Imagine a situation where a seller failed to supply goods under a contract. The buyer applies for interim injunction on goods to prevent their further resale. The buyer wins, but fails to recover judicial-related costs, since according to the applicable national law, each party shall bear its own costs. The buyer wants to recover these costs and later files a claim for damages which resulted from the breach of the contract by the seller - a failure to supply the goods. Would the buyer be able to recover its legal costs incurred in the injunction proceedings as damages in subsequent proceedings?
This is precisely the question this article aims to explore, i.e. whether judicial-related costs, which were not imposed on a party in breach by a court, can be further claimed as damages incurred as a result of a contractual breach. We have chosen the United Nations Convention on Contracts for the International Sale of Goods (hereinafter the CISG) as the substantive framework for this issue, bearing in mind that the findings of this article can potentially be applied within other set of rules on the recovery of damages.
2. REGULATORY FRAMEWORK
The world of legal systems imposes different standards for the recovery of judicial-related and extrajudicial costs (Schlechtriem, 2002 and Gotanda, 1999).
Extrajudicial costs usually refer to the legal costs incurred before litigation/arbitration, such as attorneys’ fees for issuing debt collection letters or fees for telephone consultations (e.g. Garments case, 2002; Fabrics case, 1997; Memory module case, 2001; Lawn mower engines case, 1996; Flagstone tiles case, 1995). These costs are unrelated to pending proceedings and the general practice is to recover them as damages for a breach of contract under domestic substantive law (DiMatteo, 2014).
Judicial-related costs, on the other hand, typically include filing fees, witness fees, transportation expenses, and attorneys’ fees incurred during client representation (Gotanda, 1999), and are ‘accessory’ to every proceeding from which they stem (Jäger, 2010). Since these costs are closely linked to legal proceedings, their allocation by a court is usually regulated by domestic procedural or institutional rules, with the exception of Germany and Switzerland, the only two jurisdictions that allow allocation of judicial-related costs under the substantive law (Jäger, 2010; Zapata case, 2002).
The worldwide practice in relation to allocation of judicial-related costs is anything but uniform. The majority of countries apply the ‘English rule’ which requires a losing party to pay for the winner’s reasonable expenditures (Gotanda, 1999). At the same time, the USA, Taiwan, and Japan are in the minority that applies the ‘American rule’, requiring each party to bear their own expenses, no matter who prevails in the dispute (Lovells, 2010). Furthermore, the practice in some countries is to award all recoverable costs to a prevailing party, while other countries allocate them in proportion to a party’s success (Gotanda, 1999).
The matter at hand has not been researched much in theory or encountered upon in practice. The key to enabling the recovery of legal costs in subsequent proceedings is viewing such costs through a different lens: as damages caused by the breach rather than as litigation/arbitration expenses subject to cost allocation. In this case, the expenditures that were judicial-related for the purpose of initial proceedings (e.g. injunction proceedings in our hypothetical), are extrajudicial for the purpose of subsequent proceedings (contractual breach proceedings, respectively). This, in our opinion, brings them within the purview of substantive laws and enables their recovery under the provisions on damages, including Article 74 of the CISG.
3. RECOVERY OF DAMAGES UNDER THE CISG
Article 74, CISG establishes the rules on calculating damages available to an aggrieved seller/buyer. It states that ‘[d]amages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. Such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which it then knew or ought to have known, as a possible consequence of the breach of contract.’
Therefore, if the buyer wants to recover legal costs from the previous proceedings under the CISG, he needs to establish the following: (1) that there was a contractual breach, (2) that the legal costs at issue represent the loss suffered by the buyer, (3) that this loss was a consequence of the breach, and (4) that the loss was foreseeable for the seller at the time of the conclusion of the contract. Finally, any costs of mitigating the damages (Art.77, CISG) are to be deducted from the resulting sum.
