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Contract law update 2021

Damages and privity

Corporate groups can miss out on damages if the correct entities are not parties to the contract

It is a fundamental principle of contract law that, subject to some limited exceptions, only parties to a contract can sue under the contract. A consequence of this principle is that, if a breach of contract causes loss to third parties, those third parties usually cannot recover damages under the contract.

This basic principle can cause difficulties where one party in a corporate group incurs losses under a contract entered into by another party. This problem commonly arises where a corporate group prepares consolidated accounts, with one company in the group responsible for incurring expenses on behalf of other companies in the group (even where the contracts were entered into by those other companies). Another context where this problem can arise, illustrated by the NSW Court of Appeal decision in Central Coast Council v Norcross Pictorial Calendars Pty Ltd1, is where a party to a contract is entitled to nominate another group member to exercise rights under that contract.

In Norcross, a developer entered into a contract with a local council under which the developer:

  • developed a car park on land owned by the council;
  • was given an option allowing the developer, or its nominee, to purchase adjoining land for nominal consideration; and
  • was indemnified by the council against loss resulting from the adjoining land being contaminated.

The developer nominated a related company to purchase the adjoining land, which was later found to be contaminated with asbestos and other substances. The nominee incurred expenses remediating the contamination. The question for the court was whether the developer or nominee could recover these expenses.

At first instance, the judge held that the nominee was entitled to recover its losses under a clause in the agreement that permitted 'successors' to enforce the agreement. The Court of Appeal disagreed that the nominee was a 'successor' (because, for example, the original developer retained its obligations under the agreement to build the car park).

The Court of Appeal therefore needed to consider an alternative argument: could the developer (as party to the contract) recover:

  • its own losses caused by the contamination, being either the reduced value of its shareholding in the nominee or reduction in dividends that it would otherwise have received; or
  • the nominee's losses, either on the basis that the developer held the benefit of the indemnity on trust for its nominee or on the so-called 'Linden Gardens'

The court held that the developer could not recover because:

  1. as a matter of construction, the indemnity did not extend to losses of the type claimed by the developer (reduction in dividends or in value of the shareholding). The court also concluded, in any case, that the existence of such loss had not been proved; and
  2. the parties did not contemplate that work on the adjacent land would be carried out by a corporation other than the developer (which meant there was no trust and that the Linden Gardens principle, even if it applied in Australia, would not be relevant).

In relation to the first issue, the court accepted that, in principle, a shareholder could recover such losses if they fell within the language of the indemnity. The court rejected an argument that the 'reflective loss' principle necessarily prevented a shareholder recovering these losses, in circumstances where (as here) the company itself could not recover the loss (so there would be no double recovery).

On the second issue, the developer argued that the Linden Gardens principle entitled a party to recover losses suffered by a third party where:

  • the object of a transaction was to benefit a third party; and
  • it was anticipated that the effect of a breach would be to cause loss to that third party.

The court held that this principle is not yet part of the law of Australia and that it would be for the High Court to determine whether it should be accepted . In any case, the argument failed on the facts, because it was not contemplated that a third party would carry out work on the project.

This case illustrates the importance of ensuring that the entities in a corporate group that might suffer a loss from a breach of contract are parties to the relevant contract. If that is not possible, however, then appropriate drafting (of indemnities and 'on trust' clauses) might still enable a corporate group to recover its losses.

It is often said that an 'innocent' party has an obligation to mitigate its loss. There is an academic debate as to whether this 'obligation' is, indeed, a separate obligation, or whether it should be seen as an aspect of causation. In Housman v Camuglia2 Justice Leeming (with whom President Bell and Justice White agreed) considered whether this academic debate might have some practical consequences.

