The Claimant’s ‘Legitimate Interest’ and the Role of Substitutability
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The Claimant’s ‘Legitimate Interest’ and the Role of Substitutability
I Introduction
In at least some common law countries, courts acknowledge that disgorgement damages may be available for breach of contract.1 But it remains unclear exactly when disgorgement will be available. In Blake, Lord Nicholls proposed that courts would award disgorgement damages according to a twofold test: first, the claimant must have a ‘legitimate interest’ in performance of the contract, and secondly, compensatory damages must be inadequate.2 Nonetheless, the attempts by courts to apply Blake indicate that ‘the legitimate interest test remains hopelessly ill-defined and difficult to apply.’3 This chapter seeks to fit the theory of disgorgement damages to the existing law, and to clarify the way in which the ‘legitimate interest’ test operates so that the law is more coherent and predictable for courts, lawyers, litigants and contractors. As prefigured in the previous chapter, the criterion according to which disgorgement damages should be awarded for breach of contract is the substitutability of the subject matter of the contract.4 Substitutability is derived from the cases where courts award specific relief, but it should not be limited to that context: it is central to an understanding of remedies for breach of contract, and also informs the measure of expectation damages. The stated aim of contract remedies for breach is to place the claimant in a position as if the contract had been performed. The contractual context must be emphasised. Substitutability looks to what the claimant hoped to gain from the contract, and therefore what remedy the defendant must give the claimant as a substitute for the performance which was denied as a result of the breach. An effective contractual remedy encourages vindication of the claimant’s interest. Although contractual damages may seem at first glance only to be concerned with compensating for loss, in fact the focus of contract damages is generally to vindicate the claimant’s performance interest in the best way possible. Generally, courts use the market to ascertain the value of the claimant’s expectation, and award expectation damages on that basis, but where that measure would provide an inadequate substitute for performance, courts also use other measures, such as rectification damages (which will be discussed in greater detail in chapter six), reliance damages and damages for loss of a chance.
Before considering the way in which remedies operate in detail, it is first necessary to consider the effect of the parties entering into a contract. I will adopt Professor Stephen Smith’s suggestion that there are two effects when parties enter a contract: a tangible effect whereby resources are shifted between parties to the contract, and an intangible effect involving the creation of bonds of trust between the parties.5 However, cases and commentary tend to favour one effect to the exclusion of the other. The promissory or rights-based analyses emphasise the claimant’s right to performance, and argue that the primary obligation arising from a contract is the claimant’s right to have the contract performed. On the other hand, others argue that the primary obligation arising from a contract is merely an obligation to compensate the claimant for financial losses suffered as a result of the breach. Primary among those who take this approach are certain law and economics scholars who favour the ‘efficient breach’ explanation of breach of contract. Neither approach wholly fits with the data which the case law provides. Both theories explain a proportion of the cases, depending on the circumstances of the contract and, pivotally, the nature of the interest contracted for.
