Q&A on the scope of the transferred loss principle

10 August, 2021

Written by Katherine Ratcliffe of Essex Court Chambers.

Q&A on the scope of the transferred loss principle

Where a third party suffers loss as a result of the defendant’s conduct, but has no cause of action itself, the principle of transferred loss may be applied to ensure that the defendant is held accountable. However, a myriad of issues surrounds the application of that principle, several of which have received significant judicial attention in the last four years. After briefly summarising the principles of transferred loss, this article sets out answers to the four key issues in light of the guidance provided by the courts since the Supreme Court’s decision in Swynson v Lowick Rose in 2017.

A. THE PRINCIPLE OF TRANSFERRED LOSS

Following Lord Sumption’s judgment in Swynson v Lowick Rose [2017] UKSC 32, it is now generally accepted that there are two aspects to the principle of transferred loss: [1]

  1. The narrow ground explains that in certain situations a claimant will sometimes be able to recover damages for a third party’s loss provided the claimant holds the damages on account for the third party.
  2. The broad ground explains that a claimant suffers a loss where the claimant does not get what he bargained for (specifically where what is bargained for is a benefit to a third party) such that the claimant is entitled to recover damages for his own loss of performance.

For either ground to apply, the claimant must establish that:

  1. At the time that the contract was entered into, there was a known object to benefit the third party or a class of persons to whom the third party belonged.[2]
  2. There is a legal black hole, such that the only way for the loss to be recovered is if the claimant sues the defendant.[3]

B. HOW CAN A CLAIMANT ESTABLISH THERE WAS A KNOWN OBJECT TO BENEFIT A THIRD PARTY?

The language of ‘known object’ comes from Lord Sumption’s decision in Swynson v Lowick Rose.

Prior to 2017, the test for the narrow ground was instead typically framed in terms of whether it was in the contemplation of the parties that proprietary interests in the goods or property may be transferred to a third party after the contract has been entered into.[4] However, there was some uncertainty as to whether foreseeability or intention was in fact a necessary requirement for the narrow ground or whether what was actually going on was that that in certain circumstances – such as a contract for the carriage of goods – the parties were treated in law as having entered into the contract on the footing that the promisee would be entitled to enforce contractual rights for third parties who suffered harm.[5] Lord Sumption in Swnyson v Lowick Rose has now affirmed that there is in fact an intention element to the narrow ground test.

The question then is: how does a claimant satisfy the known object test?

Sir Michael Burton recently clarified in Argos Pereira Espana SL v Athenian Marine Ltd [2021] EWHC 554 (Comm) that a known object can be either an intention to benefit or an intention not to harm or cause detriment.[6]

The example of a known object which is most often cited is the example given by Lord Griffiths in Linden Gardens Trust Ltd v Lenesta Sludge Disposal Ltd [1994] 1 AC 85 – namely of a builder installing a new roof who would have known that he was benefitting the owners of the house, even if he was unaware of their specific identity. However, there are substantially more examples of what does not satisfy the known object test than examples of what does. For example:

  1. In Palmali Shipping SA v Litasco SA [2020] EWHC 2581 Foxton J considered that the known object requirement was not satisfied merely because the claimant may contract with third parties, as it was a matter for the claimant how it went about putting itself in a position to perform its reciprocal obligations with third parties.[7]
  2. The fact that the claimant and the third party are part of the same group of companies is of limited relevance. Although Lord Clyde in Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 A.C. 518 recognised that a legal black hole akin to that which arose in Panatown “is most likely to arise in the context of the domestic affairs of a family group or the commercial affairs of a group of companies”, two recent cases (BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 and Palmali Shipping SA v Litasco SA [2020] EWHC 2581) have clarified that this does not mean that the known object test will necessarily be satisfied.[8]
  3. The inclusion of a clause which curtails any obligation owed to third parties (such as a clause which states “nothing in this contract confers or is intended to confer any right to enforce any of its terms on any person who is not a party to it”) prevents the known third party requirement being satisfied, as HH Judge Russen QC held in Dr Jones Yeovil Limited v The Stepping Stone Group Limited [2020] EWHC 2308 (TCC).[9]

