Should punitive damages be part of the judicial arsenal in contract cases?

© 2006 The Author. Journal Compilation © 2006 The Society of Legal Scholars. Published by Blackwell Publishing,9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA

Legal Studies, Vol. 26 No. 3, September 2006, pp. 369–393DOI: 10.1111/j.1748-121X.2006.00016.x

Should punitive damages be part of the judicial arsenal in contract cases?

Ralph Cunnington*

Lecturer in Law, University of Birmingham

This paper challenges the traditional assumption that punitive damages are unavailablefor breach of contract. It is shown that

Addis v Gramophone

provides weak authority forthis assumption. The paper considers whether there is a logically coherent argument forretaining punitive damages in tort, while denying them for breach of contract, and it isshown that there is not. The main arguments advanced against punitive damages in civilproceedings are examined and shown to be unpersuasive. Finally, the efficient breachtheory is considered and rejected on the ground that it significantly underestimates thecosts associated with breach. In conclusion, the paper recommends that punitive damagesshould be exceptionally awarded to deter outrageous breaches of contract in cases wherecompensatory damages are inadequate and gain-based damages are unavailable.

INTRODUCTION

They are a ‘monstrous heresy . . . an unsightly and unhealthy excrescence, deformingthe symmetry of the body of the law’. Those were the acerbic words used byFoster J to describe punitive damages in 1872.

1

Since then, there have been numerousattempts to discredit and question their legitimacy. Exemplary damages (or punitivedamages as they will be labelled in this paper)

2

are controversial for the simple reasonthat they are punitive in effect; they seek to punish the wrongdoer for his conductand to deter similar behaviour by him or by others in the future. Many commentatorsclaim that that this is an illegitimate purpose for the civil law.

3

Indeed, in the recentHouse of Lords’ decision in

Kuddus v Chief Constable of LeicestershireConstabulary

4

Lord Scott of Foscote indicated that he would have been ‘receptive toa submission that exemplary damages awards should no longer be available in civilproceedings’.

5

* I am extremely grateful for all the comments I received when I presented an earlierversion of this paper at the Society of Legal Scholars Conference in Glasgow on 7 September2005. Thanks are also due to Professor Peter Jaffey, Dr Warren Swain and the anonymousreferees who made comments on earlier drafts. As ever, the fault for any errors and omissionsthat remain is entirely my own.

1.

Fay v Parker

(1872) 53 NH 342 at 382.

2.

Punitive more aptly describes their purpose, embracing punishment, example, vindicationand deterrence.

3.

See H Street

Principles of the Law of Damages

(London: Sweet & Maxwell, 1962) p 33;

McGregor on Damages

(London: Sweet & Maxwell, 17th edn, 2003) p 369; A Beever ‘Thestructure of aggravated and exemplary damages’ (2003) 23 OJLS 87; S Todd ‘A New Zealandperspective on exemplary damages’ (2004) 33 Common World Law Review 255.

4.

[2002] 2 AC 122.

5.

Ibid, at 157.

370 Legal Studies, Vol. 26 No. 3

© 2006 The Author. Journal Compilation © 2006 The Society of Legal Scholars

Against this backdrop of criticism the present paper will argue for both theretention and the expansion of punitive damages. Most commentators on English lawassume that punitive damages are unavailable for breach of contract.

6

This paper willchallenge that dogma by exposing its weak foundations and critiquing the mainobjections to punitive damages, particularly the efficient breach theory. It will beshown that, in exceptional cases, punitive damages can serve a useful purpose byprotecting the performance interest of a contract and upholding the facilitative insti-tution of contracting.

1. A BRIEF HISTORY OF PUNITIVE DAMAGES

To contextualise the present discussion, it is necessary to provide a brief overview ofthe legal history of punitive damages.

7

Prior to the eighteenth century, the assessmentof damages had been a rather unprincipled exercise, left to the jury’s discretion withonly a few formal constraints.

8

By the early 1700s, judges began using the motion fora new trial as a means of curtailing jury discretion in the assessment of damages,

9

butthe juries continued to exercise a largely unfettered discretion until the end of the eigh-teenth century. In the 1760s, some courts began to explain large jury verdicts as awardsof ‘exemplary damages’. Two such awards were made in connection with the gov-ernment’s attempts to stop the

North Briton

from being published. A number of indi-viduals suffered interference at the hands of public officials and punitive damages weresuccessfully recovered in a claim for false imprisonment

10

and a claim for trespass toland.

11

In the years that followed, awards were made for other torts including assault,

12

seduction,

13

enticement,

14

defamation,

15

illegal search

16

and trespass to goods.

17

Punitive damages quickly became established as part of the legal landscape in Englandand Wales, even though the purpose of such awards often remained unclear.

18

6.

See G Treitel

The Law of Contract

(London: Sweet & Maxwell, 11th edn, 2003) p 935;J Beatson

Anson’s Law of Contract

(Oxford: Oxford University Press, 28th edn, 2002) p 592.

7.

For more detailed commentary on the early history of exemplary damages, see

Mayne &MacGregor on Damages

(London: Sweet & Maxwell, 12th edn, 1961) pp 196–200; Note‘Exemplary damages in the law of torts’ (1957) 70 HLR 517; A Sebok ‘What did punitivedamages do? Why misunderstanding the history of punitive damages matters today’ (2003) 78Chicago-Kent Law Review 163.

8.

G Washington ‘Damages in contract at common law’ (1931) 47 LQR 345.

9.

Ash v Lady Ash

(1696) Comb 357, 93 ER 526;

Woodford v Eades

(1721) 1 Stra 425, 93ER 612;

Parr v Purbeck

(1723) 8 Mod 196, 88 ER 142;

Chambers v Robinson

(1726) 2 Stra691, 93 ER 787;

Pinock v Willett

(1734) Barnes 228, 94 ER 889;

Markham v Middleton

(1746)2 Stra 1259, 93 ER 1167.

10.

Huckle v Money

(1763) 2 Wils KB 205, 95 ER 768.

11.

Wilkes v Wood

(1763) Lofft I, 18, 98 ER 489.

12.

Benson v Frederick

(1766) 3 Burr 1845, 97 ER 1130;

London v Ryder

[1953] 2 QB 202.

13.

Tullidge v Wade

(1769) 3 Wils KB 18, 95 ER 909.

14.

Lough v Ward

[1945] 2 All ER 338.

15.

Ley v Hamilton

(1935) 153 LT 384;

Rook v Fairie

[1941] 1 KB 507.

16.

Bruce v Rawlins

(1770) 3 Wils KB 61, 95 ER 934.

17.

Owen and Smith v Reo Motors

(1934) 151 LT 274.

18.

Some courts explained these awards as compensation to the claimant for mental sufferingand injured feelings, while other courts explained the awards as serving the purpose ofpunishing the defendant for his misconduct; see

Merest v Harvey

(1814) 5 Taunt 442, 128ER 761.

Punitive damages in contract cases 371


In 1964, there was a radical change of direction following the decision of theHouse of Lords in

Rookes v Barnard

.

19

Lord Devlin delivered the leading speech andinsisted that punitive damages were anomalous, for the reason that they confuse thecivil and criminal functions of the law. On account of this, his Lordship sought torestrict the availability of punitive damages in two ways. First, he distinguished‘exemplary’ (punitive) and ‘aggravated’ (compensatory)

20

damages and reclassifiedmany past cases that purported to award punitive damages as examples of aggravateddamages. Secondly, his Lordship restricted the availability of punitive damages tojust three categories of torts:

21

1. oppressive, arbitrary or unconstitutional action by servants of the government;2. wrongful conduct that has been calculated by the defendant to make a profit for

himself, which may well exceed the compensation payable to the plaintiff; and3. where such an award is expressly authorised by statute.

The decision of the House of Lords was questioned 7 years later by the Court ofAppeal in

Broome v Cassell & Co

.

22

However, on appeal, the House of Lords refusedto depart from its previous decision.

23

Furthermore, several members of the Housesuggested that the decision in

Rookes

had introduced a further test into the law – the‘cause of action’ test, which denies punitive damages for any tort where its use wasnot countenanced by previous authority.

24

These comments were faithfully appliedby the Court of Appeal in

AB v South West Water Services Ltd

,

25

when finding thatpunitive damages were unavailable in claims for public nuisance and negligence. Thustwo tests were established, both of which must be satisfied prior to an award ofpunitive damages:

26

1. the ‘categories’ test, under which the facts had to fall within one of Lord Devlin’sthree categories;

2. the ‘cause of action’ test, under which the cause of action relied upon could notbe one for which, under the established law, punitive damages were unavailable.

In the years that followed, the cause of action test was subjected to intense criticism.The authors of

Winfield and Jolowicz

commented that:

‘. . . whatever one’s views on exemplary damages this is an unfortunate stateof affairs because it commits the law to an irrational position in which the resultdepends not on principle but upon the accidents of litigation (or even law reporting)before 1964, at a time, moreover when the distinction between exemplary andaggravated damages was by no means so clearly drawn as it is now.’

27

19.

[1964] AC 1129.

20.

Aggravated damages compensate the claimant for the mental distress caused by thedefendant’s wrongdoing.

21.

[1964] AC 1129 at 1226–1227.

22.

[1971] 2 QB 354.

23.

[1972] AC 1027 at 1083.

24.

Ibid, at 1086 per Lord Reid, at 1131 per Lord Diplock, at 1114 per Lord Wilber-force.

