Where a defendant settles a claim with the claimant and then seeks to recover his losses from a third party, the third party may attempt to challenge the settlement on the basis that it was unreasonable. What approach, therefore, would the courts take in assessing whether a settlement was reasonable? This was one of the main issues upon which the Court of Appeal provided valuable guidance in the recent case of Supershield Limited v Siemens Building Technologies FE Limited [2010] EWCA Civ 7.

In Supershield, X, the contractor, constructed new offices at the order of the developer. X sub-contracted various electrical and mechanical works to Y, including the supply and installation of sprinklers. Y then subcontracted the supply and installation of the sprinklers to Siemens. Siemens subcontracted the installation of the sprinklers systems to Supershield. Shortly after the offices were constructed, the water sprinkler system storage tank overflowed and caused extensive flooding which resulted in damage and loss.

A mediation was held, attended by all parties to the dispute. Siemens settled the claims with the parties up the contractual chain, but was unable to reach a settlement with Supershield and, therefore, pursued its part 20 claim against Supershield to trial.

At first instance, the judge found that the cause of the flooding was defective works carried out by Supershield. On the issue of damages, Supershield disputed Siemens’ contention that the sum for which Siemens had settled the claims was reasonable. Supershield argued that the settlement did not reflect the strengths of the defences which were available to Siemens against the claims which had been brought against it. The judge at first instance, however, found that the overall settlement was, in fact, reasonable and gave judgment for Siemens for the amount of the settlement (plus interest).

Supershield appealed on three grounds: (1) the judge had misconstrued the subcontract; (2) the judge was wrong to find that Supershield had installed a ball valve, a mechanism which was found to have caused the sprinkler to fail; and (3) the judge was wrong to find that the settlements which Siemens concluded with the other parties to the dispute were reasonable.

Lord Justice Toulson, giving the judgment of the court, had no difficulty in dismissing the first two issues. He carefully considered all of the relevant contractual documents between the parties and, construing the meanings given in those documents, found that the judge had correctly interpreted the subcontract between the parties and that Supershield had, in fact, installed the ball valve.

Toulson LJ then went on to consider issue (3): was the settlement reasonable? His lordship proceeded by firstly acknowledging that parties to a dispute will, understandably, have different perceptions of what would be a fair settlement figure without either being unreasonable. The object of mediation or negotiations was to close the gap to a point which each party found to be acceptable, and this will be an important factor which a judge, who is considering whether a settlement is reasonable, will take into account.

Another factor which would influence a judge’s conclusion as to whether a settlement was reasonable would be that a judge is likely to have a less complete understanding of the relative strengths of the settling parties than they had themselves, and this was particularly so in complex litigation. Toulson LJ argued that a judge would essentially have to ask himself whether the settlement was "within the range of what was reasonable". If a judge does find that the settlement was reasonable then "…an appellate court will not interfere with his decision unless persuaded that he erred in principle or (which is intrinsically unlikely) that his decision was incapable of justification on any reasonable view".

Supershield raised arguments of remoteness of damage in contract to support its argument that the settlement was not reasonable. Supershield contended that the cause of the flooding was due to blockage in the storage tank or that the cause of the flooding was too remote a consequence for Siemens to have been liable to the main subcontractor on a proper application of the rule of Headley v Baxendale (1854) 9 Ex 341. Supershield maintained that imputing knowledge of the existence of the drains (which the judge at first instance had done) was incorrect. Rather, it was the fact that the tank room was designed and constructed with drains, and the usual and natural course of any water which overflowed from the sprinkler tank would have been to run away via the drains into a sewer. The fact that the drains were blocked meant that this prevented the water from draining away, which would have been the case if the drains had not been blocked.

Turning to the issue of the degree of likelihood required for the damage not to be regarded as too remote, Toulson LJ reinforced the application of Hadley: ‘Hadley v Baxendale remains a standard rule but it has been rationalised on the basis that it reflects the expectation to be imputed to the parties in the ordinary case, ie that a contract breaker should ordinarily be liable to the other party for damage resulting from his breach if, but only if, at the time of making the contract a reasonable person in his shoes would have had damage of that kind in mind as not unlikely to result from a breach.’

Further, Toulson LJ, following the House of Lords case of Transfield Shipping Inc v Mercator Shipping Inc [2008] UKHL 48, stated: ‘If, on the proper analysis of the contract against its commercial background, the loss was within the scope of the duty, it cannot be regarded as too remote, even if it would not have occurred in ordinary circumstances.’

Finding that the cause of the flood was due to the defective works carried out by Supershield, Toulson LJ concluded that Siemens had only to show it was reasonable to settle the claims against it and this had been done.

Supershield helpfully illustrates the approach the courts are likely to take when asked to consider whether a settlement is reasonable. It is clear that a court is under no obligation to carry out a detailed assessment of the merits of the case when assessing reasonableness. If the lower courts conclude that a settlement was reasonable then, as Toulson LJ made clear, the higher courts will not usually interfere. Therefore, Part 20 defendants would be wise to tread carefully when seeking to challenge a settlement on the grounds of reasonableness and this will especially be the case when settlements are reached in complex disputes.

Masood Ahmed is a senior lecturer in law at Birmingham City University