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Reproduced with permission of 104 Law Quarterly Review (1988) 383-388

Restitution of Profits Gained by Party in Breach of Contract

Daniel Friedmann

(1) Profits gained through breach of contract
(2) The problem of alternative remedies
(3) The effect of recission upon restitution
(4) Non-specific goods

The Supreme Court of Israel has recently rendered a decision of major importance on the issue of restitution of profits gained by a [page 383] party in breach of a contract. The question arose in further hearing 20/82 Adras Ltd. v. Harlow & Jones GmbH (to be published in (1988) 42(1) P.D.) in which the defendant, a German corporation, contracted in 1973 to sell to the plaintiff, an Israeli corporation, 7,000 tons iron c.i.f. Haifa at a price of 570 German marks per ton. Because of the October (Yom Kippur) war there was delay in delivery. But some 5,025 tons were shipped to the plaintiff between January and April 1974.

On April 8, 1974 the seller (the defendant) notified the purchaser (the plaintiff) that because of high storage costs, it had to sell the remaining quantity of iron. Three days later the purchaser replied demanding the remaining 1,925 tons of iron. The defendant did not comply and it was not disputed that about this quantity of iron was sold by the defendant in Hamburg, to third parties, for 804.70 German marks per ton f.o.b. In 1976 the plaintiff sued for damages claiming in the alternative restitution of the defendant's gains.

In its first decision, the Supreme Court dismissed the claim (C.A. 815/80 Harlow & Jones v. Adras Ltd. (1983) 37(1) P.D. 225). The decision was based upon the Hague Convention on the Uniform Law for the International Sale of Goods, 1964 (hereinafter the Uniform Sales Law), which was ratified by Israel and adopted by legislation (the more recent Uniform Sales Law (Vienna Conference, 1980) has not been incorporated into Israeli law). The purchaser failed to prove that it had suffered a loss as a result of the breach. An attempt to utilize Article 84 of the Uniform Sale Law was of no avail. Under this article if a contract is avoided, the party claiming damages may recover the difference between the contract price and the market price at the time of avoidance. However, the plaintiff's statement of claim did not state that the contract had been avoided. The filing of the claim in 1976 was not regarded as avoidance of the contract for the purpose of the Uniform Sales Law and in any event, on this date the price of iron returned to its former level, so that no recovery could be had on this ground.

The claim in restitution to recover the profits made by the defendant by selling the iron to third parties was also dismissed on the ground that the "law of unjust enrichment has always applied only where there is no contract between the parties." The latter point became the subject of a further hearing in which the court, by a majority, reversed its original decision and held these profits to be recoverable.

The issues addressed by the court included: (1) the right to recover profits gained through breach of contract; (2) the problem of alternative remedies; (3) the effect of rescission of the contract [page 384] upon the right of restitution; (4) restitution of gains where the contract related to non-specific goods.

(1) Profits gained through breach of contract

The majority (Levin, Barak and Bach JJ.) held that restitution was available and that the plaintiff was entitled to recover the profits which the defendant had gained by selling to third parties that which was promised to the plaintiff. Levin and Barak JJ. in detailed and thorough opinions discussed the views expressed in Anglo-American and Israeli legal literature on the subject. They preferred the approach supported by Professors J. Dawson (1959) 20 Ohio L.J. 175, G. Jones (1983) 99 L.Q.R. 443, G. Palmer, The Law of Restitution (1978) vol 2, pp. 439-441 and myself (1980) 80 Col. L.R. 504, to a more restrictive view. Levin J. was sympathetic to the view that the concept of "property" can be broadened to encompass contractual rights and other legally protected interests. He added, however, that it was not essential to follow this since there is no need to confine restitution to the infringement of strict property rights. The general principle against unjust enrichment is broad enough to enable restitution of gains made at the expense of another, even if no property right in the strict sense is involved. Barak J. adopted a similar approach. He pointed out that in Anglo-American law restitution of profits is granted to the purchaser of land, if the vendor, in breach of the contract, sells it to a third party. Such recovery is predicated on the purchaser's equitable ownership (Lake v. Bayliss [1974] 1 W.L.R. 1073). But in his view it should suffice for recovery that the purchaser's contractual right has been infringed.

Both Levin and Barak JJ. pointed out that under Israeli law specific performance is the primary remedy to which a contracting party is prima facie entitled. There is no reason to treat a breach lightly. Restitution of gains may thus serve an additional function of deterrence. They also rejected the idea of "efficient breach," under which a breach should be allowed or even encouraged, if the benefit to the party in breach exceeds the loss to the other party (Posner, Economic Analysis of Law (2nd ed., 1977), pp.89-90).

(2) The problem of alternative remedies

Both Levin and Barak JJ. regarded the problem as analogous to that decided by the House of Lords in United Australia Ltd. v. Barclays Bank Ltd. [1941] A.C. 1 in the context of torts and restitution. Levin J. referred to the distinction developed in that case between inconsistent rights and alternative remedies and proposed the adoption of a similar rule regarding the relationship [page 385] between the cause in action in contract and that in restitution. Under his approach the existence of a cause of action in contract does not preclude a claim in restitution. The claims are alternative. The only relevant question is whether the plaintiff has acted in a way that precludes recovery in restitution or whether there are other circumstances that ought to lead to the denial of restitution.

