The rule in Hadley v Baxendale

What is it?

The rule in Hadley v Baxendale basically says that if A has committed a breach of a contract that he has with B by doing x, and B has suffered a loss as a result, that loss will count as too remote a consequence of A’s breach to be actionable unless at the time the contract between A and B was entered into, A could have been reasonably been expected to foresee that his doing x was likely to result in B suffering that type of loss, because either: (1) it would have been quite normal or natural for B to suffer that type of loss as a result of A’s doing x; or (2) A was informed before he entered into the contract between him and B of any special circumstances which meant it was likely that A’s doing x would result in B suffering that type of loss.

Why do we have it?

The rule in Hadley v Baxendale is basically a rule of fairness; one of about ten different features of the English contract law that can be seen as requiring the parties to a contract to deal fairly with each other. The reason why we have the rule in Hadley v Baxendale is to give each contracting party a fair chance to decide whether or not they want to enter into the contract, and if so on what terms. A would be deprived of that chance if he were held liable for a loss suffered by B as a result of A’s breach of contract when he had no way of knowing at the time the contract was entered into that B stood to suffer that type of loss if he breached. Had A known this, and known that he might be held liable for that loss, he might have refused to enter into the contract with B, or bargained for an alteration in the terms of the A-B contract to protect himself against being held liable for that loss, or to reward him for running the risk of suffering that loss. As Alderson B remarked in Hadley v Baxendale (1854) itself, of the case where B suffers a loss as a result of A’s breach due to special circumstances that A was unaware of at the time he entered into his contract with B,

‘…had the special circumstances been known, the parties might have specially provided for the breach of contract by special terms as to the damages in that case, and of this advantage it would be very unjust to deprive them.’

A concrete example can make this point clear. Suppose that Loaded enters into a contract with Builder for the construction of a swimming pool in Loaded’s country house. The contract specifies that the swimming pool must be ready for use by June 1st. A few days after the contract is entered into, Loaded tells Builder that he needs the swimming pool to be installed by June 1st because a movie company is taking over his estate during the summer to do some filming in and around it, but they have made it a condition of their contract with him that he have a swimming pool installed as a number of crucial scenes take place in and around a swimming pool. Loaded also tells Builder that the movie company are paying him ‘crazy money’ – £5m – to hire his estate from June 15th – September 15th. Builder does not complete the swimming pool until July 1st, and Loaded’s deal with the movie company falls through.

At the time Builder breached his contract by failing to complete the swimming pool on time, it was perfectly foreseeable that his doing so would result in Loaded suffering a loss of £5m. However – unlike the position in tort law (most of the time) – we do not determine the remoteness or otherwise of a loss suffered as a result of a breach of contract by looking at what was foreseeable at the time the breach occurred. Instead, we look at what was foreseeable at the time the contract was entered into. The reason is that not to do so would be unfair on Builder. Had Builder known that his failing to complete the swimming pool on time might result in his being held liable for the loss of Loaded’s  deal with the movie company, he might have refused the job completely, or negotiated a much higher price for getting the work done on time, or insisted that there be a clause in the contract limiting the scope of his liability. So fairness demands that Builder only be held liable for the losses that he could have contemplated that Loaded might have suffered as a result of his failing to build the pool on time at the time Builder entered into his contract with Loaded, as those were the only losses Builder could have taken the risk of being held liable for when he decided to enter into a contract with Loaded, and on what terms.

The letter and the spirit of the rule

For the most part, giving effect to the letter of the rule in Hadley v Baxendale will also give effect to the spirit of fair dealing that underlies the rule. Where the two diverge, though, is where A enters into a contract with B, knowing that B is likely to suffer a particular kind of loss if A breaches that contract, but A does not factor that knowledge into his decision as to whether or not to enter into his contract with B.

If A’s breach does result in B suffering that kind of loss, the letter of the rule in Hadley v Baxendale indicates that A should be held liable for that loss: at the time A entered into his contract with B, it was reasonably foreseeable that if A breached his contract with B, then B would suffer that type of loss.

However, the spirit of the rule indicates that A should not be held liable for B’s loss – at least where he wasn’t at fault for not factoring in the prospect of B’s suffering that type of loss into his decision as to whether or not to contract with B, and if so on what terms. The reason is that holding A liable for that kind of loss would mean that he wasn’t given a fair chance to consider whether or not he should contract with B, and if so on what terms. Had A taken seriously the prospect that he might be held liable for the sort of loss that B has suffered as a result of A’s breach, he might have refused to contract with B, or have contracted on different terms. As he did not take that prospect seriously – and, apparently, acted reasonably in failing to take that prospect seriously – he should not be held liable for the loss that B has suffered.

