UK: "The Solace Of Quantum" .. Or .. Recovering Expenditure Incurred Post-Breach But Before Proceedings — Damages Or Costs?

Last Updated: 5 September 2008
Article by Markus Esly

Your business is the victim of a breach of contract that requires immediate action to deal with the consequences: a fuel leak necessitates a clean-up operation, or defective machinery needs repairs. Health and safety issues may arise. Claims may be brought by third parties against your business as a result of the breach, even though your company is not at fault. You may need to engage professionals, technical experts or allocate company staff to manage the situation. Lawyers may be instructed to defend the business against third parties, while getting ready to bring the company's own claim against the ultimate wrongdoer.

This articles focuses on recovering expenditure incurred in the aftermath of a breach, but before proceedings are commenced. The law offers two ways for the innocent party to recover what it has spent: a claim for damages, or seeking an award of costs. As we will see, the principles applying to these heads of claim differ quite considerably. An assessment of costs will usually not lead to a complete indemnity, while an award of damages is more likely to give a full recovery. This should be borne in mind when considering how to make a claim: there is a "grey area" where damages and costs overlap.

Damages or costs?

Before looking at the principles that govern recovery of costs and damages, we consider first how different types of expenditure or costs are categorised in law.

Company employees assigned to manage the problem

Company employees may need to spend a significant amount of time dealing with the aftermath of a breach, being unable to carry out their day-to-day tasks. In principle, a claim for damages is possible here. However, it will be difficult to recover an employee's salary as this is payable in any event, irrespective of the breach1.

It will not be enough to point to the employee carrying out unusual tasks at the expense of his normal "job description". The Court of Appeal has emphasised that it is necessary to show that the company's resources engaged in dealing with the breach led to a "significant disruption in ... business or any loss of profit or increased expenditure"2. In that case, a claim for out-of-pocket expenses in respect of a prolonged stay in Vietnam succeeded. This kind of outlay is much easier to recover on the basis that it would not have been incurred "but for" the breach.

You may therefore be in a better position if you engage additional resources to deal with the problem (perhaps on a temporary basis), because it will not be possible to argue that this expenditure would have been incurred in any event.

Managerial time

In reality, it may be impossible to point to only a single employee engaged in managing the consequences of the breach. Can a company claim damages for lost "managerial time" on a more general basis? Again, the answer is yes, in principle. The issue arose in Tate & Lyle v Greater London Council [1981] 3 All ER 716 at 720 and 721. Tate & Lyle sued the GLC because continuous dredging operations to remove silt were carried out near its jetty, which affected deliveries of raw sugar to its refinery. The Court commented on a claim for managerial time as follows:

" I have no doubt that the expenditure of managerial time in remedying an actionable wrong done to a trading concern can properly form the subject matter of a head of special damage. In a case such as this it would be wholly unrealistic to assume that no such additional managerial time was in fact expended. I would also accept that it must be extremely difficult to quantify. But modern office arrangements permit of the recording of the time spent by managerial staff on particular projects. I do not believe that it would have been impossible for the plaintiffs in this case to have kept some record to show the extent to which their trading routine was disturbed by the necessity for continual dredging sessions..."

Again, the real obstacle to such a claim succeeding will be proof. Despite the Judge's readiness to assume that managerial time would be lost, the claimant must put forward some evidence as to what the loss in fact amounts to. As we will see, when awarding damages (but not costs), the Court will not refuse to quantify damages simply because there cannot be absolute certainty, but it will not engage in idle speculation if the claimant cannot prove any actual loss at all. Following the judge's advice and getting management to keep timesheets is likely to be a considerable help in this regard.

Expert and professional assistance

The costs of engaging experts or professional advisers in the immediate aftermath of a breach of contract are also claimable, either as costs or damages — depending on the purpose of their work. If the main purpose of the expert's work was to assist the claimant with dealing with the breach, then the cost may be claimed as damages3. However, a report which goes beyond merely establishing the cause of the problem and seeks to allocate responsibility may be too closely connected with contemplated litigation — and so must be claimed as "costs" in any subsequent proceedings. The distinction was explained by the Court of Appeal in Bolton v Mahadeva [1972] 2 All ER 1322 as follows (at 1327):

" So far as the defendant's claim in respect of fees for the report which he obtained from his expert is concerned, it seems to me clear that that report was obtained in view of a dispute which had arisen and with a view to being used in evidence if proceedings did become necessary, and in the hope that it would assist in the settlement of the dispute without proceedings being started. In those circumstances, I think that the judge was right in reaching the conclusion that that report was something the fees for which, if recoverable at all, would be recoverable only under an order for costs."

