England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE QBENF 95/0033/C

IN THE COURT OF APPEAL (CIVIL DIVISION )

(MR JUSTICE MORLAND )

Royal Courts of Justice

Strand

London W2A 2LL

Thursday 17th Octobe 1996

B e f o r e

LORD JUSTICE OTTON

LORD JUSTICE AULD

LORD JUSTICE THORPE

BENCE GRAPHICS INTERNATIONAL LIMITED Respondent

v.

FASSON UK LIMITED Appellant

(Handed down transcript of

Smith Bernal Reporting Limited, 180 Fleet Street

London EC4A 2HD

Tel: 0171 831 3183

Official Shorthand Writers to the Court)

MR ANDREW MORAN QC and MR ANTHONY EDWARDS (instructed by Messrs Hill Dickinson Davis Campbell, Liverpool) appeared on behalf of the Appellant (Defendant).

MR STEPHEN GRIME QC and MR DAVID HEATON (instructed by Messrs Lace Mawer, Manchester) appeared on behalf of the Respondent (Plaintiff).

J U D G M E N T

(As approved by the court)

©Crown Copyright

LORD JUSTICE OTTON: The defendants appeal against a judgment of Morland J whereby he ordered that there be judgment for the plaintiff for £564,328.54 together with interest. The appellants seek to set aside the judgment and assert that in substitution there be judgment for the plaintiff for the sum of £22,000 (being the admitted value of returned goods) together with interest or alternatively that there be a new trial or that an assessment of damages according to the correct measure (being that contended for by the appellant) be directed in any event.

The sole issue raised on this appeal is whether the correct measure of damages was (as the judge found) the difference in market value or the actual losses (if any) suffered by the respondents under or arising from a breach of contract for onward sales.

The appellants (defendants) were one of a small number of suppliers of cast vinyl film, one of the uses for which is to manufacture decals which are used to identify bulk containers, this being the only end use intended in the case of film sold by them to the respondents (plaintiffs). The plaintiffs' manufacturing process involved screen printing words, numbers or symbols on the film and cutting it to size. The decals were then attached to the containers by reason of the self-adhesive character of the vinyl. Between 1981 and 1985 the defendants supplied to the plaintiffs film to the value of £564,328. This was to produce in excess of 100,000 decals. Of the decals manufactured from the defendants' film, 93% went for use on Sea Containers Limited (SCL) who were an important customer of the plaintiffs and who imposed their own specifications for containers and decals on manufacturers. SCL owned the containers and leased them to shipping lines and others so that the containers passed out of physical possession of the owners for the vast majority of their life and were used all over the world.

It was common ground that the standard requirement in the container industry for such decals was that they should have a "guaranteed minimum five year life". The defendants know this to be so. Moreover it was a term of the contract between the parties that the film would be of such a nature as to survive in use in good legible condition for a period of five years at least.

The plaintiffs alleged that the film did not fulfil the warranties with which it was sold, was not reasonably fit for its intended purpose and was not of merchantable quality. The reason for the defective condition was that the polymer constituting the film had insufficient stabiliser against the effects of ultra violet light and became degraded upon such exposure. The defendants were at pains in their promotional literature to assure customers that their film would be of such a nature as to survive in use in good legible condition for a period of five years at least. The Dutch manufacturing associate of the defendants incorrectly formulated the film sold to the plaintiffs by putting insufficient UV stabiliser in the film so that, in use, it tended to degrade over a period eventually making some decals illegible. There were extensive complaints from customers of SCL about the poor performance of the film. However, only one claim relating to 349 Tsujii Containers was met by the plaintiffs who applied new decals at their expense and the defendants paid an agreed amount to the plaintiffs in compensation. There was also an intimation of a claim from SCL which was has so far not been pursued. The plaintiffs retained about £22,000 worth of unused and defective material.

