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Saggi, Conferenze e Seminari 39. Reproduced with permission of Centro di studi e ricerche di diritto comparator e straniero, diretto da M.J. Bonell

How Modern is English Contract Law?

Michael P. Furmston
Roma (July 2000)

Professor Bonell has suggested that I should talk this afternoon about the extent to which a case law system of the kind which operates in the common law countries is capable of evolution and development. Undoubtedly, there is an apparent paradox in the development of law through cases, if each case has to evolve out of previous cases, in seeing how later cases can diverge radically from earlier ones. This doctrine can be encapsulated in the well known but misleading aphorism that the doctrine of precedent means that nothing can ever be done for the first time. In my experience, however, this is a principle more beloved of non lawyers than of lawyers. Anyone who has worked for a long time in a large organisation like a university will recognise the attraction of this approach to administrators.

I think all common lawyers will recognise that the aphorism is untrue for at least two reasons. One is that, even if we view the law as a completely static set of rules, the cases do not provide answers to all the problems which are recognised to exist. One of the features in the case law system is that it is in a sense at the mercy of litigants. So it is [page 1] easy to identify problems which have never arisen in a decided and reported case and to which it is in a sense impossible to say with complete confidence what the correct answer is. Of course, this will often not prevent the writers of books expressing confident opinions as to what the correct answer is. In English law, and indeed I think in all common law systems though not in exactly the same way, there is a similar problem even when there are cases because in English law, decisions of the High Court, although often reported, are not in themselves binding and decisions of the Court of Appeal, though binding on the Court of Appeal and on the High Court, are not of course binding on the House of Lords. So, if you read an English text book on a common law subject where there is no statutory material, you will find the cases cited in the footnotes to support many of the propositions are decisions of the High Court and/or the Court of Appeal. There are surprisingly few propositions which depend on clear and unchallenged decisions of the House of Lords. Curiously, this causes surprisingly little practical difficulty because, for reasons which are not easy to explain clearly, professional opinion at any given moment is content to accept that the vast majority of the Court [page 2] of Appeal and High Court decisions on which the system rests are correct and effectively indisputable.

It is possible, however, for propositions which have for generations appeared acceptable and uncontroverted suddenly to be overturned. So, for instance, English law has for two hundred years had a rule under which payment made under a mistake of fact could usually be recovered by the mistaken payer. However, payments made under a mistake of law were excluded from this rule and were irrecoverable. This distinction between statements of fact and statements of law appears to have been readily accepted in the 19th century but it has certainly been regarded as a somewhat arid and unhelpful distinction for the last 50 years. Most commentators criticised the rule, argued that it was ripe for statutory reform but assumed that it was the law. Then one day, recently, the House of Lords decided that it was not the law.

The decision of the House of Lords in Kleinwort Benson v Lincoln City Council [1998] 4 All ER 513 is in this respect extremely interesting and instructive. This is one of a whole series of cases in [page 3] which local authorities had borrowed money from merchant banks under what were described as swap transactions. Mostly these were transactions involving variable interest rates (though I believe some also involved foreign currency fluctuations). Usually there would be two related transactions in one of which money would be lent at a fixed interest rate and the other would be a transaction in the opposite direction where interest rates were to fluctuate according to market trends. There could be perfectly legitimate commercial reasons for a transaction of this kind so as to lay off the risk of adverse interest rate movement but most of these transactions seem to have been a way of borrowing money on attractive terms.

