Contractual interpretation – the “duty” of mitigation and capping contractual liability

Insight

02.12.2021

There was much of interest in this recent High Court case for both our litigation and corporate law colleagues, but two particular aspects of the judgment stood out for us commercial contract lawyers, namely: what an express duty to mitigate losses meant in practice; and how to interpret a contractual cap on liability. On both, the judge took something of a restrictive reading, providing some obvious learning points for both contract drafters and litigators in the process.

The facts of the dispute were complex and various but, put simply, Equitix, the claimant, purchased from the defendants the entire issued share capital of Gaia, an energy company, which supplied steam from biomass boilers to its sole customer, Greenergy. Greenergy terminated its contract with Gaia shortly after the share sale, citing performance failures. Equitix claimed damages for breaches of certain warranties given by the defendants in the SPA. On the facts, the judge, Mr Justice Kerr, found that the warranties had indeed been breached.

The court awarded damages of £11 million (the full amount of the liability cap under the SPA), assessed in accordance with the usual measure applicable to breaches of warranties of quality, namely by reference to the reduction in the value of the shares attributable to the falsity of the breached warranties.

Mitigation

The defendants argued that Equitix was under a duty to mitigate its losses and the level of damages payable should be reduced accordingly. In assessing this argument, the court had to consider the impact (if any) of: (1) the common law doctrine of mitigation; and (2): an express contractual obligation on Equitix to mitigate any loss suffered by it.

The judgment contains some helpful reminders about the scope of the doctrine of mitigation. The judge starts by making the point that what is commonly called the common law duty to mitigate one’s losses is not a duty in the true sense: there is no positive obligation on the party who suffers a loss to do anything. It is instead a rule, or doctrine, that the innocent party cannot recover for any loss which was reasonably avoidable.

It was noted that the threshold for recovery is a low one. A claimant does not have to take all reasonable action to avoid a loss before it can recover damages. Instead the rule, as formulated by the judge, can be expressed as “the claimant cannot recover for loss unreasonably not avoided”. It is an inelegant formulation, and the judge apologised for the awkward double negative, but it is clear that the rule is not designed to impose an onerous obligation on a party who has suffered loss, nor to severely reduce the amount of damages a party might expect to recover as a result; instead, a party is simply not entitled to recover losses if it acted unreasonably in failing to stop such losses from escalating following the breach. It is only where it would be unreasonable not to act in a particular way, and yet such action is not taken, that the doctrine kicks in to reduce the level of damages owed.

The judge makes clear that this doctrine is rarely applicable in breach of warranty cases because the measure of damages is calculated with reference to the diminution in the value of the shares attributable to the falsity of the breached warranties. The loss in question crystalises at the point of purchase and therefore whatever the buyer does or does not do after purchase is irrelevant or too late for the purposes of quantifying quantum.

Accordingly the judge was very quick to dismiss the defendants’ argument that the common law doctrine of mitigation had any impact on the level of damages owed.

A contractual obligation to mitigate

The judge turned next to an express clause that stated:

“The Buyer [Equitix] shall (and shall procure that the Company [Gaia] shall) take all reasonable action to mitigate any loss suffered by it or the Company which would, could or might result in a claim … against the Sellers [Defendants].”

Equitix argued that this clause added nothing to the common law doctrine which, as mentioned above, was of no use to the defendants in this case because of the way that damages for breach of warranty were calculated. In contrast, the defendants argued this clause codified the common law doctrine as well as setting a higher threshold akin to a best endeavours obligation to mitigate loss. The defendant listed a number of actions it considered the claimant should have taken to mitigate its losses in accordance with this contractual obligation. Failure to take these actions, it argued, should mean that the damages should be reduced accordingly.

In assessing these arguments, the judge had to determine:

(1) Whether this clause had a separate meaning, or simply restated the common law doctrine.

(2) If the clause did have a separate meaning, what precisely it required of Equitix.

In answering these questions, the judge takes what might be seen as a surprising approach, finding that the clause in question did have meaning, beyond merely restating the common law doctrine, but its meaning was not much different from the common law doctrine.

