Disgorgement of profits is the forced return of the profits that the breaching party gained as a result of their illegal or unethical acts. The CISG, however, does not mention this concept when dealing with damages for breach of contract. The following debate therefore tackles the issue of whether the United Nations Convention on Contracts for the International Sale of Goods can be interpreted in such a way that it should a allow claims for disgorgement of profits.
We invite you to read the persuading arguments of our guest writers for this issue, and decide for yourselves which ones were the most convincing.
Anastasiia Filipiuk
Anastasiia graduated from National University ‘Yaroslav the Wise Law Academy of Ukraine’ and is currently studying at an LL.M. Program in International Business Law at Central European University. Prior to joining the CEU, Anastasiia completed various internships both in Ukraine and abroad, and worked as an associate at a recognized Ukrainian law firm in the life sciences and tax practices.
Olha Hrynkyv
Olha received her Bachelor’s Degree in Law from National University ‘Kyiv-Mohyla Academy’ (Ukraine). During her undergraduate studies she participated in several moot court competitions in the WTO law and international commercial arbitration. She also held various internship positions in leading Ukrainian law firms in the field of real estate and contract law. Currently Olha is pursuing her LL.M. in International Business Law at Central European University.
Opening Statement - Anastasiia
Imagine a situation: the seller promises goods to one buyer but instead resells them to another buyer for a higher profit. Under the default rules of most contract laws, if sued, the seller will be obliged to compensate the first buyer for its losses. However, this will still leave the seller better off than in case of performing its promise to the first buyer, since the seller gets to keep the price difference. The end result is that the seller gets to profit from its breach. Moreover, the seller will most probably do the same in the next similar situation, since the breach brings him profit. Such situations will not occur if the law of damages for the breach of contract knows the concept of disgorgement of profits.
Disgorgement refers to the practice of stripping away of the profits the breaching party gained as a result of its wrongdoing. Disgorgement focuses not on the loss of the aggrieved party, but on the gain of the breaching party (Hondius/Janssen, 2015). It is a usual remedy for intellectual property and competition law offences, as well as for breaches of confidentiality and fiduciary duties (Hondius/Janssen, 2015) – i.e. where the amount of loss is difficult or unviable to prove by focus on the losing party. Lately the trend has emerged in domestic legal systems supporting disgorgement of profits for breaches of contract (Schlechtriem/Schwenzer, 2010). I argue that the CISG can and should be interpreted to embrace disgorgement.
Scholarship differentiates between disgorgement as a method of calculation of losses (tied to the loss of the aggrieved party) and as a remedy per se (applicable irrespective of the loss) (Schwenzer/Hachem/Kee, 2012; Hondius/Janssen, 2015). In terms of the former, article 74 CISG (reflecting the rules on calculation of damages) does not specify methods for calculation of the loss of the aggrieved party. This allows the court or tribunal a wide discretion to choose a method best suited to the circumstances of each individual case (CISG-AC Opinion No.6, 2006), including a method of disgorgement. Measuring the innocent party’s losses by the breaching party’s gains is ‘possible and necessary’ (Schlechtriem/Schwenzer, 2010, p.1017) in cases where the losses of the aggrieved party are difficult or impossible to prove with conventional methods, e.g. in second-sale cases as described above (Schlechtriem/Schwenzer, 2010; Schwenzer/Hachem/Kee, 2012). Disgorgement in this context is tied to the existence of the loss and thus stays within the realm of compensatory purpose of damages (Saidov, 2008).
As far as disgorgement as a remedy is concerned, the CISG may be interpreted to accommodate it, though this interpretation does present a greater challenge. Admittedly, it goes against the ‘damages as a sum equal to the loss’ adage of article 74 CISG, since damages awarded do not depend on the existence of the loss, and thus may exceed the losses of the aggrieved party. At the same time, the CISG commentators expressly acknowledge that ’[a]gainst the background of the paramount performance principle [i.e. that the party is primarily interested in performance of the contract, and not in economic benefits in lieu of performance] … the general idea that a breach of contract must not pay also has to be upheld under the Convention’ (Schlechtriem/Schwenzer, 2010, p.1017). The same idea flows from the principle of good faith underlying the CISG.