A very large number of transactions had been entered into when the House of Lords in Hazell v Hammersmith and Fulham London B C [1991] 1 All ER 545 decided that local authorities did not have power to enter into transactions of this kind and that the contracts were accordingly all void. This decision meant that the contract could not be enforced. However, there was then a further round of litigation in which the party which was out of pocket, usually of course the bank which had lent the money, sought to recover it not on the basis of the contract but on the basis of the [page 4] law of restitution. In general terms, it is easy to see that if the transaction was brought to an end half way through, the local authority would be left with a lot of the bank's money which it ought not to be entitled to keep. However, there was a second group of transactions which had been carried through to completion before it was discovered that there was anything legally wrong with the transaction. In the case where the transaction is realised to be invalid while partly performed, it is obvious that one party has been enriched. In the case where the whole transaction has been performed before anybody realises that anything is wrong, this is less obvious since, if the contract were valid, the parties would have got exactly what they contracted for. However, if the contract is and always has been invalid, it will be the case that one of the parties will be a net gainer and one a net loser though which will depend on the way in which interest rates have varied during the running of the transaction. In the Kleinwort Benson case, the House of Lords had to consider what the legal effect of such a transaction was. The starting point in the argument was that the payments were made by the parties in this case under a mistake and that therefore there was a net balance one way or the other which proceeded from the mistake. The apparent [page 5] difficulty with this argument was that the mistake was, to all appearances, one of law since it was as to the validity of the underlying contract which had wrongly been assumed to be within the power of the local authority. The House of Lords held that the distinction between mistake of fact and mistake of law was unhelpful and should be discarded. All of the five Lords of Appeal who heard the case agreed that the distinction between mistake of fact and mistake of law should go. However, there was a very interesting and important difference of view as to the impact of that on the particular case. A minority took the view, with which I have much sympathy, that at the time when the contract was made and the payments carried out, everyone thought that the transaction was legally valid. The minority took the view that, at the time the payments were made, all lawyers thought the local authority had power to enter into such a transaction. It was not a case that some people thought one thing and some people thought another. The majority took the opposite view. They applied the undoubted general rule that judicial changes in the law, unlike legislative changes are (at least usually) in their nature retrospective. What they do is to state what the law was, not only at [page 6] the time of the decision, but at the time when the facts being considered took place.

This discussion, to remind you, is all within the context of what I call a static system. By a static system, I mean a system which is taking no account of social and economic changes in the society in which the system is based. The arguments for and against the distinction between mistakes of fact and mistakes of law has relatively little to do with the society in which the judge is living. The arguments would have been comprehensible to Ulpian as to Lord Goff. English law took a wrong turning and then 200 years later it recognised it had done so and reversed it.

But, of course, we do not live in a static society. Pressure for change comes from the ways in which society is evolving. It is easy to see that rules have been changed as a result of the invention of the railway or the motor car and equally easy to predict that rules will be changed as a result of the development in e-commerce. Of course, predicting exactly what changes is a different matter. [page 7]

How does the common law system develop in response to social and economic change? If one looks at the areas of law, contract and commercial law, in which I am personally most interested, it is clear that some of the changes at least are of a glacial kind. One cannot see the glacier move from one day to the next but, nevertheless, at least in Rome, one can say with Galileo eppur si muove. Sometimes, however, the appropriate metaphor would be less a glacier moving slowly down the slope of the Alps and more the behaviour of pack ice in Antarctica which may produce free floating blocks the size of Sicily.

Let me give first two examples of dramatic changes in the law of remedies which have been invented more or less overnight by English judges in the last 25 years. One is the Mareva Injunction, invented in Mareva Compania Naviera SA v International Bulk Carriers [1975] 2 Lloyd's Rep 509. This was designed to make it significantly more difficult for debtors to put their assets outside the grasp of their creditors. In the 19th century, courts had regularly refused to help creditors by imposing restrictions on debtors where the creditor had no legal or equitable interest in the relevant property. Mareva [page 8] Injunctions are now regularly used to prevent the defendant either from removing assets from jurisdiction (nowadays, of course, much easier to do with the possibilities of electronic transfer) or from handling the assets within the jurisdiction in a way which would frustrate the plaintiff's attempts to enforce his rights. The jurisdiction has been developed so that it is normal for the plaintiff to apply to the court ex parte (that is without notice to the defendant). The obvious practical importance of this is clear. If the defendant knew that the plaintiff was going to make such an application, he would obviously, if he were so minded, move the assets before the court had time to make the order. Of course, this possibility is capable of causing serious hardship to the defendant and appropriate safeguards have therefore been developed.

