What are the practical implications for businesses following the High Court’s decision on recovery of contractual damages for wasted expenditure?

Key takeaways

• If there is uncertainty as to whether a claimant would have recouped the expenditure it has incurred in anticipation of, or reliance on, performance of the contract by the other party (such that the expenditure can properly be described as “wasted”) that uncertainty is resolved in favour of the claimant.
• As a result, parties who try to avoid their obligations under an inconvenient or unprofitable contract may be liable for more than they initially contemplated.
• Liability for wasted expenditure can be excluded by an appropriately drafted exclusion clause.

Background

As part of an initiative to develop Cessnock Airport, Cessnock City Council (Council) entered into an agreement for lease (AFL) with a company then-known as Cutty Sark Pty Ltd (Cutty Sark), by which Cutty Sark was to lease a prospective lot on the airport land.

The grant of the lease required subdivision of part of the Council's land and, accordingly, a term of the AFL was that the Council would take all reasonable action to apply for, and obtain, registration of the plan of subdivision by a certain date.

The Council breached that term and repudiated the AFL. Cutty Sark never obtained a lease.

By that time, Cutty Sark had spent considerable money in anticipation of, or reliance on, the Council performing its obligations under the AFL, by constructing an “iconic” aircraft hangar on the site of the proposed lot.

Cutty Sark’s businesses failed and, following the Council's breach and repudiation of the AFL, the AFL was terminated by Cutty Sark.

Cutty Sark commenced proceedings seeking damages for its wasted expenditure in constructing the hangar.

How do courts quantify contractual damages?

The aim of contractual damages is to put the claimant in the position it would have been in had the contract been performed. This is the rule from Robinson v Harman¹, and reflects the principle that expected performance is the essence of Australian contract law.²

Accordingly, contractual damages are ordinarily calculated by reference to the benefit or profit that the claimant would have obtained had the contract been performed, but which has been lost as a result of the breach of contract. This type of loss is known as “expectation loss”.

A claimant always bears the legal onus of proving the benefit or profit, if any, it would have made if the contract had been performed. But what if, because of the defendant’s breach, there is uncertainty as to whether the claimant would have received a benefit or made a profit?

In Cessnock City Council, Cutty Sark could not prove whether it would have made a profit (and thereby recouped its expenditure on the hangar) from the businesses conducted from the hangar. Due to the Council’s failure to have the plan of subdivision registered, in breach of the AFL, the following matters necessary to prove Cutty Sark’s potential profit were uncertain and depended entirely on speculation:³

• whether the Council would have further developed Cessnock Airport if the plan of subdivision had been registered;
• how soon that development would have occurred;
• how much more business would have been attracted to the precinct; and
• how Cutty Sark would have responded to any increase in business and operations at the airport.

As a result, following the leading High Court cases of McRae⁴ and Amann Aviation⁵, Cutty Sark claimed contractual damages assessed as:

• the expenditure it had incurred in constructing the “iconic” hangar on the airport land;
• in reliance upon the Council’s promise to register the plan of subdivision; and
• which was wasted as a result of the Council’s breach and the lease not being granted.

What were the issues before the High Court?

The question for the High Court was whether, in order for Cutty Sark to be awarded damages for its expenditure on the hangar, Cutty Sark needed to prove that it would have recouped that expenditure if the Council had obtained registration of the plan of subdivision and the lease had been granted, so that expenditure could properly be said to have been “wasted” by the breach.⁶

This is because all contractual damages seek to put the claimant in the position it would have been in if the contract had been performed. This is the principle from Robinson v Harman and is the “sole, obvious, and justified measure” of compensation for breach of contract in Australia⁷. This principle still applies in circumstances where the claimant cannot prove the benefit or profit it would have obtained due to the uncertainty created by the defendant’s breach. A majority of the High Court made it clear that the aim of contractual damages is not to put the claimant in the position it would have been in if the contract had not been made.⁸

What did the High Court decide?

The High Court unanimously held that Cutty Sark could recover as damages its wasted expenditure of $6.2 million (including interest) incurred in constructing the hangar.