Therefore, the CISG can be interpreted to allow disgorgement. Allowing disgorgement can significantly improve the CISG framework by providing solutions to situations that CISG damages provisions in their current interpretation do not address (e.g. second-sale cases). This will encourage compliance of parties with their contractual obligations, deter ‘profitable’ breaches, and thus will ensure a higher degree of legal certainty for the parties.
Opening Statement - Olha
Failure to perform any obligation under the contract entitles an aggrieved party to seek various remedies, including, but not limited to damages under Article 74 of the CISG. Article 74 aims to compensate the aggrieved party for all foreseeable losses and to place it in the same position it would have been in if the contract had been duly performed (Schlechtriem/Schwenzer, 2010).
Disgorging the profits made by the party in breach and granting them to the aggrieved party as damages goes against this aim. Using the disgorgement as a remedy under the CISG is neither supported by the general practice nor compatible with the basic principles underlying the CISG and therefore, should not be allowed for the following reasons.
Firstly, by definition, Article 74 of the CISG precludes the disgorgement of profits (Schmidt-Ahrendts, 2012). The very wording of the article provides that ‘damages 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’ (CISG, 1980). The conclusion one would ultimately draw is that the CISG allows an aggrieved party to claim only those damages which correspond to the loss it suffered.
Imagine a situation where a seller did not perform its delivery obligation under the contract with a buyer but sold the goods to the third party instead. In this case, the profits gained by the seller from the transaction with the third party do not constitute the loss to the buyer, since there is no prima facie link between the two. Therefore, to grant the seller’s profits to the buyer would go against the compensatory character of Article 74 irrespective of whether the buyer is asking for the disgorgement of profits as a method of calculation of damages or as a remedy for the breach of the contract per se.
Secondly, the disgorgement of profits bears the risk of overcompensation. If the aggrieved party suffered no loss or if the sums awarded to it were in excess of actual loss, it would amount to punishing the party in breach for its misconduct. Granting punitive damage, however, is forbidden under the CISG and the general rule is that the award of damages should not put the aggrieved party in a better position than it would have been in if the contract had been properly performed (CISG-AC Opinion No. 6, 2006).
Finally, the disgorgement of profits contradicts the principle of mitigating loss. As governed under Article 77, ‘a party who relies on a breach of contract must take such measures as are reasonable in the circumstances to mitigate the loss, including loss of profit, resulting from the breach; [i]f it fails to take such measures, the party in breach may claim a reduction in the damages in the amount by which the loss should have been mitigated’ (CISG, 1980). However, if the disgorgement of profits is allowed and the party could simply request the profits made by the party in breach, it would no longer have an encouragement to mitigate (McCamus, 2003).
In light of these considerations, Article 74 of the CISG should not cover a claim for the disgorgement of profits.
Anastasiia starts off by distinguishing between disgorgement of profits as a way of calculating losses and a remedy in itself. She argues, by way of example of a second-sale type of transaction, that disgorgement as means of measuring damages under art. 74 of the CISG is not only possible but necessary. Olha, however, points out that the wording of the said article does not allow disgorgement of profits. Moreover she argues that disgorgement of profits goes against two principles of the Convention i.e. prohibition of punitive damages and the principle of mitigating loss.
Rebuttal - Anastasiia
My opponent raised very convincing arguments in respect of not allowing disgorgement of profits under the CISG. However, all of them can be easily rebutted, I hope, in the similarly convincing manner.