A similarly dramatic remedial development is to be found in the Anton Pillar Order recognised in Anton Pillar K.G. v Manufacturing Processes Ltd [1976] Ch 55. The development of this Order was in a sense a development of the rather dramatic possibilities provided by the Anglo American system of discovery under which parties are in principle required to reveal to the other party material in their [page 9] possession which is relevant to the case. It was perceived that, in some cases, defendants might choose to dispose of such material rather than to reveal it.

In Anton Pillar itself, the plaintiffs were foreign manufacturers who owned the copyright in the design of a high frequency converter used to supply computers. They learnt that the defendants, who were their English agents, were planning to supply rival manufactures with information belonging to the plaintiffs which would enable their rivals to produce a similar product. The plaintiffs wished to restrain the defendants from infringing the copyright, using confidential information or making copies of their machines but they were afraid that the defendants, if notified, would take steps to destroy the documents or would send them out of the jurisdiction so that there would be none in existence by the time that the action reached the stage of discovery. The plaintiffs accordingly made an ex parte application for an Order requiring the defendants to permit the plaintiffs to enter the defendant's premises in order to inspect, remove or make copies of documents belonging to the plaintiffs. [page 10]

Let me turn finally to two important decisions of the House of Lords in relation to damages for breach of contract. The first, Ruxley Electronics v Forsyth [1995] 3 All ER 268, concerned damages for breach of a building contract. In this case, the plaintiff contractors had agreed to build a swimming pool for the defendant. (By a separate contract, an allied company had agreed to build a structure in which the swimming pool was housed. No questions about this contract arose before the House of Lords.) It was a term of the swimming pool contract that the swimming pool should be 7 ft 6 in deep at the deep end so that Mr Forsyth could safely dive into the pool. In fact the pool, as built, was only 6 ft 9 in deep and at the natural diving point not more than 6 ft. However, the trial judge held that the pool was perfectly safe for diving; that the shortfall in depth made no difference to the value of the pool; that it would cost some 21,000 to cure the defect since all that could be done was to break out the bottom of the pool and dig deeper. He further held that it was extremely unlikely that Mr Forsyth would spend such damages on rebuilding the pool and that it would not have been reasonable of him to do so. On these findings, he held that the appropriate measure of damages was the difference in value between the pool as it was and the pool as it should [page 11] have been if the contract was properly performed but made an award of 2,500 to Mr Forsyth for loss of amenity. (The effect of this finding was a judgement for the plaintiffs because there was substantially more than 2,500 outstanding on the price of the pool.)

The Court of Appeal, by a majority, reversed the trial judge and awarded Mr Forsyth the full cost of cure. The House of Lords unanimously reversed the Court of Appeal and upheld the trial judge's decision.

There are many earlier cases in which the courts have held that the measure of damages for a defectively carried out building contract is sometimes the difference in value and sometimes the cost of cure (see especially the decision of the House of Lords in East Ham B C v Bernard Sunley [1965] 3 All ER 619 and of the New York Court of Appeal's in Jacobs & Youngs v Kent (1921) 230 NY 239). In deciding which measure to adopt, the courts have often referred to the question of whether cure would be reasonable in all the circumstances and also to whether the injured party would be likely to carry out the cure. The House of Lords attached much more importance to reasonableness page 12] than to intention. They regarded intention as primarily a matter going to reasonableness. In other words, in the cases where the courts had not believed that cure would be carried out, this has always been because in the circumstances it would not be reasonable to carry it out.