In the same way as the work of experts can become too closely connected with legal proceedings, it is also possible for work by company employees to take on the mantle of costs if done in connection with pending litigation. Next, we will consider some examples of expenditure that can only be claimed as costs (if at all), and this includes help by company staff with a claim or litigation.

Legal costs incurred before proceedings

Legal fees incurred in connection with a claim cannot be claimed as damages from the opposing party. They fall within the Court's sole jurisdiction (and discretion) to award costs if litigation ensues — as further discussed below4. However, it is well established that legal costs incurred before an action has been commenced can be recoverable in the subsequent litigation. In Ross v Caunters [1980] Ch. 297 at page 323, the Court noted that:

" The statement of claim also claims the legal expenses of investigating the plaintiff's claim up to the date of the issue of the writ .... . ... at present I doubt whether any sum is recoverable under this head. If an order for costs is made in favour of the plaintiff, then some of these legal expenses of investigation may fall within that order as being "costs of or incidental to" these proceedings, and so of course could not be claimed as damages."

Provided they are "costs incidental to proceedings", pre-action costs are therefore recoverable. Whether costs are incidental depends on the circumstances: for instance, the costs of work carried out under one of the pre-action protocols should normally be incidental to subsequent proceedings5.

There is, however, a potential complication. In the early stages of a dispute, it may be thought prudent to investigate a range of potentially relevant issues. Not all of these issues may feature in a subsequent claim. In Re Gibson's Settlement Trusts [1981] 1 All ER 233, the Vice-Chancellor expressed the following view (239 to 240):

" Obviously the test cannot be simply whether the materials in question proved in fact to be of use in the action, for otherwise when a case is settled before trial ... it would often not be possible to say with any certainty which materials had been or would have been of use in the action. Nor would it be right to penalise the successful litigant for obtaining materials which appeared likely to be of use in the action but which, in the event, were never used because the other party did not contest the point. Whatever may be the position on a party and party taxation, if the taxation is on the common fund basis I think that one must go back to the words 'costs reasonably incurred'..."

A note of caution must be sounded immediately. Re Gibson's Settlement Trust is a pre-CPR case. It does not deal with the assessment (or "taxation") of costs as between litigants ("party and party costs" — where the loser generally pays the winner's costs, as set out below). Recent decisions show that a defendant who succeeds in rebutting some allegations following preaction protocol exchanges, so that the claimant does not include those allegations in subsequent proceedings, will generally be unable to claim for the pre-action costs relating to the abandoned claims. HHJ Coulson QC so held in McGlinn v Waltham Contractors Ltd. [2005] EWHC 1419:

" ... as a matter of principle, unless the circumstances are exceptional and thereby give rise to some sort of unreasonable conduct, costs incurred by a Defendant at the Pre-Action Protocol stage in successfully persuading a Claimant to abandon a claim (either in whole or in part) are not costs incidental to any subsequent proceedings if, in those subsequent proceedings, such claims do not feature at all."

It is not yet clear what would qualify as "exceptional circumstances", allowing the recovery of "wasted" pre-action costs.

In our view, the somewhat more generous approach suggested in Re Gibson's Settlement Trusts is to be preferred to the approach taken in McGlinn. A test on the basis of whether costs were reasonably incurred at the time, but without applying the benefit of hindsight, to see how proceedings eventually played out, seems much fairer. However, that is not the legal position at this time.

All the while, it must be recalled that if no proceedings are commenced, it will generally be impossible to recover the legal costs of dealing with a claim or allegations. The Court in Re Gibson's Settlement Trust affirmed this:

" Of course, if there is no litigation there are no costs of litigation. But if the dispute ripens into litigation, the question then arises how far the ambit of the costs is affected by the shape that the litigation takes"

The point was again emphasised by Ramsey J in Charles Church Developments Ltd v Stent Foundations Ltd & Anor [2007] EWHC 855 (TCC)6. If there is no subsequent litigation, the parties incur all legal costs at their own risk and will need to come to a commercial agreement. The Court under the CPR only has limited power to entertain "costs only" proceedings, but this procedure cannot be used to claim legal costs from a party who has made a claim but has stopped short of going to Court. Under CPR 44.12A, costs only proceedings can only be issued if there are no other proceedings and the parties to a dispute have reached agreement on all the issues (including which party is to pay the costs), and where this agreement is either made or confirmed in writing7.