25.

[1993] QB 507.

26.

See

Kuddus v Chief Constable of Leicestershire Constabulary

[2002] 2 AC 122 at 142per Lord Nicholls of Birkenhead.

27.

WVH Rogers

Winfield & Jolowicz on Tort

(London: Sweet & Maxwell, 15th edn, 1998)p 746.



This latter point is particularly pertinent. The law effectively compelled practitionersto undertake a trawl of the authorities to discover whether punitive damages wereavailable, and this task was made even more difficult by the fact that, prior to 1964,a clear distinction between punitive and aggravated damages had not been drawn. Inits 1997 report, the Law Commission deplored ‘the rationally indefensible positionwhich the common law had reached’ and recommended that the cause of action testshould be abolished.

28

This is precisely what occurred 5 years later in

Kuddus

. The House of Lordsrejected the cause of action test and their Lordships made some important observa-tions regarding the availability of punitive damages more generally. Unfortunately,the implications of these observations are unclear and the law has been left in aprofound state of uncertainty.

29

Despite promptings by their Lordships, counsel for the defendant declined to arguefor the total abolition of punitive damages. Lord Scott of Foscotte lamented thisfailure and indicated that he would have been receptive to such a submission. How-ever, he recognised that he was in the minority.

30

At the other extreme, Lord Huttoninsisted that ‘exemplary damages [continue to] serve a valuable purpose in restrainingthe arbitrary and outrageous use of executive power and in vindicating the strengthof the law’.

31

Lord Nicholls of Birkenhead agreed, noting that ‘the availability ofexemplary damages has played a significant role in buttressing civil liberties, in claimsfor false imprisonment and wrongful arrest’.

32

He continued, ‘Exemplary damages,as a last resort, fill what otherwise would be a regrettable lacuna’.

33

The significanceof the decision in

Kuddus

should not be underestimated. Not only did their Lordshipsabolish the irrational and unworkable cause of action test, but they also explicitlyrecognised that ‘the availability of exemplary damages should be co-extensive withits rationale’.

34

Regrettably their Lordships stopped short of overruling Lord Devlin’scategories test.

This was in marked contrast to the approach taken by the courts in other commonlaw jurisdictions. Three years after Lord Devlin’s speech in

Rookes

, Spencer J in theSupreme Court of Canada declared that the jurisdiction to award punitive damagesin Canada was not limited to Lord Devlin’s three categories.

35

This judgment waslater confirmed by the Supreme Court in

Vorvis v Insurance Corporation of BritishColumbia

.

36

The High Court of Australia also rejected the categories test in

Uren vJohn Fairfax & Sons Pty

.

37

Taylor J observed that:

‘the limitation of [punitive damages] to the categories specified in

Rookes vBarnard

is not, in my view, justified either upon principle or upon authority, andthe adoption of those categories would not remove the suggested anomaly, but onthe contrary, introduce others.’

38

28.

Law Commission

Aggravated, Exemplary and Restitutionary Damages

(London: HMSO,1997) (Law Commission Report) para 5.49.

29.

[2002] 2 AC 122 at 145 per Lord Nicholls of Birkenhead.

30.

Ibid, at 157.

31.

Ibid, at 147.32. Ibid, at 145.33. Ibid, at 146.34. Ibid, at 145.35. McElroy v Cowper-Smith (1967) 62 DLR (2d) 65.36. (1989) 58 DLR (4th) 193 at 206 per McIntyre J, Beetz and Lamer JJ concurring.37. (1966) 117 CLR 118.38. Ibid, at 139.



In rejecting Lord Devlin’s three categories, the High Court reaffirmed its previousdecisions insisting that ‘exemplary damages are given only in cases of consciouswrongdoing in contumelious disregard of another’s rights’.39 The courts in NewZealand have also rejected the categories test,40 and award punitive damages for awide range of causes of action in both law and equity, including breach of confi-dence,41 and even negligence.42

2. PUNITIVE DAMAGES FOR BREACH OF CONTRACT IN ENGLISH LAW

As is apparent from the above analysis, the availability of punitive damages hasgenerated significant debate in this country and overseas. Until recently, the Englishcourts have taken a far more restrictive approach than their Commonwealth counter-parts. However, following the rejection of the cause of action test in Kuddus and thecourt’s re-examination of Lord Devlin’s categories, there are signs of a more expan-sive approach for the future.

Thus far, the analysis in this paper has focused entirely on punitive damages fortorts. This is for the simple reason that, historically, it has always been assumed thatpunitive damages are unavailable for breach of contract. Indeed, this remains the viewof Professor Treitel who insists that ‘punitive damages cannot be awarded in a purelycontractual action, since the object of such an action is not to punish the defendantbut to compensate the claimant’.43 Professor Beatson agrees, citing Addis v Gramo-phone Co44 as authority.45 Beatson’s reliance on Addis is somewhat surprising giventhat only two of the Law Lords directly addressed the issue of punitive damages andone of them, Lord Collins, was in dissent.

The case concerned an action for wrongful dismissal. The plaintiff was employedas the manager of the defendant’s business in Calcutta at a salary together withcommission on trade done. His contract entitled him to 6 months’ notice. The defen-dants gave him notice and immediately replaced him with another employee. Thisaction deprived the plaintiff of his right to act as manager during the notice periodand thus deprived him of the commission he would have earned. The plaintiff suedfor breach of contract. The House of Lords held that, although the plaintiff couldrecover a sum representing his salary for the period of notice and the commission hewould have earned during that period, he could not recover damages to compensatehim for the harsh manner in which he was dismissed. Lord James of Hereforddescribed such an award as damages based on ‘aggravation of the injury in

39. Whitefield v De Lauret & Co Ltd (1920) 29 CLR 71 at 77.40. Taylor v Beere [1982] 1 NZLR 81; Donselaar v Donselaar [1982] 1 NZLR 97; Danielsv Thompson [1998] 3 NZLR 22.41. Aquaculture Corp v New Zealand Green Mussel Co [1990] 3 NZLR 299.42. McLaren Transport Ltd v Somerville [1996] 3 NZLR 424; Coloca v BP Australia Ltd[1992] 2 VR 441; L v Robinson [2000] 3 NZLR 499; A v Bottrill [2002] UKPC 44, [2003]1 AC 449.43. G Treitel The Law of Contract (London: Sweet & Maxwell, 11th edn, 2003) p 935.44. [1909] AC 488.45. Beatson, above n 6, p 592. Beatson devotes a mere 150 words to exemplary damages. Asimilar view is expressed by Professor Bridge ‘Contractual damages for intangible loss: acomparative analysis’ (1984) 62 Can Bar Rev 323 at 365. See also Mayne & MacGregor onDamages, above n 7, p 200.



consequence of the manner of dismissal’.46 Today such damages would be properlylabelled aggravated damages because the manner of the breach aggravated the loss.As noted above, the House of Lords rightly distinguished between aggravated andpunitive damages in Rookes.47 The former are compensatory, while the latter are not.The decision in Addis was only authority for a proposition that aggravated damageswere unavailable for the manner in which the dismissal took place.48

Only Lord Atkinson and Lord Collins considered whether the plaintiff in Addiscould recover punitive damages. Lord Atkinson thought not. For him damages forbreach of contract are always compensatory:

‘I have always understood that damages for breach of contract were in thenature of compensation, not punishment . . . In many cases of breach of contractthere may be circumstances of malice, fraud, defamation, or violence, which wouldsustain an action of tort as an alternative remedy to an action for breach of contract.If one should select the former mode of redress, he may, no doubt, recoverexemplary damages, or what is sometimes styled vindictive damages; but if heshould choose to seek redress in the form of an action for breach of contract, helets in all the consequences of that form of action: Thorpe v Thorpe (1832) 3 B &Ad 580. One of these consequences is, I think, this: that he is to be paid adequatecompensation in money for the loss of that which he would have received had hiscontract been kept, and no more.’49

Lord Collins dissented in Addis. He cited a number of cases in which punitivedamages had been awarded for breach of contract,50 including one case in which theHouse of Lords had sanctioned punitive damages for breach of a commercial con-tract.51 His Lordship concluded:

‘I think we are not bound to disallow [punitive] damages in this case, and I amnot disposed, unless compelled by authority to do so, to curtail the power of thejury to exercise what is a salutary power, which has justified itself in practicalexperience, to redress wrongs for which there may be, as in this case, no otherremedy’.52

It is thus clear that, contrary to popular belief, Addis is not sound authority for theproposition that punitive damages are unavailable for breach of contract.

In the pages that follow, this paper will consider whether there is a logicallycoherent argument for retaining punitive damages in tort, while denying them for

46. [1909] AC 488 at 492.47. [1964] AC 1129 at 1229–1230 per Lord Devlin.48. Indeed, it was for this proposition that the case was cited and followed in Groom v Crocker[1939] 1 KB 194. In recent years, this ratio has been made subject to several exceptions; seeMalik v BCCI [1998] AC 20; Johnson v Gore Wood & Co [2002] 2 AC 1. Damages for non-pecuniary losses are now available in actions for breach of contract where the purpose of thecontract is to provide pleasure and enjoyment: Jarvis v Swan Tours [1973] QB 233; Jackson vHorizon Holidays [1975] 3 All ER 92; Farley v Skinner [2002] 2 AC 732.49. [1909] AC 488 at 494 and 496.50. Smith v Thompson (1849) 8 CB 44; Bell v Midland Ty Co (1861) 10 CB (NS) 287;Maw v Jones (1890) 25 QBD 107. His Lordship also cited Chitty on Contracts (London:Sweet & Maxwell, 14th edn, 1904).51. Lord Sondes v Fletcher (1822) 5 B & A 835.52. [1909] AC 488 at 500.



breach of contract. It will be shown that there is not. Next, a number of commonobjections to punitive damages will be examined and shown to be unpersuasive.Finally, the most common objection to punitive damages for breach of contract, theefficient breach theory, will be considered. It will be shown that, far from denyingpunitive damages, economic efficiency actually requires punitive damages in certainexceptional circumstances.

