SUBSTITUTIVE DAMAGES AND MITIGATION IN CONTRACT LAW

• Author: Katy BARNETT BA/LLB (Hons), PhD (University of Melbourne); Associate Professor, Melbourne Law School, University of Melbourne.
• Citation: (2016) 28 SAcLJ 795
• Date: 01 December 2016
• Published date: 01 December 2016

Tension between Two Competing Norms

While one aim of contract damages is to seek a substitute for performance for the plaintiff, mitigation attempts to effect a just allocation of burdens and benefits between plaintiff and defendant. First, plaintiffs cannot recover avoidable loss, which reflects the court's desire to encourage self-help, among other things. Second, courts take into account avoided loss, which involves a simple mathematical quid pro quo, but it is suggested that courts should be cognisant of the distributive ramifications when mitigation has not in fact taken place or the plaintiff is not subject to claims by third parties.

I. Introduction

1 There has been much attention on substitutive interpretations of contract law damages, particularly in light of Winterton's recent lucid and thought-provoking book on the topic.1 Although substitutive accounts differ in their detail, in broad terms they commonly conceptualise at least some forms of damages for breach of contract as providing a pecuniary substitute for either the plaintiff's “performance

interest”2 or a purported right to performance.3 Such damages are usually distinguished from other forms of contractual damages which are said to compensate for pecuniary losses flowing from the breach (whether those damages for “pecuniary loss” are conceived of as damages for difference in value or damages for “consequential losses”).4

2 I am generally sympathetic to the notion that contract damages act (at least in part) as a substitute for performance itself.5 Indeed, such a substitutive understanding seems a good way to begin to approach the famous statement by Parke B in Robinson v Harman:6

The rule of the common law is, that where the 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.

On this approach, the object of at least some forms of contract damages is to provide a pecuniary substitute for the promised performance to put the plaintiff in the next-best position to actual performance itself (or in the case of Robert Stevens, to compensate for the right to performance itself). This approach requires courts to identify where the plaintiff would have been had the contract been performed and then to make a damages award that will, so far as money can do it, place the plaintiff in an equivalent position.

3 However, there is still disagreement as to precisely which awards are substitutive and how such awards should be measured. These

fractures tend to be revealed when assessing the role and propriety of rules that operate to limit the defendant's scope of liability for the plaintiff's loss. Concepts such as mitigation and rules of remoteness operate to reduce damages awards in a way which seems fundamentally to contradict or undermine the substitutive aim of contract damages. Some scholars respond to that challenge by rejecting those doctrines as unprincipled or unnecessary. In recent writings, for example, Stevens and Winterton respectively argue that the doctrine of mitigation does not apply to awards for direct loss in contract as opposed to awards for consequential loss (in Stevens' terms)7 or to money awards which substitute for performance as opposed to money awards which compensate for loss (in Winterton's terms).8 These scholars are, if you like, “hard substitutivists”, in that they argue that for those categories of contractual damages which they identify as substitutive, substitution is the sole aim, whether it is a substitute for the right to performance (Stevens) or for performance itself (Winterton). On these accounts, mitigation does not operate as a principled limit on such awards. Stevens then favours a “difference in value” measure as the primary approach to valuing the “right to performance” for which a substitutive monetary award must be made,9 while Winterton takes a rather more expansive approach to the proper measure of actual performance, which allows for damages for difference in value and for cost-of-cure to both be substitutionary in different circumstances.10

4 By contrast, I am what one might call a “soft substitutivist”11 as I do not contend that the substitutive aim operates to “trump” other doctrines such as mitigation, rendering them irrelevant. In this article, I posit rather that the doctrine of mitigation is in direct tension with the substitutive aim, and that this tension permeates a large range of awards. This has been recognised in the well-known case of British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd12

(“British Westinghouse”) when Viscount Haldane LC said:13

The first [principle of contract damages] is that, as far as possible, he who has proved a breach of a bargain to supply what he contracted to get is to be placed, as far as money can do it, in as good a situation as if the contract had been performed. The fundamental basis is thus compensation for pecuniary loss naturally flowing from the breach; but this first principle is qualified by a second, which imposes on a plaintiff the duty of taking all reasonable steps to mitigate the loss consequent on the breach, and debars him from claiming in respect of any part of the damage which is due to his neglect to take such steps.

