Primary obligation: contracts first, damages second
James Harrison considers a recent Court of Appeal decision which ruled a victory for equity over contract when seeking interim injunctions
James Harrison considers a recent Court of Appeal decision which ruled a victory for equity over contract when seeking interim injunctions
One strength of English law is the ability for parties to identify, allocate and cap risks by agreeing limitations on the levels of damage or excluding heads of loss. However, should a party who has agreed such limits be able to subsequently claim that as a result, damages are an inadequate remedy when seeking an injunction? This was the question the Court of Appeal was asked to contend with in the recent case of AB v CD
[2014] EWCA Civ 229.
The resulting judgment provides clear insight into the court’s application of the tests for an interim injunction and may catch out any unwary parties who think that their limitation and exclusion of damages has removed this risk.
Just and convenient
The jurisdiction to grant interim injunctions derives from section 37(1) of the Senior Courts Act 1981. This jurisdiction may be exercised whenever “it appears to the court to be just and convenient to do so”. Every law student knows that the proper approach to the exercise of this jurisdiction was outlined by Lord Diplock in American Cyanamid Co v Ethicon Ltd [1975] AC 396, which set out the following test:
i. Is there a serious question to be tried?
ii. Are damages an adequate remedy?
iii. Who does the balance of convenience favour?
iv. Are there any special factors?
The courts have repeatedly warned parties not to use these guidelines ‘mechanistically’ to fetter the broad discretion conferred by section 37.
IP rights
The respondents, CD, owned the intellectual property rights in an online platform (eMarketplace) for the sale and purchase of
goods in an international mining and metals business. The respondents granted a licence to the appellants to market eMarketplace in the
Middle East.
The respondent sought to terminate the licence with effect from the end of 2013. The exploitation of this licence was the appellants’ sole business; therefore, the termination of this licence would not only be likely to result in lost profits, but also potentially in the appellant being wound up.
The key clause in question was 11.4, which comprised both an exclusion of liability for certain heads of claim, including ‘lost profits’, and a cap on damages that might nevertheless be recoverable. It was claimed by the appellant that this would cap their damages at approximately £17,000.
Entitlement to terminate
The appellant claimed that the respondent was not entitled to terminate and commenced arbitration proceedings in accordance with the arbitration clause.
Prior to the resolution of the arbitration and pursuant to section 44 of the Arbitration Act 1996, the appellant brought proceedings in the Queen’s Bench Division seeking an interim injunction requiring the respondent to continue to perform its obligations under the licensing agreement.
This application for an interim injunction came before Stuart-Smith J on 31 December 2013, who refused the appellant’s application on the following grounds:
i. There was a serious issue to be tried; but
ii. on the issue of adequacy of damages, the court was bound by Ericsson AB v EADS Defence and Security Systems Ltd [2009] EWHC 2598 (TCC), the effect of which was that where parties to a commercial contract have agreed that in the event of a breach damages for certain heads of loss will be irrecoverable it is right, in considering whether an injunction should be granted, to ignore the facts that the innocent party may suffer loss falling under those heads; and
iii. while it was irrelevant as a result of (ii), the
balance of convenience would have favoured the granting of an injunction.
However, Stuart-Smith J believed that there was
a tension between the Ericsson decision and other case law and that he felt some unease at the result. He therefore gave permission to appeal.
Breach of contract
The appeal concentrated on the question of principle about the proper approach to the granting of an interim injunction. Specifically, how the test of adequacy of damages applies in cases of an alleged breach of contract where the contract contains a provision limiting the recoverable damages to less than might otherwise have been awarded as a matter of general law.
The submissions
The appellant’s primary submission was that
Bath and North East Somerset District Council v Mowlem Plc [2004] BLR 153 (“Mowlem”) constituted binding authority that damages would not be an adequate remedy because the recoverable damages were limited by a clause excluding or limiting liability.