3. THE DISTINCTION BETWEEN CONTRACT AND TORT

In Addis, Lord Collins criticised Lord Atkinson’s attempt to draw a sharp distinctionbetween damages for breach of contract and damages for trespass and other torts. Heinsisted that breach of contract was itself an actionable wrong and could ‘be commit-ted with accompanying circumstances just as deserving the reprobation of a jury asthose which might accompany the commission of a trespass’.53 A number of counter-arguments have been advanced to contend that contractual obligations are somehowdifferent from other common law obligations, thus justifying punitive awards for thelatter but not for the former. It will be shown that none of these arguments stand upto scrutiny.

(a) The distinction between voluntary and imposed obligations

The classical distinction is that contractual obligations are voluntarily assumed, whiletortious obligations are imposed by the law. This distinction continues to exert con-siderable influence on the courts54 and legal scholars,55 and it is offered by ProfessorBurrows as an explanation for why punitive damages are unavailable for breach ofcontract:

‘[B]eing based on a voluntary undertaking, the courts ought to tailor the remedyin contract to what was voluntarily undertaken and should therefore be reluctantto invoke non-compensatory remedies, such as punitive and restitutionary dam-ages. In contrast, where the liability is purely imposed, as in tort, there need beno such reluctance’.56

This distinction is false. As Richard Craswell has noted: ‘[I]t is well understood thatthe distinction between contract and tort is not that simple . . . it does not line upneatly with any distinction between voluntary and involuntary obligation’.57 Indeed,it is clear that in both contract and tort, rights and obligations are to some extent

53. Ibid, at 498.54. Henderson v Merrett Syndicates Ltd [1995] 2 AC 145 at 194 per Lord Goff of Chieveley:‘. . . the tortious duty is imposed by the general law, and the contractual duty is attributable tothe will of the parties’. See also Astley v Austrust Ltd (1999) 197 CLR 1 at 36 per Gleeson CJ,McHugh, Gummow and Hayne JJ.55. PH Winfield The Province of Tort (Cambridge: Cambridge University Press, 1931) p 40;WR Anson The Principles of the English Law of Contract (Oxford: Clarendon Press, 1893)pt 1, para 2(2); H Beale (ed) Chitty on Contracts (London: Sweet & Maxwell, 1999) vol 1, p 31.56. A Burrows Understanding the Law of Obligations (Oxford: Hart Publishing, 1998) p 13.57. R Craswell ‘Against Fuller and Perdue’ (2000) 67 University of Chicago Law Review 99at 130.



shaped by the will and voluntary actions of the parties. Duties in tort can, in somecircumstances, be avoided by the use of exclusion clauses.58 Even when this is notpossible, it is still true to say that nearly every example of liability in tort arises inthe course of the performance of voluntary actions. As Professor Atiyah explains: ‘Aperson who negligently injures another while driving his car is voluntarily on theroad, voluntarily driving his car, and may be said to submit himself to the requirementof the law with as much or as little truth as the seller of goods’.59 So, to a certainextent, it can be said that duties in both contract and tort are voluntarily assumed.

Similarly, both contract and tort are concerned with what people do, as well aswhat they intend.60 This can be seen in the objective approach taken by the courtswhen considering issues of contract formation,61 contractual interpretation62 andimplication of terms.63 In all these areas, the courts heavily rely on the notion ofreasonableness, which necessarily involves the application of community standards.As Atiyah has observed, reasonableness appears to be a ‘basic community judgment,drawing its sustenance less from private autonomy and more from collective moralideas and even customary practices and redistributive ideologies’.64 Lord Steyn hasmade similar comments, extra judicially, observing that ‘reasonableness postulatescommunity values . . . it is concerned with contemporary standards not of moralphilosophers but of ordinary right thinking people’.65 In light of the modern relianceon the concept of reasonableness in contemporary contract law, it is extremelydifficult to maintain the classical distinction between voluntary contractual obliga-tions and involuntary tortious obligations.

Even if it were to be accepted that contractual obligations are voluntarily assumed,this proves nothing in regard to punitive damages since contracts very rarely makeprovision for the remedial consequences of breach. Indeed, in all but the mostsophisticated commercial contracts, the quantum of damages is left for the court todetermine in accordance with criteria external to the contract itself. It is thereforefictitious to suggest, as Professor Burrows does, that recourse to compensatory dam-ages is the voluntarily assumed position of the parties. Instead, it is the defaultremedial regime imposed on the parties by the law. The fiction is further compoundedby the rule against penalty clauses in English law. This rule prevents the parties from

58. Subject, of course, to the Unfair Contract Terms Act 1977.59. P Atiyah Essays on Contract (Oxford: Clarendon Press, 1986) p 41.60. See A Robertson ‘On the distinction between contract and tort’ in A Robertson (ed) TheLaw of Obligations: Connections and Boundaries (London: UCL Press, 2004) pp 91–106.61. Smith v Hughes (1871) LR 6 QB 597 at 607 per Blackburn J; Centrovincial Estates plcv Merchant Investors Assurance Company Ltd [1983] Com LR 158. See D Howarth ‘Themeaning of objectivity in contract’ (1984) 100 LQR 265.62. Reardon Smith Line Ltd v Hansen-Tangen [1976] 3 All ER 570 at 574 per Lord Wilber-force; Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 All ER98 at 114 per Lord Hoffmann. See A Kramer ‘Common sense principles of contract interpre-tation’ (2003) 23 OJLS 173 at 176–177; JM Perillo ‘The origins of the objective theory ofcontract formation and interpretation’ (2000) 69 Fordham Law Review 427.63. Shirlaw v Southern Foundries Ltd [1939] 2 KB 206; Crossley v Faithful & Could HoldingsLtd [2004] 4 All ER 447.64. Atiyah, above n 59, p 87.65. J Steyn ‘Contract law: fulfilling the reasonable expectations of honest men’ (1997) 113LQR 433 at 434.



voluntarily assuming a remedial regime that includes punitive damages.66 Surely sucha rule is irreconcilable with the assertion that recourse to compensation is the volun-tarily assumed position of the parties. Indeed, it could well be argued that the penaltyrule is irreconcilable with the court-imposed remedial regime now that it includesgain-based damages for breach of contract.

Professor Burrows suggests that, ‘where liability is purely imposed, as in tort’ thecourts need feel no reluctance about awarding punitive and restitutionary damages.67

But surely, the reverse is true. The closeness engendered by many contractual rela-tionships, as opposed to the arms’ length relationship owed to a neighbour under thelaw of tort, justifies the imposition of harsher penalties for breach of contract thanfor breach of tortious obligations. The same point was made by Wilson J (dissenting)in the Canadian Supreme Court decision of Vorvis v Insurance Corporation of BritishColumbia:

‘Nor would I draw the wide divergence that my colleague does between theduties owed to a neighbour under the law of tort and the duties that are breachedin contract by the type of flagrant and deliberate misconduct that would merit anaward of punitive damages. I agree with the appellant that it would be odd if thelaw required more from a stranger than from parties to a contract. The verycloseness engendered by some contractual relationships, particularly employer/employee relationships in which there is frequently a marked disparity of powerbetween the parties, seems to me to give added point to the duty of civilisedbehaviour.’68

The distinction between voluntary and imposed obligations is fictitious at root andutterly unconvincing as a justification for the court’s refusal to award punitivedamages for breach of contract.

(b) The distinction between fixed and discretionary damages

In the US Court of Appeals (Second Circuit) decision of Thyssen Inc v SS FortuneStar,69 Friendly J offered a second distinction between contract and tort that justifiedthe law’s refusal to award punitive damages for breach of contract. He argued that:

‘the law of contracts governs primarily commercial relationships, where theamount required to compensate for loss is easily fixed, in contrast to the law oftorts, which compensates for injury to personal interests that are more difficult tovalue, thus justifying noncompensatory recoveries.’70

There are two parts to this argument. First, it is asserted that contract loss is easilyfixed, while loss in tort is not; thus justifying punitive damages.71 It is doubtfulwhether this is still true. Damages for breach of contract are now available to

66. Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 87 perLord Dunedin; Jobson v Johnson [1989] 1 WLR 1026.67. Burrows, above n 56, p 13.68. (1989) 58 DLR (4th) 193 at 224.69. 777 F2d 57 (2nd Circ, 1985).70. Ibid, at 63.71. See Note, above n 7, at 531.



compensate a claimant for infringement of his non-commercial interests72 and for thepain and suffering caused by a breach.73 These measures of loss are not easily fixed,and even if they were, the point still fails to explain why, when other remedies areinadequate, the defendant should not be deterred from breaching his contract by anaward of punitive damages.74

The second part of the argument distinguishes contract from tort on the basis thatthe former governs primarily commercial relationships, while the latter governs pri-marily personal relationships. Since stability and predictability are of crucial impor-tance in commercial affairs, punitive damages should be denied for breach of contract.This argument has exerted considerable influence on the courts75 and legal scholars.76

Indeed, it was cited by Lord Atkinson as a reason for refusing punitive damages onthe facts of Addis.77 However, the argument is fundamentally flawed. First, it rests ona false dichotomy between contract and tort. It is simply not true that tort concernsitself with personal affairs, while contract concerns itself with commercial affairs.78

Secondly, even if it were true, the argument is far from compelling because it onlyapplies in relation to individuals whose plan of action includes the breach of theircommon-law obligations. As Mr McBride has noted, ‘we have no interest in thesepeople’s plans being undisrupted or in allowing them to anticipate what the cost ofbreaching their common-law obligations will be and to budget accordingly’.79 Finally,the commercial certainty argument does not even apply in relation to wilful contractbreakers. A wilful contract breaker may obtain at least the same level of predictabilityunder a rule allowing punitive damages by simply negotiating release from thepromisee. Indeed, negotiation offers the promissor even greater predictability sincehe will know exactly what he has to pay to be released from the contract, whereasthere is always some uncertainty in the assessment of damages.

