When a party breaches a term of a contract or commits a tort, the innocent party is an entitled to an award of damages, as of right.
In order to recover substantial damages – more than nominal damages – the loss must be:
- caused by the breach, and
- reasonable foreseeable or - to put it another way - not too remote.
What is Reasonable Foreseeability in Damages Law?
Reasonable foreseeability is a set of common law principles which operate to limit compensation recoverable by an innocent party for breach of contract and for tortious loss.
So for example, a contract breaker or intellectual property infringer is not liable for all possible loss which the breach of contract or tortious wrongdoing caused.
To be reasonably foreseeable, a type of loss or damage:
- must be within the contemplation of the parties at the time:
- in contract law: when the contract was made, or
- in tort law: when the wrongdoing took place, and
- within "the usual course of things" or
- from the result of special knowledge known to the parties.
Loss is too remote (and not reasonably foreseeable) if:
- it was highly unlikely to happen in the circumstances of the case
- the parties foresaw it as a consequence of the breach.
Again, it's assessed in hindsight: as at the date of the contract, or when the civil wrong was committed.
Reasonable: Objective Standard
Courts decide reasonable foreseeability on the basis that the claimant and defendant are reasonable people: an objective test.
The subjective intentions of the parties aren't relevant.
That takes the decision out of the hands of the parties and into the hands of the court to decide on an objective basis.
The Rule in Hadley v Baxendale (1854) is still the leading case on remoteness of damage. We come onto that case law below.
Firstly, some context.
Damages and Reasonable Foreseeability
The same concepts apply in tort law and for breach of contract.
The purpose of damages is to put the party whose rights have been breached in the same position, so far as money can do so, as if the legal rights had been observed.
That purpose, if pursued to its end, would give the innocent party a complete and unqualified indemnity for any and all losses no matter how trivial, unlikely or unpredictable. Although an indemnity is a legal remedy in some circumstances, liability under an indemnity is not assessed in the same way as damages. An indemnity ≠ normal damages claim.
In the common law of damages, damages are awarded for kinds or types of loss. After that they're assessed for the amount of compensation payable. That's known as an assessment of damages or an enquiry as to damages.
So reasonably foreseeability is not about quantifying the precise amount of damages itself. It's more about identifying the types or kinds of recoverable loss.
The Limits of Damages
To have a claim for substantial damages, a claimant is required to show:
- causation in law: the loss was caused by the breach – ie a causal connection between the breach and the loss
- reasonable foreseeability of loss: the loss was not too remote, and
- it mitigated its loss where it was reasonable to do so
These rules apply to limit what may be argued in favour of - and against - an award of damages. They narrow the grounds that the parties have to argue whether or not a particular type or kind of compensation is payable.
The overall affect is that they drive down the amount ultimately payable by a defendant. Otherwise the claimant would have an indemnity for a breach of contract or tort.
An innocent party is only entitled to recover the kind or type of loss which was reasonably foreseeable to result from the breach.
In order to be reasonably foreseeable, the kind or type of loss likely to be reasonably foreseeable when it is within the knowledge of the party in breach.
The rule in Hadley v Baxendale asks primarily what the parties must be taken to have had in their contemplation, rather than what they actually had in their contemplation. To arrive at the answer to what they had within their contemplation (which is the objective test referred to above), involves questions of fact about their knowledge.
There are two types of knowledge which are relevant:
- imputed knowledge: includes information about the type of business that the claimant (ie the innocent party) runs, market prices, business practices, requirements and necessities of the trade it's involved in
- actual knowledge: special circumstances which are not typical from one business to another. Special circumstances are those made perfectly clear to the defaulting party, such that the defaulting party can be said to have accepted the contract with that knowledge, and taken them into account prior to entering the contract in question.
Again, the date of the assessment of that knowledge is:
- in contract law, the date a contract is formed; and
- in tort law, the date that the wrong was committed.
So, whether a kind of damage is recoverable centres around the knowledge the defendant has – or is deemed to have – as a reasonable person.
Test of Reasonably Foreseeability
More formally, the test of reasonable foreseeability is whether the loss in question is:
of a kind which the defendant, when he made the contract, ought to have realised was not unlikely to result from the breach … the words "not unlikely" … denoting a degree of probability considerably less than an even chance but nevertheless not very unusual and easily foreseeable.
So the question is whether:
the loss claimed was of a kind or type which it would have been within the reasonable contemplation of the parties at the time that the contract was made as being “not unlikely” to result from the breach.
Conversely, the type of loss must be “substantially likely” to arise from the breach.
The relevant question is whether at the time of the contract the parties would reasonably have contemplated that the breach would "in the ordinary course of things" cause the innocent party to the kind of loss claimed.
If the parties don’t have a particular type of loss within their contemplation, they’re not liable for it.
The Two Limbs of Hadley v Baxendale
The law of damages – through Hadley v Baxendale, recognises two types of loss:
- First Limb: Direct Loss
- Second Limb: Consequential Loss
These two types of loss encapsulate what the law sees as fair and reasonable.