My theory recognises the claimant’s ‘performance interest’.6 Courts have long suggested that the performance of a contract is central. However, despite general acceptance of the significance of the performance interest, the remedies awarded for breach of contract seem to suggest that the aim of remedies for breach of contract is not to ensure performance, but to compensate the claimant for her loss. The cases ‘do not speak with one voice.’7 Some cases emphasise the importance of performance, others say that the only obligation is to pay damages to the claimant for financial losses. Sometimes the same case contains conflicting judgments. Consequently, the law has a schizophrenic approach towards contract remedies.8 This occurs because when courts award ‘expectation damages’, they simultan- eously compensate the claimant for loss and satisfy the claimant’s performance interest. Compensation for loss is, however, merely one way of satisfying the claimant’s performance interest, although it is the most commonly used method. While the primacy of expectation damages might suggest the law is mainly concerned with compensating loss, this is not the case. Courts are concerned to vindicate the claimant’s performance interest.9
‘Vindication’ is derived from the Latin vindicatio, and has a number of different meanings, including justification of a right and asserting or maintaining a right.10 In this context, I intend to use it to mean a making good of, and recognition of, a claimant’s rights. For a claimant’s contractual rights to be recognised, she must have an adequate remedy. In an oft-cited passage, Holt CJ said in Ashby v White:
If the plaintiff has a right, he must of necessity have a means to vindicate and maintain it, and a remedy if he is injured in the exercise or enjoyment to it; and, indeed, it is a vain thing to imagine a right without a remedy; for want of right and want of remedy are reciprocal.11
Thus, when a court awards a claimant a contractual remedy, the court vindicates that right by recognising the claimant’s assertion of it. The award of the remedy makes the defendant accountable for his breach, in the sense that he has to take responsibility for the consequences flowing from his failure to perform his contractual obligation. The law favours expectation damages as the primary remedy which a claimant can assert, because it is a less intrusive way of vindicating the claimant’s performance interest, and ordinarily it will be adequate for the purpose. 12 Frequently, the claimant’s right to performance may be vindicated by something less than actual performance by the defendant; compensatory damages will be adequate if a substitute performance can be purchased with damages. Thus, sometimes a defendant is ‘free’ to breach his contract, subject to his obligation to pay damages (as the supporters of ‘efficient breach’ allege). In addition, there may be situations where we want to allow breach, for example, when unforeseen circumstances mean that the defendant breaches to avoid a loss (as opposed to the situation of ‘efficient breach’ where the defendant breaches to obtain a gain).13 However, where damages are inadequate to provide the claimant with a substitute performance, courts are increasingly willing to award specific relief which directly vindicates the claimant’s right to performance by awarding her the interest which she contracted for.
It is in this context that the claimant’s legitimate interest in the performance of a contract must be assessed. In keeping with the deterrent rationale, the object of disgorgement damages is to encourage future defendants to perform or negotiate out of the obligation rather than merely to breach, at least where certain kinds of contract are concerned. Clearly it is too late to deter the particular defendant in question from breaching: yet the claimant’s contractual right should still be vindicated or recognised in some way. The best way to vindicate the claimant’s performance interest in the cases where disgorgement damages should be awarded is to strip the defendant of the profit he has made, and put him in a position as if he had performed his contract.
I have explained in the previous chapter that deterrence and punitive rationales shape disgorgement, but I have not yet established the precise limitations on an award of disgorgement damages for breach of contract. ‘Substitutability’ is an essential limitation: courts must assess whether the claimant is entitled to a sub- stitute performance if the defendant breaches his contract. Generally speaking, disgorgement damages will only be available if compensatory damages are inadequate to recognise the claimant’s performance interest, specific relief is no longer available, and if the defendant has made a profit. In these circumstances the ‘next best’ remedy available to vindicate the claimant’s performance interest may be disgorgement damages. Courts have already given extensive thought to questions of substitutability when making awards of specific relief. Thus, disgorgement damages are coherent and consistent with existing principles of contract remedies. Substitutability is also consistent with my ‘middle ground’ approach to enforcing the claimant’s performance interest. That is to say, the claimant is not always entitled to performance, or disgorgement in lieu of performance: it depends upon the subject matter of the contract and the degree of substitutability thereof.
At the end of this chapter, I will introduce the two classes of case where disgorgement damages may be awarded, namely the ‘second sale’ cases and the ‘agency problem’14 cases. The detailed application of my theory to these categories of case will be found in chapters four and five.