On my account, this tension is justified because the mitigation rule reflects a well-recognised and overriding general policy of the law in favour of encouraging self-help by plaintiffs, and is concerned with issues of distributive justice. On this approach, damages for breach of contract act as a substitute for performance itself, but the doctrine of mitigation necessarily limits the extent to which they can ever be fully substitutive.

5 Thus, far from being irrelevant to the measure of contract damages, the doctrine of mitigation implicitly and necessarily applies to damages awards made according to a “difference in value” measure. It follows that these awards are never solely substitutionary. The difference in value measure applies to marketable commodities precisely because in such cases a substitute can be obtained, and the courts expect a plaintiff to do so. More generally, this approach to mitigation is consistent with the law's broader policy to encourage self-help on the part of a plaintiff,14 which necessarily and properly limits the extent to which damages can ever be entirely substitutive.

6 This article will be laid out as follows. Part II15 shows how the tension between mitigation and substitutive awards raises localised questions of distributive justice in the sense of an allocation of benefits and burdens between plaintiff and defendant (and sometimes third parties). Part III16 sets out the general nature of mitigation and explains that mitigation is implicitly built into some measurements for “direct loss” or “substitutive awards”. The effect is to dilute the substitutive nature of the award. The question then becomes why the

law has approached damages in this way, given that (as discussed above) a substitutive approach may be regarded as the general starting point for such awards. Part IV17 addresses this through examining the concept of avoidable loss in mitigation. It identifies the general policy behind the concept of avoidable loss as being concerned to encourage self-help – where the defendant cannot be forced to perform and will not do so, the plaintiff is best placed to help herself if she has access to substitute performance in the market. The law accordingly deems plaintiffs with access to substitute performance in the market as having effected self-help, even where that is contrary to the proven facts. Part V18 then turns to the treatment of avoided loss in mitigation. This is quite different to avoidable loss. The policy behind it is simply a mathematical quid pro quo: just as the defendant must pay if the plaintiff gets a worse performance by seeking a substitute performance, the defendant can benefit if the plaintiff gets a better performance through exercising self-help and obtaining a substitute. However, if the plaintiff gets an identical performance to that which was promised, the court simply awards the cost of the substitute. Distributive questions are raised if the plaintiff then further exercises self-help by passing on the costs of purchasing the substitute to third party purchasers, as in Clark v Macourt.19 That case is discussed and it is suggested that the result is insufficiently cognisant of the distributive ramifications of the decision. The article then moves to consider a further difficult situation of betterment, which arises where a sub-sale to a third party leaves the plaintiff in a better factual position than she would have been if the contract had been performed. As McGregor has noted, this is not strictly speaking part of proper mitigation at all. Here the policy of the law has generally been to ignore sub-sales. It is suggested that while the law should generally ignore the possibility or fact of sub-sale, the defendant ought to be able to bring the sub-sale into the account where, following the breach, mitigation has not taken place and the plaintiff is not subject to a claim by third parties.

II. Localised questions of distributive justice: The tension between mitigation and substitutive awards

7 It is suggested that the tension between the mitigation requirement and providing a full pecuniary substitute for performance raises a question of “localised” distributive justice20 between the parties. Gardner suggests that the central norm constituting tort law is one of

corrective justice, but that tort law cannot help but also raise questions of “localised” distributive justice between the parties, precisely because it involves corrective justice.21 The same arguably can be said for contract law: the fundamental aim of contract law, and of many of the remedies which arise...