Contrary to what my opponent stated, Article 74 CISG does not preclude disgorgement. According to my opponent, claimable damages under the CISG comprise those corresponding to the losses of the aggrieved party. As the matters stand now, this is without a doubt. However, in some cases the behaviour of the breaching party causes significant difficulties or even impossibility for the aggrieved party to calculate its losses by conventional means (e.g. second-sale cases). This should not be a barrier to holding the party liable for its breach (CISG-AC Opinion No. 6, 2006). This is where disgorgement as a method of calculation may fit in: it is presumed for the purposes of calculation of damages that profits made by the party in breach are a good indication of the losses of the aggrieved party (Schmidt-Ahrendts, 2012). A link between gains of the breaching party and losses of the aggrived party is thus ‘engineered’ by necessity in order to ensure that same compensatory purpose of the damages for the aggrieved party that my opponent advocates. As for disgorgement as a remedy, I already admitted in my first submission the difficulty of fitting it within the ‘damages equal to the loss’ rule of Article 74 CISG. However, in my opinion, in certain cases courts and tribunals can and should utilize the principle of good faith to interpret the CISG in a way as not to allow the breaching party to profit from its wrongdoing.
Secondly, my opponent argues that disgorgement bears the risk of overcompensation, which is a punishment of the breaching party that is not allowed under the CISG. I argue that this statement is not correct. With respect to disgorgement as a method of calculation, disgorgement simply supplements the conventional methods of loss calculation under the CISG. Its application is still conditioned upon the existence of the loss, and therefore it does not go outside of the CISG compensatory framework. As to the disgorgement as a remedy, good faith considerations demand that it be irrelevant whether profit of the breaching party exceeds the aggrieved party’s loss, as long as such profit directly flows from the breach. However, requiring the breaching party to disgorge its ill-gotten profit does not punish it (Hillman, 1995). It merely puts the breaching party in a position it would have been had it performed the contract (Thel/Siegelman, 2010).
Thirdly, my opponent contends that disgorgement goes against the principle of mitigating loss under Article 77 CISG. With regards to disgorgement as a method of calculation, this is not true. If one asks to apply such a calculation method, one does not ask the court or tribunal to deviate from the accepted rules on calculation of damages under the CISG. Along with proving its losses, the aggrieved party is still obliged to demonstrate that it took all reasonable measures to keep its losses to a minimum. As for disgorgement as a remedy, indeed, its mechanism is such that it does not require mitigation of losses. However, ‘[w]hy not let the plaintiff be free to accumulate losses after learning of breach because the defendant will not be responsible for paying for them anyway?’ (Roberts, 2008). In this case, the rule on loss mitigation is inapplicable, since a remedy of disgorgement is based on good faith considerations and is not tied to the actual loss of the aggrieved party.
To conclude, all of the above proves that the CISG can accomodate disgorgement.
Rebuttal - Olha
Law as it is should always be distinguished from law as the parties to a dispute want it to be.
My opponent pointed out that in a situation where a seller unlawfully resells the goods to the third party for a higher price and compensates the first buyer for its loss, it will still get to profit from its breach. I would like to highlight that even in this scenario, the profits made by the seller do not correspond to the loss suffered by the first buyer. Neither is it the aim of the CISG to prevent the seller from doing the same in future by punishing it. As I discussed in my opening statement, damage calculation under the CISG does not incorporate penal elements and has a purely compensatory character. Therefore, disgorgement of profits should not be allowed under Article 74 of the CISG either as a method of calculation of damages or as a remedy for a breach of contract.
It is widely accepted that a disgorgement claim cannot be granted under Article 74 (Schlechtriem/Schwenzer, 2010). Trends in domestic legal systems should only be considered as a means to interpret the CISG if they represent an established practice. However, disgorgement of profits is anything but a generally established practice. Not only such a claim is prohibited under the national rules in most jurisdictions (Schlechtriem/Schwenzer, 2010), but the criteria for it are also too different across legal systems (where it is actually allowed) to constitute any uniformity on the issue (Hondius/Janssen, 2015). Consequently, no court has ordered disgorgement in a CISG case to date (Schmidt-Ahrendts, 2012). The primary reasons for this are discussed below.
As it was stated by my opponent, Article 74 does not specify methods for calculation of the loss of the aggrieved party. Nevertheless, it is generally admitted that, under Article 74 of the CISG, a concrete calculation method (based on the actual circumstances of each case) must be preferred over an abstract one (based on a fixed formula referring inter alia to party`s in breach profits) (Zeller, 2005; Saidov, 2008).
