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The English Law of Damages for Breach of Contract: Part III - Mitigation


Introduction

This issue is the third in the recent series of newsletters looking at the English law of damages for Breach of Contract. In this issue, we examine the extent to which the innocent party's right to recover his loss may be compromised where he fails to take steps to limit - or 'mitigate' - his loss.

As we have seen in our previous issues, the general approach of English law to the question of damages for breach of contract is compensatory - the measure of damages seeks to place the victim of a breach in the position he would have been in, had the contract been properly performed. Consistent with the principle of compensation, English law recognises that where the innocent party takes steps which successfully avoid or reduce the loss he has suffered, the innocent party must give credit for the savings in his claim for damages. Thus, for example, where a company defaults on its contract with a broadcaster, under which the broadcaster was to receive fees for airing advertisements for the company's products, the broadcaster's entitlement to damages will be reduced where it succeeds in securing alternative fee paying clients for the same advertisement slots.

English law, however, goes one step further: the innocent party must also give credit for any loss which he should reasonably have avoided. This is the concept of "mitigation", often referred to as the innocent party's "duty to mitigate". This terminology is slightly misleading, as the innocent party is not subject to any legal duty or enforceable obligation - it is simply the case that in the calculation of damages for breach of contract, the contract-breaker is not liable for loss which has been avoided, or which should reasonably have been avoided. The rule has been justified on the basis that avoidable losses are not caused by the original breach, but instead by the subsequent failure of the innocent party to take reasonable steps in response to the breach.

What steps are expected of the Innocent Party?

The concept of mitigation can lead to difficult questions in the calculation of damages for breach of contract. It is not always clear which, if any, claimed losses ought reasonably to have been avoided by the innocent party.

Broadly speaking, these difficult questions are often resolved in the favour of the innocent party. Certainly, the standard by which the innocent party's acts and omissions are examined is not an onerous one. English law traditionally takes a sympathetic and generous view of what amounts to reasonable conduct by a party seeking to mitigate loss caused by a breach of contract. The position is well summarised in Banco de Portugal v Waterlow in which it was held where an innocent party is placed in a difficult situation by reason of another party's breach of contract, the measures which he chooses to take in response "ought not to be weighed in nice scales....It is often too easy after an emergency has passed to criticise the steps which have been taken to meet it, but such criticism does not come well from those who have themselves created the emergency".

Whether the innocent party ought to have mitigated his loss is a question of fact to be decided on each case and each set of circumstances. The burden of proof, however, is placed firmly on the contract breaker to show that the innocent party's acts or omissions were unreasonable.

This is not a straightforward exercise and there are therefore comparatively few cases where it has been successfully done. Examples include a failure to affect a prompt sale of a borrower's security following the borrower's default under a mortgage, where the delayed sale resulted in increased losses because of a reduced sale price on a falling market.

There is, by contrast, rather more legal guidance as to what will not be expected of the innocent party (which is itself illustrative of the difficulty in successfully challenging an innocent party's claim on the basis of failure to mitigate). In particular, the innocent party will not be expected to take any steps to mitigate his loss which would:

  • amount to steps taken other than in the ordinary course of business;
  • risk his money too far (for example, by entering into speculative trading contracts);
  • destroy or sacrifice rights or property of his own;
  • injure innocent persons (for example, by breaching contracts with third parties; or
  • injure his own commercial reputations.

The Corollary: The Costs of Mitigation

As mitigation encourages the innocent party to take active steps to reduce his loss, the innocent party is at the same time protected by the corollary rule that where he takes reasonable steps to avoid his loss, he is entitled to include in his damages the costs incurred as a result of taking those steps.

Indeed, this rule goes further than allowing the innocent party to recover his expenses incurred taking action in mitigation: the innocent party may recover these costs even if this has the overall effect of increasing his loss beyond that which would have been suffered had the steps not been taken at all. In Banco de Portugal v Waterlow, the defendant had printed a large number of forged bank notes which had passed into general circulation. Once the presence of these notes was discovered, the bank withdrew the entire affected class of banknotes and gave genuine notes in exchange to those innocent third parties who had acquired the forgeries. The bank then sought to recover its losses from the defendant printers who had, in breach of contract, passed notes to an intermediary without proper authorisation.

Even though the losses suffered by the bank in taking these actions substantially increased its claim against the defendant, the House of Lords had little sympathy for the defendant's argument that alternative, cheaper, steps could and should have been taken in response to the problem. In dismissing the" argument, Lord Macmillan explained that "The law is satisfied if the party placed in the difficult situation by reason of the breach of duty owed to him has acted reasonably in the adoption of remedial measures he will not be held disentitled to recover the cost of such measures merely because the party in breach can suggest that other measures less burdensome to him might have been taken".

The House of Lords' attitude, neatly illustrates the difficulties for defendants wishing to challenge claims on the basis of failure to mitigate.

Herbert Smith ADR Newsletter
October 2005

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