So the letter and the spirit of the rule in Hadley v Baxendale will go in different directions in the situation where a contracting party foresees that the other party might suffer a particular type of loss if the contract was breached, but does not factor in the prospect of being held liable for that loss in deciding whether or not to enter into the contract, and if so on what terms. But when would such a situation arise?

The Achilleas (2008)– otherwise known as Transfield Shipping v Mercator Shipping – apparently presented one such situation. The defendants hired a ship from the claimants. The ship was due to be given back on May 2 2004. Expecting to get the ship back by May 2 at the latest, the claimants agreed on April 21 to hire out the ship for 191 days to Cargill International SA for $39,500 a day, with the period of hire to start once the claimants got their ship back from the defendants. Under the agreement, Cargill had the option of cancelling it if they had not received the ship by May 8. By May 5, the defendants still hadn’t handed the ship back to the claimants, and there was no prospect of the claimants getting it back by May 8. Fearful that Cargill would cancel the contract to hire the ship, the claimants renegotiated its terms, extending the cancellation date, but at the same time agreeing to a substantial reduction in the rate of hire for the ship – $31,500 a day rather than $39,500 – to reflect the fact that there had been a sharp fall in the general market rates for hiring ships like the claimants’. The claimants finally got their ship back from the defendants on May 11, nine days late.

The claimants sued the defendants for damages, arguing that ‘Had you not been late redelivering the ship, we would now be hiring out the ship for 191 days to Cargill at $39,500 a day rather than $31,500 a day. So we have suffered a loss of about $1.5m (191 x $8,000) as a result of your breach of contract, and you are liable to us for that loss.’ However, the defendants argued, ‘The custom in the industry is that when a ship is delivered back late, all the owner can sue for is the difference between what he could have earned hiring out the ship during the period the ship was wrongfully retained, and what is due under the hire contract for retaining the ship for that period of that time. So we are only liable for $158,000: the extra amount you could have made during the nine days we retained the ship compared with what we have to pay under our contract of hire for retaining the ship for those nine days.’ If the defendants were right – and this is something that is disputed – that the custom in the shipping industry on late return of a ship was simply to sue for the loss suffered as a result of not being able to hire out the ship to someone else during the period it was detained, then it would have been unfair on the defendants to hold them liable for the $1.5m loss that the claimants suffered because the defendants’ hanging on to the claimants’ ship for nine extra days resulted in the claimants losing out on the chance of hiring the ship out to Cargill for $39,500 a day, as opposed to $31,500 a day. This is because the defendants never seriously contemplated that they might be held liable for that kind of loss when they agreed to hire the claimants’ ship, and had they known that they might be held so liable, they would almost certainly have renegotiated the terms of the contract under which they hired out the claimants’ ship.

So if the defendants were right about the custom in the shipping industry, then The Achilleas was a case where the letter and the spirit of the rule in Hadley v Baxendale might have produced divergent results. According to the letter, whether or not the defendants should have been held liable for the claimants’ $1.5m loss depended on whether the defendants contemplated when they entered into the contract with the claimants that their hanging on to the claimants’ ship beyond the hire period would result in the claimants suffering the kind of loss on the follow-on contract of hire that they suffered here.

On the other hand, if we followed the spirit of the rule in Hadley v Baxendale, then we would regard it as irrelevant whether or not the defendants knew what losses might be suffered by the claimants if the defendants held on too long to the claimants’ ship. If the custom in the industry was such as the defendants described, then the scope of the defendants’ liability should have been determined by that custom. To hold the defendants liable on any other basis, and hold them liable for losses they contemplated the claimants might suffer as a result of breach when they hired the claimants’ ship, would be unfair on the defendants as they never seriously contemplated that they might be held liable for those losses, and did not factor in the possibility that they might be held liable for those losses when they decided to hire the claimants’ ship on the terms they did.