(c) The distinction between private and public interests

A third distinction that is often drawn between contract and tort is that a breach ofcontract only affects the promisee, while a tort affects the public at large. But againthis distinction is false because it only applies to certain torts. It is true that the tortsof trespass and negligence affect the public at large because the public has an interestin the resources that are wasted. But there are other torts that only affect a single

72. Ruxley Electronics Ltd v Forsyth [1996] 1 AC 344.73. Farley v Skinner [2002] 2 AC 732; Hamilton Jones v David & Snape (A Firm) [2004] 1All ER 657; Jarvis v Swan Tours [1973] QB 233; Jackson v Horizon Holidays [1975] 3 AllER 92.74. See J Edelman ‘Exemplary damages for breach of contract’ (2001) 117 LQR 539 at 543;A Phang and PW Lee ‘Restitutionary and exemplary damages revisited’ (2003) 19 JCL 1 at 22.75. Addis v Gramophone Co [1909] AC 488; Foley v Interactive Data Corp (1988) 254 CalRptr 211 at 237–239.76. Washington, above n 8, at 365; J Fleming ‘Is wrongful dismissal a tort?’ (1990) 106 LQR8 at 11.77. [1909] AC 488 at 494 and 495.78. The growing number of economic torts bears testimony to the impact of tort on commer-cial affairs. Likewise it is undeniable that each one of us enters into numerous non-commercialcontracts each day.79. N McBride ‘Punitive damages’ in P Birks (ed) Wrongs and Remedies in the Twenty FirstCentury (Oxford: Clarendon Press, 1996) p 198.



person. For example, defamation only affects the person whose reputation isdefamed,80 and yet punitive damages may be awarded for the tort. This cannot beexplained on the ground of public interest.

Furthermore, it is clear that breach of contract can, in certain circumstances, affectthe public interest. For example, if the provider of fire-fighting services fails toprovide the contractually stipulated number of fire trucks this affects the publicinterest.81 Likewise, if an MI6 spy breaches his contract with the Crown and defectsto the USSR this affects the interests of all UK citizens.82 Thus, it is clear that thereis no straightforward distinction between the private interest in contract and the publicinterest in tort.

(d) The distinction between serious harm and trivial harm

It is sometimes contended that the harm done to the victim of a tort is more seriousthan the harm done to the victim of a breach of contract, thus justifying punitivedamages in the former but not in the latter.83 But is this true? In both contract andtort the harm suffered is economic. Of course, it is often argued that economic lossin tort is more serious because it is present loss, while the loss in contract is future.But again this is fallacious. The law of tort frequently compensates victims for futurelosses; damages for loss of future earnings being a classic example.84 In Thyssen,Friendly J suggested that the loss caused in tort was more serious than that in contractbecause breaches of contract do not cause ‘resentment and other mental or physicaldiscomfort’.85 The veracity of this statement is surely questionable in light of theavailability of contract damages for mental distress.86 Even if it were true, the argu-ment is tied to the retributive purpose of punitive damages and, as we will see, a keyfunction of punitive damages is deterrence.

In summary, it has been shown that none of the arguments advanced to distinguishcontractual obligations from tortious obligations are convincing. Thus, the historicalrefusal to award punitive damages for breach of contract while continuing to awardthem in the law of tort is indefensible. The point was succinctly stated by Linden Jin the Ontario High Court decision of Brown v Waterloo Regional Board of Commis-sioners of Police:

‘Although the general principle that punitive damages are not awarded forbreach of contract survives, there is no requirement that the general principle befollowed invariably . . . To tie the hands of the courts by denying them the powerto penalize defendants, who flout contract-law in a high-handed and outrageousfashion, is unwise and unnecessary. Punitive damage awards should be part of thejudicial arsenal in contract cases in the same way as they are in tort cases. I can

80. N McBride ‘A case for awarding punitive damages in response to deliberate breaches ofcontract’ (1995) 24 Anglo-American Law Review 369 at 382.81. City of New Orleans v Fireman’s Charitable Association 9 So 486 (1891).82. Attorney General v Blake [2001] 1 AC 268.83. See Law Commission Report, above n 28, para 5.72.84. McBride, above n 80, at 382.85. 777 F2d 57 at 63 (2nd Circ, 1985).86. Farley v Skinner [2002] 2 AC 732; Jarvis v Swan Tours [1973] QB 233; Jackson v HorizonHolidays [1975] 3 All ER 92.



see no sound reason to differentiate between them. Canadian courts, unlike Englishcourts, have retained their broad power to award punitive damages in tort cases.Thus, if a high-handed breach of contract also happens to amount to tortiousconduct, punitive damages would be awarded pursuant to tort theory. It is said thatif the conduct is purely a breach of contract and not tortious then no punitivedamages can be awarded, despite the callousness of the conduct. That makes nosense. It is wrong to treat one contract breach differently from another merelybecause one violates tort principles while the other does not. In recent years, theprinciples of damages in tort and contract are becoming more consistent. That isgood and should be encouraged. By allowing punitive damages for contract breach,that laudable trend will be advanced. Moreover, hopefully those who plan to breachcontracts in a callous fashion will think twice.’87

This passage is a powerful reaffirmation of Lord Collins’ view that the availabilityof punitive damages should be dependent on the substance of the defendant’s conductand not on the legal classification of the cause of action.88 This view has recentlyreceived endorsement from the House of Lords in its decision in Kuddus. LordNicholls of Birkenhead recognised that the availability of punitive damages shouldbe co-extensive with its rationale, that being the need to assuage the sense of outrageevoked by the defendant’s conduct.89 Contracts are frequently broken in circum-stances that evoke outrage and require deterrence. All too often compensatory dam-ages are inadequate for this purpose. Surely there is a strong argument that, in suchcases, punitive damages should be awarded to effect deterrence.

It is anticipated that many readers will find this suggestion unacceptable on theground that a promisee obtains no right to performance of his contract. This importantviewpoint will be critically examined in section five of this paper. First, it is necessaryto consider a few further objections to punitive damages.

4. FURTHER OBJECTIONS TO PUNITIVE DAMAGES

Unlike the objections considered in the previous section these objections do not relyon the making of a distinction between contractual obligations and other common-law obligations. Thus, they apply with equal force against punitive damages for torts.

(a) Civil and criminal function

The first and most common objection to punitive damages is that punishment is aninappropriate thing for a civil court to do; it fails to delineate a correct dichotomybetween criminal and civil functions.90 This is a very weak objection since it statesa conclusion without providing any supporting argument. As Mr McBride hasexplained:

‘what anyone is trying to do when they present an objection to awards ofpunitive damages is to show that it is inappropriate for the civil courts to concern

87. (1981) 136 DLR (3d) 49 at 65.88. [1909] AC 488 at 500.89. [2002] 2 AC 122 at 145.90. See Street, above n 3, p 33; McGregor on Damages, ibid, p 369; Beever, ibid; Todd, ibid.



themselves with punishing those who willingly breach their common law obliga-tions and have not been adequately punished by the criminal justice system for sodoing.’91

It is also clear that this objection fails to correspond with the reality of what the civilcourts are doing. If compensation for loss really was the sole function of the civilcourts then the present system of fault-based liability would be indefensible; indeed,logic would require it to be replaced by a no-fault system along the lines of the NewZealand Accident Compensation Scheme.92 Likewise, nominal and gain-based dam-ages would need to be abolished since they serve no compensatory function. However,in reality, these radical reforms are unlikely to take place because the function of thecivil courts does extend beyond mere compensation. Indeed, it is clear that evencompensatory awards serve non-compensatory functions by vindicating the strengthof the law and deterring wrongdoing.

