Waterlow & Sons Ltd v Banco de Portugal [1932] UKHL 1, [1932] AC 452

Facts

The appellants, Waterlow & Sons Ltd, were a firm of printers who held a contract with the respondent, the Bank of Portugal, for the exclusive printing of 500-escudo banknotes. A criminal mastermind, Marang, pretending to be an authorised agent of the Bank, deceived Waterlow into printing 580,000 additional banknotes of the same design. These unauthorised notes were physically indistinguishable from the genuine ones. Marang and his confederates successfully introduced these notes into circulation in Portugal, causing a significant inflation of the currency and a crisis of confidence in the nation’s monetary system. Faced with this crisis, the Bank of Portugal took the drastic step of withdrawing the entire issue of the affected 500-escudo notes from circulation and exchanging them, at face value, for new, genuine banknotes of a different design. The Bank then brought an action against Waterlow for breach of contract, claiming damages for the loss it had incurred.

Issues

The central legal issue before the House of Lords was the correct assessment of damages flowing from Waterlow’s breach of contract. The key questions were:

1. Causation and Remoteness: Was the loss suffered by the Bank a direct and natural consequence of Waterlow’s breach, or was the chain of causation broken by the intervening criminal act of Marang or the Bank’s own policy decision to withdraw the entire issue?
2. Mitigation of Loss: Was the Bank’s decision to withdraw all notes of that series—both genuine and fraudulent—and exchange them for new currency a reasonable step in mitigation of its loss? Waterlow argued that this action was extravagant and that a less costly alternative should have been pursued.
3. Measure of Damages: What was the correct principle for quantifying the Bank’s loss? Was it merely the cost of printing new banknotes to replace the fraudulent ones? Or was it the full face value (in sterling equivalent) of the fraudulent notes that the Bank was compelled to honour to maintain the integrity of its currency?

Judgment

The House of Lords, by a 4-1 majority (Lord Russell of Killowen dissenting), dismissed the appeal and found in favour of the Bank of Portugal, affirming the decision of the Court of Appeal.

The Majority Opinion

The majority (Lords Sankey, Warrington, Atkin, and Macmillan) held that the Bank had acted reasonably in a commercial emergency and was entitled to substantial damages. The reasoning was based on principles of mitigation, causation, and the assessment of loss.

Reasonableness of Mitigation

The Court established that a party faced with a breach is not required to act with perfect wisdom; their actions in mitigation must only be reasonable in the circumstances. The Bank’s decision to withdraw the entire issue was deemed a prudent and necessary step to restore public confidence, which was its primary duty as a central bank. Lord Macmillan provided the classic formulation of this principle:

Where the sufferer from a breach of contract finds himself in consequence of that breach placed in a position of embarrassment the measures which he may be driven to adopt in order to extricate himself ought not to be weighed in nice scales at the instance of the party whose breach of contract has occasioned the difficulty.

The court concluded that the Bank’s action was a direct and justifiable response to the situation created by Waterlow’s breach.

Measure of Damages

The majority rejected the argument that damages should be limited to the printing cost of the notes. The true loss was the liability the Bank was forced to assume to honour the fraudulent but indistinguishable notes. By exchanging the spurious notes for good currency, the Bank incurred a loss equivalent to the face value of those notes. As Lord Sankey, LC, stated:

… the Bank is entitled to the cost of replacing the spurious notes by genuine notes of a new issue, i.e., the cost of providing currency to the face value of the spurious notes. This sum is the loss which they suffered as a direct consequence of the Appellants’ breach of their contract.

The loss was quantified as the sterling equivalent of the face value of the 580,000 fraudulent notes at the date they were exchanged.

The Dissenting Opinion

Lord Russell of Killowen delivered a powerful dissent. He argued that the majority’s assessment of damages was fundamentally flawed. In his view, the Bank’s liability was always to honour all its notes in circulation. By exchanging old notes (both good and bad) for new notes, the Bank was simply swapping one form of liability for another. He contended that the Bank had not actually ‘lost’ the face value of the notes; it had merely incurred the cost of a new printing. He argued that the true measure of damage should have been the cost of printing replacement notes and any proven damage to the Bank’s business or reputation, which he felt had not been established. He stated:

… the damages must be such as flow naturally from the breach, or such as may reasonably be supposed to have been in the contemplation of the parties. … It appears to me that the Bank have failed to prove any damage, beyond the expense to which they were put in providing the substituted issue of notes …

Implications

Waterlow & Sons Ltd v Banco de Portugal is a landmark decision in contract law, particularly concerning the principles of mitigation and the assessment of damages. Its primary importance lies in the flexible and pragmatic standard it sets for the duty to mitigate. It confirms that a court will not judge a plaintiff’s mitigating actions with the benefit of hindsight, provided they were reasonable at the time. The case underscores that the defendant who caused the breach cannot complain if the plaintiff, in a difficult position, takes commercially reasonable steps to protect its interests, even if those steps prove costly. Furthermore, it provides a crucial example of how damages can be assessed in complex situations where the loss goes beyond simple replacement cost and involves protecting intangible assets like public confidence and commercial reputation.

Verdict: The appeal was dismissed with costs.