Cessnock City Council has clarified that:

• a claimant can recover, as contractual damages, reasonable expenditure that it has incurred in anticipation of, or reliance on, the defendant’s performance of the contract, and that has been wasted following the defendant’s breach of contract;⁹ and
• although the claimant bears the legal burden of proof to establish that the expenditure is wasted, when a defendant's breach of contract has resulted in uncertainty about the state of affairs that would have obtained if the contract had been performed, a court will facilitate discharge of the claimant’s legal burden of proof by assuming in the claimant’s favour, giving the claimant a “fair wind” to establish that, had the contract been performed, the claimant would have recovered that expenditure – that is, the evidentiary uncertainty will be resolved in favour of the claimant on the balance of probabilities.¹⁰

In the circumstances, as the Council's breach of contract had caused sufficient uncertainty about the position Cutty Sark would have been in had the contract been performed, Cutty Sark was to be taken to have established its loss as the amount it had expended on the hangar. That is, the expenditure was taken to have been incurred in anticipation of, or reliance on, the performance of the Council's obligation to obtain registration of the plan of subdivision, and which was wasted due to the Council’s breach of contract.

The High Court also relied on the above reasoning to settle some other issues that had been left open by its previous decisions:

• A claimant seeking damages for wasted expenditure does not need to establish that the defendant’s breach had rendered it “impossible” or even “difficult” to prove the benefits that would have flowed to the claimant from the contract.¹¹
• The rationale for the award of damages for wasted expenditure is not based on a “presumption” that a commercial party would not ordinarily enter into a loss-making contract (the so-called ‘presumption of profitability’).¹²
• A claimant can recover wasted expenditure incurred in anticipation of, or reliance on, the performance of the contract by the defendant. Those amounts are not limited to amounts incurred in furtherance of the claimant’s performance of the contract.¹³

How can a claim for wasted expenditure be defended?

To the extent that some, or all, of the expenditure would not have been recoverable had the contract been performed, those amounts will not be recoverable as damages from the defendant. Once the claimant establishes that it has incurred expenditure in anticipation of, or reliance on, the defendant’s performance of the contract, the defendant bears the evidential burden of proof of showing that some, or all, of that expenditure would not have been “wasted”¹⁴. The defendant’s task is likely to be a difficult one.

For example, in Cessnock City Council, the High Court held it was not enough to provide that there was a “prospect” that Cutty Sark would not have recouped its expenditure on the hangar.¹⁵ Nor was the fact that Cutty Sark had made actual losses (in the three years it had operated businesses from the hangar) enough to prove that Cutty Sark would not have recouped its expenditure, given the 30 year term of the lease which would have been granted.

The High Court has not excluded the possibility of a defendant proving that the claimant would only have recovered some lesser amount of its total expenditure. In Amann Aviation, the High Court majority held that it was appropriate to consider whether the contract between the parties would have been lawfully terminated, or whether it would not have been renewed, so the claimant would not have recovered the entirety of its expenditure. On the facts of that case, however, the High Court majority resolved both of these questions in the claimant’s favour on the balance of probabilities.¹⁶ The Council did not run a similar argument in Cessnock City Council.¹⁷

The Council was ultimately liable for $6.2 million (plus costs), comprising the cost of constructing the hangar ($3.7 million) plus interest.

By comparison, in choosing to breach and repudiate the AFL, the Council had relied on an estimate that expenditure of $1.3 million would have been required to be incurred by the Council to comply with the conditions enabling registration by the agreed date.

Cessnock City Council is therefore a salutary reminder that parties who try to avoid their obligations under an inconvenient or unprofitable contract may become liable for more than they initially contemplated.

Can liability for wasted expenditure still be excluded?

Yes. Cessnock City Council has not disturbed the long-standing position that the scope of an exclusion clause is ordinarily a matter of commercial negotiation. Exclusion clauses are construed like any other contractual term – objectively. The question is what a “reasonable businessperson would have understood” its meaning to be¹⁸, by reference to “text, context … and purpose”.¹⁹

This approach prevails even if the expenditure specifically excluded relates to the “main purpose” of the contract. Some courts have suggested a narrower construction may be warranted, which can involve the rejection of “words, indeed whole provisions, if they are inconsistent with … the main purpose”.²⁰ But the prevailing position is that an exclusion that denies the “main purpose” of a contract will still be effective if that is its true construction.²¹

