When a loss becomes a gain: accounting for gains made when mitigating losses
01 February 2016
Following a breach of contract, the innocent party is usually entitled to damages. Broadly speaking these are set at a level required to put them in the position they would have been had the contract been performed properly. However, there is no entitlement to recover for avoidable loss and so this gives rise to what is sometimes referred to as a “duty” to take all reasonable steps to mitigate one’s loss. If the steps taken increase the loss overall, the increased figure is recoverable. On the other hand, if steps taken in mitigation are successful, the wrongdoer is entitled to the benefit accruing and their liability is for the resulting loss as lessened. But what happens when the claimant’s steps to mitigate are so effective that he makes a profit, wiping out any loss arising from the breach?
In Fulton Shipping Inc of Panama -v- Globalia Business Travel S.A.U.  EWCA Civ 1299 the Court of Appeal faced this very question. Upon review of the authorities, and the particular circumstances of the case, the Appeal Court overruled the decision below. It held that the defendant was indeed entitled to the benefit of a capital gain the claimant had made whilst mitigating its loss. This meant an €11.3m gain was brought into account, eliminating entirely losses claimed of €7.6m.
The decision gives a helpful summary of the rules on mitigation and the circumstances in which gains must be brought into account. It also accords with the decision reached in the earlier arbitration proceedings which were the subject of an appeal to the Court under s.69 of the Arbitration Act.
Globalia chartered a vessel under a time charterparty. Fulton, the owner, had the benefit of two years’ left to run on the charterparty when Globalia sought to re-deliver the vessel. Fulton alleged anticipatory repudiatory breach of the charterparty and claimed damages calculated by reference to the net loss of profit for the remaining two years (€7.6m).
Fulton duly sought to mitigate its loss. There was no available chartering market and so the vessel was sold in October 2007 for US$23.8m. With hindsight, this was a particularly good deal as the world economy plummeted following the collapse of Lehman Brothers in September 2008. By November 2009, at the end of the two year charterparty, the vessel’s value would have been as low as US$7m. Thus, whilst Fulton had lost two years of profits under the charterparty, its recovery on sale of the vessel in 2007 was spectacularly better than it would have been in 2009 (by some US$16.8m).
Globalia sought to rely on the gains whereas, unsurprisingly, Fulton argued that they should not be brought into account.
First instance decision
Mr Justice Popplewell set out 11 principles to consider when deciding whether to bring a gain into account. He determined that Fulton’s decision to sell was independent of the breach. This led him to conclude that the breach was not sufficiently causative of the benefit accruing and on this basis he ruled that Fulton was not required to account for the gain. He noted the lack of judicial authority on point and gave Fulton permission to appeal.
The decision on appeal
After considering the relevant authorities, Lord Justice Longmore noted the important principle is to consider whether the measure taken in mitigation arises out of the consequences of the breach and is in the ordinary course of business. If so, the benefit arising is normally brought into account unless that measure is wholly independent of the relationship between the parties.
He went on to consider the effect of the lack of an available market. If there had been an available market to charter the vessel when it was returned to Fulton, a decision to sell would have been a decision to speculate. Any resulting gains or losses would not then be brought into account as they would have arisen from Fulton’s decision to speculate and not to avail itself of the available market as opposed to the breach itself. However, the position was different here. There was no available market and Fulton’s decision to sell was not a decision to speculate. Fulton was simply bringing into account the consequences of its decision to mitigate loss and the resulting consequences did arise from the breach of contract.
The decision below was overturned and the Court of Appeal ordered that the gain be brought into account when assessing Fulton’s loss.
The Appeal Court acknowledged that this is a difficult area of law, with each case dependent on its facts. When assessing whether gains or losses arising on mitigation should be brought into account, it is important to give consideration to the available market in appropriate cases. This will help to determine whether a measure taken in mitigation is to be treated as speculation or if it is sufficiently related to the breach, requiring it to be brought into account.
January has seen the world economy get off to a shaky start to the year. China’s growth is slowing, financial markets are suffering from volatility and the Bank of England has postponed a rise in interest rates. In this climate, there is potential for increased gains and losses for those seeking to mitigate. Consider an innocent party on the wrong end of negligent advice. An assessment must be made when considering the range of options available in mitigation. Depending on their circumstances and appetite for risk, they may wish to speculate on their own account. On the other hand, a more conservative approach may be preferred with the aim of ensuring that resulting losses can be brought into account later. These factors may well influence the strategy and decisions taken in mitigation.