As it happens, the House of Lords did not think that the letter and the spirit of Hadley v Baxendale did diverge in The Achilleas as to what the result of the case should be. Lord Rodger applied the letter of the rule in Hadley v Baxendale and found that at the time the defendants hired the claimants’ ship, there was no reason for them to contemplate that a delay in returning the ship would result in the claimants suffering the type of loss that they had suffered on the follow-on contract as the loss was purely due to ‘unusual’ (at [53]) movements in the market rates for hiring ships. Lord Hoffmann’s approach to the case (which I will discuss in more detail below) was much more consistent with the spirit of Hadley v Baxendale and was – for the reasons explained above – consequently not in favour of holding the defendants liable for the losses suffered by the claimants on their follow-on contract. Baroness Hale agreed with Lord Rodger’s approach, though with some doubts about how it applied in this case. The fact that both approaches resulted in the same outcome allowed Lords Hope and Walker to agree with Lord Rodger and Lord Hoffmann, thus resulting in The Achilleas producing no overall majority in favour of whether the letter or the spirit of Hadley v Baxendale should be followed when they diverge.

And there will be cases where they will diverge in terms of the result they reach. For example: Executive hails a taxi driven by Driver. Executive tells Driver, ‘Take me to the airport. I have a plane to catch in two hours. A huge deal is riding on my making the plane.’ Shortly afterwards, Driver carelessly crashes the taxi. Executive is unharmed but is unable to make his plane, and fails to close the business deal that he was flying out to negotiate; the deal was worth $5m to Executive. Can Executive sue Driver for this loss? According to the letter of the rule in Hadley v Baxendale, yes he can. At the time Driver let Executive into his car, he knew that if he screwed up driving Executive to the airport, that Executive would suffer this kind of loss. According to the spirit of the rule in Hadley v Baxendale, Executive shouldn’t be able to sue Driver for the loss of his deal. At the time Driver let Executive into his car, Driver wasn’t factoring the possibility that he might be sued for that kind of loss into his decision as to whether or not to take Executive to the airport. In fact, Driver wasn’t making any kind of conscious decision as to whether or not to accept Executive as a passenger – as soon as Executive hailed his cab, he was going to take Executive as a passenger, whatever Executive said. Given this, it would be unfair to hold Driver liable for the loss of Executive’s deal. If Executive wanted to be able to sue Driver for that kind of loss, he should have been much more explicit with Driver: ‘Take me to the airport. I have a plane to catch in two hours. There is a huge deal riding on this, and I will sue you for millions if something happens to stop me catching the plane. Are you happy to take me on that basis?’ But if he said something like that, then Driver’s reaction would almost certainly have been: ‘No, I’m not – hop off mate and find someone else to take you.’ Holding Driver liable for the loss of Executive’s deal when that would have been Driver’s reaction had the possibility of his being held liable for that loss been brought home to him illustrates just why the spirit of the rule in Hadley v Baxendale stands opposed to holding Driver liable for that loss.

Where the letter and spirit of the rule in Hadley v Baxendale diverge, which should we prefer? In favour of following the spirit is simple common sense – the letter is supposed to serve the spirit, and must give way when it fails to do this. But in favour of following the letter in all cases is the desire for commercial certainty. Applying the letter of the rule in Hadley v Baxendale across the board may do injustice in individual cases such as Executive v Driver, but it does at least allow litigants in breach of contract cases to know where they stand so far as their potential liabilities are concerned. In contrast, applying the spirit of the rule in Hadley v Baxendale to determine the scope of a contract breaker’s liabilities requires the court to make difficult inquiries into the contract breaker’s expectations when he entered into the contract as to what he might be held liable for if he breached the contract.

Where Lord Hoffmann went wrong in The Achilleas

I said in the preceding section that Lord Hoffmann’s judgment in The Achilleas was ‘consistent’ with the spirit of the rule in Hadley v Baxendale, as I have explained it above. However, this is not quite true. According to the spirit of the rule in Hadley v Baxendale, a defendant should not be held liable for a loss that he did not take the risk of being held liable for when he entered into his contract with the claimant. (Compare the argument of counsel for the defendants in Hadley v Baxendale: ‘Where the contracting party is shewn to be acquainted with all the consequences that must of necessity follow from a breach on his part of the contract, it may be reasonable to say he takes the risk of such consequences.’) Lord Hoffmann said something different in The Achilleas. He said that a defendant should not be held liable for a loss that he did not agree to be held liable for when he entered into the contract (all emphases added):

[12] It seems to me logical to found liability for damages upon the intention of the parties (objectively ascertained) because all contractual liability is voluntarily undertaken. It must be in principle wrong to hold someone liable for risks for which the people entering into such a contract in their particular market, would not reasonably be considered to have undertaken.

