Reed Smith Client Alerts

It is well-established that, when faced with a breach of contract, the innocent party must take reasonable steps to avoid or reduce the damage caused by the breach. A failure to do so interrupts the chain of causation and can, accordingly, reduce the damages which the innocent party can recover.

This note considers the circumstances in which it may be considered reasonable or unreasonable for an innocent party to reject an offer in mitigation made by the defaulting party.

This question is fundamental, not only where an innocent party is confronted with such an offer, but also where a party needs or wishes to avoid a contract, and is weighing up the risks of committing a deliberate default and then seeking to minimise its exposure with a well-deployed offer in mitigation.

Mitigation of damages – general principles

1. In a claim for damages for breach of contract, the starting point is that the non-defaulting party should be compensated for all of the pecuniary loss which is caused by the defaulting party’s breach.

2. It follows that:

a. any pecuniary loss which is not caused by the defaulting party’s breach is not recoverable; and

b. therefore, the defaulting party will not be liable for a pecuniary loss which could have been avoided by taking reasonable steps.1

3. What constitutes a ‘reasonable’ step will depend on what a hypothetical prudent person ought reasonably to have done in the same circumstances in order to avoid all or part of their loss, and is a matter of fact to be decided on a case-by-case basis.2 The burden will be on the defaulting party to demonstrate that the non-defaulting party failed to meet this standard.

Mitigation of damages – offers received from the defaulting party

4. This note focusses on the circumstances in which it will be considered ‘reasonable’ for the non-defaulting party to accept, or ‘unreasonable’ for the non-defaulting party to reject, an offer in mitigation made by the defaulting party. This is an important question for both parties because:

a. if the non-defaulting party fails to act reasonably, it may miss out on damages which would otherwise have been recoverable; and

b. the defaulting party may be able to deploy an offer in mitigation strategically in order to force the non-defaulting party into accepting a position which will reduce the defaulting party’s exposure (and, in turn, this may influence the defaulting party’s decision on whether to perform its obligations, or to take a calculated risk on falling into default).

5. In the leading case of Payzu v. Saunders3  it was held that in the context of a commercial contract, it will “generally” be reasonable for the non-defaulting party to accept an offer in mitigation received from the defaulting party. However, the court deliberately chose the word ‘generally’, since the statement cannot be construed as a rule, and indeed subsequent case law has confirmed that there are many situations when it will be reasonable for the non-defaulting party to reject such an offer.

6. Whilst what is reasonable turns on the specific facts of the case, the legal authorities nevertheless provide an insight into the types of factual circumstances which the courts of England and Wales may take into account.

7. From this, a number of factors can be identified which may be of use when making (in the case of the defaulting party) or assessing (in the case of the non-defaulting party) an offer in mitigation.

8. Please note that although the cases referred to in this note relate principally to the sale of goods and real property, some of the principles which emerge from the judgments can be applied by analogy to other categories of contract.