By the statement of claim served in August 1988 the plaintiffs claimed for the difference in value (ie the recovery of the whole purchase price). By an amendment served three years later the claim was enlarged to include an alternative claim for indemnity against "all claims" by customers of the plaintiff. The appellants sought to rely on exclusion clauses contained in their standard trading terms. However, on the penultimate and final days of the trial the appellants made several admissions including that their terms did not operate so as to exclude or limit their liability for any breach and that they were in breach of their warranty that their product was durable for five years. Thus in the concluding stages of the trial the only issue left to the judge was the proper measure of damage. The defendants conceded that at least the plaintiffs were entitled to be reimbursed in the sum of £22,000 in respect of the stock returned to them. The judge accurately summarised the position thus :

"In the present case the plaintiffs have not suffered a loss in the shape of a claim for damages from their customers in respect of the decals processed by them from the defective Fasson 940 sold to them by the defendants to whom they have paid the contract price. Although they have suffered no such loss, they have been exposed and remain exposed to claims from their customers and they have been put to the expense of investigating and answering complaints. Also their commercial reputation may have suffered."

The judge found applying a section 53(3) Sale of Goods Act 1979 that the plaintiffs were entitled to the difference between the value of the goods at the time of delivery and the value they would have had if they had fulfilled the warranties.

At the heart of this appeal is the appellants' assertion that the judge mis-directed himself in defining the issue as to the proper measure of damages which fell for determination.

Section 53 Sale of Goods Act 1979 is headed "Remedy for Breach of Contract":

"(1) Where there is a breach of warranty by the seller, or where the buyer elects (or is compelled) to treat any breach of a condition on the part of the seller as a breach of warranty, the buyer is not by reason only of such breach of warranty entitled to reject the goods; but he may -

(a) set up against the seller the breach of warranty in diminution or extinction of the price, or

(b) maintain an action against the seller for damages for the breach of warranty.

(2) The measure of damages for breach of warranty is the estimated loss directly and naturally resulting, in the ordinary course of events, from the breach of warranty.

(3) In the case of breach of warranty of quality such loss is prima facie the difference between the value of the goods at the time of delivery to the buyer and the value they would have had if they had fulfilled the warranty.

(4) The fact that the buyer has set up the breach of warranty in diminution or extinction of the price does not prevent him from maintaining an action for the same breach of warranty if he has suffered further damage."

Section 54 provides:

"Interest

Nothing in this Act affects the right of the buyer or the seller to recover interest or special damages in any case where by law interest or special damages may be recoverable, or to recover money paid where the consideration for the payment of it has failed."

The Sale of Goods Act 1979 lays down the basic principles for remoteness of damage in language derived from the leading case of Hadley v Baxendale (1854) 9 EXCH 341 where the main proposition was:

"Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may be fairly and reasonably be considered either as arising naturally, ie according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it." Per Alderson B. at page 354."

The principles in Hadley v Baxendale have been interpreted and restated by the Court of Appeal (see Victoria Laundry (Windsor) Ltd v Newman Industries Ltd [1949] 2 K.B. 528 and in the House of Lords in Koufos v C. Czarnikow Ltd [1969] 1 AC 350 - " The Heron II "). In the latter case the word "directly" is eliminated and more emphasis is placed on the "reasonable contemplation" of the parties. Such moderately differing formulations of the Common Law principles for remoteness of damage in contract are still based on Hadley v Baxendale . Lord Reid in the latter case stated:

"The crucial question is whether, on the information available to the defendant when the contract was made, he should or the reasonable man in his position would, have realised that such loss was sufficiently likely to result from the breach of contract to make it proper to hold that the loss flowed naturally from the breach or that loss of that kind should have been within his contemplation." (At page 385)

Lord Upjohn at page 424 stated:

"A broad rule as follows : what was in the assumed contemplation of both parties acting as reasonable men in the light of the general or special facts (as the case may be) known to both parties in regard to damages as the result of a breach of contract."

The so-called second rule in Hadley v Baxendale applies when the loss caused by the breach of contract is greater than, or different from, what would have been in "normal" circumstances. The rule is that:

"If the special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily follow from a breach of contract under the special circumstances so known and communicated." (Supra 354 - 355)

Section 53(2) lays down the basic rule in terms of Hadley v Baxendale . The second rule is not expressly incorporated in the SOGA 1979 but is considered to be impliedly accepted by the wording of section 54 : "Nothing in this Act affects the right of the buyer or the seller to recover... special damages in any case where by law... special damages may be recoverable..." (See Benjamin Sale of Goods 4th Edition 126-040).