At one level, the judgements are simply an affirmation of orthodox doctrine. Nevertheless, there are some significant signs for development and change in the future. Particularly significant is Lord Mustill's acceptance that the damages award in a case of this kind should reflect the consumer surplus, that is the special benefit which the promisee expects to receive from performance. It is noteworthy also that he stated that at bottom there are not two tests for quantification of damages but only one, that is what is the loss which the injured party has suffered. This is particularly important in a case of the present kind where the injured party has received a defective but nevertheless substantially useful performance. The decision of the House of Lords reflects a strong intuitive feeling that if Mr Forsyth had received 21,000 and kept the pool as it was, he would have been overcompensated. On the other hand, if he had simply received nothing, he might have reasonably have felt that he was [page 13] undercompensated. So one way to approach the question is to ask what figure between 0 and 21,000 would together with the usable pool leave him in, as near as money could do it, the same position as he should have been in. This is substantially what happened in the case, though it should be noted there was no argument before the House of Lords by either side as to whether 2,500 or some other figure was the correct one.

The final case is so recent that its result was not yet known at the time this lecture was given. Nevertheless the facts and the arguments are so dramatic that is certainly worth discussing now. This was the case of Attorney General v Blake (Jonathan Cape Ltd third party) reported in the Court of Appeal at [1998] 1 All ER 832. George Blake was for many years employed by the British secret intelligence service. Unknown to them, he was also working for the KGB. In 1961, this was discovered and he was charged and convicted with five offences receiving a sentence of 42 years; an extremely long sentence by British standards. In 1965 he managed to escape from prison and went to Russia, where he has been ever since. After many years in Russia, he entered into a contract with Jonathan Cape Ltd to publish his [page 14] autobiography. This contract was on extremely generous terms, presumably because Jonathan Cape thought it would be a best seller (though it appears it was not). Under the contract, Blake was to receive 150,000 by way of an advance against royalties and it appears that 60,000 has actually been paid. In practice, the chances of the Crown obtaining any of the money which is safely in Blake's hands in Moscow is obviously minimal and the purpose of the present action was apparently either to prevent Cape from paying the money to Blake or even to require it to pay the money to the Crown.

The case for the Crown involved a number of different arguments ranging over both public and private law.

One argument put forward by the Crown was that Blake was a fiduciary. If this argument had been upheld on the facts, it would, on the face of it, certainly have justified the Crown having a claim to all the money Blake received from the book. It would have been on a par with the famous case of Reading v Attorney General [1951] AC 507. In that case, a British sergeant had been paid handsomely for sitting in front of a lorry in wartime Cairo which was carrying contraband so as [page 15] to discourage searching of the lorry. It was held that the Crown was entitled to freeze all the profits from this dishonesty which could be found. On the basis that Blake was a fiduciary, the case would have been similar to the decision of the United States Supreme Court in Snepp except that Snepp was not a spy but a patriot who wrote a book revealing the incompetence of the CIA during the last days of the American presence in Vietnam. Perhaps surprisingly, in view of the importance of the constitutional guarantee of freedom of speech in the American system, the majority of the Supreme Court held that Snepp was a constructive trustee and that all the proceeds of the book should go to the Government. However, in the present case, Scott VC held that Blake was no longer a fiduciary since he had long since ceased to work for the Government and none of the information revealed in the book was confidential. This view was not challenged on appeal.

In the Court of Appeal, the primary argument of the Crown was that it was entitled to seek an injunction to restrain Jonathan Cape from paying the money over to Blake or to restrain Blake from receiving it on the basis that it was part of the historic function of the Attorney General acting in his public law capacity in support of the [page 16] control of criminal activity. On any view, this involved a substantial extension of the existing law. The Court of Appeal was willing to make this step and challenging this decision was the primary purpose of the appeal to the House of Lords. Argument in the House of Lords was conducted pro bono and without payment for the purpose of seeing that the important issues in the case received a full argument.

In the House of Lords, all five Lords were agreed that the view of the Court of Appeal on this point was clearly wrong. Four of the five Lords thought that there was no need to make this extensive addition to the public law position since there was an adequate private law remedy for the Crown. Lord Hobhouse dissented on the private law point and did not think the Crown should have a remedy either in public or in private law.

