Sale of Goods contracts: Seller’s liability for subcontracts

The basic premise of a sale of goods contract is very simple: a seller contracts to sell goods to a buyer. But what happens if a seller is in breach of its obligations to the buyer?

Where the seller fails to deliver, or delivers late, or delivers defective goods, the remedies of the buyer are set out in sections 51-53 of the Sales of Goods Act 1979. The legal presumption is that the buyer will go into the market and attempt to source the goods from an alternative provider and recover any difference in price from the seller. Where a buyer is unable to source the goods from an alternative source, he is entitled to recover losses that occur directly and naturally from the breach.

The buyer’s losses are likely to include a claim for loss of profit. Lost profit is usually recoverable when it results from business interruption, namely the inability of the buyer to use the goods and the resultant impact on its trading, such as production downtime. But what about where the buyer is not the end user of the goods, but a second-hand dealer who has contracted to re-sell the goods to a subsequent buyer at a profit? Can the buyer recover profit lost on the subcontract for re-sale, or is this loss too remote, in the sense that it does not arise directly and naturally from the breach?

The wealth of case law derives from the shipping industry, where it is accepted industry practice that the appropriate measure of loss is as set out in section 51 of the Sales of Goods Act and that losses on subcontracts are not recoverable.

However, more recent cases have examined the issue and, if the door to recovery of such losses has not been opened, it has at least been left slightly ajar.

Can a buyer recover the profit lost on a subcontract that it cannot perform due to the breach of the seller?

For a seller to be liable for profits lost on a subcontract for the re-sale of goods, the buyer must establish that the seller assumed responsibility for such losses at the time of the main contract. In essence, the buyer will need to prove some special knowledge on the part of the seller, and that one of the following applies:

• The seller knew of the subcontract at the time of the main contract with the buyer (this will be unlikely on the facts, as this will require the buyer to conclude a subcontract prior to the conclusion of the main contract). If the buyer can establish that the seller had particular knowledge of the subcontract and its terms, then it may recover the profit actually lost on the subcontract.
• The seller knew that it was probable that the buyer would re-sell the goods, perhaps because the seller knew that it was trading with a dealer rather than an end-user. The lost profit will be calculated by reference to average trading margins in the buyer’s business, rather than the specific margin agreed on the subcontract.
• The seller had contracted to sell specific goods that could not be replaced. Such goods must be so specific that it would be impossible for the buyer to replace them, for example the contract is for a quantity of goods with specified serial numbers.

How remote can the loss of profit be?

What about profits lost on sub-subcontracts? Would a buyer succeed on a claim for damages from the seller, where the buyer is on the receiving end of a claim by the party with whom the buyer subcontracted? Probably not - such losses are likely to be too remote. The buyer would need to establish that, at the time of the main contract, the seller had sufficient knowledge of the supply chain that it had assumed responsibility for such losses in the event of a breach. In this case, the buyer would be ill-advised to settle a claim by a sub-buyer in the hope that it will recover from the seller.

What are the implications for my business?

If you are entering a contract to buy a valuable asset, you should consider notifying the seller in writing of your intention to deal further with the asset or otherwise to put it to any use other than the “normal” use of an asset of that type. This should make it easier to recover from the seller any loss arising from late or non-delivery, or as a result of the asset proving defective or unsuitable.

It may not, of course, in all cases be in your business interests to divulge to the seller information of this sort, and it may be necessary to balance the need for confidentiality against the right of recourse to your seller.