North Sydney Leagues' Club Ltd v Synergy Protection Agency Pty Ltd

North Sydney Leagues' Club Ltd v Synergy Protection Agency Pty Ltd - [2010] NSWSC 256 - NSWSC 2010 case summary — Zoe

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Expectation damages and net profits 11 The measure of expectation damages upon breach or repudiation of contract is that the innocent party is to be put in the same position as if the breach had not occurred. Where the breach was such as to deny the innocent party the opportunity of performing services and so earning a reward, it is obvious that the innocent party must bring to account as against the reward lost (revenue) such costs as would have had to be expended by it in order to earn the reward (expenses). It is for this reason that the parties in the present case agreed that the measure of damages was to be "net profits". 12 The only dispute is whether some proportion of overhead costs have to be brought into account as expenses to be set off against revenue in the calculation of net profits. 13 As a matter of principle, it is difficult to see why overhead costs should not have to be brought into account. If, in order to provide the contractual services, it was necessary for the contracting party to pay expenses including for maintaining an office, insurances, utility bills, maintaining plant and equipment and paying head office staff, why is not some proportion of that expense properly to be regarded as an expense which should be brought into account when calculating net profit? It is to be expected that contract rates for charging out for services will incorporate as an element some amount representing the overheads of the party providing the services. Thus in building contracts, typically contract sums and contract rates build in provision for preliminaries and overheads (as elements either in a fixed price, or in a cost-plus contract). In calculating the real profit of the builder, those items would be deducted from the total contract sum, in order to determine the margin. 14 The contrary argument effectively assumes that at all times fixed overheads were to be paid from revenue streams from other contracts which Synergy had, but not from the Norths contract. There is no basis for making such an assumption. There is no basis for assuming that if the contract had been performed no part of the fixed overheads would need to have been incurred in order to earn the revenue from that contract. 15 The reverse issue has tended to arise for consideration in the context of building, construction and engineering contracts where contractors make claims for damages for delay caused by the principal in breach of contract, including a claim for unabsorbed head office overheads (ie. where head office costs continues but the revenue stream does not continue because of the principal's delay). In such cases, the contractor is seeking to make the principal contribute to the ongoing cost of the contractor's head office arising by reason of the principal's delay. Such claims have a well-established pedigree. Frequently recourse is had to the so-called "Hudson formula" for unabsorbed overheads: Head Office Percentage x Contract Sum x Period of Delay (weeks) 100 Contract Period (weeks)

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16 That situation does not provide any great assistance to the present case. Cases in this field do, however, indicate that where increased overheads are to be taken into account in favour of a contractor, it is necessary for the contractor to be able to show that it has suffered loss by reason of being unable to deploy those overheads elsewhere to produce income. Similarly, in the present kind of situation, the contractor is not entitled to the benefit of a presumption that no proportion of its fixed overheads were necessary to be incurred in earning the contract sum unless it puts on evidence showing that to be the case. 17 There have not been many authorities in Australia relating to the question of whether a proportion of fixed overheads is to be brought into account as against a contractor's claim for revenue foregone by reason of the principal's breach of contract, although there have been authorities relating to the reverse position where a contractor is claiming in respect of overheads [See, e.g., Hughes Bros Pty Ltd v The Trustees of the Roman Catholic Church for the Archdiocese of Sydney (unreported, 16 October 1997, Supreme Court of NSW (Giles CJ Comm D)); Bulk Materials (Coal Handling) Pty Ltd v Compressed Air & Packaging Systems (NSW) Pty Ltd (unreported, 17 July 1997, Supreme Court of NSW (Giles CJ Comm D)); GEC Marconi Systems Pty Ltd v BHP Information Technology Pty Ltd [2003] FCA 50]. 18 However, clear guidance is provided in the joint judgment of the High Court in TC Industrial Plant Pty Ltd v Robert's Queensland Pty Ltd [(1963) 180 CLR 130], where, in rejecting the proposition that there had to be an election between loss of profits and wasted expenditure [see pp.138-143], the English case of Cullinane v British "Rema" Manufacturing Ltd was analysed at some length [at p.139.7]. It was observed in the course of that consideration that loss of profit was derived by subtracting from estimated receipts running costs, office expenses, interest and depreciation. The High Court also observed (at p. 140.2] that it would not have been right to award loss of profits without deducting depreciation as well as capital expenses, because that would entail awarding full profit without the expense of earning it [See also Cheshire & Fifoot 9th Australian Edition p [1081]-[1082]; Gates v City Mutual Life Assurance Society Ltd (1986) 160 CLR 1 at [11]-[12]]. That decision should govern the outcome in this case. In remitting the matter, the High Court [at p.143] said:

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"The allowance for overheads … represents the contribution of the project to the general overheads of the contractor for all of its business activities. For this reason it is difficult to understand why it was included in the margin which is applied to a particular activity rather than to the contract as a whole. Perhaps it is merely a convenient way to deal with this contribution from an accounting point of view. For my purposes, however, it is not part of profit because it is part of the expense of conducting the [business], which expense is incurred whatever happens to a given project ". (emphasis added). 21 On the facts of that case, his Honour applied a ratio of 1.5% (which was the proportion of the contract value of the unperformed work which the contractor's expert had attributed to profit when breaking down the "margin" figure) to the estimated cost of the works, and then adjusted it upwards to reflect the fact that not all of the amount allocated to risk in the margin would have been consumed in performing the works (i.e. not all risk would have come home, so expanding the real amount of profit). This decision was upheld on appeal by the Court of Appeal of Victoria [A J Lucas Drilling Pty Ltd v McConnell Dowell Constructors (Aust) Pty Ltd [2009] VSCA 310]. 22 It would appear therefore that the Supreme Court of Victoria and the Court of Appeal proceeded on the basis that where the contract rates do build in an amount on account of corporate overheads, if there is evidence to establish the true costs of performing the works, and to establish what proportion of the margin is attributable to overheads (as distinct from profits or risk (if applicable), then it is appropriate to deduct overheads in order to establish profits. 23 The correct analysis is that a proportion of head-office overheads should be deducted in calculating the net profit figure, with the question of wasted overheads (arising from their lack of deployment on the Norths contract), subject to mitigation, being the subject of a separate claim being in the nature of a reliance loss claim rather than expectation loss. However, the present plaintiff has not sought to put its case that way and there is simply no reason why the decision of the High Court in TC Industrial Plant should not govern the situation. 24 During address Mr Douglas QC put the central question in relation to the present dispute in the following terms:

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