To what extent are pre-action costs recoverable?

United Kingdom

In many instances, the cost to a company to recover damages for another's breach of contract will begin to mount long before an action is commenced in litigation or arbitration. So, for instance, where a subcontractor's works are defective, the contractor may have spent a considerable amount of time dealing with the effects of the defects, investigating the cause of the defects, and putting them right. Further, the contractor may have expended a considerable amount of time locating documents and records in order to prepare a claim against the subcontractor. But to what extent are those costs recoverable?

Wasted management and employee time

The case of Tate and Lyle v GLC 1982 established the principle that the claimant could be compensated in damages for the cost of wasted management time incurred as a result of a breach of contract by the defendant. However, since then the Courts have narrowed the extent to which managerial time can be claimed. In Phee Farrar Jones Ltd v Connaught Mason Ltd 2003, the Court held that managerial time can only be claimed as damages if it is established that, either the claimant's trading was disturbed in a way that resulted in a discrete expense being paid, or it is possible to demonstrate that a specific loss of revenue has been incurred that would otherwise have been obtained.

The first limb of this test can be satisfied by evidence of overtime payments to employees, or employing agency staff to cover the short-term additional labour requirement to deal with the effects of the defect. The second limb requires a demonstration that, had it not been for the breach in question, a specific individual would have been generating income for the company on other tasks or projects. This may be relatively clear-cut in the case of an employee who has been deployed from another contract to the one in question with the sole intent of trouble-shooting the effects of the breach, or where an employee is engaged on the project for a longer time than would have been required had the breach not occurred. Such employees would be regarded as "profit-making" individuals whose income-generating potential is easily identifiable and quantifiable.

Further, the ruling in Phee Farrar means that the time that non-profit making individuals spend in relation to the defect, i.e. employees who are a "fixed cost" of the company, therefore including in-house legal teams who are specifically employed to deal with claims, would not be recoverable. However, it is possible that the restrictive approach of Phee Farrar will be distinguished from cases such as Horace Holman Group Ltd v Sherwood International Group Ltd 2001, in cases where it can be demonstrated that the breach in question affected both profit and non-profit making individuals in such a way that the cost of non-profit making employees could be claimed. In Horrace Holman, the Court found that the effect that a redundant software package, supplied in breach of contract by the defendant, had on all elements of the claimant's business, meant that the Court found it unnecessary to distinguish between profit-making and non-profit making employees.

So, once one has established a loss to the company, how is it to be quantified?  The overriding principle is that the loss must be quantified in a manner that is objectively reasonable. What is reasonable will depend on the facts and circumstances of a particular case. In Euro Pools Ltd v Clydeside Steel Fabrications 2003, Lord Drummond Young approached the question of the rate at which an employee's time could be recovered on the basis of how a contractor would approach the question in pricing for the contract, i.e. both the cost of the salary or wages paid to the employee for the time taken to perform the remedial works, and a contribution to general overheads of the business, will be recoverable.

So, in principle, you have a recoverable loss and a means of quantifying that loss, but to what extent do you need to prove that the hours claimed were actually spent as a result of the breach?  Those defending a claim for costs would immediately cry out the basic principle in Tate & Lyle: "no records, no recovery!". However, since that case, the Courts have been quick to recognise that, in Tate & Lyle, the reason why no costs were recoverable was because the claimant did have a means of recording the time claimed, but failed to do so. In recent cases the Courts have recognised that it may not always be appropriate or possible to make contemporary records of time spent, and so instead will accept witness evidence of recollections of the time spent. Where the Court has accepted such evidence, however, it has been limited in the amount of damages it could award, as it has had to account for inaccuracies in people's recollections of time spent.

Accordingly, where possible, one should establish a system of time-recording that clearly identifies the time spent in dealing with each aspect of the particular breach in question as early as possible.

Costs of an in-house team preparing and presenting a claim

This head of claim was considered in Amec Process and Energy Limited v Stork Engineers and Contractors BV 2003. In that case, Amec used considerable in-house and agency resources, together with forensic quantity surveyor advice as to the presentation of complex issues, in presenting its claim. It was acknowledged that, in undertaking this work itself, Amec's costs in preparing the claim were less than had Amec's solicitors undertaken the same work.

Under Part 44 of the Civil Procedure Rules the Court has a wide discretion as to the costs it can award. Under Part 44(3), when exercising its discretion, the Court must have regard to all the circumstances including the conduct of the parties before as well as during the proceedings. In Amec v Stork the Court found that it would be contrary to the overriding objective of the CPR if in-house expenses that are less than if a solicitor had been engaged to undertake the same work, could not be recovered in principle. The Court regarded Amec's in house costs as falling within the definition of "costs" in Part 43.2(1)(a) as being "fees, charge, expenses and remuneration" and therefore recoverable costs under Part 44(3).

However, the Court restricted this principle to circumstances where the costs would have been recoverable if Amec's solicitors had undertaken the same work.

In the same case, the Court considered the instance where the cost of abortive work in investigating and presenting a claim was being recovered. It was held that, given the size of the tasks before Amec's team, and the uncertainty involved investigating the claims, Amec could not be faulted for taking steps that, with hindsight, involved unnecessary expenditure.

Costs incurred whilst following the pre-action protocol

As stated above, Part 44.3(5)(a) of the CPR provides that the Court must, in exercising its discretion in awarding costs, take into account the extent to which the parties followed the pre-action protocol. Judge Thornton held in Amec v Stork that, where parties had followed the pre-action protocol in order to achieve a compromise or narrow the issues in dispute, the reasonable cost of following the pre-action protocol will be recoverable to the successful party.

For further information please contact Emma Schaafsma at emma.schaafsma@cms-cmck.com