II The ‘Legitimate Interest’ Test and Substitutability
Substitutability is not mentioned in the Blake decision, which is now the basic English authority supporting an award of disgorgement damages for breach of contract. Lord Nicholls, who delivered the principal speech, said:
Normally the remedies of damages, specific performance and injunction, coupled with the characterisation of some contractual obligations as fiduciary, will provide an adequate response to a breach of contract. It will be only in exceptional cases, where those remedies are inadequate, that any question of accounting for profits will arise. No fixed rules can be prescribed. The court will have regard to all the circumstances, including the subject matter of the contract, the purpose of the contractual provision which has been breached, the circumstances in which the breach occurred, the consequences of the breach and the circumstances in which relief is sought. A useful general guide, although not exhaustive, is whether the plaintiff had a legitimate interest in preventing the defendant’s profit-making activity and, hence, in depriving him of his profit.15
This has become known as the ‘legitimate interest test’.16
Lord Steyn also refused to lay down a general principle. He said:
I am not at present willing to endorse the broad observations of the Court of Appeal. Exceptions to the general principle that there is no remedy for disgorgement of profits against a contract breaker are best hammered out on the anvil of concrete cases.17
Lord Hobhouse, the sole dissentient in Blake, concluded with a ‘note of warning’ about the principles introduced by the majority:
[I]f some more extensive principle of awarding non-compensatory damages for breach of contract is to be introduced into our commercial law the consequences will be very far reaching and disruptive.18
Some commentators share Lord Hobhouse’s concern that Blake will create commercial uncertainty by allowing ‘open slather’ for disgorgement damages in commercial contracts.19 The spectre of unlimited liability can be found in the argument that a promisee has a legitimate interest in preventing the other party from profiting from a breach of contract in almost all circumstances.20 Other academics have noted the lack of precision in the ‘legitimate interest test’.21 The results of cases which have subsequently applied the ‘legitimate interest test’ confirm that there is confusion as to how it operates.
Lord Nicholls’ test has typically been divided into two stages: first, the claimant must have a ‘legitimate interest’ in performance of the contract, and secondly, compensatory damages must be inadequate.22 The two parts of Lord Nicholls’ test are really different ways of posing the same intertwined question: is this the kind of bargain where compensatory damages are inadequate to put the claimant in a position as if the contract had been performed, and therefore is it the kind of bargain in which a claimant has a legitimate interest?
Before attempting to answer this question it is necessary to tease out the nature of the rights which a promisee gets under a contract, because to do so assists in identifying when a ‘legitimate interest’ ought to be found. We must look at the rights of the claimant which courts are seeking to vindicate or recognise when they award remedies for breach of contract.
III Policies behind the Primary Duty to Perform Contracts
We can only fully understand remedies for breach of contract if we understand the policies behind the primary duty to perform contracts.23 Courts seek to recognise or vindicate the claimant’s rights in a way which recognises what people seek when they enter into a contract. As I have observed previously, Stephen Smith has argued that performed contracts have two different effects:24
1. They have a tangible effect because they allow for a shifting of resources between the parties to the contract; and
2. They have an intangible effect because they create bonds of trust between contracting parties.
I will now flesh out Smith’s analysis further. Breach of contract harms claimants in two different ways. First, it has a tangible effect because it means that resources cannot be shifted between the parties in the manner agreed. Secondly, it has an intangible effect because it erodes the bonds of trust between the parties. Any remedy awarded for breach of contract must recognise and vindicate both harms to be adequate.
Scholars and cases tend to emphasise one kind of harm to the exclusion of the other. One approach, which emphasises performance and the morality of promising, focuses on the second effect of the performed contract, that is, the creation of a relationship of trust between the parties. A primary example of this is Professor Fried’s ‘promise theory’ of contracts, in which he argues that when a contract is breached, the disappointment of the promisee’s expectation is an abuse of trust.25 This analysis fits with the rhetoric of many of the cases mentioned below, where courts strongly insist on the existence of the claimant’s performance interest as a matter of principle. Interestingly, given the prominence which he gives to performance of a promise, Fried does not consider why contract law favours expectation damages over specific performance.26 His analysis does not explain the actual remedies which courts award in practice for breach of contract in many cases, where expectation damages are generally seen as an award of first resort.
