Counting the cost

What is the measure of loss for breach of contract? This is an important question, particularly in the construction and building industry where claims against contractors for breach of contract are frequent.

Janine Stewart
Janine Stewart

Riaia Donald
Riaia Donald

Helena Hallagan
Helena Hallagan

The fundamental objective of an award of damages is to put the innocent party in the position it would have been in had the contract been performed correctly. What loss is caused by the breach, and how that loss is to be measured, are questions that are addressed on a case by case basis with reference to the purpose of the contract and considerations of reasonableness.

The two principal measures of loss for breach of contract are “cost of reinstatement” (the cost of curing the breach) and “diminution in value” (the difference in value between what was promised and what was supplied or what in fact occurred). Cost of reinstatement has been the traditional measure in contract claims and diminution in value is usually applied when a tortious duty has been breached, but these rules are not inflexible.

As Tipping J noted in Marlborough District Council v Altimarloch Joint Venture Ltd [2012] 2 NZLR 726, there are no absolute rules and what measure of loss is appropriate is a question of fact.

The Supreme Court decision in Altimarloch considered the differences between the two measures in the context of the sale and purchase of land where the purchaser did not receive water rights represented to it during the transaction. The difference in value of the land without the water rights was $400,000 whereas the cost of remedying the vendor’s failure to supply the represented water rights was $1,055,907.

The majority (3:2) of the Supreme Court found that, in light of the purpose of the contract and in order to adequately compensate the purchaser, the cost of reinstatement was the appropriate measure. The purchaser was awarded the cost of constructing a dam to store water as this was the only way to put the purchaser “in the position it would have been in had the representations about the water rights been true.”

Although the majority judges differed in emphasis, their conclusion was based on the purpose of the contract, namely, to plant a vineyard, and the purchaser could not do this without cost of reinstatement damages.

The Altimarloch decision is a shift away from the emphasis on proportionality in Ruxley Electronics Ltd v Forsyth [1996] 1 AC 344 (HL). The approach in Ruxley requires consideration of whether the cost of reinstatement would be disproportionate to the benefit obtained by the innocent party. Ruxley favours diminution in value where cost of reinstatement is an “unreasonable” measure of the actual loss suffered.

In Ruxley, the diminution in value of the pool was nil (it was still functional despite being a foot shallower than specified), whereas the cost of reinstatement was £21,560. The House of Lords held that where the contractual objective has been achieved to a substantial extent (as it had in the circumstances), the cost of reinstatement to satisfy personal preference may be disproportionate and unreasonable. The pool owner received a nominal award for breach of contract and loss of amenity.

“Reasonableness” remains an essential component of an assessment of the measure of loss. However, Altimarloch is authority for the proposition that if the diminution in value measure does not provide satisfactory compensation to the innocent party, then the cost of reinstatement is the reasonable measure and the differences between the two measures should not factor into the decision. The emphasis is on the purpose of the contract.

In the decision of Stevenson Precast Systems Ltd v Kelland (High Court, Auckland Registry, CP303-SD01, 9 August 2001), the High Court gave effect to the purpose of the contract when awarding damages. The High Court considered whether it was reasonable to require the contractor for a dwelling on Waiheke to meet the cost of replacing defective/ cracked panels with new panels ($414,800) when they could be repaired at substantially less cost (between $20,000-$50,000).

In this case, the owner had a significant interest in architecture and had spent considerable effort designing the property in a particular style that left no room for imperfection in the architectural finish.

The Court considered that replacing the defective panels was the only reasonable solution as it was not satisfied that any patch repair job would meet the standard of quality required by the contract.

This raises the issue of the intention of the innocent party and whether it has a genuine interest in having the contract performed. It is clear that if the reinstatement or replacement work will never be done, this counts against the cost of reinstatement measure being “reasonable” (Bellgrove v Eldridge (1954) 90 CLR 613).

The innocent party must therefore have a genuine and serious intention of expending any damages on remedying the breach. This is more likely to be the case in construction projects that require a high standard of quality, a particular finish or design, or projects that involve materials that are difficult to substitute.

Whilst advocates of the diminution in value measure may argue that the innocent party is entitled to no more than the cost of the cheapest remedy for the damage caused, cases such as Stevenson and Altimarloch encourage the Court to consider awarding the cost of reinstatement (which is usually the more expensive measure) if this gives effect to the purpose of the contract. This requires consideration of the project as a whole.

Arguably, if a contractor breaches a building contract, it cannot subsequently deny liability for remedying that breach because the cost of reinstatement is expensive. The cost of reinstatement would not be necessary if the contractor had fulfilled its obligations in the first instance. The argument that this would result in the apparently inequitable position that the contractor is initially paid a reasonable sum to carry out the work, and is later liable for a considerably greater sum when it fails to carry out that work properly, is countered by an alternative finding that no contract for building work could ever be effective. The contractor could try its best (or not) and never be liable for the failure of the entire purpose of the contract.

On balance, it would defeat the purpose of contract law (to provide certainty in commercial relationships) to allow contractors to escape their obligations, particularly specialist contractors whose very purpose of engagement is to produce a particular result. The reasonable expectations of the innocent party in having that result achieved point towards cost of reinstatement as the appropriate measure of loss in particular circumstances. Moreover, the contractors’ overheads in building contracts would normally include the cost of insurance, which should cover a damages award of cost of reinstatement in the event of breach.

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