BACKGROUND

It is a much-professed rule of the law of contract that a plaintiff can only recover its own losses as damages for breach of contract. Exceptions to this general rule are limited.
 
However, in July 1993, the House of Lords in the related decisions of Linden Gardens and St Martin's Property Corporation allowed an employer under a building contract to recover damages for the losses suffered by a third party.

The Court of Appeal in the recent case of Darlington Borough Council -v- Wiltshier Northern Limited has applied the House of Lords decisions with the result that a nominal employer who at no time had ever had a proprietary interest in a building site was permitted to recover substantial damages for breach of contract in respect of losses suffered by the freehold owner of the site.

THE FACTS

Darlington Borough Council ('Darlington') owned land on which it wanted to build a facility (the 'Dolphin Centre').
 
Funding was required for this construction project, but Government restrictions on borrowing in the Local Government Act 1972 led to a fear that funding would not be available to Darlington. In order to avoid the constraints of the Act, Darlington devised a scheme with Morgan Grenfell (Local Authority Services) Limited ('Morgan'). Morgan was specifically created for this purpose, and acted as financier to Darlington in connection with the construction of the Centre.

Morgan as Employer then entered into two JCT '63 contracts dated 29 October 1979 and 1 December 1981 with Wiltshier as Main Contractor. Clause 17 of the contract forms, which prohibited assignment, was deleted. Morgan entered into these contracts as principal, and not as agent.

Morgan and Darlington entered into a collateral 'Covenant Agreement' on 1 August 1980 and the more important terms of this Agreement were:-
• that Morgan would pay Wiltshier under the building contracts, and Darlington would reimburse Morgan.
• that any warranties by Morgan as to the state of the building, or performance by Wiltshier of the Building Contract, were excluded.
• that Morgan would assign to Darlington "… the benefit of any rights against [Wiltshier] to which [Morgan] may then be or become entitled…" and any cause of action.
• that Morgan would not be liable to Darlington for any loss arising from the use of the building, through defects, delay etc.

All three parties - Morgan, Darlington and Wiltshier - entered into a tri-partite deed contemporaneously with and supplemental to each of the building contracts giving Darlington direct contractual rights against Wiltshier in respect of liquidated damages in the event that Wiltshier failed to complete the project by the Completion Date under the building contracts. No other direct contractual rights were in place between Wiltshier and Darlington.

In 1983/84 defects appeared allegedly due to breaches of the building contracts by Wiltshier. In August 1991 Morgan assigned to Darlington all rights and causes of action against Wiltshier.

In 1992 Darlington issued proceedings against Wiltshier in respect of alleged breaches of contract by Wiltshier.

WILTSHIER'S DEFENCE - THE 'NO LOSS' ARGUMENT

Wiltshier sought to rely upon two propositions of law. These were:

1. that Darlington, as assignee, could recover no more in damages against Wiltshier than Morgan could have recovered had the assignment not taken place, and

2. if the assignment had not taken place, Morgan would not have been entitled to recover substantial damages because it had suffered no loss - the loss occasioned by the defective work was incurred by Darlington who owned the building and paid for remedial works.

Wiltshier argued that as a result the claims for breach of contract and damages had disappeared down a 'legal black hole'. At first instance the Official Referee held that Darlington had no claim against Wiltshier other than for nominal damages. Darlington appealed to the Court of Appeal.

THE COURT OF APPEAL DECISION

The first proposition was not challenged by Darlington in the Court of Appeal, and the Court of Appeal unanimously held that Darlington's damages could not exceed those to which Morgan would have been entitled in the absence of the assignment.

However, the Court of Appeal rejected Wiltshier's second proposition and expressed the following conclusions:

1. A third party cannot sue for damages on a contract to which it is not a party (this is why Darlington required an assignment of Morgan's rights under the building contracts).

2. Subject to certain exceptions, the general principle for the assessment of damages for breach of contract is compensatory i.e. to compensate the plaintiff for its own loss.

3. One exception to this general rule arises in certain situations where it is in the contemplation of both parties at the date of the contract that breach of the contract may cause damage to someone other than the contracting parties themselves.

In Linden Gardens the House of Lords had applied the rationale of this exception to the particular situation in that case and said:-

"The contract was for a large development of property which, to the knowledge of both [the Employer] and [the Contractor], was going to be occupied, and possibly purchased by third parties and not by [the Employer] itself Therefore it could be foreseen that damage caused by a breach would cause loss to a later owner and not merely to the original contracting party … In such a case, it seems to me proper ... to treat the parties as having entered into the contract on the footing that [the Employer] would be entitled to enforce contractual rights for the benefit of those who suffered from defective performance ... It is truly a case in which the rule provides 'A remedy where no other would be available to a person sustaining loss which under a rational legal system ought to be compensated by the person who caused it' " (per Lord Browne-Wilkinson).

The above passage did not fit precisely the facts in the Darlington case. Morgan had never had a proprietary interest in the property. However, the Court of Appeal thought that it came 'within the rationale' of the House of Lords decision, viz:-

"It was plainly obvious to Wiltshier throughout that the Dolphin Centre was being constructed for the benefit of Darlington on Darlington's land" (per Steyn LJ).

4. Morgan would have been entitled to recover Darlington's loss occasioned by Wiltshier's defective work, and that entitlement had been assigned properly to Darlington.

As an alternative ground for allowing Darlington to recover its loss, two of the three Court of Appeal Judges held that in the light of Morgan's agreement to assign its rights against Wiltshier to Darlington upon request, Morgan could have recovered from Wiltshier the losses of Darlington to whom it stood, in that respect, as a constructive trustee.

THE EFFECTS OF THE DECISION

Although the Darlington case and the Linden Gardens and St Martin's decisions were concerned specifically with building contracts, the decisions would all appear to have relevance to almost all commercial contracts. This is a developing area of the law and the following are some of the points to emerge:-

• It remains the law that a defendant/respondent is only liable for such loss as was at the time of the contract reasonably foreseeable as likely to result from the breach. It now seems that the range of foreseeable (and thus recoverable) loss can in certain circumstances extend to third parties' losses.

• Whereas previously contractors have sought to limit their liability to third parties by prohibiting the right of the employer to assign the contract and/or by refusing to provide collateral warranties, these cases have demonstrated that those steps will not always guarantee immunity from third party claims.

• The plaintiff cannot recover losses sustained by a third party where that third party has its own contractual remedy against the defendant pursuant to a collateral warranty. What is less clear is the right of a plaintiff to recover losses suffered by a third party in circumstances where a collateral warranty has been given but does not permit the third party to recover the loss sustained.

• Despite this, a plaintiff employer cannot recover, as liquidated and ascertained damages under his contract with a defendant contractor, loss sustained by a third party. The deduction of liquidated and ascertained damages will only be permitted where they represent a genuine pre-estimate of the employer's own loss. In the Darlington case, it was obvious that Morgan was never going to suffer any loss caused by delay, so by a separate agreement Darlington was given direct contractual rights against Wiltshier in respect of those losses.

CONCLUSION

It seems to be the case, as I indicated above, that the circumstances allowing a plaintiff to recover for another parties' loss are being extended. The Court of Appeal commented in the Darlington decision at length upon the sometimes unfair 'privity of contract' rule. That this development is of major importance is demonstrated by the fact that I understand that both parties have petitioned the House of Lords for leave to appeal against the Court of Appeal findings.