The reason why courts award expectation damages for preference in contractual cases is because often, such damages are adequate to vindicate the breach of the bonds of trust between the parties, but it depends very much upon the nature of the subject matter of the contract. An analysis which emphasises the importance of performance should explicitly recognise that the bond of trust has been broken in the remedies which it awards. Indeed, a need to vindicate the breach of the bond of trust on the part of the defendant is one reason why courts may wish to award disgorgement damages; particularly in the category I call the ‘agency problem’ cases, but also in the category I call ‘second sale’ cases.
Like Fried, Professor Smith adopts an approach which emphasises the importance of promises to contract law, although he argues that common law contract principles favour expectation damages over specific relief precisely because of the importance of promising.27 According to Smith, ordering specific relief prevents parties from knowing ‘whether or not performance has been done for the right reasons’, and if it were ordered routinely, contract law would have less opportunity to strengthen bonds between parties.28 By contrast, following Dori Kimel, I argue that the common law favours expectation damages over specific relief not because of the importance of promising, or because of any concern by parties as to the motives for fulfilling obligations, but because the law is concerned to remedy the claimant’s performance interest in a way which is least intrusive, via expectation damages.29 But where expectation damages do not adequately vindicate the breach of the bonds of trust between the parties, and a substitute performance is not available from elsewhere, courts may award specific relief, or – exceptionally – disgorgement damages.
To be contrasted with the promissory theorists, the proponents of ‘efficient breach’ argue that the only obligation arising from breach of a contract is to pay expectation damages, and that parties should be free to breach their contracts when resources could be allocated more efficiently elsewhere.30 This analysis focuses only on Smith’s first effect of the performed contract, that is, the shifting of resources between the parties and whether this shift is desirable. Thus, under this kind of analysis, the law should favour expectation damages in almost all circumstances because they are more efficient and do not deter parties from breaching their contracts. I argue that this theory does not adequately fit with the case law.31 Although, as explained above, contract law generally favours expectation damages, there are circumstances where they do not adequately vindicate the performance interest and where courts concentrate not on the shifting of resources, but seek to enforce the promise itself, thus reinforcing the bonds of trust between the parties. Furthermore, courts sometimes require a defendant to disgorge his profit, even if this was not generally explicitly recognised by case law before Blake.32
Both promissory theory and efficient breach theory can be criticised for taking an unduly individualist approach to contract law which does not fit the way in which contracting parties see their agreements, or the way in which the law operates. Sometimes the more important aspect of the bargain for parties is the performance of the promise, sometimes the more important aspect of the bargain for the parties is the efficient allocation of resources and they happily accept expectation damages in lieu of performance.
Fried’s promise theory adopts an unduly individualist approach to contract law because it insists that all promises should be kept, regardless of context.33 Contract law has a role in increasing our autonomy and choice; but an overly strict concept of contract as promise may reduce choice rather than increase it.34 In addition, promise theory does not take into account the subjective nature of a promise, and the different meanings which parties may ascribe to certain terms of the contract.35
Efficient breach scholars have also been criticised for taking an overly individualist approach which fails to take into account the broader context and the desirability of cooperative behaviour and trust.36 A relational analysis of contract law exposes the fallacy that contracts are isolated individual transactions without social context.37
It may seem that I am trying to resolve incommensurables here by trying to reconcile these two theories, but I assert that contract law can only really be understood if we seek a via media between these two approaches, and acknow- ledge that the two theoretical approaches to the interest a claimant possesses under a contract only fit some contract cases some of the time, and that the extent of the fit depends on the subject matter of the contract in question.