The issue arose because the respondent argued that the appellants did not properly particularise the steps that allegedly should have been taken to mitigate the loss. If the duty to mitigate is an independent obligation, then the alleged mitigatory steps needed to be pleaded and the failure to do so would have been fatal to the argument. If the 'duty' to mitigate is, in fact, just one matter to be considered as part of the broader issue of causation, then it is less clear whether it needs to be properly pleaded – particularly having regard to those provisions of the civil liability legislation that impose on the plaintiff the burden of proving 'any fact relevant to the issue of causation'.3

The court found that there had not, in fact, been any failure to mitigate. It was therefore not necessary to resolve these competing views of mitigation. The discussion by Justice Leeming does, however, operate as a reminder of the importance of properly pleading and particularising any alleged failure to mitigate. Until the High Court finally determines whether or not mitigation is a part of causation, it might be safer to plead any failure to mitigate both as part of a denial of causation and as an independent allegation.

Central Coast Council v Norcross Pictorial Calendars Pty Ltd [2021] NSWCA 75

Privity of contact and recovery of subsidiary company's loss – Linden Gardens principle and suing for a third party's loss directly – construction of indemnities

In this case, the NSW Court of Appeal considered whether a developer that transferred land to its subsidiary could claim for the subsidiary's loss after the land was found to be contaminated, in circumstances where the original landowner had agreed to indemnify the developer but not the subsidiary.

The court held that the subsidiary was not party to the agreement, so could not itself claim for damages. On the other hand, the court held that the company could not claim for the subsidiary's losses, because the indemnity did not extend to cover it and because the subsidiary's damages did not form part of the company's loss.

Under the doctrine of privity, subject to limited exceptions, only a party to a contract can sue under it. This case discusses some possible exceptions to that principle, and is a stark reminder of the importance of considering privity issues when assets or rights are transferred within a group of companies.

Facts

In 2002 NPC and the Central Coast Council entered into a joint venture agreement, under which NPC was to develop a car park on council land, and a residential and commercial building on adjoining council land (PTL land)

As part of the JV agreement, NPC and the Council entered into a separate option agreement, permitting NPC or its nominee to purchase the PTL land for nominal consideration. The option could be exercised between three months and three years after commencement of the works under the JV agreement.

Under the JV agreement:

  • clause 4.1 required the Council to grant easements over the car park land requested by NPC acting reasonably;
  • clause 7.1 provided the Council warranted that the PTL land was free from contamination; and
  • clause 7.2 provided the Council indemnified NPC against 'any loss, claim, liability, cost or expenses suffered or incurred by NPC in respect of … any Contamination existing on the [PTL Land]'.

Clause 19.9 of the JV agreement provided:

The obligations imposed and the rights conferred on the parties under this Agreement are binding upon any successor to a party and such successor must upon such succession assume all rights [conferred] and [obligations imposed] by the provisions of this Agreement, mutatis mutandis, as if such successor were named in this Agreement as a party, but this clause does not permit the obligations and rights to be transferred or otherwise dealt with or disposed of by any of the parties … otherwise than in accordance with the terms and conditions of this Agreement.

In 2005 NPC's wholly owned subsidiary (PTL) exercised the option as NPC's nominee.

In 2015 PTL commenced construction on the PTL land. It requested an easement for electricity over the Council's car park land, which the Council did not grant. PTL also discovered that the PTL land was contaminated, and incurred remediation costs.

At trial, the judge held that PTL, having exercised the option, was NPC's 'successor' under JV agreement clause 19.9 and was entitled to recover its losses from the Council. PTL was awarded approximately $285,000 for the Council's failure to provide an easement and $630,000 for the Council's failure to indemnify PTL for its remediation costs.

The Council appealed, claiming the trial judge erred in finding PTL was a 'successor' to NPC under the JV agreement and therefore able to sue under it. NPC cross-appealed, claiming that if PTL were not a successor, then NPC itself was entitled to damages under the JV agreement for the Council's breaches.

