If your client happens to benefit from your negligence, can you offset that benefit from any damages you owe? This is what the court had to say

Have you heard the latest about the housing market? Apparently, it’s about to crash. Or maybe it’s still booming. Either that or it’s holding firm.

Who cares? Housebuilders, those of us who might be moving home and those of us who don’t have enough to worry about. And what about contractors and consultants working for residential developers? Generally speaking, they are paid their contract sum or fee without reference to the market conditions that apply when selling completed houses. But it is when things go wrong that movements in the market could become relevant, as they did in the case of Earls Terrace Properties vs Nilsson Design.

Let’s focus on two questions that the court answered in a way that might surprise you. Assume, as the court was asked to, that Nilsson (the architect) was negligent in its design. This negligence allowed water penetration into the basement of some upmarket houses. While remedial works were carried out, the sale of those houses was delayed by 15 months.

Question one. Can the developer recover holding costs on the money that it had wrapped up in the project for that additional 15 month period, even if its funding arrangements were such that no interest was incurred?

Question two. If during the period of the delay the housing market for these properties moved from shaky to strong and the developer was able to sell them for more than it would have been able to if the development had been completed on time, should it knock that extra profit off any damages it was able to recover from the architect?

Off the top of my head, I would have said no to question one and yes to question two. The court did the opposite, and a closer look at the circumstances helps to explain why.

Changes in the market were not caused by or sufficiently close to the architect's obligations

On the question of interest it was found that the architect knew full well that the developer was a special purpose company set up solely for the purpose of undertaking this speculative housing development. Against that background, it followed that there would be borrowing at a cost that would reflect the risks involved. Delay to the project would result in funds being tied up for longer, so they could not be used for other purposes. Because the precise amount of the loss could not be established, the court was allowed to assess a reasonable rate of return that might have been achieved on the money. The developer did not need to prove an actual loss in order to recover damages for holding costs.

Moving on to question two, the basic test for deciding what damages to award for a breach of contract is to assess what is necessary to put the developer in the position it would have been in if the 15 month delay had not occurred.

The court said that in the circumstances of this case, the scope of the architect’s duty would not have extended to additional losses to the developer had the market fallen during the period of delay. Changes in the market were not caused by or sufficiently close to the architect’s obligations. The inevitable flip side of this is that the architect cannot take advantage of a rise in the market.

Putting all of this in the context of an office development, if rents or tenant demand collapses during the period of any delay to the project, the commercial impact on the developer could be massive. Applying the Earls Terrace test, the developer would not normally be able recover damages to cover this from any member of the team that caused the delay. That said, the rules about damages for breach of contract are such that if a particular category of loss is brought to the attention of the contracting parties when they enter into their contract, it can become recoverable even if it would normally be regarded as unforeseeable and too remote as a class of damages. So the canny developer might want to write something into its appointments to help cover its downsides …