The only recent example of the known object requirement being satisfied is Argos Pereira Espana SL v Athenian Marine Ltd [2021] EWHC 554 (Comm). Sir Michael Burton held that because on its proper construction the arbitration agreement extended to claims against the third party (the manager of the owners of the vessel), the parties must have intended the arbitration agreement to extend to claims made under bills of lading against the third party and the third party therefore derived benefit from the arbitration agreement.[10]

Ultimately the question is a simple one: did the claimant contract for the third party to receive any benefit?[11] Or, to put it another way, is the object of the contract to benefit a third party or class of third parties, or is it something else?[12] It is apparent from recent judgments that the courts are not amenable to complex explanations as to how the known object requirement is satisfied, but instead prefer to adopt a straightforward approach focused on the two questions above.

C. DO THE PRINCIPLES OF TRANSFERRED LOSS APPLY TO ALL CONTRACTUAL CLAIMS?

In Swynson v Lowick Rose Lord Sumption (albeit obiter) suggested that the narrow ground only applies where the loss relates to transferred property.[13] The basis for that proposition was Linden Gardens Trust Ltd v Lenesta Sludge Disposal Ltd [1994] 1 AC 85, where losses were sustained by a third party as a result of defective work done to a property prior to a transfer of title, and The Albazero [1977] A.C. 774, where the third party suffered losses as a result of damage to goods during carriage where the contracting parties had intended that the carriage was for the benefit of both the seller and the buyer of the goods.

However, Lord Sumption did not seem to take into account the decision in Darlington B.C. v Wiltshier Northern Ltd [1995] 1 W.L.R. 68, approved by the House of Lords in Panatown,[14] which establishes that the principles of transferred loss apply (at least in relation to loss arising from defective building work) even when there is no transfer of the property affected by the breach from the promise to the third party. Neither Lord Sumption nor Lord Neuberger in Swynson v Lowick Rose referred to Darlington. Furthermore, Lord Mance cited Darlington without disapproval (and without suggesting that Lords Sumption and Neuberger had cast doubt on it).[15] The authors of Chitty therefore suggest that Lord Sumption’s statements have to be read merely as general statements on the scope of the Albazero exception.[16]

As for the broad ground, Lord Sumption accepted that the principle was not limited to cases where the loss related to transferred property.[17] More recently Coulson LJ in BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 left open the question whether the broad ground applies in relation to contracts for the sale of goods as “it may be difficult to justify treating different types of contracts in a different way.”[18] Coulson LJ recognised that “ultimately, it will depend on the analysis of the particular contract in question.”

The recent decisions of BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 and Palmali Shipping SA v Litasco SA [2020] EWHC 2581 indicate a shift away from limiting the transferred loss principle to certain categories of contract. Instead, Foxton J in Palmali suggested that the question that the courts should be asking is whether there is a legally protected interest on the part of the third party (such as a right of property or to possession or contractual rights) from which the loss arises due to interference with or diminution in the value of that interest. This approach is to be commended as it avoids arbitrary distinctions being drawn between different categories of contract and the difficulty of determining which category a contract falls into.

Nonetheless, certain types of contracts – such as contracts for works to be carried out on a party’s land where it is foreseeable that the land will then be sold to a third party – may be more likely to be entered into with the intention that performance will benefit a third party than other types of contracts. As a result, the very fact that the particular type of contract was entered into may be relied upon as evidence of the intention to benefit the third party.[19]

D. CAN THE PRINCIPLES OF TRANSFERRED LOSS APPLY TO NON-CONTRACTUAL CLAIMS?

Earlier this year Sir Michael Burton, sitting as a High Court judge, held in Argos Pereira Espana SL v Athenian Marine Ltd [2021] EWHC 554 (Comm) that there is no reason for the principle of transferred loss to be limited to contract.[20] Sir Michael Burton therefore applied the principle of transferred loss to losses arising from a breach of equitable obligations “equivalent to contract”, namely the so-called derived rights obligation (where a party to whom a contractual right has been assigned is obliged to only exercise that right in accordance with the forum clause in the contract) and the equitable obligation not to seek to take the benefit of a contract without the burden of the exclusive forum clause to which that contract is subjected.[21]

The basis for Sir Michael Burton’s decision was Lord Sumption’s judgment in Swynson v Lowick Rose. Sir Michael Burton noted that Lord Sumption had not couched his exposition of the principles of transferred loss in terms of contract but had instead referred to the “known object of a transaction” and the “anticipated effect of a breach of duty”.