The real problem with this objection is that it overlooks the true dividing linebetween the criminal law and the civil law. Civil actions concern the private enforce-ment of individual rights. Criminal actions concern the public attribution of blamefor offences against the state. It is here that the dividing line lies, not in the distinctionbetween punitive and compensatory functions. Indeed, the common law has neverrestricted punishment exclusively to the domain of the criminal law, or compensationexclusively to the domain of the civil law.93 Therefore, it is a serious error to confusepunitive damages with criminal punishment. As Lord Wilberforce succinctly observedin Broome v Cassell & Co:

‘It cannot lightly be taken for granted, even as a matter of theory, that thepurpose of the law of tort is compensation . . . or that there is something inappro-priate or illogical or anomalous (a question-begging word) in including a punitiveelement in civil damages, or, conversely, that the criminal law, rather than the civillaw, is in these cases the better instrument for conveying social disapproval, or forredressing a wrong to the social fabric, or that damages in any case can be brokendown into the two separate elements. As a matter of practice English law has notcommitted itself to any of these theories: it may have been wiser than it knew.’94

(b) Lack of criminal safeguards

The second objection flows out of the first. Those who are potentially subject tocriminal punishment are entitled to a number of procedural safeguards: the presump-tion of innocence, the right to non-incrimination, the rule against double jeopardy,the criminal burden of proof, etc. It is objected that those who have awards of punitivedamages made against them do not have the benefit of these protections.95 But thisobjection is dependent on the assumption that punitive damages are akin to criminalpunishment, which is not true. As was noted above, a crime is a wrong against societyrather than a wrong against an individual. As such, it carries with it a stigma that

91. McBride, above n 79, p 195.92. Injury Prevention, Rehabilitation and Compensation Act 2001 (NZ).93. M Graham ‘Exemplary and punitive damages in contract and tort’ [2002] LMCLQ 453at 459.94. [1972] AC 1027 at 1114.95. Broome v Cassell & Co [1972] AC 1027 at 1100 per Lord Morris of Borth-y-Gest.



punishment for a civil wrong does not. As HM Hart writes, ‘What distinguishes acriminal from a civil sanction and all that distinguishes it . . . is the judgment ofcommunity condemnation which accompanies and justifies its imposition’.96 Sincethis punishment is more severe than that for a civil wrong, the procedural safeguardsfor the defendant’s protection need to be more robust. This is not to say that thoseexposed to claims for punitive damages require no procedural safeguards;97 the pointis simply that they do not require the same procedural safeguards as the law providesto criminal defendants.

(c) Windfall

The objection that the claimant receives a windfall from the defendant is not restrictedto the award of punitive damages: the same objection can be made against disgorge-ment damages for wrongs.98 This argument has proved popular with the courts,99 butit is utterly unconvincing for the simple reason that it asserts the very thing it seeksto prove.100 Why is it wrong for an individual to be made wealthier through goodfortune? The windfall argument fundamentally fails to answer this all-importantquestion. It merely reasserts the dogma that damages must be restricted tocompensation.

Furthermore, as Professor Coote has shown, those who cite the windfall argumentagainst punitive damages exhibit merely a ‘selective concern’ since the common lawhas often been prepared to allow a degree of actual or apparent over-compensationin other contexts.101 For example, when a promissor breaches an entire contract, thepromisee ends up with both the price of the works (because he does not have to payfor it) and the partially completed works.102 Similarly, damages for loss of wagesinclude an element of windfall since they are not reduced for work not having beendone,103 or by the expenses which have not been incurred.104 Non-compensatorydamages are accepted in these contexts. Merely asserting that punitive damagesconstitute a ‘windfall’ does not provide a convincing argument against theiravailability.

96. HM Hart ‘The aims of the criminal law’ (1958) 23 Law and Contemporary Problems 401at 404.97. Some American states require evidence ‘beyond a reasonable doubt’ before punitivedamages are awarded (Gruntmeier v Mayrath Industries 841 F 2d 1037 (10th Cir, 1988)). Manyjurisdictions avoid double jeopardy by refusing to award punitive damages if the defendant hasalready been adequately punished for his conduct by the criminal justice system (Wirsing vSmith 70 A 906 (SC Penn, 1908); Watts v Leitch [1973] Tas SR 16). See the recent discussionof double jeopardy in the context of punitive damages in Borders (UK) Ltd v Commissionerof Police of the Metropolis [2005] EWCA Civ 197, [2005] The Times, April 15 at [41] per RixLJ, at [46] per May LJ.98. Attorney General v Blake, above n 82, at 273.99. This objection has frequently been noted by the courts; see Ruxley Electronics v Forsyth[1996] 1 AC 344 at 353 per Lord Bridge of Harwich; Tito v Waddell (No 2) [1977] Ch 146 at332 per Megarry VC.100. Dr Edelman labels the term a ‘pejorative syllogism’: Edelman, above n 74, at 542.101. B Coote ‘Contract damages, Ruxley, and the performance interest’ (1997) 56 CLJ 537 at548.102. Sumpter v Hedges [1898] 1 QB 673; Bolton v Mahadeva [1972] 1 WLR 1009.103. British Transport Commission v Gourley [1956] AC 185.104. Dewes v National Coal Board [1978] AC 1 at 12–13.



(d) Encourages litigiousness

A fourth objection to punitive damages is that they encourage litigation and discour-age settlement. One US judge has described punitive damages as ‘a golden carrot thatentices in court parties who might otherwise be inclined to resolve their differ-ences’.105 This is an incredibly complex issue that cannot be dealt with in detail here.A few observations will have to suffice.

First, the objection starts from the assumption that litigiousness is always badfor society. Litigiousness certainly can be a bad thing, particularly when it inhibitssocially beneficial activities, such as medical practice, or when it encourages litigationas a money-making activity. However, it would be wrong to suggest that litigiousnessis always socially detrimental. Litigiousness can be a good thing, especially whenlitigation is seen as a means of bringing people to account for their activities.106 Whichview of litigation people adopt depends on their pre-formed attitudes towards litiga-tion. These views are formed by environmental factors, such as personal experienceof litigation, experience of litigation on television or in films and books, advertise-ments for law firms, etc. Awards of punitive damages do not encourage people to takea particular view of litigation. Rather people’s pre-formed attitudes towards litigationdictate what awards of punitive damages will encourage them to do.107

Secondly, the objection assumes that the number of torts and contract breacheswould remain the same once punitive damages were allowed. In fact, making punitivedamages available would deter wrongdoing and encourage individuals to negotiaterelease from their common-law obligations. By decreasing the number of torts andcontract breaches, the threat of punitive damages should decrease the amount oflitigation.108

Thirdly, as the Law Commission has explained, the combined facts of the highcost of litigation, the prospect of costs orders, the moderate level of punitive awardsand the ability of the courts to strike out plainly ‘bad cases’, should all serve as apowerful impediment against excessive litigation.109

(e) Excessive and uncertain awards

The fifth objection is linked to the fourth: it is the fear that awards of punitive damageswill become excessive and uncertain. While it is true that awards of punitive damagescan and have been excessive and uncertain,110 this need not be so. The Law Commis-sion has recommended that the risk of excessive uncertainty can be minimised inthree ways:111

105. Oki Am Inc v Microtech International Inc 872 F 2d 312 at 315 (9th Circ, 1989) perKozinski J.106. McBride, above n 79, pp 196–197.107. Ibid, p 197.108. TA Diamond ‘The tort of bad faith breach of contract: when, if at all, should it be extendedbeyond insurance transactions?’ (1981) 64 Marq Law Rev 425 at 449; W Dodge ‘The case forpunitive damages in contracts’ (1999) 48 Duke Law Journal 629 at 691.109. Law Commission Report, above n 28, para 5.30.110. John v Mirror Group Newspapers Ltd. [1997] QB 587; Rantzen v Mirror Group News-papers [1994] QB 670.111. Law Commission Report, above n 28, para 5.32.



1. the allocation of the role of assessment to judges, rather than to juries – this couldbe accompanied by the establishment of fixed tariffs and the promulgation ofguideline judgments by the Court of Appeal;

2. a non-exhaustive list of factors that ought always to be considered by the courtswhen assessing punitive damages awards;

3. a guiding principle of ‘proportionality of punishment’.

It is submitted that the implementation of these recommendations, some of whichhave already been implemented in other jurisdictions,112 would greatly reduce the riskof excessive and uncertain awards.

5. THE NATURE OF CONTRACTUAL OBLIGATIONS

Undoubtedly, the most frequently cited argument against punitive damages for breachof contract is the efficient breach theory, which insists that contractual promises entailno obligation to perform. Oliver Wendell Holmes Jr remains the leading proponentof this view. His theory of liability was based on two core principles. First, the primarypurpose of the law is to ‘induce external conformity to rule’113 and, secondly, moralblameworthiness is not generally part of liability.114 Holmes wished to ‘wash withcynical acid’ all idealistic theories on the law. He suggested that all legal principlesshould be tested against ‘the bad man’s point of view’: what would a bad manunderstand the legal duty to mean? Looking at contracts in such a moral vacuum,Holmes insisted that the obligation to perform a contract was imaginary. Holmescompared the situation to that of committing a tort. He writes: ‘You commit a“contract” and are liable unless the event agreed upon, over which you have no, andnever have absolute, control,115 comes to pass’.116 Damages are thus an alternative toperformance.