Barak J. went in some respects even further. He suggested that if a certain interest is protected under more than one branch of the law (e.g. contract and tort or contract, tort and restitution) there is no reason to deny their simultaneous application, subject to two qualifications: (1) that the plaintiff will not be unjustly enriched by the multiplicity of remedies; (2) that the granting of one remedy is not in conflict with the substantive law upon which the other remedy is predicated (this apparently is the rule against reliance upon inconsistent rights). Thus, in the case of breach the plaintiff cannot both recover in restitution that which he paid under the contract as well as damages in contract reflecting the value of that which was promised to him. The result of such a cumulative recovery would be that he himself was unjustly enriched. On the other hand, there are situations in which a combination of remedies will not lead to such unjust enrichment nor will they be in conflict with each other. A good illustration is offered by G. Bach J., under which the defendant undertakes to transfer a house on a certain date, but in breach of the contract rents it to a third party. There is no reason why the purchaser should not be granted both specific performance as well as restitution of gains, i.e. the rent collected by the party in breach from the date on which he had undertaken to transfer the property until he actually did so. But obviously such gains cannot be recovered in addition to damages for the loss suffered by the delay in the transfer of the property.

(3) The effect of recession upon restitution

One of the dissenting justices, Ben Porath J., was willing to recognise in principle the right to recover gains which the party in breach derived from selling to a third party the property which he promised the plaintiff, but only if the contract had not been rescinded. In such a case the plaintiff is entitled to have the contract performed, and if the party in breach transfers the promised property to a third party, the plaintiff can, through tracing, claim the proceeds of the sale. The claim for the gains is, thus, but a corollary of the right to specific performance. If, however, the plaintiff rescinds the contract, his right to specific performance is lost and so is his claim to the proceeds of the sale made by the party in breach. As mentioned, in its original decision [page 386] the Supreme Court held that the contract had not been avoided. For this reason Barak J. considered that the whole question did not arise. However, Ben Porath J. concluded that the holding in the original decision was only for the purpose of the Uniform Sales Law, which requires actual notice within reasonable time. For all other purposes the contract was to be treated as rescinded.

Two of the majority (Levin and Bach JJ.) expressly stated that in the present case the plaintiff could recover even if the contract had been rescinded. It is submitted that this approach is correct. Instances are conceivable in which rescission will involve the choice of a legal right that is inconsistent with the recovery of gains made by the party in breach. In these instances such recovery will be denied. But where no such choice has been exercised, there is no reason to deny restitution merely because the contract has been rescinded. Let me offer the following example. A undertakes to manufacture a specific machine and to sell it to B on 1.1.1987 for $10,000. Time is of the essence. A is unable to complete on time and offers to deliver the machine a month later. B refuses to accept it after such a delay and rescinds the contract. A sells the machine to a third party for $15,000. B may be entitled to damages and to restitution of that which he paid under the contract, but he is not entitled to claim A's profits from the sale of the machine to the third party. Such a claim is inconsistent with his refusal to accept it. By his refusal B relinquished his right to the machine and A was free to sell it. In this example restitution of gains is inconsistent with the rescission of the contract. The position is, however, different if A sold the machine before he offered it to B and if B rescinded the contract only after he learnt that the machine was sold to a third party (C). In this situation the rescission has a more limited meaning. It may deprive B of the right to specific performance against C. (This possibility might have been open to B, if C was aware of the contract between A and B). But there is nothing in his conduct that is inconsistent with a claim for recovering the gains which the other party obtained by selling the machine to C in breach of the contract and prior to its rescission.

(4) Non-specific goods

In her dissent Ben Porath J. considered that there was no room for restitution of gains in case of breach of a contract for the sale of non-specific property. In the present case it was open to the defendant, after receiving the plaintiffs demand for performance, to obtain iron from any source and to ship it to the plaintiff. Similarly, if a merchant who has a large stock of similar goods [page 387] breaches a contract with the plaintiff, and sells to various other customers, it is impossible to say which sale is related to the goods to which the plaintiff was entitled, when in reality he had no right to any specific goods.

The majority considered, however, that the general principle of unjust enrichment, which calls for restitution of profits obtained through breach of contract, applies irrespective of whether the contract was for the sale of specific or non-specific goods. Obviously there must be a causal connection between the breach of contract and the defendant's gain. In the present case it was clear that such a connection existed. It was evident that the iron stored in Hamburg was destined to the plaintiff, and it was sold to third parties because of the opportunity of gain.

The majority approach is preferable. It is necessary to "identify" that which was sold to the third party as that to which the plaintiff was entitled. But such "identification" may be possible in the case of non-specific goods or even fungibles. A related question arises where a debtor, instead of paying his creditor, hands the amount due to a third party. It has been held, in various contexts, that the creditor is entitled to recover from the third party the amount paid by the debtor. Possible examples include collection by a third party of rent due from tenants on the plaintiff's land and the receipt of remuneration for an office to which the plaintiff was entitled (see Hedley, (1984) 100 L.Q.R. 653, 663-664). The money paid, although fungible, can be "identified" as that which was due to the plaintiff. There is no reason to adopt a different approach in the present case in which the claim is against the promisor (the debtor) himself, who instead of transferring to the plaintiff that which he owed him, chose to sell it to a third party. [page 388]

Pace Law School Institute of International Commercial Law - Last updated June 26, 2006
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