Sir Michael Burton framed his decision broadly and seemed to consider that the principles of transferred loss could apply where the duty which was breached was neither contractual nor equivalent to contract.

However, it is unlikely that the law would be expanded beyond the specific equitable obligations considered in Argos Pereira. Taking the broad ground first, the basis for the broad ground is that the claimant is entitled to performance of the contract – the so-called “performance interest” which Daniel Friedmann defined in his seminal 1995 article as follows[22]:

“Ordinarily, a person enters into a contract because he is interested in getting that which the other party has to offer and because he places a higher value on that other party’s performance than on the cost and trouble he will incur to obtain it. This interest in getting the promised performance (hereafter the “performance interest”) is the only pure contractual interest.”

The broad ground is therefore available where the duty which has been breached is contractual or at most where, as in Argos Pereira, had the claim not been assigned there would have been a breach of contract and the assignment gave rise to an equitable obligation equivalent to contract which was breached.

Furthermore, the principle of transferred loss is an exception to the general rule that a claimant can only recover for loss which he has suffered. The courts are therefore likely to be very cautious about applying the principle to other areas of law.

Indeed, in Dr Jones Yeovil Limited v The Stepping Stone Group [2020] EWHC 2308 (TCC) HH Judge Russen QC rejected a claim for pure economic loss sustained by the third party on the basis that the principles of transferred loss apply only to losses which are recoverable for breach of contract and not to any wider non-contractual duty of care to avoid economic loss.[23] HH Judge Russen QC’s decision is clearly correct, as to have held otherwise would have undermined the Spartan Steel and Alloys Ltd v Martin & Co [1973] 1 Q.B. 27 line of authority, which establishes that a third party does not have a claim in tort for pure economic losses. For this reason, the approach adopted by Foxton J in Palmali which requires the third party to have a legally protected interest ensures that the principles of transferred loss do not enable the claimant to recover damages for loss suffered by a third party in circumstances where in tort the third party could not recover damages for the loss.[24]

E. WHAT LOSSES CAN BE CLAIMED VIA THE PRINCIPLES OF TRANSFERRED LOSS? 

Under the narrow ground

It is a necessary requirement for the narrow ground to apply that the claimant accounts to the third party for the damages. Provided the claimant does so, there is no reason in principle why all losses cannot be recoverable under the narrow ground. Nor is there any authority which suggests that consequential losses would not be recoverable under the narrow ground.

Indeed, Lord Jauncey in Panatown seemed to consider that one of the fundamental differences between the narrow ground and the broad ground was that consequential loss resulting to the third party due to delay and resultant loss of profits would appear to be irrecoverable under the broad ground.[25] For the reasons set out below, this conclusion in respect of the broad ground seems to be open to challenge (and was disputed by Lord Millett in Panatown[26]). Nevertheless, it appears that in relation to the narrow ground Lord Jauncey agreed that consequential losses were recoverable.

Under the broad ground

The basis for the broad ground is that the contracting party has the right to enforce performance of the contract, or alternatively obtain substitutionary remedies such as damages assessed by reference to the cost of cure.[27] Indeed, the cases in which the principles of transferred loss have led to recovery to date are exclusively cases where damages for the cost of cure were awarded.

However, in the recent decision of BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 at [78], Coulson LJ stated obiter that since a claim for loss of profit is a recognised head of loss in claims under or for breach of commercial contracts, “it may be difficult” to exclude the principle of transferred loss merely because of the nature of the damages claimed.