Holmes was convinced that such a theory was essential to free the subject fromthe ‘superfluous theory that contract is a qualified subjection of one will to another,a kind of limited slavery’.117 He insisted that such an ad hoc servitude would exist ifthe law compelled men to perform their contracts. For Holmes, the obligation of acontract was a disjunctive one: the contractor being required either to perform thecontract or to undergo the stipulated penalties.118

112. The proportionality of punishment principle is applied in Canada; see Whiten v PilotInsurance Co (2002) 209 DLR (4th) 257 at 299–304 per Binnie J (McLachlin CJC, L’Heureux-Dubé, Gonthier, Major and Arbour JJ concurring).113. O Wendell Holmes Jr (edited by M de Wolfe Howe) The Common Law (Boston: HarvardUniversity Press, 1963) p 42. See also L Fuller and W Perdue ‘The reliance interest in contractdamages’ (1936) Yale LJ 352 at 373.114. See comments of Atiyah, above n 59, p 57.115. Holmes does not consider the doctrine of frustration, which relieves the oppressivenessof contractual obligations where performance is rendered impossible. See the Law Reform(Frustrated Contracts) Act 1943; BP Exploration Co (Libya) Ltd v Hunt (No 2) [1979] 1 WLR783.116. See M de Wolfe Howe (ed) Pollock-Holmes Letters (Cambridge: Cambridge UniversityPress, 1942) vol I, p 177.117. Wendell Holmes, above n 113, p 235.118. See Pollock-Holmes Letters, above n 116, vol I, p 177. Also see Wendell Holmes, aboven 113, p 235.



(a) The efficient breach theory

In the twentieth century, the legal economists developed Holmes’s views into a fullyformed theory of ‘efficient breach’. As Chief Judge Posner has put it: ‘[Holmes’sview] contains an important economic insight. In many cases it is uneconomical toinduce completion of performance of a contract after it has been broken’.119 SupposeA has entered into a contract with B for the sale of 1000 widgets, which only A cansupply. B agrees to pay £1000 for the widgets and will suffer £100 loss if they arenot supplied. Subsequently C offers to pay A £1500 for the widgets. The efficientbreach theory suggests that it is socially desirable for A to break his contract with Bin these circumstances and supply the widgets to C instead. This is because A willbe able to compensate B for his loss, while still making an additional £400 profit forhimself from the sale of the widgets to C. This is said to be ‘Pareto efficient’ becauseit causes a net increase in wealth and no person is made worse off by the transaction.120

The efficient breach theory seeks to provide an economic justification for the ideathat a party has the right to break a contract and choose to pay compensatory damagesinstead of rendering performance. If the argument were to be accepted, specificperformance, gain-based damages and punitive damages, all of which seek to protectthe performance interest of the contract by deterring breaches, would never be appro-priate. Indeed, Posner has argued that, in the above scenario, the contract breaker (B)should not be liable for punitive damages because ‘a penalty would deter efficient aswell as inefficient breaches, by making the cost of the breach to the contract breakergreater than the cost of the breach to the victim’.121 The efficient breach theory hasexerted considerable influence, particularly in the USA, where it has become thestandard explanation of why punitive damages are not awarded for breach ofcontract.122

(b) Objections to the efficient breach theory

In recent times the efficient breach theory has come under sustained criticism. Thereare a number of compelling reasons why it should be rejected.

(i) the theory is economically inefficient

First, the theory is not as economically efficient as its name might suggest. This isbecause it fails to distinguish between opportunistic and efficient breaches of contract.A breach is opportunistic if the breaching party attempts to get more than he bargainedfor at the expense of the non-breaching party. For example, if you supply me with

119. R Posner Economic Analysis of Law (New York: Aspen Publishers, 6th edn, 2003) p 119.120. Pareto efficiency can be contrasted with Kaldor-Hicks efficiency. A transaction is Kaldor-Hicks efficient if it increases net wealth, regardless of any change in wealth distribution. Inother words, it is Kaldor-Hicks efficient if the gainers gain more than the losers lose;see G Calabresi and AD Melamed ‘Property rules, liability rules and inalienability: one viewof the cathedral’ (1972) 85 HLR 1089 at 1094; R Cooter and T Ulen Law and Economics(Reading, MA: Addison-Wesley, 2nd edn, 1997).121. Posner, above n 119, p 128.122. See Restatement (Second) of Contracts (American Law Institute, 1981) reporter’s note at101.



1000 widgets and I withhold payment in bad faith in the hope that you will reducethe contract price then I am breaching the contract opportunistically.123 Such breachesare neither Pareto efficient nor Kaldor-Hicks efficient, since they do not increase thenet wealth of society; the breaching party merely gains at the expense of the non-breaching party.

Opportunistic behaviour does not create wealth; it simply redistributes wealth fromone party to another. And this redistribution actually consumes wealth because ‘poten-tial opportunists and victims expend resources perpetrating and protecting againstopportunism’.124 None of these expenditures increase the net wealth of society. There-fore, even Chief Judge Posner has recognised that, when a promissor breaches oppor-tunistically, ‘we might as well throw the book at the promissor . . . Such conduct hasno economic justification and ought simply to be deterred’.125 Thus, it is clear thatthe doctrine of efficient breach does not apply to all types of breach as Holmes andothers would suggest.126 Opportunistic behaviour is economically inefficient andshould be deterred.

Secondly, it is not even clear that the efficient breach doctrine applies to so-called‘efficient breaches’. This is because the theory fails to take into account transactioncosts. This point was made many years ago by Ronald Coase,127 who argued thatefficient breach was actually unnecessary since, where resources would be moreefficiently employed elsewhere, parties to a contract will compromise for release.This, it is argued, is more economically efficient, since the costs associated withrelease are less than those associated with breach.128

The proponents of the efficient breach theory disagree. Posner recognises that theparties are free to negotiate release from their obligations but he argues that ‘theadditional negotiation will not be costless’.129 Specifically, he asserts that negotiatingrelease will be more costly because it requires an additional transaction to achieveefficiency.130 If the widget manufacturer from the above example (A) is required tonegotiate release from B before selling to C, then two transactions are required. If Acan breach and pay damages to B, there is only one transaction between A and C.However, as Professor Friedmann has shown, this all depends on what transactionsyou count.131 He argues that, if A is allowed to break his contract with B, there willbe two transactions: one between A and C for the sale of the widgets and the othera dispute between A and B regarding the assessment of the damages.132 Friedmanncontinues:

123. For further examples of opportunistic breaches see Dodge, above n 108, at 657–662.Dodge provides illustrations of three types of opportunistic breach: pretextual termination ofcontract; stonewalling; and bad faith refusal to pay for services already performed.124. TJ Muris ‘Opportunistic behavior and the law of contracts’ (1981) 65 Minnesota LawReview 521 at 524.125. Posner, above n 119, p 118.126. Posner recognises that Holmes’s position is ‘overbroad’: ibid, p 119.127. R Coase ‘The problem of social cost’ (1960) 3 Journal of Law and Economics 1.128. IR Macneil ‘Efficient breach: circles in the sky’ (1982) 68 Virginia Law Review 947 at950–953; Adras Building Material Ltd v Harlow and Jones Gmbh [1995] RLR 235 at 272 perBarak J.129. Posner, above n 119, p 131.130. Ibid, p 120.131. D Friedmann ‘The efficient breach fallacy’ (1989) 18 JLS 1 at 6.132. Macneil, above n 128, at 954.



‘The implied assumption in Posner’s analysis is that the payment of damagesby A to B entails no transaction costs. This, however, is totally unrealistic. Thepayment of damages is hardly ever a standard transaction of the type the partiesare routinely engaged in. It is likely to follow protracted negotiations, or evenlitigation, over difficult questions of fact and law. Finally, the breach may lead toan expensive tort action for inducement of breach of contract by the promisee (B)against the third party (C). The claim may breed another transaction between Cand A regarding A’s liability for losses suffered by C.’133

Posner also argues that the costs of negotiation will be high because of the existenceof a ‘bilateral monopoly’, that is, neither party has a good alternative to dealing withthe other.134 This will encourage the parties to behave strategically, attempting toobtain as much as possible from each other. Posner even suggests that the parties‘may be so determined to engross the greater part of the potential profits from thetransaction that they never succeed in coming to terms’.135 This point is undoubtedlyover-stated. Although strategic behaviour may increase the costs of negotiation, it isgenerally agreed that it will not prevent parties from coming to terms.136 Furthermore,it is wrong to assume that the costs of breach and subsequent litigation will be anyless. Litigation carries its own costs that arise from the difficulty in coming toagreement about the compensation to be paid to the disappointed promisee. It isimportant to remember that litigation over damages, like negotiation for a release,occurs in a bilateral monopoly. Indeed, it has been said that litigation is the ultimatebilateral monopoly.137 It is therefore unsurprising to see that litigation over damagesis also affected by strategic behaviour. In addition, there are further costs associatedwith litigation, such as the cost of lawyers, the costs of going to court and the errorcosts of misdetermining damages.138 These costs outweigh the transaction costs asso-ciated with negotiation. This, in turn, decreases the net wealth of society and providesa compelling objection to the efficient breach theory.