Contracts often include general exclusion clauses that seek to oust liability for losses that might otherwise be recoverable under the general rule of “remoteness”. The High Court in Cessnock City Council confirmed that the ordinary rule that contractual damages are only recoverable if they are not too remote remains an effective control on the damages a claimant can recover for wasted expenditure.²² Contractual damages are not too remote if the amount claimed relates to either: “loss arising in the usual course of things from such breach as occurred”, or loss that “may be supposed to have been in the parties’ contemplation, when they made the contract, as the probable result of breach”.²³

In Cessnock City Council, the High Court found that the wasted expenditure was not too remote as the Council was aware that Cutty Sark intended to construct a hangar on the proposed lot – it had granted development approval for a new hangar, and had permitted Cutty Sark to commence construction before the AFL was entered into.²⁴ The AFL also contained “extensive provisions” in relation to the construction of the hangar.²⁵ Accordingly, whether the Council could avoid liability for Cutty Sark’s loss associated with construction of the hangar was a matter of ordinary construction of the exclusion clause contained in the AFL.

It is a common drafting technique for general exclusion clauses to contain general expressions such as “indirect” or “consequential” loss to exclude losses for which parties would be liable because they are not too remote.

These general expressions (which appeared in the AFL) are notorious for having an objective meaning that contracting parties may not subjectively have intended. The authorities in this area are unsettled. Some Australian courts have held the term “consequential loss” ordinarily includes expenses incurred by a party.²⁶ Other Australian courts have considered that this is not a fixed and inflexible rule.²⁷ In England, the opposite is true – "wasted expenditure” is an “obvious and common” type of loss, so in order to be excluded, an exclusion clause should make express reference to it, or words to similar effect.²⁸ As a result, an exclusion clause for “indirect” or “consequential” loss may not always cover wasted expenditure.

Instead, an appropriately drafted provision of a contract can exclude or limit damages for wasted expenditure provided that is what it clearly and unambiguously provides. We identify some relevant considerations below.

How can liability for wasted expenditure be excluded?

A general exclusion clause may be effective to exclude liability for wasted expenditure if, in addition to open-textured expressions such as “indirect” or “consequential” loss, it instead adopts the formulation for liability from Cessnock City Council, and refers to loss incurred by a party “in anticipation or reliance on performance” of the contract.

In addition, when parties to a contract contemplate that certain kinds of expenditure will be incurred, parties may be able to rely on a specific exclusion clause that expressly refers to those discrete kinds of expenditure, carefully drafted with regard to how each party intends to rely on the contract, and the expenditure they intend to incur. A clause is more likely to be effective to exclude wasted expenditure if it states, with specificity, the categories of expenditure in the contemplation of the parties.

The AFL did contain a “release” provision that attempted to exclude specific kinds of loss. While the relevant provision of the AFL made reference to discrete matters such as “the Aerodrome or Aerodrome Infrastructure Facilities not being available for use by [Cutty Sark]”, the “loss of [Cutty Sark’s] profits”, and “any change in the flow of members of the public in or around the Land or Aerodrome for any reason”, it did not make specific reference to Cutty Sark’s expenditure on the hangar and therefore such losses were found not to be caught by the exclusion.²⁹

Cessnock City Council is therefore a reminder to take particular care to ensure that exclusion clauses are drafted to exclude wasted expenditure, if this is what is intended by the parties.

What are some other practical considerations for negotiating provisions that exclude liability for wasted expenditure?

The High Court in Cessnock City Council confirmed that only reasonable expenditure incurred in reliance on a contract is recoverable. This includes expenditure that might “naturally be incurred in preparing for, performing, or exploiting the benefit of the contract, or that is or ought to have been contemplated by the defendant”.³⁰

While it is not clear how reasonableness adds to the ordinary enquiry as to whether a loss is too remote (see above),³¹  it is likely that consideration of whether an amount is reasonable is relevant to the amount or extent of expenditure incurred, rather than the type of loss incurred.

For example, in Cessnock City Council, the Council was aware that Cutty Sark would undertake construction of an “iconic” hangar that would cost “around $1.8 million”.³²

In circumstances where a counterparty will not agree to exclude wasted expenditure entirely, a limitation or cap on liability may be appropriate.