Service Contracts: New Forms of Liability

August 31, 2002

The issue described in this note is a simple one: if there is an obligation to do something, and that thing is not done, what damages can be claimed? The classic answer is to go to those well known cases starting with Hadley v Baxendale and look for the loss caused. Every contract lawyer knows that damages in contract claims are compensatory in nature – an account of profits may be an option in intellectual property cases, but not in contract cases. In the light of recent cases, this position is not correct.

The problem starts to get complex if the obligation in question is in fact a minor one. The contract for outsourcing might require a service provider to make monthly reports, for example: what happens if the service provider does not do so? What is the loss? The situation becomes more complex when there is an obligation to do something, and that thing is not done, and as a result the contract-breaker makes a profit. For example, a contract for outsourcing states that the service provider must maintain a staff of not less than 20 persons; in fact the service provider employs just 15, and for the duration of the contract manages to provide just as good a service as if 20 had been employed. Obviously, the service provider has saved some money, but where is the loss to the other party?

According to Hadley v Baxendale, there is none, but recent case-law suggests that the courts are developing remedies in this area – and the measure of loss in this case might be the saving that the service provider has made. This might be referred to as “restitutionary damages” or an “account of profits”.

This situation is not far-fetched. A good example of the situation from the USA is the case of City of New Orleans v Fireman’s Charitable Association[1] where the defendants undertook the contract for the provision of a fire-fighting service in New Orleans for a period of time. The contract (similar to a Service Level Agreement in an outsourcing contract) made a number of specific provisions as to the equipment and manpower the defendant had to maintain – so many feet of hosepipe, so many staff and so on. The plaintiff paid the sums due under the contract but it was only after the contract had expired that the plaintiff discovered that the defendant had not in fact complied with the specific provisions of the contract as to equipment and manpower. The result was that the defendant had made some $40,000 in additional profit. However, and this was a very important point, the service actually delivered by the defendant was otherwise faultless – fires were put out, and the plaintiff could not point to any incident where the defendant’s cost-cutting measures had actually caused any loss. In these circumstances, the Supreme Court of Louisiana held that the plaintiff’s claim failed in the absence of any evidence as to loss. Moreover, the plaintiff could not even recover any of the sums paid under the contract.

Older case-law

In this jurisdiction, there have now been a number of cases concerning this area of the law. This note will mention them and show how the law has developed quite considerably, and certainly has moved a long way from the simple proposition that an account of profits is not possible for contract claims. English Law, confronted with the situation in New Orleans, might well now come to quite different conclusion.

In Wrotham Park Estate Co Ltd v Parkside Homes Ltd[2], the defendant owned a plot of land with a restrictive covenant preventing development of the land except with the approval of the plaintiff. In fact, the defendant built 14 houses on the land without seeking that approval. The plaintiffs applied for an injunction requiring the demolition of the houses, which was refused (on the basis that valuable housing should not be wasted). However, damages were awarded. The starting point for the judge was that, absent an injunction, awarding nominal damages or no damages would mean that “justice will manifestly not have been done”. It was therefore held that the amount of the damages would therefore be “such a sum of money as might reasonably have been demanded by the plaintiffs from [the defendant] as a quid pro quo for relaxing the covenant”. The judge rejected the plaintiff’s claim for a share of the development value of the land, and instead awarded damages at the rate of just 5% of the anticipated profit that the defendant expected to make (£50,000) i.e. the plaintiff recovered just £2,500.

Surrey County Council v Bredero Homes Ltd[3] was another case to look at this area. The plaintiffs sold two adjoining plots of land to the defendant for the development of a housing estate. The agreement contained a covenant by the defendant that it would only build in accordance with the plaintiff’s scheme. However, the defendant built 77 houses on the land, whereas the scheme provided for a maximum of 72. Naturally, the additional houses meant that the defendant made more profits from the land.