Company staff assisting with claims or litigation

The final question relates to work done by company employees assisting with the preparation (or the conduct) of a claim. This head of expenditure is perhaps most likely to come up during litigation rather than before a claim is made, but the general principles ought to apply also to the pre-action period (provided the assistance is "incidental" to proceedings).

The general rule is that litigants cannot recover for their own costs incurred in connection with litigation. However, there is an exception to this rule as regards corporate litigants and "expert" staff, the modern authority for which is the case of Re Nossen's Letter Patent [1969] 1 WLR 6838. In that case, the UK Atomic Energy Authority faced a claim for patent infringement. As part of the defence, its own staff carried out complex experiments and research. The Court noted that if expert assistance is properly required for the conduct of a claim, it may well be that a corporation's own specialist employees are the most suitable or convenient experts to employ. If that is the case, then direct costs incurred, but not a contribution to overheads, are in principle recoverable.

What is the situation where a company's own employees do not act as experts but simply assist with the review of claims or documents, or the collation of evidence? Some disputes or claims are very document-heavy. For example, in a large EPC project, a contractor may claim extensions of time or variations from the employer. The employer may need to verify a large amount of documentation to assess whether the contractor's assertions are true. Can costs be claimed if the contractor turns out to have no such entitlement?

One would assume that the answer is "no". However, HHJ Thornton QC reached a different view in Amec Process and Energy Limited v Stork Engineers & Contractors VB (No3) [2002] (unreported). Costs were allowed for work done by Amec's personnel, assisting solicitors with the conduct of the case. The judge found:

" Amec engaged its own personnel and agency staff to undertake much of the work involved in collecting, analysing and presenting the primary evidence and the supporting evidence of Mr Prudhoe. These personnel also undertook much of the preparation of visual evidential aids such as isographs, histograms, graphs, bar charts, photographs, tables, as built programmes and overlays. Had this work been undertaken, at greater expense and with the use of many more hours of time, by legally qualified personnel employed by Masons, as Amec's solicitors, this work would in principle be recoverable."

Warren J in Sisu Capital Fund Ltd v Tucker subsequently disapproved of the Amec decision. He could not reconcile the approach taken in Amec with other, established authority and with the provisions of the CPR that govern precisely when a litigant itself can recover costs — only in very limited circumstances, including where there is no legal representation. Although HHJ Thornton QC's approach seems sensible — he was clear that the work by Amec's own staff had helped to save costs — it is very doubtful that his reasoning survives the comprehensive review of the authorities set out by Warren J in Sisu. A claim for costs of this nature might still be made, though it would be speculative.

Corporations therefore have a choice to make: assist the solicitors by providing internal resources to reduce legal costs (but incurring an irrecoverable, internal cost), or accepting that a larger team of external lawyers should work on the case, preserving the possibility of reclaiming a proportion of these increased external costs if the case succeeds? To avoid putting the innocent party to this election, we would welcome it if HHJ Thornton QC's approach became the norm.

Does the distinction matter?

Whether a claim is made for costs or damages does matter, as the principles the Courts apply to determining the recoverable amounts differ quite considerably.

Damages

Damages are meant to provide compensation for the innocent party. Generally, in a claim for breach of contract, the aim of the law is to put the party into the position they would have been in had the contract been performed. We have already seen that the Court will not be too harsh on a claimant here and may even strive to provide some assistance, although the burden of proof must of course be discharged by the claimant. The approach to be taken in claims for damages (as opposed to claims for a sum due under a contract) is illustrated by Keating on Construction Contracts as follows9.

" Where the claim is for breach of contract the court is more likely to resolve matters of doubt in the contractor's [claimant's] favour and, even where the evidence of loss is very unsatisfactory, if satisfied that there was substantial loss, will make some award ..."

When it comes to assessment, where it is clear that the claimant has suffered some loss10, the Courts will "do the best they can" on the evidence that is available — see the Privy Council in Tai Hing Mill v Kamsing Factory [1979] AC 91, 105H-106D. This will often involve the Judge in simply finding that a particular figure is due.