There is support for the position that consequential losses should be recoverable via the principles of transferred loss. Lord Millett in Panatown stated that damages “may be measured by the cost of obtaining alternative performance, but they may also take account of loss from delay and other consequential loss”.[28] Similarly, Lord Goff suggested that loss of profit suffered by a third party would be recoverable by the claimant when caused by the breach of a time clause in a contract.[29]

There is also arguably no basis for treating the cost of cure differently to consequential losses, as the cost of cure is itself a species of consequential loss. Oliver J in Radford v de Froberville [1977] 1 WLR 1262 held that cost of cure can only be obtained if it has been or will be suffered – like other forms of consequential or special loss. The cost of cure is the cost of getting the harm cured and must be a loss which you have or will suffer – and is therefore a loss consequent on the wrong (counterfactually). This explains why the House of Lords in Ruxley Electronics v Forsyth [1995] 1 A.C. 344 thought that the cost of cure would only be reasonable where the cost was or would be incurred. If cost of cure is recoverable, there is no reason why other forms of consequential loss should also not be recoverable. Drawing arbitrary distinctions between different forms of consequential loss would only lead to confusion.

The main counter-argument to the suggestion that consequential losses should be recoverable via the principle of transferred loss is that there is a difference between enforcing performance and seeking consequential losses.[30] If consequential losses were recoverable, the contracting party could obtain damages for profits that he himself would never have made and which he is not obliged to hold on account for the loss suffering party. That goes beyond obtaining the specific type of performance (or equivalent to performance) promised by the defendant. Indeed, Lord Mance (dissenting) noted in Swynson Ltd v Lowick Rose llp [2017] UKSC 32 at [53] that the potential difficulties with the theory of a performance interest include “that it cannot prima facie embrace consequential losses suffered by the company actually (as opposed to contractually) interested in the quality of the property or services”.

Nevertheless, the issue of whether consequential losses such as loss of profit are recoverable via the principles of transferred loss has not been determined by the English courts. The few cases in which this point has arisen were decided on other grounds such that the references to consequential losses in the judgments are all obiter. For example:

  1. And So To Bed v Dixon [2001] FSR 47 at [54], in which David Donaldson Q.C. held obiter that loss of profit was not recoverable under the broad ground. David Donaldson Q.C.’s decision was considered but not followed by Coulson LJ in BV Nederlandse;
  2. Rolls-Royce Power Engineering Plc v Ricardo Consulting Engineers Ltd [2003] EWHC 2871 at [128], in which Judge Richard Seymour QC declined to determine whether the broad ground actually covers loss of profits as these were “treacherous waters”;
  3. Dr Jones Yeovil Limited v The Stepping Stone Group Limited [2020] EWHC 2308 (TCC) at [214], in which HHJ Russen QC stated that he would have rejected the case on transferred loss on the basis that the claim was for a secondary consequential loss akin to a claim for loss of profits. However, HHJ Russen QC also acknowledged that in light of the observations of Coulson LJ in Nederlandse any decision to that effect “would probably have been worthy of consideration on appeal”; and
  4. Palmali Shipping SA v Litasco SA [2020] EWHC 2581 at [54], in which (as discussed above) the claim was for the loss of an opportunity to conclude contracts with other parties such that the loss transferred did not arise from interference with or diminution in the value of a legally protected interest. It is therefore not clear from Foxton J’s judgment whether it was the fact that the loss was for the loss of profits which was significant or whether it was the cause of the loss.

F. CONCLUSION

The scope of the transferred loss principle has been defined more in the last two years than in the preceding nineteen years since Panatown was handed down. Anyone seeking to rely on the principle of transferred loss must now take heed of the guidance given by Lord Sumption in Swynson v Lowick Rose, by Coulson LJ in BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc, and by various first instance judges, in particular Foxton J in Palmali Shipping SA v Litasco SA. It would be unwise to underestimate how unwilling judges at first instance are to adopt complex arguments as to how the principles of transferred loss apply, as opposed to adopting a straightforward approach, looking simply at whether the object of the contract was to benefit a third party.

Written by Katherine Ratcliffe, Essex Court Chambers

This note is provided free of charge as a matter of information only. It is not intended to constitute, nor should it be relied upon as constituting, legal advice, and no responsibility is assumed in relation to the accuracy of the contents of the same as regards anyone choosing to rely upon it.