(ii) the theory does not correspond to the present law

The second major criticism of the efficient breach theory is that it fails to correspondto the existing law. Holmes himself once said that ‘the first call of a theory of law isthat it should fit the facts’.139 The efficient breach theory manifestly fails to do this.140

For example, the right to specific performance is incompatible with the efficient

133. Friedmann, above n 131, at 6–7.134. Posner, above n 119, p 60; R O’Dair ‘Restitutionary damages for breach of contract andthe efficient breach: some reflections’ (1993) CLP 113 at 122.135. Posner, ibid, p 61.136. Dodge, above n 108, at 671–673. Dodge references the work of Hoffman and Spitzerwho conducted a series of tests with students to see if they would bargain to Pareto-optimalsolutions. In 20 experiments, 19 of the pairs bargained to the Pareto-optimal solution: EHoffman and ML Spitzer ‘The Coase Theorem: some experimental tests’ (1982) 25 Journal ofLaw and Economics 73 at 92.137. L Smith ‘Disgorgement of profits of breach of contract: property, contract and “efficientbreach” ’ (1995) 24 Canadian Business Law Journal 121 at 134; Macneil, above n 128, at 968.138. Dodge, above n 108, at 675. Posner himself recognises this: above n 119, p 119.139. Wendell Holmes, above n 113, p 167.140. See WW Buckland ‘The nature of contractual obligation’ (1944) 8 CLJ 247 at 249–251.



breach theory, since it compels the contract breaker to perform his primary obliga-tions.141 Holmes concedes that ‘it is true that in some instances equity does what iscalled compelling specific performance’.142 However, he argues that he is speakingonly about the common law and not equity. Furthermore, he argues that equity neverwholly compels specific performance.143 This reasoning is not really satisfactory sincea rigid bifurcation between law and equity is no longer accepted today.144 Further-more, whenever equity intervenes to enforce a contract, there is clearly an impliedduty to perform the contract.

In addition to the right to specific performance, there are a number of other contractrules that presuppose the existence of a duty to perform a contract, for example thetort of inducing a breach of contract.145 In the leading case of Lumley v Gye,146

Erle J declared: ‘He who maliciously procures a damage to another by violation ofhis right ought to be made to indemnify, and that whether he procures an actionablewrong or a breach of contract’.147 It is clear from this extract that Erle J viewedperformance of the contract as a right belonging to the plaintiff.148 If he did not thenhis comments make no sense because the plaintiff had not been deprived of anythingother than performance of the contract. Mr Lumley still had recourse against MissWagner on the contract and indeed he brought a separate action for this.149 Thus, theonly right that required indemnification from a third party was the right to perfor-mance, a right which the doctrine of efficient breach rejects.

English law also protects the performance of contracts by the right to repudiate acontract for breach of an essential term150 and, in the case of entire contracts, to refuseto pay anything for less than substantial performance.151 Similarly, where a claimanthas contracted for a special service but an inferior service has been delivered, theclaimant will only have to pay the value of the inferior service, even if he has notsuffered any loss.152 The efficient breach theory is irreconcilable with these legaldoctrines.

Finally, the efficient breach theory is inconsistent with what the courts claim to bedoing in contract cases.153 As Atiyah has noted:

141. J Edelman Gain-Based Damages (Oxford: Hart Publishing, 2002) p 164.142. Wendell Holmes, above n 113, p 236.143. Ibid.144. A Burrows ‘We do this at common law but that in equity’ (2002) 22 OJLS 1. Cf WMCGummow ‘Equity: too successful’ (2003) 77 ALJ 30.145. R Cunnington ‘Contract rights as property rights’ in Robertson, above n 60, pp 179–181; J Finnis Natural Law and Natural Rights (Oxford: Clarendon Press, 1980) p 324.146. (1853) 2 E & B 216.147. Ibid, at 233.148. Also see Gaudron J in Hill v Van Erp (1995) 188 CLR 159 at 197. Gaudron J said thatthe tort of interference with contractual rights ‘is no different from trespass, conversion, detinueand slander of title which, as I pointed out in Hawkins v Clayton (1988) 164 CLR 539, 594,are directly concerned with the protection of legal rights’.149. Lumley v Wagner (1852) 1 De GM & G 604.150. Bunge Corporation v Tradex [1981] 1 WLR 711. See Coote, above n 101, at 543.151. H Dakin & Co Ltd v Lee [1916] 1 KB 566; Bolton v Mahadeva [1972] 2 All ER 1322;Sumpter v Hedges [1898] 1 QB 673.152. White Arrow Express Ltd v Lamey’s Distributors Ltd [1995] CLC 1251.153. See Finnis, above n 145, p 323.



‘If judges constantly describe the duty to perform a contract in moral terms andif they constantly devise rules which they justify by praying in aid the principlethat a contract does impose a duty of performance, then the realist will not reallyunderstand how the law works if he ignores what the judges have to say.’154

(iii) the theory is anomalously applied

The third criticism of the efficient breach theory is that its proponents only ever seekto apply it to the law of contract. Since the theory is not predicated on the nature ofa contractual right, the theory should be equally applicable to property rights. How-ever, no one has ever made a serious argument for the adoption of a theory of ‘efficientconversion’ or ‘efficient theft’, even though the economic justification for thesetheories would be exactly the same.155

(iv) the theory fails to correspond to the expectations of contracting parties

The final line of criticism against the efficient breach theory is that it fails to corre-spond to the reasonable expectations of contracting parties. As Buckland once noted:‘One does not buy a right to damages, one buys a horse’.156 Similarly, Pollock hasobserved: ‘A man who bespeaks a coat of his tailor will scarcely be persuaded thathe is only betting with the tailor that such a coat will not be made and delivered withina certain time. What he wants and means to have is the coat, not an insurance againstnot having a coat’.157

In light of these objections, the efficient breach theory should be rejected, and withit the last remaining obstacle to punitive damages for breach of contract.

6. PUNITIVE DAMAGES: THE FUTURE

The purpose of this paper has been to provide a response to the main argumentslevelled against punitive damages for breach of contract. It has been shown that thehistorical refusal to award punitive damages for breach of contract, while continuingto award them in the law of tort, is indefensible. It now remains to be seen whetherthe English courts will be bold enough to recognise a role for punitive damages inthe law of contract.

Recent developments suggest that they might be. In A v Bottrill,158 the PrivyCouncil was asked to consider whether, under the law of New Zealand, punitivedamages were available for the tort of negligence. Lord Nicholls of Birkenheadreiterated the view he expressed in Kuddus that the availability of punitive damagesshould be co-extensive with its rationale.159 On this basis, he remarked that:‘ “Never say never” is a sound judicial admonition’.160 The question for us is: can

154. Atiyah, above n 59, p 61.155. Friedmann, above n 131, at 4.156. Buckland, above n 140, at 249–251.157. F Pollock Principles of Contract (London: Stevens, 5th edn, 1881) p 19.158. [2003] 1 AC 449.159. Ibid, at 455. See Kuddus, above n 26, at 145.160. [2003] 1 AC 449 at 456.



an award of punitive damages for breach of contract ever be co-extensive with itsrationale?

In Rookes, Lord Devlin suggested that a key function of punitive damages is thevindication of the strength of the law.161 This view was developed by Lord Nichollsof Birkenhead in Kuddus, where he remarked that ‘conscious wrongdoing by adefendant is sometimes so outrageous, his disregard of the plaintiff’s rights so con-tumelious, that something more [than compensatory damages] is needed to show thatthe law will not tolerate such behaviour’.162 In other words, for Lord Nicholls ofBirkenhead, punitive damages are sometimes necessary to fill what would otherwisebe a regrettable lacuna in the law.163

This ‘gap-filling’ role for non-compensatory damages had already been recognisedin the context of an action for breach of contract in Attorney General v Blake.164 Inthat case, their Lordships acknowledged that compensatory damages are not alwaysadequate to protect the plaintiff’s interest in performance of a contract.165 In mostcases, specific remedies, such as specific performance or an injunction, will beavailable.166 However, since those remedies are discretionary and not always avail-able, gain-based awards may be needed to protect the plaintiff’s interest in perfor-mance. Lord Nicholls of Birkenhead said:

‘In the same way as a plaintiff’s interest in performance of a contract mayrender it just and equitable for the court to make an order for specific performanceor grant an injunction, so the plaintiff’s interest in performance may make it justand equitable that the defendant should retain no benefit from his breach ofcontract.’167

Protection of the plaintiff’s interest in performance is important both for the individualconcerned and for society in general because of the commercial desirability ofpreserving the security of transactions. One of the central functions of the law ofcontract is to promote and facilitate security of transactions. This is of benefit tosociety as a whole because it provides a framework in which individuals can submittheir own will to the will of others, thus allowing them to benefit from coordinationand constructive action.168 The law of contract provides a facilitative institution forthis practice by protecting the performance interest of contracts between partiesthrough orders of specific performance and gain-based damages.169 These protectionsof the private performance interest all serve to achieve the greater societal goal ofpromoting and facilitating security of transactions. Without such security, contractingparties are not able to plan their future commercial activity. As a result, commercialactivity is stifled with significant social and economic repercussions. Far from being

161. [1964] AC 1129 at 1226 per Lord Devlin.162. [2002] 2 AC 122 at 144.163. Ibid, at 145. See also Borders, above n 97, at [42]–[43] per Rix LJ.164. [2001] 1 AC 268.165. Ibid, at 285.166. Ibid, at 282.167. Ibid, at 285 per Lord Nicholls of Birkenhead.168. See C Fried Contract as Promise (Cambridge, MA: Harvard University Press, 1981)p 7; Finnis, above n 145, p 325; J Danforth ‘Tortious interference with contract: a reassertionof society’s interest in commercial stability and contractual integrity’ (1981) 81 ColumbiaLaw Review 1491 at 1509 and 1511–1514.169. See I Jackman ‘Restitution for wrongs’ [1989] CLJ 302 at 318–321.



economically inefficient, protection of the performance interest of contracts by meansof non-compensatory remedies promotes economic efficiency by providing stabilityto economic markets and by minimising the transaction costs involved in contractualbreach.170

In Blake, the House of Lords recognised that gain-based damages have an impor-tant role to play in protecting the performance interest of contracts. In most cases,compensatory damages will provide sufficient protection, which is why such damagesremain the primary remedy for breach of contract in English law. However, there area number of well-recognised situations in which compensatory damages are regardedas inadequate.171 In such situations, specific performance or an injunction will usuallybe ordered. Due to the equitable nature of these remedies, they are sometimesunavailable for jurisdictional or discretionary reasons.172 In such situations, gain-based damages will be required. The most common measure of gain-based damagesis the Wrotham Park measure,173 a judicial assessment of the objective value receivedby the defendant as a consequence of his breach.174 This will usually be sufficient but,if it is not, damages measured on the Blake basis, requiring the defendant to disgorgeall the profits he has received from the breach,175 will be required.