Judgment

The Council's Appeal

The court held that the trial judge erred in holding that PTL was NPC's 'successor' under clause 19.9 of the JV agreement. The court considered that PTL had not succeeded to NPC's rights under the JV Agreement but, rather, that PTL's rights to the PTL land came from the option agreement. The court noted:

  • the JV agreement specifically contemplated NPC performing work;
  • the option agreement was standalone to the JV agreement, and it would be unusual if a nomination under the option agreement had the effect of conferring all rights and obligations under the JV agreement onto the nominee; and
  • the option was exercisable three months after commencement – on NPC's construction, all of NPC's rights and obligations under the JV agreement could be transferred to a party unknown to the Council, after work had only just commenced. The court considered no reasonable businessperson in the Council's position would have contemplated that result.

Accordingly, PTL was not a successor under the JV agreement and could not sue for its breach.

NPC's cross-appeal

In its cross-appeal, NPC sought, itself, to claim damages for the Council's breach of the JV agreement. NPC argued its shares in PTL had diminished in value, and that loss was equal to PTL's expenditure in remediating the PTL land, either because:

  • PTL would have paid an amount of money equal to its claimed damages as a dividend to NPC; or
  • the value of NPC's shareholding in PTL had decreased equal to PTL's claimed damages.

In the alternative, NPC claimed it could recover PTL's loss directly, under the principle in Linden Gardens.4

Reflective loss principle

Council argued that the 'reflective loss principle', discussed by the English Court of Appeal in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, applied to prevent NPC recovering its loss. The principle is that where loss is suffered by a company as a result of a wrong where a shareholder and the company have a cause of action, the shareholder cannot claim for the company's losses. The court noted various claimed sources for the principle, including:

  • preventing double-recovery for the same loss;
  • that a shareholder does not suffer a loss distinct from the company, and is barred from claiming the company's loss under the rule in Foss v Harbottle (1843) 2 Hare 461;
  • the maintenance capital – if a shareholder is permitted to recover for what a company could itself have claimed for, this represents a depletion of the company's capital in favour of the shareholder.

The court considered that, whatever its rationale, the reflective loss principle did not apply in this case. Only NPC, and not PTL, could claim under the JV agreement. There was no question of double-recovery, no outflanking of the rule in Foss v Harbottle or reduction in company capital, as PTL could not claim for damages, and NPC was not seeking to sue under PTL's cause of action but, rather, for its own.

Construction of the indemnity in the JV agreement and loss

The court considered that the indemnity in clause 7.2 of the JV agreement, while broad, did not extend to losses indirectly suffered by NPC as a result of its subsidiary incurring remediation costs. The indemnity was to be read in the context of the JV agreement as a whole, and that agreement did not contemplate that anyone other than NPC would undertake the project.

Moreover, the court considered that NPC had not, in any case, proved its loss was equal to PTL's remediation costs. The director of NPC and PTL claimed that PTL was intended to be wound up and the surplus proceeds of the project transferred to NPC, but the evidence did not establish this was ever done.

As an alternative, it may have been that PTL was a cashbox with no liabilities, holding only the surplus of the development, such that any loss to it would correspond to an equal reduction in the value of its shares. But NPC led no evidence of this, despite it being a simple matter to do so. No other evidence of loss was put forward.

Linden Gardens

As an alternative to claiming for the reduction in PTL's share price, NPC argued it could claim directly for PTL's loss.

NPC relied on a line of authority following Linden Gardens, in which English courts have held that where parties to a building contract contemplate developed property being transferred to a third party, a builder may, in some circumstances, be liable to a developer directly for loss suffered by a new owner.

The principle in Linden Gardens is said to avoid a 'legal black hole' that arises when a contract is breached, but no one can be compensated – the old owner suffers no loss themselves, while the new owner who does suffer loss cannot claim for it because they are not party to the contract.