Professor Berryman has said in relation to expanded notions of specific performance of contracts:
Reform which purports to liberalize the availability of specific performance but does not wish to create specific relief as the presumptive remedy for breach of contract, will fail if it is not accompanied by the realization that a single contractual paradigm is not applicable to all circumstances.38
Thus, courts must keep in mind both effects of contractual breach when seeking to award remedies which effectively make good the rights of the parties: both the hampering of the ability to shift resources between the parties in the manner agreed and the erosion of the bonds of trust between the parties. It is not advisable to focus on one effect to the exclusion of another. There may be some circumstances in which a contracting party should be entitled to breach his promise, for example, to avoid a loss because of unforeseen circumstances.39 But by the same token, the effect of allowing parties to breach willy-nilly whenever it is ‘efficient’ to do so erodes trust in society, and may ultimately erode the concept of contract itself. Both promise theory and ‘efficient breach’ theory focus on only one effect of breach of contract, and each seeks to exclude contracts from their social context and the reality of the way in which the law operates in different ways. However, if we are to effectively recognise the rights which parties gain when entering contracts, we cannot afford to do this.
Professor Raz argues that the purpose of contract law should not be to enforce promises:
but to protect both the practice of undertaking voluntary obligations and the individuals who rely on that practice. One enforces a promise by making the promisor perform it, or failing that, by putting the promisee in a position as similar as possible to that he would have occupied had the promisor respected the promise. One protects the practice of undertaking voluntary obligations by preventing its erosion – by making good any harm caused by its use and abuse.40
Contract law should be flexible enough to offer parties choice in the obligations which they undertake, but also to put claimants who are injured by breach in a position where their interest in performance is adequately recognised and vindicated by the courts. Contract law must also uphold the institution of contract itself and make it more reliable, otherwise society generally would be harmed by a lack of certainty as to whether obligations are likely to be upheld.41 To reduce contract law simply to ‘upholding promises’ or ‘promoting economic efficiency’ ignores the twofold effect of contractual performance. Contract law is more complex and nuanced than either of these extreme poles of opinion. In many circumstances it results in the upholding of voluntary obligations, but it also has the flexibility to allow parties to breach their contracts at times.
IV The Performance Interest
It should be evident from what has been said previously that to understand the role of disgorgement damages more clearly, we must consider what a claimant seeks to gain from a contract. The right the promisee gains as a result of entering into the contract has been described as the ‘performance interest’.42 As Buckland said, ‘One does not buy a right to damages, one buys a horse.’43 A full understanding of the performance interest is essential to understanding when a claimant may have a ‘legitimate interest’ in the performance of a contract so as to give rise to disgorgement damages.
Courts emphasise the importance of keeping bargains in principle, but in terms of remedies the preference for expectation damages over specific relief could indicate that the law’s commitment to performance is less than wholehearted. In this section, I will first canvass the stated attitudes of the courts towards the perform- ance interest. I will then turn to the way in which the performance interest is vindicated – in the sense of being protected or recognised – by contractual remedies (to a lesser or greater degree). The thread that runs through this discussion is substitutability: that is, how courts best ensure that the claimant gets what she bargained for, or an appropriate substitute, in a way that is as non-intrusive as possible.44
A The Courts’ Attitude towards the Performance Interest: Support in Principle
Much case law on contract emphasises the principle of pacta sunt servanda or the notion that agreements must be kept. Courts around the world have adopted a very strict rhetoric in relation to contractual obligations. Roskill LJ famously stated in The Hansa Nord, ‘contracts are made to be performed and not to be avoided.’45 It has been stated that upon entry into a contract, each party assumes ‘a legal right to the performance of the contract’46 and, at the same time, each party ‘assumes a legally recognised and enforceable obligation to perform’.47
The US Restatement of Contracts hints at the importance of the performance interest when it defines contract as ‘a promise . . . for the breach of which the law gives a remedy, or the performance of which the law in some way recognises as a duty’48 (emphasis added).