In the Court of Appeal, the Court considered an alternative line of reasoning which had not been relied upon by the Crown. This was that Blake had undoubtedly committed a breach of contract because, when he had entered into employment with the Crown, he had made a life long contract to keep everything he learnt confidential. In a case [page 17] of ordinary contract of employment, it would probably be the case that a life long covenant of this kind was not enforceable but it is argued that, in the case of a Crown employee, such agreements were effectively sanctified by the provisions of the Official Secrets Act. The question was what remedy the Crown might have as a matter of private law in respect of this breach of contract. The Court of Appeal spent some time discussing this question although, strictly speaking, it was not before the Court. It came to the conclusion that, in the exceptional circumstances of the case, it would probably have been proper to order Blake to disgorge the profit he had made from the book.

There is no doubt that the traditional view of English law has long been that the purpose of damages in contract is to compensate the plaintiff and that the function of the Court is to ascertain in money terms what the loss of the plaintiff is. It has been thought irrelevant what profit the defendant has made from his breach of contract. So, in Occidental World Wide Investment Corp v Skibs [1976] 1 Lloyd's Rep 293, the defendants had wrongfully terminated charters of ships on a rising market and let them at much higher rates elsewhere. Kerr J [page 18] treated it as clear that the plaintiff could not recover sums based on the defendant's profits. The most important recent affirmation of this general principle is contained in the decision of the Court of Appeal in Surrey County Council v Bredero Homes [1993] 1 WLR 1361. In this case, Surrey County Council had sold land to the defendants with a view to the defendants developing it by building houses on it. The contract between the parties contained a restriction on the number of houses which could be built. The County Council was also the planning authority and so had a public law control over the number of houses. The defendants applied to the Council in their public law capacity for planning permission to build extra houses but did not seek to renegotiate the contractual provision. It simply went ahead and built the houses. It is clear that the Council could have gone to Court and would certainly have been given an injunction to restrain the defendant from building more houses than they had agreed in the contract. However, the Council did not do so. What it did was to wait until the houses were finished and then bring an action for damages, seeking to recover the profit which the defendants had made by building the extra houses. There was no significant loss for the plaintiffs and the Court of Appeal held that the plaintiffs could not [page 19] recover damages based on the profit made by the defendant. The arguments for granting restitutionary damages were clearly put and forcibly rejected. Surrey County Council v Bredero Homes has been much discussed in the literature since its decision. It is, I think, fair to say that no-one suggests that the plaintiff can always recover restitutionary damages. Everybody recognises that this is an exceptional remedy. It is perhaps also fair to say that those who argue for the creation of an exceptional remedy of this kind are not on the whole clearly agreed amongst themselves.

The Court of Appeal recognised two possibilities, one of which certainly can not apply on the facts of Blake. This is the so-called case of skimped performance, that is where the defendant deliberately does a cheap job and the amount he saves by doing so is more than the loss in value to the plaintiffs. On one view, the facts of Ruxley v Forsyth might have been treated as a case of this kind though in fact no point of this kind was argued and probably it was not a case of skimped performance as, in fact, the shallow pool was the plaintiff's second attempt and it is very doubtful that the plaintiffs made any money out of building the pool a few inches shallow. [page 20]

A case that is often referred to in this context is City of New Orleans v Firemen's Charitable Association (1891) 9 So 486 though much of the discussion misrepresents the reasoning of the case which is in any case not very helpful. However, the facts are quite instructive. Basically, it was a contract under which the defendants agreed to provide a fire service for the city and the contract contained provisions about the number of firemen, number of fire engines, and so on. In fact, the defendants never had the contractually agreed number of fire engines or firemen but it was agreed that, by lucky chance, no property had been burnt down as a result. Some commentators have assumed that, in this situation, there was no loss to the plaintiff and that it would be an appropriate case for ordering a damages award based on the savings made by the defendants. However, in the light of the actual decision in Ruxley, this seems incorrect. Clearly, the plaintiffs had not got what they were entitled to under the contract. They were not buying fire insurance but a contract to provide a prescribed level of service. Although they could not point to direct financial loss arising immediately from the breach it seems [page 21] perfectly sensible to say that they had suffered compensatable loss by not receiving what they had contracted for.