Furthermore, the aggrieved party alone has the burden of proving that it sustained a loss, in order to be entitled to damages resulted from the breach (CISG-AC Opinion No. 6, 2006). The concept of disgorgement, however, would allow the aggrieved party to solely rely on the profits made by the party in breach without proving the extent of its loss and thereby it would unbalance the rules on the burden of proof set forth in the Convention (Sachs, 2003).
Anyway, in cases where the amount of loss is difficult or unviable to prove by focus on the aggrieved party, the CISG allows the recourse to abstract calculation of damages (as it is only available under Article 76) based on the difference between the contract price and the current market price. It is therefore neither appropriate nor necessary to refer to disgorgement as to a method of calculation under Article 74 of the CISG.
Regard for compensatory character of the CISG also suggests an argument against construing the ambiguous text of Article 74 to permit disgorgement of profits as a remedy for a breach of contract. While acknowledging the importance of the performance principle and the principle of good faith in commercial trade, I would like to clarify that they are not meant to introduce new remedies like disgorgement into the Convention (Zeller, 2005; Schlechtriem/Schwenzer, 2008). This understanding of the CISG`s underlying principles appears to be consistent with the purposes of the Convention and the international practice regarding the rules on damages.
In the rebuttals, Anastasiia tried to refute Olha’s arguments by stating that in cases where it is difficult to calculate the extent of the suffered loss, disgorgement should be used, without the risk of overcompensation seeing that it serves as a tool to establish the extent of the damages. Moreover disgorgement could serve the purpose of not enabling parties to benefit from their breach. In response, Olha argues that this is not the aim of the CISG and shoes that there haven’t been any decisions in favour of disgorgement in any CISG related cases and there isn’t an established practice in domestic cases.
For the last part of the debate, read the authors’ conclusions, see which one manages to persuade you the most and then form your own opinion on the matter!
Conclusions - Anastasiia
If one says that the CISG does not permit disgorgement, one says ‘yes’ to allowing the breaching party to profit from its breach. Moreover, one gives the breaching party the green light to breach again in the future. The ‘second-sale’ example cited above highlights the ‘grey’ areas within the CISG. To deal with them, CISG provisions should be interpreted to allow disgorgement. The wording of Article 74 CISG does not preclude disgorgement as a method of calculation of the aggrieved party’s losses. Conditioned upon the existence of the loss, disgorgement does not alter the CISG damages framework in this case: mitigation rules, for instance, will apply, as usual.
Furthermore, good faith and performance principle militate in favour of the CISG adopting disgorgement as a remedy, even though it requires no connection to the aggrieved party’s actual loss. This is in line with the recent trend of recognizing disgorgement in national jurisdictions. Thus, disgorgement will not conflict with, but will rather complement and strengthen the current set of remedies under the CISG. With the disgorgement in its arsenal, the remedies provisions of the CISG will not only better serve the compensatory purpose, but will also promote the parties’ compliance with the contract and deter wrongful behavior.
Conclusions - Olha
There are strong arguments that Article 74 of the CISG should not be construed so as to permit disgorgement of profits. Article 74 does not refer to the profits made by the party in breach. Instead, its emphasis is solely on the compensation of the loss suffered by the aggrieved party. Disgorgement of profits, however, is inherently non-compensatory. Moreover, it has been characterized as ‘supercompensatory’, or ‘overcompensatory’ damages (DiMatteo, 2015), which are prohibited under the CISG. As a result of this slippery slope, so far there are no precedents which favor a disgorgement claim within the context of the Convention.
Neither is it possible to justify disgorgement of profits relying on the performance principle and the principle of good faith. To the contrary, allowing such a claim under Article 74 would be incompatible with CISG`s rules on burden of proof and mitigation of loss. In particular, in order to recover damages for a breach of contract, the aggrieved party should prove that it has suffered a loss as a result of the breach and that it has tried (where possible) to mitigate its loss. To override these rules on the recovery of damages by merely referring to the profits made by the party in breach would mean to disregard the uniform application of the Convention.
Disclaimer: The arguments presented in this debate do not represent the opinions of the two authors.