Aspect of Contract & Negligence in Business
Aspect of Contract & Negligence in Business
The aim of this brief article is to set out some key aspects of contract and the tort of negligence using the following headings: •The relationship between the parties
•The nature of the obligation
•Causation and remoteness of damage
•The measure of damages.
Using the same headings should remind you of the key aspects of each of the two areas in such a way that you are less likely to confuse them. (The words ‘contract’ and ‘negligence’ are deliberately repeated in each heading so that you get into the habit of distinguishing between the rules for each area, rather than having a general set of notes on, say, remoteness of damage, which confuses material from both areas.)
KEY ASPECTS OF THE LAW OF CONTRACT
Contract – the relationship between the parties
A contract is a legally binding agreement formed by the mutual consent of the parties. The parties may be known to each other, as with a client and an accountant, or they may be strangers, as with a software company and a person who downloads and installs the software. In either case, there is a clear relationship between the parties and this relationship is both formed and governed by the contract. (The rules governing the formation and content of contracts are set out in syllabus areas B1 and B2 of Paper F4 (ENG) syllabus.)
Contract – the nature of the obligation
In a contractual relationship, the nature of the obligation is determined by the terms of the contract. By entering into the contract, the parties agree to accept the resulting obligations. That is not to say that there is complete freedom of contract, since certain contractual terms may be restricted by statute – for example, under the Unfair Contract Terms Act 1977. Nevertheless, in order for a contract to be binding, the parties must intend to create legal relations and their contractual obligations are based
on mutual consent.
Contract – causation and remoteness of damage
This issue concerns the extent of the defendant’s liability for the chain of events set in motion by the breach of contract. The leading case is Hadley v Baxendale (1854) in which the defendant was contracted to transport a broken mill shaft from the claimant’s mill to the repairers. The defendant was late in delivering the shaft and the mill was idle for a longer period as a result. The claimant sought damages for loss of profits during the delay. The court found for the defendant, setting out a two-stage test for remoteness of damage. In order to be recoverable, the loss must be: •either a normal result of the breach, or
•one which, at the time of the contract, both parties would have contemplated as a probable result.
Here, given how important a drive shaft was to a mill, neither test was satisfied, since it was reasonable to expect that the mill would have a spare shaft. Another useful case here is Victoria Laundry v Newham Industries (1949). Here, the defendant’s delay caused the defendant loss of profit, including the loss of an unusually lucrative contract. The defendant was liable for normal loss of profit under the first limb of the Hadley test, but not for the loss from that particular contract. He would only have been liable for that had he known about it when the contract was formed.
Contract – the measure of damages
The remedies available for breach of contract include the common law remedies of damages, action for the price and quantum meruit, as well as the equitable remedies of injunction and specific performance.
Remember that a breach of contract is a breach of a legal obligation, so the aim of the remedies is to put the claimant in the position that they would have been had the defendant fulfilled the obligation. This means putting the claimant in the position that they would have been in had the contract been performed. In relation to damages, this may be divided into expectation loss (benefits that might have been gained from the performance of the contract) and reliance loss (expenses incurred by the claimant in his side of the contract).
The conduct of the claimant may also affect the amount of damages payable, since the claimant is under an obligation to take reasonable measures to mitigate the loss, as in Payzu v Saunders (1919). For example, if the buyer refuses to accept or pay for the goods, the seller must recover what they can by selling the goods to a third party. The damages will be the difference between the contract price and the amount that the seller receives. If the seller receives the contract price or higher from a third party, only nominal damages will be claimable. A claimant who does not attempt to mitigate their loss may have their damages reduced by the amount by which they could have done so. It is for the defendant to prove that the claimant failed to mitigate the loss.
We will now use the same headings in relation to the tort of negligence.
KEY ASPECTS OF THE TORT OF NEGLIGENCE
Negligence – the relationship between the parties
Negligence cases are based on a non-contractual relationship between the parties. The parties may be known to each other, as with a surgeon and a patient, or they may be strangers, as with two drivers involved in a road traffic accident. Due to the lack of any agreed relationship between the parties, the first question that arises in the case of negligence is that of whether any relationship exists between them at all. If one party is to be held liable to another in negligence, the relationship that must first be established is that of a duty of care.