The other head recognised by the Court of Appeal, and which they thought Blake represented, was the situation where the defendant prefers to do 'the very thing a person has contracted not to do'. The problem with this exception is that it is very broad and it is not at all easy to see what its outer limits are.

It is worth pointing out that the debate about restitutionary damages goes to the very heart of what contract law is about. Over 100 years ago, a great American judge, Oliver Wendell Holmes suggested that the duty to keep a contract meant that the party should pay damages who did not keep it. An allied notion is contained in the writings of the Law and Economics School particularly that of Richard Posner who campaigned for the recognition of the notion of efficient breach. That is that the rule should not prohibit a defendant from breaking the contract if the profit he can make from doing so exceeds the damages he would have to pay to the other party to the broken contract. This type of reasoning undoubtedly has received some [page 22] support in the judgement of Millett LJ in the important specific performance case of Co-operative Insurance v Argyll [1996] Ch 286 (dissenting at 304), implicitly approved by the House of Lords at [1998] AC 1.

In the House of Lords things took a surprising turn. Although the appellant did not agree with what the Court of Appeal had said about restitutionary damages, they did not appeal because what the Court of Appeal had said did not form part of the decision of the Court since the matter had not been argued on behalf of the Crown. In the House of Lords, the original argument of the Crown was confined to arguing that the Court of Appeal was right on the public law point but, some fortnight before the matter was to be argued before the House of Lords, the parties were directed to argue the private law point as to the scope of damages.

It is, I think, fair to say that in the House of Lords all five of their Lordships thought that what the Court of Appeal said about restitutionary damages was clearly wrong. Nevertheless, the majority thought that the Crown should succeed on this ground though they [page 23] disapproved of the use of the expression 'restitutionary damages'. The leading speech on behalf of the majority was given by Lord Nicholls with whom Lord Goff and Lord Browne-Wilkinson simply agreed. Lord Steyn, without disagreeing with Lord Nicholls, gave a rather shorter additional speech, no doubt largely because he had been the leading judge in the Court of Appeal in the case of Surrey County Council v Bredero Homes. The majority thought that, in principle, Blake could be forced to disgorge the money which he had made from the book. (Whatever the principle, this was of course impossible in practice since Blake was sitting safely in Moscow, outside the jurisdiction of the court. The practical question was what was to be done with the 90,000 which Jonathan Cape in some sense owed to Blake and which it had not yet paid to him. The detailed working out of this question received surprisingly brief treatment in the House of Lords and may perhaps be left on one side today.) Lord Nicholls' preferred solution was to say that the Court could grant the Crown "an account of profits" as a remedy for breach of contract. This would undoubtedly have been an appropriate remedy if Blake had been held by the trial judge to be a fiduciary but it had been assumed by the lower courts and, I think, by most commentators that it was not an [page 24] appropriate technique where Blake was not a fiduciary. What the majority of the House of Lords was saying in effect is that there may be exceptional cases where justice requires that the party who has been subjected to a breach of contract should be able to apply to the court for an account of the benefits which the defendant has received as a result of breaking the contract. This remedy is frankly recognised as being exceptional. Undoubtedly we can expect a series of cases over the next few years in which the boundaries of this exception are tested. Undoubtedly in these cases the forceful dissent of Lord Hobhouse will also have to be taken carefully into account.

The case is in many ways remarkable. The Crown put forward a case at first instance which was rejected by the court; it put forward a wholly different case in the Court of Appeal which was upheld by that Court but unanimously held to be misconceived by the House of Lords; it succeeded before the House of Lords on grounds which it had not originally wished to argue, and for reasons quite different from those which the Court of Appeal had given and which were unanimously agreed by the House of Lords to be wrong. There can be [page 25] much debate about what this case demonstrates but at least it is clear that it shows that English contract law is not in a petrified state. [page 26]

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