[15] …one must first decide whether the loss for which compensation is sought is of a ‘kind’ or ‘type’ for which the contract-breaker ought fairly be taken to have accepted responsibility.

[26] …[in this type of case] the court is engaged in construing the agreement to reflect the liabilities which the parties may reasonably be expected to have assumed and paid for.

The idea that Lord Hoffman seems to be advancing here – that a contract-breaker’s liabilities to compensate the victim of his breach are attributable to the fact that he has agreed to assume those liabilities in entering into the contract – should be rejected as heretical. As Kyle Lawson has brilliantly pointed out (in ‘The remoteness rules in contract: Holmes, Hoffmann, and ships that pass in the night’ (2012) 23 King’s Law Journal 1), Lord Hoffmann’s language in The Achilleas echoes that of Holmes J in deciding the case of Globe Refining v Landa Cotton Oil (1903) in the US Supreme Court. In that case, Holmes J said that:

‘When a man commits a tort he incurs by force of the law a liability to damages, measured by certain rules. When a man makes a contract he incurs by force of the law a liability to damages, unless a certain promised event comes to pass. But unlike the case of torts, as the contract is by mutual consent, the parties themselves, expressly or by implication, fix the rule by which the damages are to be measured… [In considering what the plaintiff is entitled to recover in this case we] have to consider…what liability the defendant fairly may be supposed to have assumed consciously, or to have warranted the plaintiff reasonably to suppose that it assumed, when the contract was made.’

Holmes’ theory of the basis of a contract breaker’s liability followed from his view – famously expressed in ‘The path of the law’ (1896-7) 10 Harvard Law Review 457 – that someone who commits a breach of contract does not actually do anything legally wrong: ‘The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it – and nothing else. If you commit a tort, you are liable to pay a compensatory sum. If you commit a contract, you are liable to pay a compensatory sum unless the promised event comes to pass, and that is all the difference’ (ibid, 462). So the only obligation that a contracting party undertakes is either to ensure that something happens or to pay damages instead. It follows that the contract breaker’s obligation to pay damages is traceable to the fact that the contract breaker undertook to pay such damages if he failed to perform.

All this is nonsense. It is not possible to argue that a contract breaker’s liability to pay damages to the victim of his breach is attributable to the fact that the contract breaker agreed to pay those damages if he did not perform. A couple of examples show this:

(1) A enters into a contract with B. Under the contract, A undertakes to pay B the penal sum of £1m if he breaches his contract in any way at all. On breach, B will not be allowed to sue A for £1m but will instead be confined to suing for the actual loss he has suffered as a result of breach. This is so even though A undertook to pay B £1m if he breached his contract with B, and not to compensate B for his actual loss.

(2) A enters into a contract with B. The contract specifies that A’s liability on breach will be capped at £5,000, whatever the nature of A’s breach, and whatever the extent of B’s losses as a result of A’s breach. It is held that the clause limiting A’s liability is invalid under some statutory provision. A is then held liable for the actual loss suffered by B as a result of A’s breach, even though A never agreed to be held liable for that loss, but only £5,000.

Examples like these show that a contract breaker’s liability to pay damages to the victim of his breach is imposed on him by the law, and is not assumed by him under the contract. So the rule in Hadley v Baxendale cannot be explained as existing to give effect to a defendant’s intentions at the time he entered into a contract as to what liabilities he was agreeing to assume under that contract. Instead, the rule operates to prevent the law imposing on the defendant a liability to compensate the claimant for a loss that the defendant did not take the risk that the law might hold him liable to compensate the claimant for that loss when he contracted with the claimant. Any suggestion to the contrary in Lord Hoffmann’s judgment in The Achilleas is to be regretted.

(Though see para [13] of his judgment, which is entirely consistent with the analysis of the basis of the rule in Hadley v Baxendale advanced here: ‘The view which the parties take of the…risks they are undertaking will determine the other terms of the contract and in particular the price paid. Anyone asked to assume a large and unpredictable risk will require some premium paid in exchange. A rule of law which imposes liability upon a party for a risk which he reasonably thought was excluded gives the other party something for nothing.’)

The fact that Lord Hoffmann adopted an unworkable theory of the basis of contractual liability in The Achilleas should not lead us to think that his refusal simply to give effect to the letter of the rule in Hadley v Baxendale in The Achilleas was a mistake. As we have seen, the letter and the spirit of the rule in Hadley v Baxendale can diverge and in such a situation, a case can be made for adhering to the spirit rather than the letter of the rule.