Case Study - Remedy of Damages
Case Study Key Information
Date: 2000.01.28
Court/Tribunal: Supreme court, Spain
Goods Involved: Sacks of jute
Citation: http://www.cisg.law.pace.edu
Key Article(s): Arts 75, 76, 77 CISG
Summary
The dispute between S, a Dutch seller, and B, a Spanish buyer, was concerned with the supply of sacks. S alleged that there was a contract between them. He had delivered the first consignment under the contract to B in January 1993. In the following seven months, B had not asked S to make any subsequent shipments of the sacks. In September 1993, B made an offer to S to purchase the remaining quantity in the alleged contract at a lower price. S did not accept the offer and resold the goods to a thirty party at a price much lower than the price in the alleged contract. The key issue here was whether S had violated his duty to mitigate loss under Art 77.
Facts
S alleged that B had entered a contract with him to purchase 800,000 sacks at a price of $0.559 per unit. Upon B’s urgent request the first consignment under the contract was delivered in January 1993. No more shipment was requested by B in the following seven months. In September 1993, while denying the existence of the contract, B faxed to S offering to buy 724,800 sacks, roughly the remaining quantity in the contract, at a price of $0.534 per unit. One month later, S refused to accept S’s offer and then resold the goods to a third party at a price of $0.3 per unit within a few days. S claimed damages from B basing on the difference between the original contract price and the resale price pursuant to Art 75. The trial court found for B, passing a judgment of non-existence of the contract.
Judgment
The Court concluded that there was a binding sales contract between S and B. The offer made by B represented an attempted renegotiation to modify the agreed price in the contract, which was rejected by S. Thus, B committed a breach of contract by failing to take over the remaining quantity at the agreed contract price. Though S was entitled to claim damages arising from B’s non-performance, S had not complied his obligation to mitigate loss pursuant to Art 77. The reasonings were: (i) the parties had maintained a smooth commercial relationship for five years without occurrence of any dispute, (ii) before rejecting B, S had asked B to open a L/C drawn from a prestigious Dutch bank to cover the purchase price; on the contrary, for the substitute sale, S only demanded payment of the purchase price after receipt of invoice, (iii) the cover sale was made at a much inferior price, and (iv) not taking B’s offer into serious consideration plus not conducting the substitute sale in a reasonable manner were sufficient to prove that S had not taken reasonable measures under the circumstances to reduce losses he had suffered. The Court held that the damages recoverable by S was calculated in accordance with the difference between the price of $0.559 per unit in the contract and the price of $0.534 per unit in the offer.
Comment/Discussion Points
1. Reasonable measure to mitigate loss under Art 77
After S refusing B’s offer to purchase the remaining 724,000 units at a lower price, it was apparent that the original contract between S and B had not been modified and B breached the contract by not taking over the remaining goods at the agreed contract price. Pursuant to Art 75, S was entitled to claim damages based on the difference between the contract price and the resale price. The amount of damages awarded by the Court to S was reduced on the ground that S had not taken a reasonable measure to mitigate losses under Art 77 by not accepting B’s offer. Question arises as to why and under what conditions an innocent party is required to accept an offer from the breaching party to perform the contract on different terms?
In CISG case law, there were different results in this type of situation reflecting the different approaches by courts to the interpretation of reasonable measures to mitigate loss under Art 77. Accepting the breaching party’s offer as a reasonable measure to mitigate loss must be treated as a very exceptional rule under Art 77. Arguably, the crucial point to justify this kind of acceptance is whether the innocent party knew in advance that the replacement transaction could cause it to suffer a larger loss, so that he could claim a larger amount of damages from the breaching party. In short, before conducting a substitute sale, if the innocent seller is able to estimate and compare losses resulting from accepting the breaching buyer’s offer and reselling to a third party, the reasonable measure of mitigation ought to have been the one that will result in the smaller amount of damages. An analogous case decided by the French appeal court on 2008.05.27 arrived at a similar result: The cover purchase price, apparently much higher than the increased price previously offered by the breaching seller, could not be used as the basis for calculation of damages under Art 75. The innocent buyer was entitled to recover only the difference between the contract price and the increased price previously offered by the breaching seller.
