Posted on March 5, 2023 by Stuart Simington and Dimitrious Havadjia
Council liable for reliance expenditures even where plaintiff went bust
Signing a contract – in this case, an agreement for lease of land at an airport – is a commitment by both parties to comply with the obligations set out in that document.
Sometimes things do not go to plan and the contract is breached. An innocent party can commence proceedings to seek damages to put themselves in the position as if the contract had been performed without breach.
Sometimes damages are easy to calculate. However, sometimes it is more difficult. Where a contract for a mining lease is breached, but the value of the minerals that could have been mined is unknown, the miner may be able to claim the costs of buying the mining equipment as “reliance damages”. Reliance damages flow from the fact that there is a rebuttable presumption that a party will not intentionally enter into a contract where it will make a loss on its reliance expenditures. Therefore, the innocent party should have its expenses reimbursed in these situations.
This principle was reaffirmed in a recent decision of the NSW Court of Appeal where Cessnock City Council was held liable for reliance damages of over $3 million dollars, despite the fact that the innocent party’s business had been wound up without ever turning a profit.
We previously blogged about the Supreme Court decision in this matter with respect to whether the Council had exercised reasonable endeavours to comply with the agreement. This issue was not raised in the appeal and provides useful background to this blog.
Background of the case
Cutty Sark (the earlier entity of 123 259 932 Pty Ltd) and the Council agreed to a 30-year lease of a section of Cessnock airport in 2007.
A precondition of the agreement for lease was that Council would take all reasonable action to obtain approval for the subdivision of the airport by 30 September 2011 to formally create the parcel of land to which the lease would apply.
The Council intended to develop the airport precinct, and the subdivision was one step in that process.
While waiting for the subdivision to be registered, Cutty Sark and the Council entered into a licence agreement on the same terms as the agreement for lease.
In 2009, Cutty Sark constructed an aeroplane hangar on the site costing it $3,697,234.41.
In mid 2011, however, the Council advised that it would not be proceeding with the subdivision because it could not afford to pay the costs of the sewerage work associated with the subdivision.
Thus, the agreement for the lease was breached.
The Council offered to continue the licence but Cutty Sark declined. Due to financial downturn, Cutty Sark ceased occupation of the hangar in in mid 2012 and was wound up in 2015. Per the terms of the licence, the Council became the owner of the hangar for $1 due to Cutty Sark becoming insolvent.
In summary, the trial judge found that while the Council had breached the contract by not taking all reasonable action to approve the subdivision, Cutty Sark was not entitled to reliance damages because it was unable to prove that it would have recouped its expenses.
The NSW Court of Appeal rejected the Supreme Court decision, instead finding that the Council was liable to pay Cutty Sark the construction costs of the hangar and Cutty Sark’s costs in the proceedings.
The full judgement is available here: 123 259 932 Pty Ltd v Cessnock City Council – NSW Caselaw.
The Court made Orders on 16 March 2023, as agreed by the parties, giving effect to the judgment.
Since then, Council has made an application for special leave to appeal to the High Court and sought a stay to Orders made on 16 March 2023 until determination of the application. The court granted the stay on 9 May 2023 (you can read the full judgment here).
When does the presumption that expenses will be recouped apply?
The trial judge was unwilling to grant Cutty Sark its costs of construction of the hangar because the evidence indicated that Cutty Sark would never have recouped its costs, and therefore the Council should not be liable for Cutty Sark’s “commercial risk”.
However, the NSW Court of Appeal rejected the approach finding instead that the presumption that a party would have recouped its reliance expenditures will apply in all cases when there is no evidence to the contrary. It was not as the trial judge had held, a precondition to the presumption arising that the plaintiff first establish that it is “impossible” to prove expectation damages, let alone that it be impossible to prove that it would not have recouped its expenditure.
What expenses can be claimed?
The expenses that can be claimed as reliance damages do not need to be directly related to the performance of the contract, as long as they were reasonably incurred in reliance on the contract.
In this case, although the lease did not require the building of the hangar, the Court found that it was reasonable and contemplated by the parties, and the presumption could be applied to the construction costs associated with the hangar. This was partly because there had been discussions between the parties as to the construction of the hangar prior to the signing of the lease, which meant that the Council knew of Cutty Sark’s intention to build it when entering into the lease.
What will rebut the presumption?
Once the presumption that expenses will be recouped applies, the burden shifts to the defendant to rebut or disprove it.
In this matter, despite:
- Cutty Sark’s operations already being unprofitable prior to the Council confirming that it would not proceed with the subdivision; and
- Cutty Sark refusing to enter into an ongoing licence with substantially the same terms as the lease,
the Court was not satisfied that over the term of the 30-year lease (had it been granted) that it had been proven that Cutty Sark would not have recouped its costs.
Cutty Sark as the innocent party was entitled to insist on its contractual rights, or damages for breach, rather than accepting the inferior alternative proposal offered by the Council. The rejection of the licence provided no reasonable basis for an inference that Cutty Sark would not have resumed operations and ultimately recouped its expenditure, had it been granted the proposed lease.
In circumstances where what would have transpired had the Council performed its obligations was speculative, but there was a high degree of likelihood (given that Council was also the consent authority) that the subdivision would be registered, and at least a prospect of further development of the airport producing a more conducive commercial environment for Cutty Sark’s business operations sometime over the ensuing thirty years of the lease, the Council could not and did not show that Cutty Sark would not over a 30-year lease have recouped its expenditure.
Therefore, where there is some uncertainty as to if the expenses would have been recouped, the Court will favour a plaintiff where the presumption applies and it is not rebutted by the defendant.
In many situations, a plaintiff will be able to point to loss of bargain damages and sue on that basis.
However, even in situations where a venture appears to have been unprofitable, a breaching party may still be liable for significant sums in terms of reliance expenditures if it cannot positively establish the unprofitability.
The damages awarded in this case were more than four times what it would have cost the Council to update the sewerage system and proceed with the subdivision.
Councils and regulatory bodies are often accountable to many different stakeholders. Plans can change, as occurred in this case once the costing of the subdivision was complete.
It is vital that authorities appreciate the gravity of the obligations taken on when signing contracts. This includes consideration of what costs each party might incur in reliance even before any profits are made.
If you wish to discuss any aspect of this article, please contact Stuart Simington on 02 8235 9704 or Dimitrious Havadjia on 02 8235 9724.