Mitigation of loss: when does a benefit need to be taken into account?

A recent Court of Appeal judgment provides clarification on a notoriously difficult aspect of the law on mitigation of loss. This is where the ‘innocent’ party to a breach of contract obtains a benefit as a result of the actions it takes in attempting to limit its losses. The court considered whether that benefit should be taken into account to reduce that party’s claim in damages. 

The Court of Appeal’s judgment overturns the Commercial Court’s decision in the same case, which we have discussed previously (here).

What was the dispute about?

The dispute in Fulton Shipping v Globalia Business Travel [2015] EWCA Civ 1299 concerned an alleged extension of a charterparty of a vessel. When the charterer (Globalia) denied the validity of the alleged extension, the ship’s owner (Fulton) considered this to be an anticipatory breach of the contract and sold the vessel. It then brought arbitration proceedings against the charterer for damages for breach of contract, amounting to the net loss of profits which would have been earned during the extension.

The charterer argued that any damages award should be reduced by the benefit the owner had received by selling the vessel when it did, rather than at the end of the alleged extension. The owner had sold the vessel for $23 million. Owing to disruption in the market caused by the financial crisis, had it sold the vessel at the end of the extension then it would only have received $7 million.

The arbitrator decided that the owner had to give credit for the difference in sale price. This was greater than its loss of profit claim, so effectively extinguished its claim altogether. The owner appealed this decision to the Commercial Court, under section 69 Arbitration Act 1996.

Popplewell J in the Commercial Court allowed the owner’s appeal, on the basis that the owner’s decision to sell the vessel was independent of the charterer’s breach, so there was not a sufficient causative connection between the breach of contract and the benefit obtained. The charterer appealed that decision to the Court of Appeal. 

The Court of Appeal’s decision

The Court of Appeal unanimously overturned the Commercial Court’s decision. Longmore LJ, giving the leading judgment, reviewed the authorities on when benefit arising from the mitigation of loss should be taken into account. The important principle which emerged, he held, was that:

“If a claimant adopts by way of mitigation a measure which arises out of the consequences of the breach and is in the ordinary course of business and such measure benefits the claimant, that benefit is normally to be brought into account in assessing the claimant’s loss unless the measure is wholly independent of the relationship of the claimant and defendant.”

In the Commercial Court judgment, Popplewell J had set out 11 principles which he considered applied to determine whether a benefit should be taken into account in such situations. Longmore LJ considered that Popplewell J had based his decision on the following three of these principles, the relevance or application of which Longmore LJ disagreed with:

• Where the benefit arises from something which the claimant could have done of his own accord, irrespective of the breach, this indicates that the breach is not sufficiently causative for the benefit to be taken into account. In this case, there was a dispute on this issue, as to whether the owners could have sold the vessel while it was subject to an existing charterparty. In any event, Longmore LJ considered that this was a side issue. The real question was whether the sale in 2007 (rather than waiting until 2009) was actually caused by the breach, and whether this was by way of mitigation of the damage caused by the breach. If so, then regardless of what the owners could theoretically have done, the benefit they obtained by selling the vessel in 2007 should be taken into account.
• For the benefit to be taken into account, it is not enough there is a causal link i) between the breach and the mitigating step, and ii) between the mitigating step and the benefit. There must be a direct causal link between the breach and the benefit. Neither Longmore LJ nor Clarke LJ (giving his own reasoning separately) considered this ‘elaborate’ test to be necessary. The simpler test that, Clarke LJ preferred, was that the benefit must “arise from the consequences of the breach”, which the arbitrator had been entitled to find had been the case.
• It would be contrary to fairness and justice if the defendant were to be allowed to take benefit from an action that the claimant had taken for his own benefit. Longmore LJ considered that the search for legal principle in this area is elusive, but the arbitrator had been entitled to base his decision on the fundamental principle that a claimant should be placed in the position that it would have been in had there been no breach. Looked at on the whole, the owner had made a considerable profit from the actions that they took, which were by way of mitigation of loss and arose from the charterer’s breach.

The Court of Appeal therefore found that the arbitrator’s original decision should stand. It was not asked, and did not need to decide, whether it would have arrived at the same decision. The important point was that the decision which the arbitrator reached was not based on an error of law, and was therefore one that he was entitled to reach.

Practice points

Longmore LJ and Clarke LJ were at pains to point out that it is difficult to formulate a set of rigid legal principles governing this aspect of mitigation of loss. Popplewell J had attempted to do so, setting out 11 principles which he then applied to the facts. These principles were not adopted by the Court of Appeal, which preferred the simpler formulation set out above.

This is likely to leave litigants less certain as to whether a judge will give credit for benefits alleged to have resulted from action taken to mitigate a breach of contract. To determine this issue, a court will be looking at all of the surrounding circumstances to arrive at a “common sense overall judgment” on the sufficiency of the causal connection between breach and any benefit.  

Arbitrators or courts of first instance have a reasonably wide discretion to decide whether a benefit should be taken into account. Following Fulton, appeal courts are less likely to interfere with this discretion.