C Czarnikow Ltd v Koufos (The Heron II) [1967] UKHL 4 (17 October 1967)

A charterer's sugar cargo was delivered late, by which time the market price had fallen. The House of Lords held the shipowner liable for the loss of profit, clarifying the test for remoteness of damage in contract is what was reasonably contemplated as 'not unlikely' to result from the breach.

Facts

The respondents (charterers) chartered the appellant’s (shipowner’s) vessel, The Heron II, to transport a cargo of 3,000 tons of sugar from Constanza to Basrah. The ship was contractually due to proceed with all convenient speed. In breach of contract, the ship made unauthorised deviations, causing a delay of nine days. The shipowner was aware that the cargo was sugar and that Basrah was a major trading centre for it, but was unaware of the charterers’ specific intention to sell the sugar immediately upon arrival. During the nine-day delay, the market price for sugar in Basrah fell. The charterers sued the shipowner for the loss of profit they would have made had the sugar been delivered on time, calculated as the difference between the market price on the due date and the actual arrival date.

Issues

The central legal issue was the correct test for the remoteness of damage in the law of contract. The House of Lords had to determine the degree of probability or foreseeability required for a loss to be recoverable. Specifically, the court considered whether the test for contract damages was the same as the test in tort (reasonable foreseeability), or if it was a stricter test, and how the two limbs of the rule in Hadley v Baxendale (1854) 9 Exch 341 should be interpreted in a commercial context.

Judgment

The House of Lords unanimously dismissed the appeal, holding that the shipowner was liable for the loss caused by the fall in the market price of sugar. The judges agreed that the loss was not too remote. They clarified that the test for remoteness in contract is stricter than in tort. It is not enough that the loss is ‘reasonably foreseeable’; it must have been within the ‘reasonable contemplation’ of the parties at the time the contract was made as a ‘serious possibility’ or ‘not unlikely’ to occur in the event of a breach.

Lord Reid

Lord Reid undertook a detailed review of the authorities, distinguishing the tests for remoteness in tort and contract. He concluded that the contractual test requires a higher degree of likelihood than the tortious one. He formulated the principle as follows:

The crucial question is whether, on the information available to the defendant when the contract was made, he should, or the reasonable man in his position would, have realised that such loss was sufficiently likely to result from the breach of contract to make it proper that he should bear the loss. It is clear that the loss need not be a certainty, but I think that the parties must have contemplated that it was ‘not unlikely’.

He argued that a shipowner, aware he was carrying a commodity to a major market, must be presumed to know that market prices fluctuate and that a delay could cause financial loss to the owner of the goods. Therefore, the loss from a fall in market price was ‘not unlikely’.

Lord Pearce

Lord Pearce also emphasised the distinction between contract and tort. In contract, the parties have the opportunity to communicate special circumstances and allocate risk. He stated that the loss must be of a kind that a defendant ought to have realised was ‘a serious possibility’ or ‘a real danger’. He observed:

The defendant is not aamed with the knowledge of a likelihood of a particular loss, if it was only a slight possibility. He must be taken to have contemplated ‘not unlikely’ damage… Applying that test to the present case, the shipowner knew that he was carrying sugar to a large sugar market… He must, as a reasonable business man, have contemplated that the respondents would very likely sell the sugar on or shortly after its arrival.

Lord Upjohn

Lord Upjohn stressed that the court must place itself in the position of the parties at the time the contract was made. He focused on the knowledge attributable to the shipowner. This included not only the express terms but also the ‘market knowledge’ of a reasonable person in his position. He concluded that given the shipowner knew the nature of the cargo and the destination, the loss was foreseeable:

So the question in this case is whether a shipowner, who is fixed with knowledge that the cargo is sugar and that it is being shipped to a place, Basrah, which is a large market for sugar, should reasonably have contemplated that a delay in transit of some 9 or 10 days might result in a loss to the owner of the sugar because the market price of sugar in Basrah had fallen.

He found that such a loss was clearly within reasonable contemplation as a serious possibility.

Implications

The Heron II is a landmark case in contract law that definitively clarified the test for remoteness of damage. It established that the standard in contract is higher than the ‘reasonable foreseeability’ test used in tort negligence cases. For a loss to be recoverable for breach of contract, it must have been in the reasonable contemplation of the parties at the time of contracting as a ‘serious possibility’ or ‘not unlikely’ consequence of the breach. This decision provides greater commercial certainty by narrowing the scope of recoverable consequential losses to those that a party could realistically be expected to foresee and potentially factor into the contract price or insure against. It reinforced the principle from Hadley v Baxendale that liability is based on the presumed knowledge and contemplation of the parties when they formed their agreement.

Verdict: Appeal dismissed.

Source: C Czarnikow Ltd v Koufos (The Heron II) [1967] UKHL 4 (17 October 1967)