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Focus: Damages – cost of reinstatement preferred over diminution in value

14 April 2009

In brief: In a recent decision, the High Court of Australia has found that in determining the appropriate amount of damages for breach of a lease, the cost of rectification is to be preferred over the diminution in value. The court stated that cost of rectification will only be considered an unreasonable basis for the calculation of damages in fairly exceptional circumstances. Partner Leighton O'Brien (view CV) and Lawyer Alicia Moody look at the decision.

• Background
• The decision
• Conclusion

Background

Tabcorp Holdings Ltd was a tenant in an office building owned and leased by Bowen Investments Pty Ltd. By clause 2.13 of the lease, Tabcorp had covenanted not to make any substantial alteration to the premises without the consent of Bowen Investments.

The leased premises contained a foyer constructed of special materials, including San Francisco Green granite, Canberra York Grey granite and sequence-matched crown-cut American cherry. The dispute arose when a director of Bowen Investments discovered that Tabcorp had badly damaged the foyer and removed large sections of it without permission, in order to install a new foyer. Despite the protests of Bowen Investments, Tabcorp continued to remove the existing foyer and substitute a new foyer until the renovation was complete.

The issue for the court to determine was whether Bowen Investments was entitled to the cost of rectification for restitution of the original foyer, or whether the amount of damages for breach of clause 2.13 was limited to the diminution in value of the premises.

The decision

The court held that Bowen Investments was entitled to the cost of rectification of the loss of rent while rectification was being carried out.

The court considered the operation of clause 2.13 in light of the 'ruling principle' for assessing damages for breach of contract: that the innocent party be placed as far as is possible in the same situation as if the contract had been performed (Robinson v Harman (1848) 1 Exch 850).

The court looked also to the case of Bellgrove v Eldridge (1954) 90 CLR 613, which examined the appropriate measure for determining damages in the context of defective building works. In Bellgrove, their Honours held that the cost of rectification was the appropriate measure of damages to restore the building to the condition it would have been in had the contract been performed. The court reasoned that since the contract entitled the respondent to have a building erected upon her land in accordance with its terms, the appellant's failure to perform his obligation under the contract led to the respondent suffering loss that could only be measured by ascertaining the cost of rectification.

This principal was not, however, without qualification. The court in Bellgrove stated that the work undertaken to rectify the premises must be both necessary to restore the premises to that state which was contracted for, and reasonable, in order for the cost of rectification principal to apply

In this instance, the court held that the requirement of reasonableness would not be satisfied, 'only...[in] fairly exceptional circumstances'.¹ Their Honours looked to the example of unreasonableness given in Bellgrove, where the breach complained of is the use of better materials than those originally contracted for, to cite with approval what was said by Justice Oliver in Radford v De Froberville [1977] 1 WLR 1262 at 1270: that the application of the cost of restitution method will be unreasonable (and the diminution in value method preferred) only where the innocent party is using a technical breach to obtain an uncovenanted profit. It would be unreasonable to demand the better quality construction be demolished and costs be paid to reinstate the lesser quality materials. It would not, however, be unreasonable to demand reinstatement merely because the cost of reinstatement was greater than the costs recoverable on a diminution in value assessment.

Conclusion

The fact that clause 2.13 was expressed as an express negative covenant gave Bowen Investments the right to obtain an interlocutory negative injunction, had it been aware of Tabcorp's intentions. It was not, so its right to equitable relief could only be secured through the payment of reinstatement costs. It was not for Tabcorp to argue that the payment of diminution costs should be sufficient because it would return the landlord to as good a financial position as that which was contracted for. This argument was criticised by the court because it ignored the existence of equitable remedies contracted for by the landlord, and sought to impose a 'doctrine of efficient breach' where the breach would be tolerated so long as damages sufficient to compensate the innocent party for any financial loss were paid.

If you have any queries about this or any other construction issue, please contact us.

Footnotes

1. Tabcorp Holdings Ltd v Bowen Investments Pty Ltd [2009] HCA 8 at 17.

Published 14 April 2009

For further information, please contact:

• Leighton O'BrienPartner, Sydney
  Ph: +61 2 9230 4205
  Leighton.Obrien@aar.com.au
• Nick Rudge Partner, Melbourne
  Ph: +61 3 9613 8544
  Nick.Rudge@aar.com.au
• Stephen McComishPartner, Perth
  Ph: +61 8 9488 3767
  Stephen.McComish@aar.com.au