London 2012: hurdles to recovery

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Commercial value of London 2012

The London 2012 Olympic Games and Paralympic Games represent a unique proposition for UK commerce. The huge influx of visitors and tourists, compounded by the attentiveness of the world’s media, offers significant commercial opportunities for local businesses.

Unfortunately, not all commercial transactions run according to plan. Some businesses will miss out on this golden opportunity, for reasons that may be attributable to alleged failings by their business partners. But could a disappointed party recover inflated profits that it missed out on during the unique window of opportunity presented by an event such as London 2012? Or are such profits too remote to be recoverable?

This article considers a hypothetical scenario to demonstrate the (often misunderstood) legal principles of remoteness, and the recoverability of damages for breach of contract.

The principles of remoteness

The seminal case of Hadley v Baxendale (1854), as refined in subsequent case law, still represents the clearest basis for understanding the principles of remoteness. This case introduced the so-called "two limb" test, describing the types of losses that are deemed to be in the reasonable contemplation of the parties:

Losses arising in the "ordinary course of things", which are matters that everyone knows or is assumed to know (limb one).

Losses arising from special circumstances of which the contracting party had actual knowledge, and of such a kind that a breach in those circumstances would be liable to cause more loss (limb two).

Losses that do not fall within either of these "limbs" will be deemed too remote to be recoverable. The distinction between the two limbs is often a source of confusion and debate, as can be well illustrated by the following scenario.

The sporting goods manufacturer

Consider a manufacturer of sporting goods who supplies a variety of retailers. In May 2012, its t-shirt printing press broke down. The manufacturer hired an engineer to repair the machinery, but the repair works were not completed by the contracted deadline at the end of May.

The manufacturer has no option but to rent replacement machinery to fulfil its typical monthly output for June and July. The rental equipment was in high demand due to the approaching 2012 Games, and so the cost was double what it might ordinarily be. Furthermore, the limited capacity of the machinery means that the manufacturer had to turn down a large number of additional orders received during this crucial London 2012 window.

What damages can the manufacturer recover?

Subject to the specific terms of the contract with the engineer, the manufacturer should be able to recover the cost of renting alternative machinery; this falls squarely within the objective test set out under limb one of Hadley v Baxendale. Once it is accepted that this expense is recoverable in principle, then it makes no difference that the rental cost was unavoidably expensive; it will still be recoverable in full.

The situation is more complicated in relation to the business that the manufacturer could not fulfil:

To some extent, the profits that the manufacturer had to forego appear to fall within "limb one". Just as with the rental cost, these lost profits are within the reasonable contemplation of the parties, as a direct consequence of the engineer’s breach of contract, arising in the "ordinary course of things".

The fact that the manufacturer anticipated making larger-than-average profits during the relevant period does not preclude the recoverability of those above-average profits. Business naturally ebbs and flows, and the recoverable damages will not be capped at some arbitrary "average" monthly profit level.

Nevertheless, the manufacturer’s opportunity for profit was exceptionally large during the relevant period, arising out of a unique window of opportunity for him, which was not necessarily appreciated by the engineer.

To the extent that this is true, the profits probably fall within limb two – that is, they do not arise in the "ordinary course of things", but are losses arising from special circumstances that would be deemed too remote unless they were brought to the engineer’s attention at the time the manufacturer contracted with the engineer.

Plainly there is much room for disagreement as to what percentage of the lost profits falls within limb one and limb two of Hadley v Baxendale and, if it is the latter, whether the "special circumstances" were brought to the engineer’s attention.

Another way to articulate the critical question is to ask whether the engineer assumed responsibility for the particular kind of losses suffered? (Transfield Shipping Inc v Mercator Shipping Inc [2008] UKHL 48 (The Achilleas)). This ‘reframing’ of the two limb test has been the subject of controversy, but does help to show how the law defines what losses are (or are not) recoverable.

BLP perspective

The legal principles of remoteness are long established, but still remain an area of judicial contention. They are most commonly debated in circumstances where a claimant considers that it has missed out on a significant profit opportunity, but the defendant asserts that such opportunity falls outside ‘the ordinary course of things’. An event such as London 2012, with the business opportunities it brings, is likely to generate exactly this kind of commercial wrangle. Those who have been upfront and identified the "London 2012 window" as being critical to their business when negotiating their contracts are likely to find their position better protected should their business partners fail to deliver.

BLP’s Olympic Heptathlon

This article is the third in a 7-part "heptathlon" series, in which our lawyers are sharing their views on the commercial and legal impact of the London 2012 Olympic Games and Paralympic Games. The previous article in this series came from our Construction team; on liquidated damages clauses in construction contracts work in the context of the Games.

In the next article, the Real Estate team will be looking at the temporary changes to the Sunday Trading laws

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