The Court of Appeal sought to distinguish Wrotham, on the basis that it had been decided under Chancery Amendment Act 1858[4]. The plaintiff argued that a different measure should be adopted in cases where the breach had been deliberate, or that no person should profit from their own wrong. This was rejected by the Court of Appeal. Dillon LJ said

“Given that the established basis of an award of damages in contract is compensation for the plaintiff’s loss, as indicated above, I have difficulty in seeing how [the plaintiff’s] suggested common law principle of awarding the plaintiff who has suffered no loss the gain which the defendant has made by the breach of contract is intended to go. Is it to apply, for instance, to shipping contracts or contracts of employment or contracts for building works?”

Dillon LJ might now be surprised at how far the law is going, as we shall see in a moment. Steyn LJ in the same case gave an admirably clear summary of the principles of damages in contract cases as he saw it then

“The starting principle is that the aggrieved party ought to be compensated for loss of his positive or expectation interests. In other words, the object is to put the aggrieved party in the same financial position as if the contract had been fully performed. But the law also protects the negative interest of the aggrieved party. If the aggrieved party is unable to establish the value of a loss of bargain he may seek compensation in respect of his reliance losses. The object of such an award is to compensate the aggrieved party for expenses incurred and losses suffered in reliance on the contract. These two complementary principles share one feature. Both are pure compensatory principles. If the aggrieved party has suffered no loss he is not entitled to be compensated by invoking these principles. The application of these principles to the present case would result in an award of nominal damages only.”

Steyn LJ accepted that restitutionary damages were possible where the object was not to compensate the plaintiff for a loss, but to deprive the defendant of the benefit he gained by the breach of contract. An example of this was to be found in a claim for the return of goods sold and delivered where the buyer had repudiated his obligation to pay the purchase price. Wrotham, according to Steyn LJ, was justified as a case concerning unlawful use of a person’s property (interpreting “property” in a wide sense). However, this should not be seen as extending the availability of restitutionary remedies for breaches of contract. Steyn LJ looked at the policy principles at stake, and gave four reasons why restitutionary principles should not play a wider role in breach of contract cases:

1. the defendant’s motive is irrelevant in breach of contract cases, and courts should not be concerned to investigate whether the defendant’s breach was deliberate or cynical

2. restitutionary remedies in breach of contract cases would lead to greater uncertainty in the assessment of damages, which would not be desirable in commercial cases

3. if the plaintiff has suffered no loss, there was no justification in providing a “windfall” claim in the form of restitutionary damages

4. in typical commercial cases, liability was covered by insurance, and there was no reason to increase exposure and thereby force an increase in premiums.

So, after Surrey, a distinction could be made between Wrotham, where there was a proprietary interest at stake (a restrictive covenant registered as a land charge) and Surrey, where there was simple contract with no proprietary interest involved at all. It might be felt that this distinction was a slender one, and after the Court of Appeal’s decision in Jaggard v Sawyer[5], it was not clear that even this distinction could be made, with some members of that Court holding that Wrotham was based on compensatory principles. Be that all as it may, other cases seemed to support the line taken in the Court of Appeal in Surrey, that there could be no restitutionary damages for a simple breach of contract[6]

Recent cases

This situation is now very different. Attorney-General v Blake[7] was undoubtedly a hard case on the facts, and one has some sympathy with the judges seeking to find a remedy where perhaps strictly at law there was none. The defendant had been employed by the Crown and his contract required that he should not make public the secret information he had learned in the course of his employment. In fact, Blake was a double agent, and after escaping from prison fled to the then USSR where he continued to live. He entered into a contract with a UK publisher to publish his memoirs and for this received substantial advances and was promised further substantial sums. In these memoirs, he proposed to publish much official Government information, although none of it could be confidential after the lapse of time involved. The question was whether the Government could claim those unpaid sums by way of damages.

The Court of Appeal and the House of Lords both held that this claim could succeed, even though there was no loss in the conventional, contractual, sense. The key part of the judgment of the House of Lords is to be found in the following passage from the judgment of Lord Nicholls

“An account of profits will be appropriate only in exceptional circumstances. Normally the remedies of damages, specific performance and injunction, coupled with the characterisation of some contractual obligations as fiduciary, will provide an adequate response to a breach of contract. It will be only in exceptional cases, where those remedies are inadequate, that any question of accounting for profits will arise. No fixed rules can be prescribed. The court will have regard to all the circumstances, including the subject matter of the contract, the purpose of the contractual provision which has been breached, the circumstances in which the breach occurred, the consequences of the breach and the circumstances in which relief is being sought. A useful general guide, although not exhaustive, is whether the plaintiff had a legitimate interest in preventing the defendant’s profit-making activity and, hence, in depriving him of his profit.”