3.1 LEGAL COSTS AS LOSSES
Let us assume that the buyer was able to prove the breach of the contract. One of the crucial issues that arises in this regard is whether judicial-related costs incurred in initial proceedings may be considered as losses within the meaning of Article 74 of the CISG for the purpose of subsequent proceedings. Article 74 does not specify what types of losses are recoverable as damages. This is in line with the drafting techniques of similar instruments in most jurisdictions (Đorđević, 2010). Indeed, as the same author notices, it would be unreasonable and hardly possible to make an exhaustive list of all types of losses that can be recovered. One may thus conclude that, logically, an aggrieved party is entitled to the recovery of any types of losses that they suffered as a consequence of a breach, if the remaining prerequisites for their recovery are met. This conclusion is supported by the prevailing principle of full compensation underlying the CISG, under which a court should aim to put a wronged party in the position it would have been in, had a breach not occurred (Schlechtriem, 2008). This necessarily translates to recouping any reductions in the asset base of an aggrieved party caused by a breach (Zeller, 2005).
Thereby, it can be argued that once the court ruled on costs, the ones that the buyer incurred in the injunction proceedings which were not shifted to the breaching seller will have become the buyer’s losses. The buyer may claim them as damages caused by the breach in order to be put into the position of a successful performance of the contract by the seller.
Such an approach would not conflict with the domain of domestic or institutional rules on cost allocation. The court allocates the costs incurred as a result of pending proceedings themselves. That is the point at which domestic (mostly procedural) or institutional rules on cost allocation should be considered. The costs of the proceedings which have not been shifted by a court under such rules to a party in breach are extrajudicial for the purpose of subsequent proceedings. In this case, their further recovery can be made on the basis of substantive rules on damages, including the CISG.
Such an approach would not lead to re-adjudication of the same claim either. The decision of allocating costs does not preclude an aggrieved party from claiming those costs as damages, given that a claim for cost allocation and a claim for damages rely on different causes of action. The former results from the proceedings from which they stem, while the latter results from the breach of contract. This is confirmed by the awards granting judicial-related costs as damages for the breach of arbitration agreement (Union Discount v. Zoller, 2001; CMA CGM SA v. Hyundai, 2008). For example, in Swiss case 4A_232/2013, the tribunal explained that it was not encroaching on the previous court’s decision on cost allocation, but was merely ruling on damages claimed as a result of the initiation of the court proceedings in breach of an arbitration agreement (in the amount of legal costs incurred in the court proceedings). At the same time, it should be acknowledged that res judicata requirements vary across jurisdictions, and there are no internationally unified binding requirements for the res judicata effect of court/arbitral decisions (ILA Interim Report: “Res Judicata” and Arbitration, 2009). It means that whereas a previous decision would most probably not be res judicata in civil law countries, one cannot be as sure of the same with regard to common law countries that operate a wider definition of res judicata (ILA Interim Report: “Res Judicata” and Arbitration, 2009).
One more concern raised by such lawsuits is whether or not they violate public policy, as one may view them as an abusive attempt to evade unfavourable national rules on cost allocation. This view is not ungrounded, given that, if successful, an aggrieved party will be able to recover its legal costs under the CISG, despite not being able to do that under national procedural rules. Allowing such lawsuits may also be viewed as giving an unfair advantage to one party over the other (since only the party that has proven a breach under the CISG would be able to recover these costs), and thus creating anomalies in legal systems (CISG-AC Opinion No.6, 2006). The response to that would be again that a claim for damages to recover legal costs in subsequent proceedings and a claim for cost allocation are substantially different (Schlechtriem, 2008), making it possible for one and the same set of legal costs to be the subject of both. The CISG framework would itself serve as a tool for prevention of any of such abuses, since damages are awarded only if all the elements set forth in Article 74 of the CISG are proven to the satisfaction of a court.
If there is no uniformity in the area of recovering judicial-related costs in different countries, then it is important to consider the underlying reason for such a difference. The possibility to recover only part of legal costs may be designed to prevent a claimant from pursuing a groundless claim. This goal, however, is not hindered if the judicial-related costs which resulted from a breach will be compensated in order to put an aggrieved party in the same position it would have been in had a breach not occurred.
