submissions in respect of excess of loss catastrophe reinsurance that a reasonable person in the position of the contracting parties would not have predicted that in the years 1988, 1989 and 1990 there would have been such a concentration of major catastrophes, and that the recoverable damages should be limited to such losses as could reasonably have been foreseen - that only one or two catastrophes would have occurred in any of those years (see also Bank of Nova Scotia).
 Find out more
 Related articles on Designing Buildings Wiki
- Breach of contract.
- Consequential losses.
- Construction contract.
- Contract v tort.
- Collateral warranty.
- Decennial liability.
- Liquidated damages.
- Liquidated v unliquidated damages.
- Loss and expense.
- The distinction between liquidated damages clauses and penalty clauses.
- Unliquidated damages.
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