Importantly, the wrongdoer may assert that damages claimed are unreasonably high and some of the loss could have been mitigated — but it is the party alleging a failure to mitigate that bears the burden of proof. To establish a failure to mitigate, it is generally necessary to provide some concrete evidence as to what could in fact have been done differently to reduce loss, rather than speculating11.

Costs

By contrast, English law has developed particular jurisprudence regarding the award of costs in civil litigation. The modern basis of the Court's jurisdiction to award costs is found in Section 51 of the Supreme Court Act 1981. Costs are always in the discretion of the Court, and the Court has "... full power to determine by whom and to what extent the costs are to be paid12." The House of Lords confirmed in Aiden Shipping Co Ltd v Interbulk Ltd [1986] 2 All ER 409 that the Court's discretion under Section 51 is very wide, and is not limited to the parties to litigation. Where appropriate, a third party can therefore be on the receiving end of an order for costs.

Both before the Courts and in arbitration, the general rule in English law is that a winning party can expect to recover its costs from the losing party — "costs follow the event". So if a claim succeeds, costs ought to be awarded. Costs are always in the discretion of the Court, exercised on the basis of the relevant principles and factors, which include proportionality, a party's conduct and the overall degree of success compared to the claim13. For example, a party who seeks to claim a total of £1 million on three distinct grounds but only recovers £100,000 on one ground is unlikely to be awarded the majority of its costs.

What is the purpose of awarding costs to the successful party in litigation? More than a century ago, the Court of Appeal described it in these terms14.

" What are party and party costs? They are not a complete indemnity, but they are only given in the character of an indemnity. I cannot do better than read the opinion expressed by Bramwell B. in Harold v. Smith (1): 'Costs as between party and party are given by the law as an indemnity to the person entitled to them; they are not imposed as a punishment on the party who pays them, nor given as a bonus to the party who receives them. Therefore, if the extent of the indemnification can be found out, the extent to which costs ought to be allowed is also ascertained.'"

"Indemnity" here should not be misunderstood — a successful party rarely gets a full indemnity (recovering what was actually spent). Instead, costs are generally assessed on the "standard basis", and such assessment usually leads to a recovery of about two-thirds of what has been spent. The basis of assessment that is ordered by the Court can, however, make a difference.

In litigation before the Courts to which the CPR apply, costs will be subject to the process of detailed assessment. A bill of costs prepared in a rather specific format records individual items of work for which costs are claimed. Items may be disputed by the paying party as being unreasonable or irrecoverable. There is usually a hearing before a "costs judge", who will determine the recoverable amount for each item claimed. The process is time-consuming and can appear to be arcane: often, it involves second-guessing how much time should have been spent on a particular task. A party who has won a costs award may come out of the process feeling it has had to justify every pound spent.

That is not wholly surprising, since the standard basis of assessment gives the losing party the benefit of the doubt. CPR 44.4 applies a two-stage test to assessing costs on the standard basis: costs must (i) be proportionate to the matters in issue, and (ii) have been reasonably incurred and be reasonable in amount. Importantly, any doubts as to whether costs are proportionate or reasonable are to be resolved in favour of the paying party (the wrongdoer). The Court of Appeal has explained that in practice, a "global" approach is to be taken to see whether the total amount of costs claimed is proportionate15 — by reference matters such as complexity, difficulty and importance of the case, and the amounts at stake16.

Alternatively, the Court may order costs to be assessed on the indemnity basis. Here, doubt is resolved in favour of the party claiming costs. Lord Woolf CJ emphasised that the indemnity basis ought to make a practical difference in terms of a more favourable outcome for the receiving party in Excelsior Commercial and Industrial Holdings v Salisbury Hammer Aspden and Johnson [2002] EWCA Civ 879:

" This is a matter of real significance ... an indemnity order is one which does not have the important requirement of proportionality which is intended to reduce the amount of costs ... payable in consequence of litigation ... an indemnity order means that a party ... is more likely to recover a sum which reflects the actual costs in the proceedings."

The common view amongst practitioners is that an award of costs on the indemnity basis means that about 85 to 90 per cent of actual expenditure is recovered. The grounds on which indemnity costs are awarded are beyond the scope of this article: suffice it to say that an element of unreasonableness, or misconduct, that removes the case from the norm, must be present.