Exam answers often state as a learned fact that liability in negligence is non-contractual, but it is worth spending a little longer thinking about what it actually means. As a future accountant, you may find it helpful to relate this point to professional negligence cases since these illustrate the extent to which an accountant may be held liable in relationships where there may be no contractual obligation.
A useful case in this respect is Caparo Industries plc v Dickman (1990). Here, the claimants were shareholders in a company and the defendants were the company’s auditors. The claimants relied on the audited accounts and purchased more shares with a view to making a takeover bid. Having taken over the company, the claimants discovered that the company had in fact made a £400,000 loss rather than the £1.2m profit shown by the financial statements. The House of Lords held that the requirements for a duty of care to exist were as follows: •the harm must be reasonably foreseeable
•there must be proximity between the claimant and the defendant •it must be just, fair and reasonable to impose a duty of care on the defendant.
Note that foreseeability at this stage in the context of negligence is used to establish whether there is any relationship between the parties; this is not necessary at this stage in contract since the contract itself establishes that there is a relationship. (We will consider foreseeability again in relation to remoteness of damage, which is discussed below.)
In Caparo, the contract was between the company and the auditors. The individual shareholders did not have a contract with the auditors. The question was whether the auditors owed a duty of care to the shareholders. The House of Lords held that the auditors owed a duty to the shareholders as a body, but that they did not owe a duty to potential investors or to existing shareholders who planned to increase their shareholding. The defendants were therefore not liable.
Caparo is one of a number of cases considering professional negligence. (This is covered by syllabus area B5 of Paper F4 (ENG).) A key theme running through these cases is the existence of the so-called ‘special relationship’. This was first established in Hedley Byrne & Co Ltd v Heller and Partners (1963). Bear in mind that the question of a special relationship is likely to be relevant where the claimant does not have a contractual relationship with the professional providing the advice.
In Hedley Byrne itself, the claimant provided services on credit to a client. It did so on the basis of a credit reference given by the defendant, the client’s bank. Note that there was a contract between the claimant and the client and a contract between the client and the bank, but no contract between the claimant and the bank. The defendant was able to avoid liability by relying on an exclusion clause contained in the credit reference. However, had the clause not been present, the defendant would have been liable because it had used its special skill to provide a statement to the claimant in the knowledge that the claimant would rely on this.
Other cases that you may find helpful to consider in this context are as follows: •JEB Fasteners Ltd v Marks, Bloom & Co (1982)
•Morgan Crucible v Hill Samuel Bank Ltd (1991)
•James McNaghten Paper Group Ltd v Hicks Anderson & Co (1991) •ADT v BDO Binder Hamlyn (1995)
•NRG v Bacon & Woodrow and Ernst & Young (1996)
In each case, identify any contractual relationships between the various parties involved and the nature of the relationship between the claimant and the defendant.
Negligence – the nature of the obligation
In relation to negligence, the nature of the obligation is not agreed between the parties but rather is imposed by operation of law. For example, a road user will owe a duty of care to other road users and a manufacturer will owe a duty of care to the final consumers of its products. Once a duty of care has been held to exist, the defendant’s actions are judged by the standard of the reasonable man in the defendant’s position:Blyth v Birmingham Water Works (1856). The standard of care for professionals is of the reasonable professional having or holding himself out as having the skill or ability in question. Learners and the inexperienced will also be judged against the standards of the fully-qualified.
Negligence – causation and remoteness of damage
In relation to negligence, issues of causation and remoteness tend to be considered separately. The key test for causation is known as the ‘but for’ test, which basically asks whether the loss would have been sustained ‘but for’ the defendant’s negligence. The leading case here is Barnett v Chelsea and Kensington HMC (1969). The claimant arrived at the hospital emergency department complaining of stomach pains. He was sent home without being examined and subsequently died. Even though the doctor owed the patient a duty of care and had breached the duty, the breach of duty had not caused the patient’s death, since the poisoning was so advanced by the time the patient arrived at the hospital that he could not have been saved even with prompt treatment. The defendant was therefore not liable.