That's because they reflect:
- the risk that that defaulting party took on when the contract was agreed
- the wrong for which the guilty party has been responsible, and
- the resulting financial disadvantage to the innocent party at the date of the breach,
when the defaulting party deprives the innocent party of the benefit of performance under the contract.
- the policy implemented by Hadley v Baxendale is that if a contracting party is aware as at the date of the contract if what might happen if the contract is breached, they are liable for it.
- a party taking on a risk when they agreed to the terms of the contract knows what the consequences will be, if it doesn't perform the contract
In this way:
- a person promising to perform takes the risk of foreseeable consequences of the breach
- the party receiving the performance takes the risk of unusual or unforeseeable consequences of the breach.
First Limb: Direct Loss
The first limb of Hadley v Baxendale involves identifying loss which is fairly and reasonably considered as:
- arising naturally, according to the usual course of things from the breach of contract, or
- such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.
What arises naturally in the usual course of things or in the contemplation of the parties is assessed by reference to the imputed knowledge of the parties as at the date of the contract.
The principle has been said in a number of different ways. They're damages which:
- occur "in the usual course of things"
- flow "naturally from the breach",
in the sense that the damage is an inevitable consequence of the breach.
Second Limb: Indirect and Consequential Loss
Consequential loss is also referred to as “indirect loss” and “special damage”. The terms are interchangeable.
Consequential loss requires knowledge of "special circumstances" by the defendant.
It covers loss that would be “too unusual” to recover under the first limb of Hadley v Baxendale.
The special circumstances are required because the damages are the sort that are outside the usual course of events: they don't flow naturally from the breach.
They’re the sort of circumstances, which if known by the defaulting party is aware that the innocent party will not just suffer the ordinary run of the mill damages under the first limb of Hadley v Baxendale.
Type of Recoverable Damages
What that knowledge does is bring different types or kinds of damages within the contemplation of the parties, as at the date of the contract.
It makes the kind of loss:
- within the contemplation of both parties,
- as the probable result of the breach of it, and therefore
- reasonably foreseeable.
The damages resulting from the breach of such a contract (which they would reasonably contemplate), would be the amount of injury which would ordinarily follow from a breach of contract under these special circumstances so known and communicated.
In The Heron II (1967), it was put like this:
The crucial question is whether, on the information available to the defendant when the contract was made, he should, or the reasonable man in his position would, have realised that such loss was sufficiently likely to result from the breach of contract to make it proper to hold that the loss flowed naturally from the breach or that loss of that kind should have been within his contemplation.
Approaching it from the other direction, when the “special circumstances” aren’t known to the defaulting party:
- it can’t be said that it could have foreseen the loss
- the loss does not flow naturally from the breach, and
- would not have made the kind of loss a reasonable and natural consequence of such breach of contract.
When the defaulting party has knowledge of the special circumstances, the loss then becomes a natural consequence of the breach - like direct loss.
It becomes reasonably foreseeable.
Consequence of Special Knowledge
If both parties know the unusual or special circumstances:
- the scope of reasonable foreseeability widens
- a greater level of damages is usually recoverable
- the defendant has the opportunity before the contract is agreed to take steps to exclude it in the contract itself.
Otherwise the defendant undertakes the risk of any special loss referable to the special circumstances.
What's the Upper Limit to Damages?
In respect of the maximum damages available which may be recoverable:
It is generally accepted that a contracting party will be liable for damages for losses which are unforeseeably large, if loss of that type or kind fell within one or other of the rules in Hadley v Baxendale …
That is generally an inclusive principle: if losses of that type are foreseeable, damages will include compensation for those losses, however large.
Remoteness of damage focuses on the type or kind of damage which must be contemplated by the defendant. It doesn’t rely on:
- the type of breach that would take place to cause it
- the events that might cause it
- the extent of loss that would be caused, or
- whether the breach was deliberate, reckless or cynical
Only the type or kind of loss which would be suffered from the breach.
In some cases, the loss might be said to unquantifiable, unpredictable, uncontrollable or disproportionate.
The factual background – such as the context, surrounding circumstances or general understanding in the relevant market - may lead a court to assess independently assess whether the defendant assumed responsibility for the particular type of breach. .
Example: Direct Loss - The Story of Hadley v Baxendale
Mr Hadley was a miller.
He sent a mill shaft out for repair, and used a courier, Mr Baxendale.
Baxendale was late returning the mill shaft.
This meant that the mill was left idle for a longer period than it would have been, had the mill shaft been delivered on time.
Mr Baxendale did not know that Mr Hadley did not have a spare mill shaft.
As a consequence, it could not be said that the idle time for the mill was an inevitable consequence of the breach of contract to fail to deliver the repaired mill shaft in time.
Accordingly, Hadley was not granted direct loss under the first limb.
Had Mr Baxendale known that Mr Hadley did not have a spare mill shaft, the loss caused of the idle time to the mill would have:
- been direct loss flowing naturally from the breach
- not too remote, and
- recoverable as damages.
