14 July 2011 | Allan Wardhaugh

Which losses can you recover for breach of contract?

Hadley, a mill owner, contracted with Baxendale, a courier, to transport a broken engine part from Gloucester to a repair facility in Greenwich within a specific timescale. It was important the part was transported quickly as the mill could not function without it. Hadley failed to make Baxendale aware of the urgency and the part was delivered late. Hadley sued for lost profits caused by the delay.

The Court decided that Baxendale was not liable for Hadley’s lost profits because they were the result of circumstances that could not have reasonably been contemplated by Baxendale. For it to have been responsible, Hadley would have had to explain the urgency at the time the contract was made.

The Court outlined the basic test to be applied when determining whether damages for breach of contract can be recovered. The loss must fall under one of two limbs:

1. Losses that are naturally flowing, in the usual course of things, from the breach of contract itself (also known as “direct losses”).

2. Losses specifically known to the parties (or at least the party in breach) at the time the contract was made, as the probable result of the breach (“indirect” or “consequential losses”).

The difference between direct and indirect loss is based on forseeability (what was contemplated in the minds of the parties at the time the contract was made) and not on the type of loss incurred.

The Hadley v Baxendale test has been applied and adapted by successive cases over the centuries. However, while the legal principles are largely settled, they provide little commercial certainty as to which losses can be recovered by way of damages. The test applied by the courts to draw a distinction between direct and indirect loss leaves room for individual interpretation.

Contracting parties will try to limit liability to pay damages by distinguishing between direct losses as recoverable and indirect as non- recoverable.

However, it may be preferable to include or exclude liability for specific identifiable types of loss or you risk leaving the quantification of contractual damages to the court’s interpretation of 19th-century principles.

☛ Allan Wardhaugh is a partner at Dundas & Wilson