How damages are measured can make a stark difference in claims for breach of a tripartite collateral warranty
06 December 2019
The High Court has given one defendant a stark lesson in how the measure of damages can make a significant – and costly – difference to the value of a successful claimant’s remedy.
The principle confirmed by this case is that where a collateral warranty relating to performance or quality is breached, damages are recoverable based on loss of profits as if the warranty had been true. This can result in much higher recovery than if damages were awarded on the basis of a claim for negligent misstatement where damages would be awarded on the basis of wasted expenditure. In those circumstances the claimant is put in the position it would have been in if the warranty had never been made.
In this case (New York Laser Clinic Ltd v Naturastudios Ltd  EWHC 2892 (QB)) the Claimant ran clinics providing laser hair removal services. The Defendant was the sole UK distributor of laser machines made by an Israeli company.
The Claimant said the Defendant’s representatives had made a number of representations about the performance and results it could expect from the machines. Those representations induced the Claimant to buy the machines via hire purchase companies on its behalf.The contracts for purchase were between the Defendant and the hire purchase companies, not between the Defendant and the Claimant. When the Claimant alleged that the machines did not live up to the Defendant’s sales pitch and were not fit to perform laser hair removal for the purposes intended, this meant that the Claimant could not bring a standard breach of contract claim for unsatisfactory goods against the Defendant.
The key claims
Initially, the Claimant pursued a claim against the Defendant for negligent misstatement, seeking damages on the tortious basis for wasted expenditure of just over £400,000. That figure represented the losses resulting from entering into the hire purchase commitments and from having to placate disgruntled customers with free treatments and refunds, and other wasted expenditure.
The Claimant later amended the claim to plead breach of collateral warranty. That became the primary cause of action because, if successful, the Claimant would be entitled to damages calculated by reference to the profits it could have earned if the laser machines had performed in accordance with the Defendant’s warranties. That figure was set at nearly £4 million.
The underlying law on breach of collateral warranty
The judgment helpfully sets out a definition of what is a collateral warranty:
“A collateral warranty is a promise or assertion, with contractual force, which leads to a contract being entered into. If the warranty that is relied upon turns out to be false, the person to whom it is made may have a cause of action against the promisor for breach of contract. It is not necessary that the warranty was made fraudulently, or even negligently.”
This case involved what are known as “tripartite” collateral warranties, where the warranty is given not by one of the parties to the main contract to another but to a third party. Where one of the parties to the main contract (A) gives a collateral warranty to a third party (B), who then causes another party (C) to enter into the main contract, the collateral warranty becomes an additional enforceable contract between the third party and the warrantor. In this case, “A” was the Defendant, “B” was the Claimant and “C” was the hire purchase companies.In bringing its claim for breach of collateral warranty, the Claimant argued that the Defendant made warranties (intended to have contractual force) about the performance and qualities of the lasers, which the
Claimant relied on and provided consideration for by paying a deposit and by procuring the hire purchase companies to enter into contracts with the Defendant. The Claimant argued it suffered financial losses as the warranties were inaccurate and the lasers defective in terms of their intended purposes. The Court agreed and held that there were no exclusion clauses in the contracts between the Defendant and the hire purchase companies which would have excluded liability for the problems that arose or for the warranties that had been made.
Can loss of profits be awarded for breach of collateral warranty?
Ultimately, the Claimant won on both the breach of collateral warranty and the negligent misstatement claims. The key issue was whether the Claimant could claim loss of profits for the breach of collateral warranty – a much more attractive proposition for the Claimant. The Judge recognised that “at first blush” it might seem surprising that the Claimant could potentially recover damages calculated by reference to profits that realistically it was never going to earn. The case came about for the very reason that the laser machines were not capable of producing the benefits the Defendant said they could. So it was never going to be possible for the machines to increase the Claimant’s profits to the tune of the £4 million it was claiming. Nor was the Claimant contending that if it had not bought these laser machines, it could have bought others that would have achieved the same results. In the real world, the loss of profits the Claimant was asking for would never have been achievable by purchasing new lasers.
Even so, the Court found that there was “a good juridical basis” for the Claimant to claim for loss of profits. Having reviewed the authorities, the Court confirmed that different approaches to damages apply depending on the nature of the warranty (even though the damage inflicted from a Claimant’s point of view is the same whatever the warranty):
- where a case concerns breach of collateral warranty about the quality or anticipated performance of the thing supplied, the successful claimant will be entitled, at its election, to damages calculated by reference to loss of profit, or losses incurred by entering into the contract – whichever is higher; but
- if the warranty was to the effect that reasonable care was taken in relation to an estimate that was given, the only damages available would be by reference to the losses incurred by entering into the contract.
As the warranties in this case fell into the first category (about quality or performance), the Claimant was entitled to elect to recover damages for loss of profits, even though such an award might seem like a windfall.
The Judge warned that courts should be cautious before finding that there is an enforceable collateral warranty because of the possibility of giving rise to an entitlement to damages which substantially exceed the profits that would ever have realistically been obtainable.
This case shows how much difference it can make whether a claimant is awarded damages based on loss of profit rather than wasted expenditure. For the Claimant in this case, the difference was worth around £3.4million – all in all an expensive lesson for parties to a contract not to make exaggerated or false claims, even to a third party.