Windeyer J’s judgment in Coulls v Bagot’s Executor and Trustee Co Ltd typifies the approach of the Australian High Court:
The primary obligation of a party to a contract is to perform it, to keep his promise. That is what the law requires of him. If he fails to do so, he incurs a liability to pay damages. That however is the ancillary remedy for his violation of the other party’s primary right to have him carry out his promise. It is, I think, a faulty analysis of legal obligations to say that the law treats a promisor as having a right to elect either to perform his promise or to pay damages. Rather, using one sentence from the passage from Lord Erskine’s judgment49 which I have quoted above, the promisee has ‘a legal right to the performance of the contract’.50
The High Court affirmed Windeyer J’s view in Zhu v The Treasurer of the State of New South Wales,51 saying:
[S]ubject to the established limits on the grant of specific performance and injunctions, in Australian law each contracting party may be said to have a right to the performance of the contract by the other.52
The High Court expressly rejected the disjunctive view of contractual obligations: namely that the defendant may elect to either perform or to pay damages.
The Israeli Supreme Court has expressed similar views to the Australian High Court in Adras:53
If one takes these decisions at face value, it seems that there will always be a legit- imate interest in ensuring a promise is kept.
However, in light of the foregoing statements, the remedies for breach of contract present a puzzle for scholars of contract law.
B The Courts’ Attitude towards the Performance Interest: Failure to Support Claimants in Practice with Remedies?
In contrast to the sentiments expressed above, there is a strand of thought which suggests that the promisee really gains a right to damages rather than a right to performance upon entry into a contract. Mr Justice Holmes of the US Supreme Court is often held up as the primary advocate of this view. He said:
The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it, – and nothing else.55
This is supported in some regards by the case law. The traditional approach of the common law towards breach of contract is encapsulated in the well-known statement of Parke B in Robinson v Harman:
[T]he rule of the common law is, that where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed.56
The default remedy for breach of contract is ‘expectation damages’, which seek to make good the expectations of the claimant by means of a monetary award. Generally, this formulation has been interpreted to mean only that the claimant will be placed in a situation as if the contract had been performed from a financial point of view. Thus, in White Arrow Express Ltd v Lamey’s Distribution Ltd,57 Lord Bingham MR (as he then was) stated that the Robinson v Harman formulation assumes ‘that the breach has injured [the claimant’s] financial position; if he cannot show that it has, he will recover nominal damages only.’58 This may create an impression that compensation is the only aim of contractual remedies – an impression which reinforces what Professor Birks called the ‘false monopoly of compensation’.59
However, as Sir Frederick Pollock responded to Mr Justice Holmes, the proposition that contract only gives rise to an obligation to pay damages is incorrect, and the law recognises the performance interest in a variety of different ways other than awarding expectation damages.60 First, the most prominent indication that contract law recognises the performance interest comes from the equitable remedies for breach of contract, particularly specific performance and injunctions to restrain breach of negative covenant which promote performance to a greater or lesser degree. Secondly, the doctrine of anticipatory breach indicates that the law ordinarily expects parties to fulfil their performance obligations under a contract. Parties can only excuse themselves from these obligations in exceptional circumstances. Finally, the tort of inducing breach of contract suggests that courts will penalise third parties who induce a party to a contract not to perform.
Nonetheless, as will be discussed in further detail in chapter four, some law and economics scholars have taken Mr Justice Holmes’ view of contract to its logical conclusion with the theory of ‘efficient breach’: promisors should be allowed to breach whenever it is economically efficient to do so, subject to the obligation to pay compensatory damages. Efficient breach continues to have influence because ‘whatever its defects, the theory appears to offer the only plausible explanation of the rules regarding specific performance and punishing breach.’61 However, as I will also discuss in chapter four, there are a number of problems with efficient breach analysis, and it does not produce an accurate fit with the case law, as Pollock foreshadowed.
As the law is currently structured, there is a notional hierarchy of remedies whereby remedies such as specific performance and injunctions are seen as exceptional, and dependent upon ‘inadequacy of damages’ at law.62 If compensatory damages are the primary remedy for breach, this suggests that, in practice, courts are not so much concerned with enforcing promises as compensating for losses occasioned by breach.63 Thus it has been noted that:
It is possible to argue that the present regime of contractual remedies does not prioritise the claimant’s interest in performance.65 The claimant’s interest in the performance of the contract is an essential precondition for the award of disgorgement damages, so it follows that if contractual remedies indicate that the claimant’s performance interest is very weak in most contracts, then disgorgement damages will very rarely, if ever, be awarded.