The key test for remoteness in negligence is one of foreseeability. In The Wagon Mound (1961), the defendants negligently allowed oil to spill into Sydney Harbour. The claimants were welding, but ceased doing so on seeing the oil. Having been advised that the sparks would not ignite oil lying on the surface of the water, they resumed work. Sparks ignited debris lying on the surface of the oil, which in turn ignited and damaged the claimants’ wharf. It was held that the defendants were not liable since the only foreseeable damage was pollution rather than fire. By contrast, in Jolley v London Borough of Sutton (2000), a local authority failed to remove an abandoned boat for two years. A 14 year-old was seriously injured when he tried to jack up the boat in order to repair it. The authority was found liable since it knew that children regularly played on the boat, so it was foreseeable that a child would be injured. It did not matter that the precise nature of the injury could not be foreseen. The cases may appear to conflict, since The Wagon Mound focuses on foreseeability of the type of damage whereas Jolley v Sutton focuses on foreseeability of some harm. There are a number of cases in this area and they are not always easy to reconcile. For the purposes of Paper F4, the key point to remember is that the test for remoteness in the tort of negligence is based on foreseeability of harm. You should be prepared to illustrate this point with examples.
Note that the law of negligence considers foreseeability twice: once in relation to duty of care and again in relation to remoteness. Remember that, if there is no duty of care, the question of remoteness does not arise.
Caparo v Dickman is a useful illustration of this: it might be foreseeable that existing shareholders would rely on an audit report in deciding whether to increase their shareholding. Nevertheless, the auditor did not owe a duty of care to potential investors. This was based on other aspects of the duty test: proximity and the question of whether it was fair, just and reasonable to impose a duty.
Negligence – the measure of damages
As with contract, once liability in negligence has been established, the next point to consider is that of remedies and the aim of the remedies is to put the claimant in the position that he would have been in had the breach of obligations not taken place. For negligence, the aim is therefore to put the claimant in the position that they would have been had the tort not been committed.
Again, as with contract, the damages payable may also be reduced because of the claimant’s conduct. In negligence, this may be due to the partial defence of contributory negligence. This happens in cases where, even though the defendant was at fault, the claimant contributed to their own loss. Where this happens, the claimant’s damages are reduced by the percentage to which the claimant is held to be at fault. The leading case here is Sayers v Harlow UDC (1958) where the claimant was trapped in a public toilet due to a defective lock. She was injured when trying to climb out and it was held that she had contributed to her own injuries. It is for the defendant to prove that the claimant was contributorily negligent.
Contract and the tort of negligence arise in separate questions on Paper F4, so you will not be asked to compare and contrast them. The aim of this article is to identify some key similarities and differences so that you are less likely to confuse these two areas. Your aim for the exam should be to be able to explain these key aspects of contract and negligence without confusing them. You may find that the following table acts as a useful revision aid: Contractual LiabilityLiability in
between the partiesThe relationship is created and governed by the contract. The parties enter the relationship by mutual consent.The relationship is non-contractual and is imposed by law. The defendant must owe the claimant a duty of care. Nature of obligationThe parties must comply with the terms of the contract.The defendant must act according to the standard of care expected of the reasonable man or the reasonable professional. Causation and remotenessIf the loss is a normal result of the breach, the defendant will be liable; if the loss is not a normal result of the breach, the defendant will only be liable if they knew of the unusual circumstances.The defendant’s negligence must cause the claimant’s loss and the loss must have been a foreseeable consequence of the breach of duty. Measure of damagesThe aim is to compensate the claimant by putting them in the position that they would have been had the contract been performed.The aim is to compensate the claimant by putting them in the position that they would have been had the negligence not taken place. Possible reduction of damagesDamages may be reduced by the amount that could have been mitigated if the claimant fails to take reasonable action to mitigate the loss.Damages may be reduced by the relevant percentage if the claimant’s conduct contributed to the loss.