It will be noticed at once how open-ended these words are: while both the Court of Appeal and the House of Lords were keen to stress the exceptional nature of the remedy, there is no precise statement of exactly when a claimant will be entitled to an account of profits as a result of a breach of contract. It can be seen, however, that the policy guidelines set out by Steyn LJ in Surrey are not the principles now applied by the courts. The modern law has come a long way in a very short space of time. There have been recent cases dealing with “skimped performance”, where the courts have struggled to bring traditional contractual principle into line with the demands of “justice”. The well-known case of Ruxley Electronics and Construction Ltd v Forsyth[8] was one such. Another less well known case is White Arrow Express Ltd v Lamey’s Distribution Ltd[9] where the plaintiff contracted for a deluxe delivery service and paid a premium for this over and above the charge for the basic service. It did not receive this deluxe service. It was held in this case that the plaintiff would receive nominal damages, unless it could produce evidence of the difference between the market value of what it contracted to receive and the market value of what was actually provided. It was not possible simply to reclaim the difference between the charges for the basic and the deluxe services. This approach is entirely in line with the established law for calculating damages.

The more recent case of Esso Petroleum Company Limited v Niad Limited[10] shows the potential for the application of Blake. Esso ran a number of service stations but was becoming concerned about the impact of petrol stations run by the large supermarket chains. It set up a scheme called “Pricewatch” whereby its service stations would respond to price information provided by Esso to try to ensure that its prices were consistently lower than those of rival stations, in particular those owned by supermarkets. Although the defendant signed up to this scheme, it did not follow it, with the result that it made profits that it would not have made if it had followed the terms of the Pricewatch scheme.

Morritt VC held, applying Blake, that the appropriate remedy was an account of profits. Damages were an inadequate remedy, since calculating the impact of the defendant’s breaches was impossible. Esso had a direct interest in enforcing the scheme as it was advertising the benefits of the scheme and if even one station did not follow the scheme, this would give the lie to the advertising campaign being run by Esso. Esso had tried to enforce the scheme and had complained to the defendant on four occasions to step into line, which it appeared to do. Finally, Esso had an interest in maintaining the scheme and thus stopping the defendant profiting from its breach.


The Esso case shows the complete reversal of judicial opinions since Surrey. Even an ordinary breach of contract will now give rise to the possibility of a claim for restitutionary damages. The uncertainty in commercial matters of which Steyn LJ warned in Surrey is now the reality, and the absence of exact guidance in Blake means that future cases will have to determine the ambits of such claims.

Going back to the situation of outsourcing contracts, the situation illustrated by the New Orleans case (and perhaps the White Arrow case) gives rise to a legitimate concern that breach by a service provider of detailed obligations in a Service Level Agreement could give rise to a claim that the service provider should disgorge its profits made by acting in breach of the terms of the agreement. It is not difficult to envisage situations where this could occur – very much along the lines of the New Orleans case.

This then leads to a consideration of the normal provisions regarding liability in such agreements. The (almost) standard provisions looking at “loss of profits” and “failure to make anticipated savings” are not appropriate to cover this sort of situation. If limits of liability refer to any claim “in contract or in tort”, does this cover a claim in restitution, or a claim for restitutionary damages in a contractual claim? If the claim is described as an account of profits, would this be covered by the common phrase “loss or damage”?

At present there is no answer to these questions, but it is as well to be aware of the issues, and some changes to standard drafting may be necessary.


Ever since Wrotham (and even before that) the academic literature on the subject is vast – probably more extensive than the cases on the subject. Perhaps I may be forgiven for – very briefly – touching on the more conceptual nature of this new remedy.