The common law’s preference for expectation damages, however, does not mean that contract law is unconcerned with the performance interest, and merely concerned to compensate for loss. First, the expectation interest involves vindicating the claimant’s performance interest by compensating the claimant for her loss, as this is the best substitute for performance in the circumstances. However, although courts usually choose to provide a substitute performance by compensating for loss, it does not follow that courts are only concerned about compensating claimants for loss of a profit, or that contractual damages are only about compensating for loss. They are concerned with providing an adequate substitute performance which properly balances the interests of the parties. The reason why contract law presumes expectation damages are the default remedy is because it is concerned to choose the remedy which is least intrusive for the defendant yet which still recognises the claimant’s interests. Courts are increasingly willing to order specific relief when damages are inadequate.
i The Nature of the Expectation Interest
The expectation interest seeks to ‘put the claimant in as good a position as if the defendant had performed his promise’.66 It has been argued that this formulation is ambiguous, because it can mean the defendant’s obligation is to ensure that the claimant receives the performance due to her, but it can also mean that the defendant’s obligation is simply to make good losses so that the claimant is no worse off.67 Ordinarily, the difference between the two is not obvious, but it emerges starkly in those cases where the cost of rectifying the performance is far greater than the reduction in value caused by the loss of the stipulated performance. 68
Charlie Webb argues that the claimant’s expectation interest under a contract is a composite of two interests which overlap in part: the performance interest and the compensation interest.70 The primary interest gained by a claimant from entry into a contract is the performance interest, and loss is irrelevant to this category of interest.71 By contrast, the compensation interest recognises the claimant’s right to be compensated for loss suffered as a result of the breach of contract. Compensatory damages seek to compensate the claimant for the loss suffered, but they also affirm the existence of a performance interest, because the breach of the duty to perform creates the obligation to compensate for loss.72 Ordinarily, expectation damages adequately recognise both the performance interest and the obligation to compensate for loss so that the difference between the two is not obvious to courts.
However, the primary concern of the law with regard to expectation damages is not just to compensate for loss, but to vindicate the performance interest. In this way, contrary to Webb, I argue that it is not so much that there are two separate interests which overlap in part, but that the performance interest is the overarching primary right sought to be vindicated by contract law remedies. Expectation damages are just one way in which courts can vindicate the claimant’s performance right. Law and economics writers distinguish between ‘the bargain principle’ (bargains should be performed according to their terms) and ‘the indifference principle’ (contractual remedies should be structured so that the claimant should be indifferent between the defendant performing on the one hand and the defendant breaching and paying damages on the other).73 A promisee enters a contract because she expects to obtain certain benefits from a transaction (or, in economic terms, ‘utility’) for the thing exchanged.74 When breach occurs, the law seeks to vindicate the promisee’s expectation interest by making her indifferent to the defendant’s breach. Compensatory damages calculated according to loss of market value are more likely to be adequate in situations where the claimant seeks to gain a financial advantage.75 This is because market value provides an adequate measure of the likely value to the claimant, and the claimant is likely to be able to purchase a substitute performance with such damages. However, when the market value of performance does not provide an adequate substitute, courts may choose not to award expectation damages calculated as ‘loss of a profit’ damages by reference to market value, but instead to calculate expectation damages in a way which more accurately reflects the claimant’s interest in performance.76
In a situation where the promisee enters into a contract to obtain performance itself, and not the financial equivalent of performance, the law of contract damages struggles to provide an adequate remedy. Contract law extends into many transactions where pursuit of profit is ‘not a primary aim for both parties.’77 This is particularly the case with consumer contracts, where parties enter the contract not to make a profit, but to have certain services performed.78 Similarly, as will be observed in chapter five, the negative covenant cases often involve contracts which are designed to protect non-financial interests. In cases where monetary awards are inadequate to vindicate the claimant’s performance interest, courts prefer to award specific relief for breach of such contracts. However, where specific relief is unavailable as a result of the defendant’s breach, I will argue that courts may also award disgorgement damages in some exceptional circumstances.
