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Mitigation of loss: Thai Airways v KI Holdings

The doctrine of mitigation of loss was considered and clarified in a judgement earlier this year concerning a dispute between a commercial airline ‘Thai’ and a Japanese aircraft seat manufacturer ‘Koito’. The question was whether the quantum of damages should be assessed against both the costs and benefits arising from the mitigating steps taken by the claimant, as a result of the defendant’s breach.

In the event of breach of contract, the three elements comprising the doctrine of mitigation can be summarised as follows:

  1. The claimant must take all reasonable steps to mitigate its loss and cannot seek damages for loss that it could have avoided;
  2. The claimant can recover losses for steps taken in mitigating its loss;
  3. Where the steps taken to mitigate loss are successful, the defendant is entitled to the benefit arising from the claimant’s action (in quantifying damages).

The breach, consequence and mitigating action

Koito had agreed to supply aeroplane seats to Thai. Thai had also purchased five new aircraft from a separate third party. Thai planned to install the seats into the new aircraft.

Koito failed to deliver the seats to Thai in breach of contract. Some seats were delivered late and some seats were not delivered at all. Thai had already accepted delivery of the new aircraft from the third party. As a consequence of Koito’s breach, Thai was unable to install the aircraft with seating. Thai had no choice but to store the new aircraft for 18 months, until alternative seats were sourced from another supplier. This meant that there was a gap in Thai’s aircraft fleet. To account for the inoperative aircraft, Thai leased three additional aircraft from another third party for a period of three years and at a cost just shy of $162million.

The claim

Thai brought proceedings against Koito for breach of contract, with respect to three separate contracts made with Koito. Koito accepted that it had breached the terms of these contracts in its failure to deliver the seats to Thai. Thai sought damages for costs incurred in mitigating its loss, particularly in relation to the cost of leasing the aircraft. The judge, Leggatt J, was concerned with the measure of damages appropriately recoverable by Thai.

Thai claimed that, when calculating the damages, any benefit that had arisen as a result of purchasing the aircraft and alternative seating, as a consequence of Koito’s breach, should not be taken into account. Thai claimed that this was the only reasonably viable option available to Thai to mitigate its loss. Any benefits were not ‘chosen’ by Thai.

Koito contended that benefits do need to be taken into account when quantifying damages and cited British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673. In summary, this case set a precedent that benefits that arise from the mitigating action of the claimant are brought into account, even when the action was not reasonably expected to mitigate loss.

Thai submitted that, if benefits are held to be taken into account, the burden of proving and quantifying the benefits, which arise from the mitigating action, is on the defendant.

The decision

Leggatt J held that, although leasing the aircraft was the only reasonable step that Thai could have taken to mitigate its loss, benefits arising as a result of leasing the aircraft would still be taken into account. Although a claimant is entitled to an award for damages to compensate the loss caused by a defendant’s breach, a general principle of the doctrine of mitigation of loss is that the defendant is credited for any benefit arising from the claimant’s action and is therefore liable only for any actual loss. It is a balancing exercise between the loss suffered by the claimant as a result of the defendant’s breach and the benefits accruing to the claimant as a result of the mitigating action.

Although this may initially appear to work in Koito’s favour, Leggatt J also held that the burden of proving any monetary benefit accruing from the mitigation is placed on the defendant. Quoting Hand CJ in L Albert & Son v Armstrong Rubber Co 178 F 2d 182 (1949), Leggatt J agreed with the assertion that “It is often very hard to learn what the value of performance would have been and it is a common expedient…in such situations to put peril of the answer upon that party who by his wrong has made the issue relevant to the rights of the other.” The judge was aware that attempting to estimate what Thai’s financial position would have been if the breach had not occurred would be a complicated task, but that it was also unjust to place this burden on Thai.

The award

Koito accepted that Thai’s actions constituted reasonable mitigation in response to the breach. However, Thai had leased the aircraft for a period of three years, when Koito’s breach only prevented Thai from using the aircraft for 18 months. Therefore, the third year of the lease was not considered to be a reasonable step for Thai to take in mitigating its loss, but was rather an independent business decision. The cost incurred for the third year was disregarded for the purposes of quantifying damages.

It followed that the burden of proof was on Koito to demonstrate that Thai had received monetary benefit from leasing the aircraft for the first two years. The complexity involved in calculating this was made very apparent. Koito had to show how the profit generated by Thai from the use of the leased aircraft would have exceeded any profit that Thai would have made if: first, Koito had not delayed the delivery of the seats, so that the new aircraft could have been refurbished; and, secondly, Thai had not leased the additional aircraft for two years to mitigate Koito’s delay.

Koito failed to show that the benefits arising from mitigation off-set the losses arising from the breach. Thai was entitled to recover $107million from Koito, with respect to the leased aircraft.

This judgment demonstrates the importance of looking into the steps taken by the claimant and whether or not these actions are a reasonable response to the defendant’s breach. If the claimant has responded reasonably, the costs and benefits incurred can be included in the calculation of damages. If the claimant has not responded reasonably, the calculation for damages will be assessed as if the claimant had acted reasonably. Parties can derive value from this judgment in making decisions about how to respond to breach of contract.

If you want to know more about this case or about mitigation of loss for breach of contract, please speak to Rebecca Fleming, trainee, Julian Johnstone, Partner or Charles Spragge, Partner, in Druces LLP’s Litigation and Dispute Resolution practice.