In that case, Mowlem was a contractor engaged to restore the old spa buildings in Bath and to construct a new building. As a major project for the city, the building contract contained a provision for liquidated and ascertained damages in the event of delay in the sum of £12,000 per week.
Defects emerged in the course of the work and there was a dispute as to whether they were the contractor’s responsibility. The council engaged alternative contractors to carry out remedial works, but the contractor refused them access. The council successfully sought an injunction requiring the contractor to allow the alternative contractors access. The contractor’s subsequent appeal
was dismissed.
The contractor’s appeal was on the basis that “the liquidated and ascertained damages stated in the JCT contract … represent a contractually agreed measure of adequate compensation” and that it was accordingly “impermissible for the council to suggest that an award of such damages would not adequately compensate them for any delay in the period up to trial”.
Mance LJ, giving the leading judgment in Mowlem, rejected this argument and, among other reasons, rejected the appeal on the basis that the agreed compensation should not be regarded as setting a price for a party’s breach
of contract, nor to preclude the court granting any other relief that may be appropriate.
Underhill LJ delivered the leading judgment and agreed that Mowlem was binding authority and that in any event the appellant’s position was right in principle.
Agreed price to breach the contract. In his analysis of Mowlem, Underhill LJ cited with approval Mance LJ's distinction between two contexts:
i. A claim to recover damages; and
ii. A claim for an injunction which is designed to avoid any cause for a claim to such damages.
The parties’ agreement as to the quantification of loss is conclusive in the first context, but not in the latter. In Mance LJ’s words: “Mowlem is not entitled to breach its contract. The agreement of liquidated and ascertained damages is not an agreed price to permit Mowlem to do so, and it does not preclude the court granting any other relief that may
be appropriate.”
Underhill LJ went further, holding that this principle applied whether or not the restriction in question took the form of a cap on the recoverable damages or an exclusion of certain heads of loss.
Primary obligation of party to perform the contract. While Mowlem constituted binding authority in the current case, in Underhill LJ’s judgment, it did not go far enough. He stated that the primary obligation of a party is to perform the contract. The requirement to pay damages in the event of a breach is a secondary obligation, and an agreement to restrict the recoverability of damages in the event of a breach cannot be treated as an agreement to excuse performance of that primary obligation.
No mechanistic application of the ‘rules’. Underhill LJ expressly affirmed similar case law where the court had also refused to allow a “mechanistic application of the ‘damages and adequate remedy’ rule to prevent the victim of a breach being able to enforce compliance with the primary obligations under the contract”. Instead, the Court of Appeal emphasised the importance of reflecting the substantial justice of the situation, which is the basis of the jurisdiction under section 37.
Floodgates: The Court of Appeal rejected the respondent’s submission that allowing the appeal would open the floodgates for every claimant seeking an injunction to claim that damages were never adequate where an agreed damages clause was in existence.
Underhill LJ stated that claimants would still need to show that there is a substantial risk that they will suffer loss that would otherwise be recoverable. Even if successful, this only ‘opens the door’ to the exercise of the court’s discretion.
Equity over contract
In a victory for equity over contract, the Court of Appeal has reaffirmed its discretion to ensure that justice is done. This is not to say that all is lost for parties with agreed limitation and exclusion of damages clauses: the court confirmed the ability
of such clauses to limit claims for damages.
While the primary obligation of parties is to perform their contractual obligations, a secondary obligation is the requirement to pay damages in the event of a breach and parties are able to allocate risk and exclude damages, reduce limitation periods and restrict certain remedies such as set-off as they may wish, subject to
certain limitations.
However, the Court of Appeal was clear that while such clauses may be worthwhile, they are
not a panacea and they do not fetter the court’s discretion to grant equitable remedies to enforce that primary obligation.
The supremacy of discretion may frustrate some parties seeking certainty, but this judgment is one of several recent decisions where the court is reasserting its discretion, such as the recent Supreme Court decision in Lawrence and v Fen Tigers Ltd and Ors [2014] 13.
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