In the present case, the court noted that in Australia it is well established that:

  • if a contract imposes an obligation on one party to benefit a third party, the other party to the contract can seek an order for specific performance of that obligation (in this case, because the indemnity was for NPC's benefit, not PTL's, NPC could not obtain such an order); and
  • if a party holds a contractual promise on trust for the benefit of a third party, the third party can sue the promisor (joining the promisee as a defendant to the action).

However, the court considered that the position in Linden Gardens has not been accepted as part of the law of Australia.

In any event, the court considered that the circumstances of this case were not similar to Linden Gardens because the parties did not contemplate that the development of the PTL land would be undertaken by anyone other than NPC. The court considered that it was therefore unnecessary to consider whether Linden Gardens represents the law of Australia, and noted that it would be inappropriate for an intermediate appellate court to further extend the principle to the present facts.

Accordingly, NPC was not entitled to damages.

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Housman v Camuglia [2021] NSWCA 106

Consequential loss – failure to mitigate

In this case, the NSW Court of Appeal considered whether the respondent was entitled to lost rental income because of damages suffered to the stairway of her apartment building.

The court held that, despite there being no safety concern, it was reasonable for the respondent not to seek to let out the units until a permanent solution was installed.

This case illustrates that the reasonableness of alleged mitigating steps can be assessed on lay, and not necessarily expert, evidence. It also contains an interesting discussion of the relationship between mitigation and causation

Facts

Mr Housman and Ms Alda hired Pacific Plus Constructions Pty Ltd (the appellants) for substantial building and excavation works on their property. These works caused damage to the stairway of Ms Camuglia's apartment building. A temporary solution was installed. Notwithstanding an engineering report that indicated this temporary solution was safe, Ms Camuglia did not seek to let the units.

Ms Camuglia commenced proceedings in the District Court, and successfully obtained damages for rectification costs and loss of rental revenue. The trial judge also awarded indemnity costs against the appellants for rejecting Ms Camuglia's Calderbank offer.

Judgment

The primary issue for the court was whether Ms Camuglia was entitled to consequential loss. Justice Leeming (with President Bell and Justice White agreeing) dismissed the appeal, stating that:

  • it was not unreasonable for Ms Camuglia to wait for a permanent solution to be constructed before letting the property, especially when there was a reasonable expectation that it would soon be installed;
  • it was reasonable for Ms Camuglia not to seek to let the property, based on her leasing manager's opinion that it was incapable of being advertised for let;
  • the perception that Ms Camuglia and her leasing manager formed of the superficial appearance of the stairway's safety was critical in assessing the reasonableness of the decision not to re-let the units; and
  • it was not reasonable to engage in short-term leasing because it faced the same difficulties as above and was also unlawful under local council rules.

Separately, the court said that the appellants had failed to particularise their claim that Ms Camuglia should have mitigated her loss by re-letting the units. It was, therefore, arguably not open for the appellants to make this argument on appeal. While it was unnecessary for the court to consider this point further, it said that the present case is an example when the taxonomy matters between treating mitigation as either separate to or nested within causation. This issue therefore remains unresolved.

Another issue that arose in preparing for the appeal was whether the appellant required special leave of the court before appealing the cost order made against them. After a detailed exploration of the history, the court said (at [83]) 'that where there is a substantial ground of appeal as a right, then even if that ground fails, the appellant may nonetheless challenge the cost order as a right.' The court, however, refused to vary the cost order because Ms Camuglia's Calderbank offer was more advantageous than the ultimate judgment.

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Footnotes

  1. [2021] NSWCA 75.

  2. [2021] NSWCA 106. In his judgment, Justice Leeming referred to the article Courtney, Wayne 'Contract Damages and the Promisee's Role in its own Loss' (2019) 42(2) Melbourne University Law Review 406, which discusses this issue (and its significance) in more detail.

  3. The provision considered by the NSWCA was s5E of the Civil Liability Act.

  4. Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd; St Martins Property Corporation Ltd v Sir Robert McAlpine Ltd [1994] 1 AC 85.