The line of reasoning adopted in the recent cases applying a restitutionary remedy for breach of contract is that such a remedy is the only effective one that the claimant has – as if justice demanded that the claimant receive at least something more than nominal damages for the going to the trouble of bringing the claim. Not all academics support this view by any means. Richard Posner has long advocated a view of law that saw it in its economic context. So in “Economic Analysis of Law”[11] he wrote

“But in some cases a party would be tempted to breach the contract simply because his profit from breach would exceed his expected profit from completion of the contract. If his profit from breach would also exceed the expected profit to the other party from completion of the contract, and if damages are limited to loss of expected profit, there will be an incentive to commit a breach. There should be. The opportunity cost of completion to the breaching party is the profit that he would make from a breach, and if it is greater than his profit from completion, then completion will involve a loss to him. If that loss is greater than the gain to the other party from completion, breach would be value-maximising and should be encouraged. And because the victim of the breach is made whole for his loss, he is indifferent; hence encouraging breaches in these circumstances will not deter people from entering into contracts in the future.”

Posner’s basic premise is that the common law is (and should be) concerned with wealth maximisation and that the basic outlines of the common law deriving from the nineteenth century laissez-faire economic approach are sound. While judges of that era did not explicitly use economic doctrines to justify their decisions, nonetheless what they achieved can be explained by reference to economic theory. As can be seen from the extract above, the natural consequence of this is that the law should tolerate deliberate breaches of contract where they have a tendency to create “wealth maximisation”. Someone from the “law and economics” school would analyse the situation in Blake and conclude that the non-disclosure provision in the contract, causing no loss as it did, was valueless and one which the law should not therefore uphold.

Even if we leave to one side the detailed cases for and against the views expressed by Posner and others, some might find it surprising that anyone would even contend that breaching a promise without providing a remedy for the promisee is something that any legal system should contemplate, let alone encourage. It leaves to one side any question of the impact of morals in the law, and reduces the law to a straight exercise in “wealth maximisation”. Indeed, Posner starts to stray into moral areas when he applies his theory to construct laws – coming up with the theory that there should be a market in babies for adoption as this would lead to stable prices for babies which would in the end benefit poorer adopters. This may be an excellent application of Posner’s theory as far as it goes, but the current moral arguments over cloning and surrogate babies show that his theory is not an all-embracing description of the law which everyone would accept.

It might seem surprising that a promisee in the situation of Blake should receive a windfall, when it has suffered no loss[12]. The conceptual arguments surrounding the law and economics theory as expounded by Posner and others show no sign of abating – they receive great attention in the USA especially in areas like antitrust law – but it should not be assumed that the traditional law as stated by Steyn LJ in Surrey is without rational foundation and justification. However, the decisions in Blake and Esso should also be seen against the background of the common law, and thus should be seen as a major change to established principles.

Richard Stephens is a Partner at Masons and an SCL Trustee.

[1] 9 so. 486 (1891)

[2] [1974] 1 WLR 798

[3] [1993] 1 WLR 1361

[4] This statute is normally referred to as Lord Cairns’s Act and allowed the award of damages in lieu of an injunction – part of the process of fusing common law and Equity in the nineteenth century.

[5] [1995] 1 WLR 269

[6] See e.g. Tito V Waddell (No 2) [1977] Ch 106

[7] [2001] 1 AC 268

[8] [1996] AC 344. The case concerned the construction of a swimming pool, which was perfectly safe in all respects, except that it had not been built to the depth stipulated in the contract. The plaintiff was held not entitled to a remedy of the total costs of reconstruction, but rather damages for “loss of amenity” of £2,500.

[9]21 July 1995

[10]22 November 2001, judgment of Morritt VC

[11] 2nd Edition, 1977, 89-90

[12] The curious case of Reading v Attorney-General [1951] AC 507 illustrates this neatly: Reading was an army sergeant who served in Egypt and who received £20,000 in bribes for sitting in lorries wearing his uniform. This meant that the lorries, which contained illegal alcohol, were not searched. The House of Lords thought that the fiduciary nature of the relationship between master and servant meant that he should be made to pay over his “earnings”. Still, the plaintiff there got a windfall.