Thus, when choosing the appropriate remedy for breach of contract, it is important to have regard to the claimant’s performance interest, and the objective which the claimant hoped to achieve.79 The court must pay attention to the claimant’s subjective interest in the subject matter of the contract,80 sometimes known as the ‘consumer surplus’.81 Some assessment must be made as to whether the subject matter of the contract has a special value to the claimant, or whether the claimant’s interest in the subject matter of the contract is wholly pecuniary, in which case damages are likely to be an adequate remedy.82 Any remedy is necessarily a ‘next best’ solution, but some solutions vindicate the claimant’s right to performance better than others. Disgorgement damages cannot grant a substitute for performance, and usually in these cases, the very difficulty is that an equivalent to performance is unavailable by the time the case is brought before the court (because damages are inadequate and specific relief is no longer available). Nonetheless, disgorgement damages are a way of vindicating the promisee’s performance interest in that the court clearly recognises the promisee’s interest, and makes the promisor accountable for the breach of contract by stripping him of his profit.
ii The Primacy of Expectation Damages
The reason for the primacy of expectation damages in the common law is because of the common law’s general presumption in favour of liberty: because specific performance is more intrusive to the defendant, damages are preferred in all cases where the claimant will not be made worse off by receiving damages.83 In a sense, the preference of the common law for expectation damages for breach of contract is an application of JS Mill’s ‘harm principle’, namely that the imposition of legal obligations on individuals is only justified when such obligations are imposed to prevent or redress harm.84 In choosing a remedy, the common law has chosen the least intrusive remedy to the defendant (in an attempt to balance the interests of the claimant and the defendant). Expectation damages may be less beneficial to the claimant than actual performance,85 but contract law is nothing if not pragmatic, and as long as damages allow the claimant to purchase a substitute performance, then the common law favours them.
Contract law is nonetheless rightly sensitive to the possibility that damages may be inadequate to recognise the claimant’s performance interest. The very concept of inadequacy of damages confirms the importance of the performance interest: ‘[i]f the primary right of the contract is a right to receive damages, then it is nonsense to speak of damages being inadequate.’86
Damages are inadequate if the plaintiff cannot use them to replace the specific thing he has lost. This is by far the most important rule in determining the doctrinal relationship among remedies. The emphasis on replaceability turns the alleged preference for damages on its head. Money is an adequate remedy if, and only if, it can be used to replace the specific thing that was lost. That is to say, money is never an adequate remedy in itself. It is either a means to an end or an inadequate substitute that happens to be the best we can do at acceptable cost. But the judicial preference is to give plaintiff specific performance if she wants it – to replace her loss with as identical a substitute as possible.89
Indeed, in the context of specific performance and injunctions, it has been suggested that the threshold question of ‘are damages inadequate?’ has been replaced by a question of ‘what is the most just remedy in the circumstances?’90 Courts often start from the position that unless damages give rise to identical consequences for a claimant to relief in specie, a court should order specific performance (subject to discretionary considerations).91 In the vast majority of cases, however, damages will suffice for a variety of reasons – because damages and specific relief will be practically indistinguishable, because parties are unable to get specific relief or because the parties do not seek specific relief.92
The Scots law of ‘specific implement’ results in a similar outcome in practice to the common law, even though Scots law starts from the presumption that the pursuer is entitled to specific performance of the contractual obligation.93 Although it is presumed that specific implement is available as of right, the right is qualified in ways which make the outcome of a Scottish contract case look very similar to the English common law outcome in practice.94 Similarly, in French and German law specific performance is the presumptive remedy for breach of contract, but in practice the exceptions to the rule are more important than the rule itself.95