When a black hole stays black: the limits of the transferred loss rule

Last month the newspapers carried remarkable images from space of a black hole. In legal circles, sadly, the term “black hole” has a more prosaic meaning. It is sometimes used in a scenario where, for example, a contractor has carried out defective work but then someone other than the employer has paid for the repair work. The original contractor may then argue that the company that had the benefit of the contract has not suffered any loss, whereas the company that has suffered the loss did not have any contract (with the original contractor, that is). Both companies may then find that any claim they might have for damages has disappeared, so it is said, into a black hole.

A claimant can generally only sue for losses suffered by itself. The principle of transferred loss is an exception to this and, as with all exceptions, there have to be some limits, or the rule would be compromised

One way in which the courts have tried to restore justice in this sort of situation is by developing what has become known as the “principle of transferred loss”. This principle originated in contracts for the shipping of goods, but it was applied in the world of construction in a landmark case in 1994, St Martin’s Property Corporation Ltd vs Sir Robert McAlpine & Sons Ltd. In that case, a developer sued its contractor for the cost of repairing a podium deck that was discovered, after completion, to be leaking. The contractor responded by saying that even if there were defects, the developer had suffered no loss –  first, because it had managed to sell the land at full market value, and second, because, even though it had initially paid for the repairs, the new purchaser had reimbursed it for those costs. 

The developer’s damages were about to fall into a black hole. However, the court said that just as a seller of goods would usually be aware that its shipper would sell the goods on to its own customer (so that it would be that customer that would suffer any loss caused by defects) so a contractor would know that a developer would probably sell the building on to a purchaser or tenant, who would have to pay for the cost of repairing defects. The court therefore allowed the employer to recover damages for, in effect, the purchaser’s outlay.

Indeed, the judge pointed out, if such a claim could be maintained, any contractor could simply add the losses of its subcontractors or suppliers to its claims against an employer

There is an important rule of law that a claimant can generally only sue for loss or damage suffered by itself. The principle of transferred loss is an exception to this and, as with all exceptions, there have to be some limits, or the rule would be compromised. A recent Court of Appeal decision has set one such limit.

The case is BV Nederlandse Industrie van Eiprodukten vs Rembrandt Enterprises Inc.  Following an avian flu epidemic that hit the US in 2015, many US companies that supplied egg products had to destroy their own birds and find a new source to fill the gap in their output. One such company, Rembrandt, found a supplier in the Netherlands, NIVE. But shortly after NIVE began to supply its products, Rembrandt alleged NIVE was failing to comply with US inspection requirements and suspended the contract. NIVE treated this as a breach by Rembrandt. The judge agreed and the case then went to appeal on the question of what damages NIVE could claim.  

Some of the egg products had been supplied to Rembrandt by a company, Henningsen, within the same group of companies as NIVE. That company had no direct contract with Rembrandt, but nevertheless NIVE wanted to claim for Henningsen’s lost profits as well as for its own. Could it do so?

NIVE argued that the transferred loss principle applied to its case. Lord Justice Coulson, a former judge in charge of the Technology and Construction Court, disagreed. A crucial ingredient of the principle was missing. Rembrandt was not even aware of the existence of the related company, Henningsen, let alone the possibility that that company might be providing some of the egg products on behalf of NIVE. Indeed, he pointed out, if such a claim could be maintained, any contractor could simply add the losses of its subcontractors or suppliers to its claims against an employer.

The principle of transferred loss has mainly been applied in construction cases where an employer has sold a building on, as in St Martin’s. The attempt in BV Nederlandse to use it to allow one party to claim for the losses of a related company was probably a step too far. The principle is better restricted to the sort of case where substantially defective work would otherwise go uncompensated. Those are the truly deserving “black hole” cases.

Ian Yule is construction and engineering partner in Shoosmiths