The rationale of this very exceptional rule actually is based on the principle of good faith, which requires the innocent party to take the interests of the other party into account. If the innocent party is in possession of some kind of advanced knowledge and then deliberately enters a substitute transaction to cause the breaching party liable for a larger amount of damages, its ill-faithed conduct must not pay off. Art 7(1)’s “observance of good faith in international trade” may require the innocent party to accept the breaching party’s offer as a reasonable measure to mitigate loss under Art 77.
2. How far the duty of mitigation under Art 77 may go
The innocent party is required to take only reasonable steps to mitigate its loss. What are the reasonable steps depends ultimately on the circumstances of a particular case. How far Art 77 may go should be determined upon the reasonableness of the efforts the innocent party is required to make, which is to be assessed under Art 8. Arguably, in the present case, advocating acceptance of B’s offer as a reasonable step for S to mitigate loss under Art 77 would be an extension of the mitigation duty having gone too far.
B had always denied the existence of the contract. After urging S to deliver the first shipment in January 1993, B had not asked S to make any subsequent shipments for the remaining quantity until September 1993. One must presume that B might have found himself falling into a market downturn situation, so that he would try to either break off from the bad bargain or at least to negotiate for a price deduction with S. When B offered to take the remaining quantity at a lower price, it was a commercially sensible reaction on the part of S to become alerted to the possibility of B’s inability or unwillingness to fully perform the obligations in the original contract. According to Art 71, S was entitled to ask B to provide adequate assurance for payment of the purchase price by opening a L/C with a prestigious Dutch bank. Absence of this L/C, S could continue to suspend his own delivery performance and, in theory, could later declare the contract avoided under Art 72. Payment term of the transactions between the parties in the past five years was “payment after receipt of the invoice”. This might be a business practice maintained by S with all his customers, so that it was not surprising at all that S set the same term with the buyer of the substitute sale. The above analysis might evidence that S had not acted in bad faith in refusing to accept B’s offer. Furthermore, accepting B’s offer should not be regarded as a reasonable measure in accordance with Art 8. The reasonable person in Art 8(2), being a competent businessperson applying commercial common sense to the facts of the present case, would consider that accepting B’s offer without obtaining any deserved compensation was a concessive act equivalent to giving a consent to the modification of the contract and surrendering the right to avoid the contract and to claim damages. No reasonable person would think S was reasonably expected to do so.
Where, before or after the breach, the breaching party makes an offer to modify the contract, it would be grossly unfair and contravene the principle of pacta sunt servanda (the maxim that promises should be kept) to force the innocent party to accept it as a reasonable step to mitigate loss and be bound to enter a new contract with the breaching party. The exceptional rule described above is solely based on the principle of good faith. The market price of the sacks might continue to be downward during the month following B’s offer. There was no evidence that S had advanced knowledge of the market price he could fetch from a potential buyer. S resold the goods within a few days after refusing B’s offer. Whether the resale was conducted in a reasonable manner depended on the market movement. If the market price continued to fall drastically, $0.3 per unit might not be an unreasonable resale price. In conclusion, if S’s conduct could not be proved as inconsistent with the requirements of the principle of good faith, the Court’s decision that S had violated the duty to mitigate loss under Art 77, arguably, had gone too far.
3. Striking a balance between the legitimate interests of both parties
Arguably, the Court could simply resolve this issue by application of Art 76. Under the CISG, where a substitute transaction has been carried out, the concrete calculation of damages under Art 75 takes prevalence. In the present case, the resale to a third party at a price of $0.3 per unit was found by the Court as an invalid substitute sale. Accordingly, an abstract calculation of damages under Art 76 should be permitted. Art 76 allows the innocent party to abstractly calculate its loss as the difference between the contract price and the current market price. Such a price would likely turn out to be higher than the resale price, but probably not as high as the price offered by B. The price of $0.534 per unit was apparently not the current market price in the sense of Art 76 because it could not be regarded as the price prevailing at the market. It was rather an individual price specially charged for the remaining goods under the contract due for taking-over solely by B.
Under Art 76, the law may only give S a ‘rough’ justice basing on the abstract calculation of damages to compensate his loss. Nonetheless, the law should not countenance B’s ill-faithed act basing on an extended duty of mitigation. The extended duty should be denied because it could result in B keeping to himself an opportunity to suffer less loss from market movement by breaching the contract he had with S. This approach, in particular, preserves an efficient outcome and maintains a balance between the parties’ interests by (i) on the one hand, protect B from avoiding to pay a larger damages and (ii) on the other hand, require S to act in his mitigation duty only to the extent that can reasonably be expected of him.