Two recent decisions of the House of Lords have developed the law on the assessment of damages for breach of contract.

In Transfield Shipping Inc v Mercator Shipping Inc (the Achilleas), [2008] UKHL 48 it was held that the fact that the loss was of a type which was foreseeable when the contract was made did not make it recoverable. In Golden Strait Corporation v Nippon Yusen Kubishka Kaisha (the Golden Victory), [2007] UKHL 12; [2007] 2 AC 353; [2007] 2 Lloyd’s Rep 164, it was held that the court can have regard to events occurring after breach when assessing damages for breach of contract.

In Achilleas, the time charterers had agreed to redeliver the ship to its owners by 2 May 2004. On 21 April, the owners agreed to charter the vessel to new charterers for her next employment on terms that they could cancel the charterparty if the vessel was not available by 8 May.

By 5 May it had become obvious that she would not be redelivered by 8 May, so the owners negotiated an extension of the new charterparty’s cancelling date to 11 May, but by then hire rates had fallen dramatically and they were forced to reduce the daily hire rate from $39,500 to $31,500 in exchange for the extension.

The owners claimed damages for loss of the original terms of the new charterparty at the difference between the original rate and the reduced rate – almost $1,365,000. The charterers admitted breach of charterparty, but contended that they only had to pay damages at the market rate for the six days the owners were deprived of the use of the vessel – only $158,301.

It was common ground that the owners’ loss of the original terms of the new charterparty was caused by the charterers’ breach and that, at the time the charterparty was made, it was foreseeable that the late return of the vessel was likely to result in the type of loss which in fact occurred, namely, loss of the vessel’s next employment.

Therefore, applying the established principles of damages in Hadley v Baxendale (1854) 9 Exch 341, 354 as developed and explained in C Czarnikow Ltd v Koufos (the Heron II) [1969] 1 AC 350, 382-383, one would have expected that the owners would have recovered their entire loss. Indeed, this was the result in the arbitration, in the Commercial Court and in the Court of Appeal. But the House of Lords held that the damages payable were limited to the market rate of hire for six days. Two separate strands of reasoning led to this result.

Lords Hoffman, Hope and Walker held that the forseeability of the type of loss suffered was not the correct test. Instead, one should ask: was the loss of a type for which the contract breaker ought fairly to be taken to have accepted responsibility at the time the contract was made? That was what was meant by the first limb of Hadley v Baxendale when saying that such damages ‘as may reasonably be supposed to have been in the contemplation of both parties at the time they made their contract as the probable result of breach’ were recoverable.

To determine what liability for damages the parties had assumed required the interpretation of the contract as a whole against evidence of its commercial setting. On the facts, the charterers could not be taken to have assumed responsibility for the loss of a following charterparty over whose timing, duration and hire rate they could have no knowledge or control and which, depending on market fluctuations, could result in an enormous claim for a minor breach.

Lord Rodger’s reasoning, with which Baroness Hale reluctantly agreed, was very different. He applied the traditional forseeability test in a novel way. He found that, although the type of loss suffered (loss of an advantageous next fixture if the vessel was delayed) was foreseeable at the time the charterparty was made, the degree of loss suffered in this case was not foreseeable. While it was common ground that the chartering market was volatile, the sharpness of the fall in the market between 21 April and 5 May was extraordinary and was not foreseeable as likely to result from breach when the charterparty was made.

I find Lord Rodger’s reasoning unsatisfactory. The essence of market volatility is unpredictability, and at what stage, one might ask, does a market fluctuation become unpredictable? Further, if his approach were correct, the damages ought to have been assessed on the basis of loss of the original new charterparty but with the recoverable hire rate capped at the foreseeable rate of volatility.

The majority’s ‘assumption of responsibility’ approach is attractive because it is likely to lead to a fairer result than strict application of the ‘forseeability of the type of loss’ approach in individual cases. It is, however, likely to give rise to uncertainty in practice; in few cases will there be evidence of a uniform market understanding of the correct measure of damages for a particular breach (as there was in Achilleas). Defendants will need to plead and prove the background facts they intend to rely upon as restricting damages for foreseeable loss. As issues concerning the assumption of liability for loss are mixed questions of fact and law, appeals from arbitration awards are bound to follow.

In Golden Victory, the vessel was time-chartered for seven years, with an earliest date of redelivery of December 2005. The charterparty contained a war clause providing that the charterers should have the right to cancel the charter if war broke out between certain countries, including the US, UK and Iraq.

In repudiatory breach of the charterparty, the charterers redelivered the vessel in December 2001 and the owners accepted that breach as terminating the charter. As at the date of termination, the charter had a period of just less than four years to run. Fourteen months later the war in Iraq commenced.

The charterers contended that if they had not repudiated, the war clause would have entitled them to cancel the charter on the outbreak of the Iraq war, and so the owners’ claim for damages only ran for the 14 months between the date of termination and the start of the war, and not the remaining four-year period of the charter.

The arbitrator found as a fact that, in December 2001 when the charterparty was terminated, a reasonably well-informed person would have considered such a war as ‘merely a possibility’ but not ‘inevitable or even probable’. He also found that, if the charter had still been running when the Iraq war began, the charterers would have cancelled it under the war clause. He reluctantly found that the charterers only had to pay damages for the 14-month period from termination to the beginning of the Iraq war based on the difference between the charter rate and the (lower) market rate.

The owners’ appeals to the Commercial Court and Court of Appeal were dismissed and they were defeated by a 3-2 majority in the House of Lords.

All five Law Lords accepted that, as a general rule, damages for breach of contract or tort are assessed based on what is known at the date of the breach or tort, but that the court could depart from this rule where it judged it necessary to do so to compensate the victim properly. But they differed about whether the court was justified in departing from the general rule in the case of commercial contracts.

The majority, led by Lord Scott, held that the owners’ right to damages stopped when war broke out. Lord Scott said that, if the damages were assessed based on what was known at the time of breach – rather than what was known at the time of assessment of damages – the owners would be overcompensated.

The minority led by Lord Bingham would have awarded damages for the entire four years. They said that contracts were made to be performed, not broken; that, on the date of termination, the owners became entitled to be compensated for the value of a charterparty with just under four years to run; that the charterers ought to have paid damages promptly following termination and they should not benefit from the delay; and that the idea that a party’s accrued rights could be changed by subsequent events militated against certainty and predictability in commercial transactions.

I would add that the majority’s decision means that the mere possibility of war or of some other terminating event at the time of repudiation now has the same effect on damages as if that event was inevitable if, by chance, the event occurs in the interval between termination and the assessment of damages.

Geraldine Clark, Barrister, Serle Court Chambers, London