[1] BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 at [71]; Dr Jones Yeovill Limited v The Stepping Stone Group Limited [2020] EWHC 2308 (TCC).

[2] BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 at [72]; Swynson Ltd v Lowick Rose LLP [2017] UKSC 32 at [14] (regarding both the narrow and the broad grounds).

[3] Swynson v Lowick Rose LLP 2017] UKSC 32 at [14].

[4] The Albazero [1977] A.C. 774 at 847, per Lord Diplock; Swynson v Lowick Rose LLP 2017] UKSC 32 at [14].

[5] See e.g. Linden Gardens Trust Ltd v Lenesta Sludge Disposal Ltd [1994] 1 AC 85 at 115 and Lord Clyde in Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 A.C. 518 at 530.

[6] Argos Pereira Espana SL v Athenian Marine Ltd [2021] EWHC 554 (Comm) at [25].

[7] At [49]-[50].

[8] BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 at [76]-[77]; Palmali Shipping SA v Litasco SA [2020] EWHC 2581 at [51].

[9] Dr Jones Yeovil Limited v The Stepping Stone Group Limited [2020] EWHC 2308 (TCC) at [211]-[213].

[10] Argos Pereira Espana SL v Athenian Marine Ltd [2021] EWHC 554 (Comm) at [25].

[11] See the first instance decision in BV Nederlandse Industrie van Eiprodukten v Rembrandt Enterprises Inc [2019] EWCA Civ 596 at [162]-[164].

[12] See Foxton J’s approach in Palmali Shipping SA v Litasco SA [2020] EWHC 2581 at [50].

[13] Swynson v Lowick Rose LLP 2017] UKSC 32 at [15] and [17]. This was why Lord Sumption held that only the broad ground could be relevant on the facts. See also Lord Neuberger at [102]. Note, however, that Lord Mance at [54] considered that the problem with the narrow ground was simply that “Swynson did not contract with HMT on behalf of or for the benefit of Mr Hunt” and did not seem to consider that the fact the contract was a contract for accounting services to be a bar to transferred loss.

[14] At 531 (per Lord Clyde), 545 (per Lord Giff), 566 (per Lord Jauncey), and 584 (per Lord Millett).

[15] At [52].

[16] Chitty on Contracts (33rd Edn.), §18-058 and footnote 382.

[17] Swynson v Lowick Rose LLP 2017] UKSC 32 at [15].

[18] At [78].

[19] See R Stevens ‘The Contracts Rights of Third Parties Act’ (2004) 120 LQR 292, 299: “the foreseeable transfer of property from the promisee to the third party is merely evidence of an intent that the promisor’s performance benefits the third party. If so, such intent should be capable of proof in other ways.”

[20] At [24].

[21] At [6]

[22] Friedmann, ‘Performance interest in contract damages’ (1995) 111 L.Q.R. 628 at 629

[23] At [216] (see also [133]).

[24] This was one of Hannes Unberath’s concerns about the “contemplation”/ “foreseeability” test for the narrow ground: ‘Third Party losses and black holes: another view’ (1999) L.Q.R. 535 at 539.

[25] At 573.

[26] At 587. See also Hannes Unberath ‘Third Party losses and black holes: another view’ (1999) L.Q.R. 535 at 543, in which Unberath indicates that he considers that the narrow ground allows recovery of “genuine third party losses”.

[27] See, for example, Lord Goff’s example of a wealthy philanthropist in Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 A.C. 518. Indeed, the cases cited by Lord Millett in Panatown in support of the broad ground (in particular Radford v de Froberville) only involved the cost of cure being awarded. See also Coote ‘Contract Damages, Ruxley, and the Performance Interest’ (1997) C.L.J. 537 at 537: cost of cure is “the damages-equivalent of performance”.

[28] Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 A.C. 518 at 587.

[29] Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 A.C. 518 at 554.

[30] On the meaning of ‘performance interest’, see Friedmann ‘Performance Interest in Contract Damages’ (1995) 111 L.Q.R. 628 at 629, and Coote ‘Contract Damages, Ruxley, and the Performance Interest’ (1997) C.L.J. 537 at 550.