3.2 CAUSATION CONSIDERATIONS
Keeping that in mind, we will proceed with causation considerations. In order to recover any losses, an aggrieved party has to demonstrate that a specific behaviour of the party in breach caused the damages sought after. Different treatment of judicial-related and extrajudicial costs results from the nature of the proceedings themselves: judicial-related costs can exist independently from a breach and their amount will hinge not only on the behaviour of a breaching party but also on the extent of the court’s orders and instructions (Đorđević, 2010). Therefore, according to Professor Jäger (2010), judicial-related costs are not caused by damaging behaviour, but rather by the need to pursue the other damages claimed.
While acknowledging that in an ordinary lawsuit, legal costs are not caused by a wrongdoing of a party in breach per se, the link between these costs and a breach may be established firstly, if the proceedings themselves resulted from such breach, and secondly, if the proceedings were necessary for the pursuit of one’s rights violated as a result of a breach. The former includes a breach of specific provisions connected with abuse of process, bad faith and public policy (Jäger, 2010). The latter refers to the cases where an aggrieved party incurred legal costs designed to mitigate its damages (e.g. by safeguarding the performance of contractual obligations) or where the claim was brought by a party in breach.
For example, in our hypothetical scenario, the buyer has incurred legal costs while applying for the interim injunction in order to mitigate its losses from the seller’s breach. If such costs were incurred in fulfilling the party’s duty to mitigate (Article 77, CISG), they may be categorised as incidental losses, recoverability of which is generally ‘beyond debate’ due to the principle of full compensation (Schlechtriem & Schwenzer, 2010).
3.3 OTHER REQUIREMENTS
That brings us to the issue of whether such legal costs can be foreseen at the finalisation of the contract. A breaching party should generally expect that in case of a breach, an aggrieved party would incur costs in trying to re-create the situation of non-occurrence of the breach (Saidov, 2008). Incurring judicial-related costs in pursuit of one’s rights is foreseeable at the time of conclusion of the contract and consequently a part of the undertaken risk (Schlechtriem, 2008). At the same time, certain costs may be considered to be well outside of the foreseeability requirement, e.g. contingency fees (if they are unknown to the countries of the parties’ origin, as well as to the country of the seat of arbitration) (Schlechtriem, 2008).
Article 77 of the CISG also requires an aggrieved party to take reasonable measures to mitigate its losses, which directly raises the issue of reasonableness of the incurred legal costs. Reasonableness of judicial-related costs is determined by a court based on all the facts and circumstances of the case, including, but not limited, to the need for legal work, an average cost of legal services, the time spent, and the prospects of success of the case (Corrs Chambers Westgarth, 2014).
Therefore, the recovery of judicial-related costs in subsequent proceedings is within the realm of possibility, if all requirements of Article 74, CISG are met. In our hypothetical example, the legal costs which stemmed from the injunction proceedings may be recovered as damages under Article 74, CISG if a court finds that they were incurred in mitigating the damage caused by the breach, and thus have the requisite connection to it, and that they were foreseeable for the seller and reasonable under the circumstances.
In light of the above, we maintain that legal costs that are not shifted in previous proceedings, despite originating as judicial-related costs, lose their status as such for the purpose of subsequent proceedings, and thus, do not fall within the scope of rules on cost allocation in the subsequent proceedings. These costs may constitute the losses suffered by a party as a result of a breach, which enables their recovery as damages under the substantive laws, including the CISG. We realise that this conclusion invites several policy concerns, e.g. whether a second claim constitutes re-adjudication of the first one. At the same time, we are convinced that the multiple requirements the CISG prescribe for a successful damage claim make the threshold for their recovery sufficiently high to ward off abusive claims and award only meritorious ones.
All in all, to answer this question in a negative fashion may run afoul of the principle of full compensation and the uniform interpretation of the CISG.
By Anastasiia Filipiuk & Olha Hrynkiv
This article was originally published in issue 4.3 of the magazine.