The judge said this clause was “obviously drafted with the common law rule in mind” and appears to mirror this standard rather than elevate it. He said that had the drafter intended to elevate the standard to the “exorbitant one” advocated by the defendants, he or she would have said so in clearer words. Finding, as he does, that this contractual obligation broadly recasts the (low) threshold of the common law doctrine, the judge did not reduce the level of damages owed, as Equitix did not fail to take all action that it would be unreasonable for it not to take.

We find this reasoning surprising, especially in light of Arnold v Britton[1] and the seam of contractual interpretation cases since, where a more literal approach is given to contractual terms. Indeed it does not seem – as the judge indicated – obvious that such a clause was drafted with this common law rule in mind. One often sees the common law duty or doctrine expressly identified by name (for example: parties’ stating that nothing in the contract alters their duty to mitigate), yet it was not identified by name here. And, if the drafter was an expert on this doctrine then he or she would have known that the doctrine would be of little use in breach of warranty claims and would have known that the threshold for this doctrine was lower than the threshold imposed by the express words used in the contract. The express words appear to impose a relatively high threshold for recovery – far beyond the threshold provided for by common law – and a positive obligation to act in a particular manner (“all reasonable action…to mitigate any losses” (our emphasis)).

It should be noted that the defendants have been granted permission to appeal the interpretation of this clause, so we may well see this point revisited by a higher court.

Whether or not this judgment is overturned, it does beg the question whether it is sensible to include clauses such as this, especially if you are the party who may by subject to the obligation imposed? If the words simply mean what the common law already provides for, then why include them? And, if they mean more than that, are you comfortable with this higher standard, especially given the potential ambiguity of meaning? The common law rules are well understood by the courts, and are there for a reason. In seeking to recast or replicate them contractually, you may risk exposing yourself to potentially lengthy arguments about contractual interpretation, without obvious gain.

We shall of course keep our eyes out for the appeal and update you on the outcome in due course.

Liability caps

The interpretation of the liability cap contained in the SPA was dealt with in a related judgment[2], where the court was asked whether the wording of the contract that created an aggregate limit of £11 million related to just damages, or whether it also included interest on damages, any uplift under CPR 36.17(4)(d), costs, interest on costs and any order to make a payment on account of costs.

The wording of the liability cap stated that liability was limited “in respect of a claim under this Agreement” (emphasis added). The claimants argued that an ancillary order to pay interest or costs does not create a liability “in respect of” the claim itself, but in respect of the litigation process to determine the claim. The judge agreed with this interpretation, saying that a claim for interest or costs is not one made under the SPA itself; it is made pursuant to the court’s jurisdiction to make ancillary orders when determining such claims. Accordingly, he awarded these costs, interest and interest on costs in addition to the (capped) damages amount.

The judge accepted that it would be possible for parties to a contract to expressly agree to limit recovery for specific costs or other ancillary consequences of a breach of contract, however this is not the norm and that “if important litigation rights were being foregone” one would expect clearer words included in the contract. This makes sense: damages and a party’s ability to recover for damages are firmly rooted in the contract and performance of its contractual obligations; in contrast, costs, interest and potential uplifts are related to the parties’ handling of any related claim, a clearly separate matter, one with well understood rules around recovery, and one where a party’s behaviour during the process can have clear consequences in relation to how costs, etc, are awarded.

The judge indicated, obiter, that although the phrase “in respect of” was wide it was not as wide as “arising out of or in connection with”: perhaps suggesting that use of this latter phrase might have resulted in a different outcome. We would suggest this indication should be treated with caution as such wording is typically aimed at capturing tort, misrepresentation or restitution, rather than including litigation costs within its ambit.

The learning point is clear: if you wish to cap litigation costs (interest on damages, any uplift under CPR 36.17(4)(d), etc) in a contract you should do so using express words. Though whether it would be commercially sensible to do so is quite another matter.

[1] Arnold v Britton [2015] UKSC 36

[2] [2021] EWHC 2781 (TCC) WL 04875641

If you require further information about anything covered in this briefing, please contact Paul Jones and Jane Randell or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.