Calculation of contract damages

The High Court of Australia recently held in Tabcorp Holdings Ltd v Bowen Investments Pty Ltd [2009] HCA 8 that a tenant who conducted unauthorised alterations to the foyer of a commercial building was liable to compensate the landlord.

There is nothing new or controversial about that.  However the court found that the basis for compensating the landlord was to be calculated not upon the effect of the alterations on the building’s value, but upon the cost of reinstating the premises to its previous condition.

The tenant argued that the damages should be assessed on the diminution in value approach being the difference between the value of the building with the old foyer and the value of the building with the unauthorised foyer. This equated to approximately $35,000.

The landlord was successful in obtaining damages of $1.3m comprising $580,000 for restoration costs and $800,000 for loss of rent during the restoration.

The lease contained an express negative covenant against any substantial alteration being carried out to the premises without the landlord’s consent (not to be unreasonably withheld).

The tenant approached the landlord with a proposal to alter the foyer.  The landlord did not consent to the proposed alterations. The tenant then asked the landlord to attend an onsite meeting to discuss the proposed alterations. When the landlord arrived the demolition was already in progress.

The tenant was aware that the landlord’s consent was required and that it had not been obtained.

The normal measure of contract damages is that where a party sustains a loss by reason of a breach of contract, he or she, so far as money can do it, should be placed in the same situation, with respect to damages, as if the contract had been performed.

The High Court referring to earlier decisions said the words” the same situation, with respect to damages, as if the contract had been performed” do not mean “ as good a financial position as if the contract had been performed” (emphasis added).

In some circumstances putting the innocent party into “the same situation… as if the contract had been performed” will coincide with placing the party into the same financial position. For example in a case involving the sale of defective goods, the prima facie measure of damages is the difference in value between the contract goods and the goods supplied. This notional approach seeks to only reflect the difference between the buyer selling the defective goods on the market and purchasing the contract goods.

Where for example the contract is not for the sale of marketable commodities, selling the defective item and purchasing an item corresponding with the contract is not possible. In such cases, diminution in value damages will not restore the innocent party to the “same situation… as if the contract had been performed”.

In the circumstances of the case the landlord was contractually entitled to preservation of the premises without the unauthorised alterations. Its measure of damages was the loss sustained by the failure of the tenant to perform that obligation and that loss was the cost of restoring the premises to the condition in which they would have been if the obligation had not been breached.

Although the behaviour of the tenant attracted the criticism of the court, the decision has wider ramifications for the assessment of damages in the case of other contractual breaches.

Where a party may decide to breach a contract it may incorrectly appear to that party to be cheaper to do so than to comply with the contract’s terms. The danger for the defaulting party is that the damages awarded by the court may be calculated differently and be significantly greater than contemplated.

Parties to a contract should be wary when considering the risks which might arise from a breach of the contract’s terms.

The decision also means that parties may be able to protect legitimate non-financial interests through careful drafting of contractual provisions.