Example: Consequential Loss
Victoria Laundry (Windsor) Ltd v Newman Industries Ltd (1949) was a case dealing with the second Limb in Hadley v Baxendale, whether consequential loss was able to be recovered by a available.
The Claimant was a commercial laundry. It operated a number of boilers to service existing contracts.
It won a government contract to dye uniforms. A new boiler was required to service the additional work once the contracts started.
The Defendant was not informed that the Laundry might lose the government contract if the boiler was delivered late.
The Claimant ordered the boiler. It arrived five months late. The Claimant was not able to service the government contract, because it did not have the boiler it required.
As a result, the government terminated the contract with the Claimant.
The laundry lost general business as a result of the failure to deliver the boiler. That was direct loss.
The dyeing contracts were more lucrative and attracted a higher profit margin. It was especially profitable. Special circumstances such as these were not in the usual course of things. It was not direct loss.
The consequential loss claimed for loss of the business which it would have serviced - dyeing uniforms was:
- not direct loss, and
- not reasonably foreseeable (by both of the parties) because the defendant did not know that the dyeing contract might be lost as a result of late delivery.
The Defendant did not know of the contract with the government. It needed to know prior to the date of the contract that there was a serious possibility that the government contract might be lost, for the loss to be recovered under the second limb.
If a minor breach of contract leads to a large sum of damages, a court is less likely to hold that the defendant should be liable for an extraordinary sum of damages, unless the defendant was on notice the likely consequences of the minor breach.
Example: Direct and Consequential Loss:
A contractor is engaged to a dig trench in a field.
The landscape is a green field which is 20 km from the nearest town. There’s nothing to suggest that there had been any building or pipework in the field.
The land owner asks the contractor to a dig trench across the field, and says nothing else.
The contractor commences work.
A subterranean pipe is cut during the digging. It’s a mains water pipe.
The contractor (the defendant) is sued by the land owner. The land owner says that the contractor did not exercise reasonable skill and care, and is therefore in breach of contract and liable for the damage caused.
The contractor says in his defence that:
- there was nothing to suggest from the land there would be any pipes, let alone mains water pipes, and
- the land owner said nothing about pipes or even the possibility of pipes in the ground
The contractor is not liable for the damage to the pipe, cost of repairs to the pipe or the consequent flooding.
Let’s change the facts in the example above. The landowner tells the contractor before the contract is agreed that there may be water pipes in the ground.
On these facts, the contractor would probably be liable for the cost of repairs to the pipe and the consequent flooding.
Example: Consequential Loss
Let’s change the facts again. This time the landowner tells the contractor that again there could be water mains in the ground, and says nothing else.
This time however, the contractor cuts the water mains and an optic fibre cable which carries internet traffic to a nearby city.
The contractor isn’t liable for the consequential loss arising from cutting the optic fibre cable but is liable for cutting the water mains.
Had the land owner told the contractor that there could be other types of cable in the ground, it might have prompted:
- an investigation by the contractor prior to commencing work to assess the risk of performing the work, and raising the price
- take a different type of care than just looking and keep a lookout for water pipes. He might have done a geophysical scan of the terrain, and included that in the contract price
- insisted on an exclusion or limitation of liability in the contract, and/or
- obtained insurance to cover mishaps.
But was it enough of the special circumstances to investigate for optic fibre cables?
Probably not. It's a different kind of loss arising from the breach to exercise reasonable skill and care. The contractor isn’t liable for the damage to the optic fibre.
There is an important corollary from the rule in Hadley v Baxendale.
The more the defendant knows about the likely consequences to the claimant of a breach:
- The more likely the damages will be recoverable as consequential loss; but more importantly
- The loss may become recoverable as direct loss.
There is nothing in principle that prevents the type of loss from being categorised as direct loss and consequential loss.
It’s an important point because consequential loss is usually excluded from recovery in commercial contracts.
Case: Hadley v Baxendale
The most often quoted text from Hadley v Baxendale is:
Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either:
- arising naturally from the breach (ie, according to the usual course of things, from such breach of contract itself), or
- such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.
Now, if the special circumstances under which the contract was actually made where communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily follow from a breach of contract under these special circumstances so known and communicated.
But, on the other hand, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such a breach of contract. For such loss would neither have flowed naturally from the breach of this contract in the great multitude of such cases occurring under ordinary circumstances, nor were the special circumstances, which, perhaps, would have made it a reasonable and natural consequence of such breach of contract, communicated to or known by the defendants. (formatting added)
Whether damage is too remote for the innocent party depends primarily on:
- the knowledge of the party in breach of contract,
- assessed as at the date of the contract.
It makes sense. The more information - special circumstances - known to a defendant, the more likely it is to know what will happen if the it is in breach of contract.
When assessing whether whether a defendant is liable for a kind of loss, the parties might do well to therefore two questions in respect of the kind of loss:
- whether the parties must be taken to have had this type of loss within their contemplation when the contract was made,
- whether they must be taken to have had liability for this type of loss within their contemplation at the time of the contract.
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