In contract law, when we talk about liability, we mean liability to pay damages (ie compensation). Here are some key principles:

1. Courts will award compensation designed to place the innocent party in the position they would have been in if the contract had been performed.
2. In the absence of a contractual limitation of liability the defaulting party’s liability for a breach of contract is unlimited. This is perhaps a slight exaggeration as the courts have developed a few “restraints” on the extent of liability as follows:

• Causation: for a loss to be recoverable it must have been caused by the breach. For example, if one breaches a contract but the loss is not caused by the breach (but rather another unrelated event), the requirement of causation is not satisfied. In practice, causation is usually pretty apparent and is rarely an obstacle to the recovery of losses.
• Remoteness: for a loss to be recoverable it must have been reasonably foreseeable at the time of contract. This is actually a pretty complicated area of law (including for lawyers). However, again in practice, remoteness is rarely an obstacle to the recovery of losses – except perhaps the more extravagant losses which really could not have been anticipated at the time of the contract.
• Mitigation: only losses which could not have been reasonably mitigated by the innocent party are recoverable. This is perhaps the most significant of the common law “restraints” upon compensation as it effectively requires the other party to use reasonable efforts to mitigate its losses. For example, if a tenant exits a fixed term lease prior to the expiry of the fixed term, the landlord cannot just automatically recover the total unpaid rent for the remainder of the term – they have to take reasonable efforts to find a replacement tenant.

If you are now wondering what can be done to protect your business from unlimited liability for a breach of contract, read our next update, which will deal with contractual limitations of liability.

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Contact Source Legal on ph: +61 428 328 452, or email Stanislav Roth at stanislav.roth@sourcelegal.com.au, for preparing, reviewing and negotiating any contracts.