There is a final wrinkle for parties seeking to recover costs: in Fourie v Le Roux [2007] UKHL 1, Lord Scott doubted whether a costs award on the indemnity basis really were all that different, looking at the language used in the CPR. It is submitted that Lord Woolf's statements are to be preferred — it should remain open to the Court to order that a litigant should recover a greater proportion of costs.

Conclusion

Many companies may be incurring expenditure or loss as a result of a failure by their counterparty to perform contractual obligations which are never claimed although they are in principle recoverable as damages. The chances of claiming managerial time and business disruption would be improved if records are kept. Provided there is some evidence of loss before the Judge, the Court should not decline to assess a figure. Instead, the Court will do the best it can. A defendant who wishes to assert that there was a failure to mitigate by acting unreasonably will have the burden of proving how and what the claimant might have done differently. However, once the line between damages and costs is crossed, the tables are turned: now doubts as to reasonableness are resolved in favour of the defendant (provided costs are assessed on the standard basis). For that reason, it should always be explored whether a claim might in fact be made for damages rather than costs.

Footnotes

1. D amages for breach of contract must be a consequence of the breach, either directly caused by it or being such a type of loss as would ordinarily have been in the contemplation of the parties as a likely consequence. Expenditure that would have been incurred irrespective of the breach will be difficult if not impossible to recover.

2. Standard Chartered Bank v Pakistan National Shipping Corporation [2001] EWCA Civ 55, per Potter LJ (paragraphs 48 and 49).

3. See Keating on Construction Contracts, 8th Edition, 8-030.

4. There is an exception to this: it is possible to claim legal costs as damages, provided the costs were incurred by the innocent party towards a third party as a result of a breach of contract from the wrongdoer who committed the breach. For example, if a seller sells defective goods, which the buyer sells on (effectively being placed in breach of contract by the seller), and the buyer then litigates against his own buyer in the on-sale, the buyer may recover the costs of the action in the on-sale from the seller. See McGregor on Damages, 17th Edition, Chapter 17 in general and cases such as Hammond v Bussey (1888) 20 QBD 79.

5. In Callery v Gray [2001] EWCA Civ 1117, Lord Woolf explained (para 54): "Where an action is commenced and a costs order is then obtained, the costs awarded will include costs reasonably incurred before the action started, such as costs incurred in complying with a pre-action protocol."

6. See paragraph 43(1) of the judgment: "If the pre-action protocol procedure leads to settlement, without the need to issue proceedings, or does not lead to proceedings, the court cannot make an order in respect of liability for the costs of complying with the pre-action protocol procedure, as they are not costs of and incidental to proceedings in the High Court, which, under Section 51(1) of the Supreme Court Act 1981 are in the discretion of the court. The court does, though, have a limited power to assess costs under CPR Rule 44.12A, if liability is agreed."

7. Senior Costs Judge Peter Hurst in Julia Bensusan v Bernard Freedman [2001] EWHC 9001 explained that costs only proceedings under Part 8 of the CPR were intended to be a cost effective method of quantifying costs where the parties were otherwise agreed. Bringing this kind of claim in respect of costs from a party reluctant to accept liability would be a breach of the overriding objective.

8. The judgment of Warren J in Sisu Capital Fund Ltd v Tucker [2005] EWHC 2321.

9. 8th Edition, Paragraph 8-048.

10. But a claimant must always prove causation and should show some actual loss to recover anything other than nominal damages – Sykes v Midland Bank Executor Co [1971] QB 113.

11. See the Court of Appeal's decision in Standard Chartered Bank v PNSC referred to above. Here, the appellant failed to establish that a sale of distressed cargo could in fact have been made at a higher price, reducing the loss. While the market price may have been higher than the price in fact achieved, and the sale had been made unreasonably without looking for better offers, the defendant could not prove how any better offers might have led to a greater recovery.

12. Supreme Court 1981, Sections 51(1) to (3).

13. The detail of the principles and factors that affect how the Court or tribunal should exercise its discretion are beyond the scope of this article. They are found in the CPR 44.3 to 44.5, and in the Arbitration Act 1996, Sections 61 to 65.

14. Gundry v Sainsbury [1910] 1 KB 645.

15. Home Office v Lownds [2002] EWCA Civ 365.

16. See CPR 44.5(3) for a full list of factors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.