In almost every case, one of these four remedies will be sufficient to protect theprivate performance interest of the contract and thus to protect the public interest insecurity of transactions. However, in exceptional cases, gain-based damages will beunavailable because the defendant has failed to make a profit from the breach.176 It isthe contention of this paper that, following the abolition of the ‘cause of action’ testin Kuddus, the next logical step would be to recognise the availability of punitivedamages in such cases. In recent times this proposition has become far less contro-versial as more and more jurists have come to acknowledge that the availability ofpunitive damages should be co-extensive with its rationale.177 On the question of when

170. F McChesney ‘Tortious interference with contract versus “efficient” breach: theory andempirical evidence’ (1999) 28 JLS 131 at 143–159; Friedmann, above n 131, at 7–8.171. Falcke v Gray (1859) 4 Drew 541; Decro-Wall International SA v Practitioners inMarketing Ltd [1971] 1 WLR 361; Beswick v Beswick [1968] AC 58.172. Cooperative Insurance v Argyll Stores (Holdings) Ltd [1998] AC 1; Johnson v Shrewsbury& Birmingham Rly (1853) 3 DM & G 914; Ryan v Mutual Tontine Westminster ChambersAssociation [1893] 1 Ch 116; Patel v Ali [1984] Ch 283; Kelsen v Imperial Tobacco Co Ltd[1957] 2 QB 334.173. Wrotham Park v Parkside Homes [1974] 1 WLR 789.174. See R Cunnington ‘Rock, restitution and disgorgement’ 1 JOR 46 at 49; J Edelman Gain-Based Damages (Oxford: Hart Publishing, 2002) p 66; Experience Hendrix LLC v PPXEnterprises Inc Edward Chalpin [2003] EWCA Civ 323, [2003] 1 All ER (Comm) 830 at [42]per Mance LJ.175. Esso Petroleum v Niad [2001] EWHC 458 (Ch) (unreported); Experience Hendrix LLC,above n 174, at [36]–[38] per Mance LJ.176. The residual value of punitive damages in such situations was recognised by Peter SmithJ in the context of a claim for breach of statutory duty in Design Progression Ltd v ThurloeProperties Ltd [2004] EWHC 324 (Ch), [2005] 1 WLR 1 at 29. On the facts of the case, therewas no claim for gain-based damages because the defendant had failed to succeed in his profit-making purpose.177. See particularly MacGregor on Damages (London: Sweet & Maxwell, 2003) p 373;E McKendrick Contract Law (London: Palgrave, 6th edn, 2005) p 404; M Chen-WishartContract Law (Oxford: Oxford University Press, 2005) p 530.



punitive damages should be awarded, the dicta of Lord Steyn in Blake should beheeded: such rules ‘are best hammered out on the anvil of concrete cases’.178

For such cases, it is sensible to look to Canada where punitive damages have beenawarded in contract cases for over 15 years.179 We will briefly examine two such cases.The first case, Royal Bank of Canada v W Got & Associate Electric Ltd,180 concernedthe appellant (Got) who had a revolving line of credit with Royal Bank of Canada.Got engaged in stalling tactics when the bank sought additional security for the debt.The bank then cut off contact with Got, brought a motion to appoint a receiver andsubsequently obtained a court approval for the sale of Got’s assets. The bank broughtan action to recover the debt and Got counterclaimed for damages for breach ofcontract and conversion, based on the bank’s lack of reasonable notice in demandingpayment and in appointing a receiver. On the counterclaim, the trial judge and theCourt of Appeal held that the bank failed to give Got reasonable time for paymentand had misled the court by tendering a misleading affidavit that created a ‘false airof urgency’. The bank was held liable in contract and tort, and Got was awardedcompensatory damages. In addition to this compensatory sum, Got was awardedpunitive damages because of the manner in which the tort and breach of contract werecommitted.

On appeal, the Supreme Court only considered the claim for breach of contractbecause it considered that the measure of damages would be the same for both thecontract action and the tort action. Of particular interest to us is the court’s discussionof the availability of punitive damages. McLachlin and Bastarache JJ delivered theunanimous judgment of the court. They acknowledged that deterrence did not, takenalone, justify punitive damages because deterrence could normally be achievedthrough an award of compensatory damages.181 However, on the facts of Got itself,the bank’s conduct was so sharp and such an affront to ‘the administration of justice’that the small award of compensatory damages was insufficient to deter the bank, andothers, from repeating the conduct.182 The bank had failed to make any ascertainableprofit from the breach and thus gain-based damages were unavailable. In the circum-stances, only punitive damages were sufficient to protect Got’s interest in performanceof the contract.

The facts of the second case, Whiten v Pilot Insurance Company,183 are quite tragic.Mrs Whiten’s home and its entire contents were destroyed by an overnight fire inmid-January when the temperature outside was minus 18 degrees Celsius. The familywere forced to flee the house wearing only their nightclothes. Mr Whiten gave hisslippers to his daughter to go for help and he suffered serious frostbite to his feet forwhich he was hospitalised and thereafter confined to a wheelchair. Pilot made a single$5000 payment for living expenses and covered the family’s rent for a couple of

178. [2001] 1 AC 268 at 291.179. Punitive damages were first awarded for breach of contract in Canada in Vorvis v Insur-ance Corporation of British Columbia (1989) 58 DLR (4th) 193. Until recently it had beenassumed that punitive damages were only available for breach of contract if the defendant’sconduct also constituted a tort for which punitive damages were available. However, thisinterpretation was rejected by the Supreme Court in Royal Bank of Canada v W Got & AssociateElectric Ltd (2000) 178 DLR (4th) 385.180. (2000) 178 DLR (4th) 385.181. Ibid, at 394.182. Ibid, at 395.183. (2002) 209 DLR (4th) 257.



months, but then ceased payment without giving notice to the Whitens. The insurerclaimed that the Whitens had burned their home and persisted in this allegation in ahostile and confrontational manner for over 2 years, despite the fact that the local firechief, Pilot’s own expert investigator and its initial investigator all concluded thatthere was no evidence of arson. Pilot’s action required Mrs Whiten to spend $320,000in legal costs to collect the $345,000 that was owed to her. At trial, the jury awardedcompensatory damages of $345,000 and punitive damages of $1,000,000 – the largestsuch sum ever awarded in Canada in a contract action. In the Ontario Court of Appeal,the punitive award was reduced to $100,000 on the ground that the lesser sum wouldbe sufficient to deter insurers form repeating such unacceptable behaviour in settlingclaims. The Supreme Court restored the jury’s award of $1,000,000.

Once again, it is the court’s discussion of the availability of punitive damages fora breach of contract that is of particular interest. Binnie J delivered the judgment ofthe court and provided an extensive review of punitive damages. He confirmed thatthe general objectives of punitive damages are ‘punishment, deterrence and denunci-ation (“proof of the detestation”)’.184 The test to be applied when considering whetherto award punitive damages is the ‘ “if but only if ” test ie, punitive damages shouldbe awarded “if but only if ” the compensatory award is insufficient’.185 Binnie J heldthat this test had been correctly applied by the jury. Compensatory damages weremanifestly insufficient to deter the defendant and others from repeating the sameoutrageous, opportunistic and exploitative conduct,186 and gain-based damages wereunavailable.

The decisions of the Supreme Court in Got and Whiten demonstrate the vital rolethat punitive damages could play in English contract law. The House of Lords hasalready accepted that gain-based damages are available to deter breaches of contractwhere other remedies are inadequate or unavailable.187 It is now time to recognisethat, in exceptional cases, where compensatory damages are inadequate and gain-based damages are unavailable, punitive damages should be awarded to deter outra-geous breaches of contract. Such damages have a key role to play in promoting andfacilitating security of transactions. As Linden J once said,188 they may yet prove tobe an essential ‘part of the judicial arsenal in contract cases’.

184. Ibid, at 277. Citing Wilkes v Wood (1763) Lofft 1, 98 ER 489 at 498–499 per Lord Pratt CJ.185. Ibid, at 305.186. Ibid, at 305–306. Whiten should be compared with Sylvan Lake Golf and Tennis ClubLtd v Performance Industries Ltd (2002) 209 DLR (4th) 318, where the Supreme Court declinedto award punitive damages because compensatory damages adequately achieved the objectivesof retribution, deterrence and denunciation.187. Attorney General v Blake [2001] 1 AC 268.188. Brown v Waterloo Regional Board of Commissioners of Police (1981) 136 DLR (3rd) 49at 65.

Documents

Should punitive damages be part of the judicial arsenal in contract cases?