The judge approached the problem thus. At page 6e-f he said:

"In my judgment -- the main issue which I have to determine in this action is whether the prima facie measure damages is displaced by some other measure. At the time the contracts were made what may the Court reasonably suppose to have probably been in the contemplation of the parties as to the remedy to be available to the plaintiffs in the event of breach of the warranty of quality, assuming the parties to have applied their minds to the contingency of there being such a breach."

At page 7f:

"... Unless the court is satisfied on the balance of probabilities that some other measure of damages was objectively in the contemplation of the parties when the contract was made, the prima facie measure set out in section 53(3) remains un-displaced if as the result of transactions by the buyer with other parties either the buyer may recover a windfall or the seller's liability may be limited to the prima facie measure albeit that the buyer's loss is much greater (emphasis added)."

At page 17e:

"A plaintiff will only be restricted in his claim for damages (by reduction from the prima facie measure) as a result of special circumstances when those special circumstances have been brought home to him in such a way as to show that he has accepted or is taken to have accepted the risk that he will not be able to claim damages in respect of defective goods supplied to him unless his customer of his processed goods brings a claim against him ."

At page 17g:

"Not only at the time that the contract was made must the parties be viewed objectively to have contemplated that the plaintiff is taking the risk of having his normal measure of damages restricted in the event that his customer does not claim against him although he may still suffer loss because his customer may not re-order from him because of the defective quality of the goods supplied to him but also they must be taken to have contemplated that the defendant is taking the risk that the damages awarded against him will not be limited to the prima facie measure but that he will be exposed to a potential open-ended liability that he will have to indemnify the plaintiff in respect of any claim made by a customer against him."

And at page 18c

"The defendants have failed to satisfy me on the balance of probabilities that having regard to all the circumstances in which the contract was made the parties must be taken to have contemplated that the section 53(3) measure of damages was displaced."

Mr Stephen Grime QC on behalf of the appellants submits that the learned judge misdirected himself in defining the issue as to the measure of damages which fell for determination. He submits that the principle issue which the learned judge had to decide was as to whether at the time of the making of the relevant contracts the parties contemplated that the loss which would be suffered by the plaintiff in the event of a serious breach of warranty of quality resulting in premature deterioration in service of the decals made from the defendant's goods was (i) diminution in the value of goods supplied by the defendant or (ii) liability in damages to purchasers of the decals together with loss of business and goodwill and any incidental loss and expense. The learned judge wrongly defined the issue as being as to the parties contemplation of the legal remedy which was available to the plaintiff in the event of breach of contract rather than as to their contemplation of the nature of the financial loss which the plaintiff would be likely to suffer upon breach.

Leading counsel advanced the following propositions:

"1. In case of sale of goods where a term as to quality is broken, the measure of damages depends upon the contemplation of the parties as to the consequence of a breach of the type committed, such contemplation being based on either their imputed or actual knowledge at the time of contracting.

2. There will be imputed to parties knowledge of facts which they had learnt as to the nature and background of their respective businesses (first limb of Hadley v Baxendale so called).

3. In SOGA S53(3) words "prima facie" are not an expression of special quality or merit being attached to difference in value measure but more a reflection of the trading/mercantile conditions of times. Where the sale contract is not made between merchants dealing in a market the displacement burden is a light one.

4. Actual knowledge of special circumstances may extend the ambit of potential damages (S.54).

5. In some cases the finding as to contemplation of the parties as to the consequences of breach may be to show that breach will give rise to difference in value measure under S.53(3) and special damages under S.54. The claimant will not be limited if he wishes to choose one or both.

6. In other cases the finding as to contemplation of the parties as to the consequences of breach will show that the possible measures are alternatives.

7. Where the measures are alternatives it is for the court to choose the correct measure, not the claimant.

8. Where the court chooses one or other measure, the effect of the choice may reduce the amount of damages which may be claimed or increase it."

Mr Andrew Moran QC on behalf of the respondents submits that the judge did not misdirect himself in defining the issue as to the measure of damages which fell for determination. The issue was whether the loss claimed by the respondent was too remote a consequence of a breach of contract. In approaching this issue the judge was correct to proceed to the measure prescribed by section 53(2) and (3) of the Act as the starting point and then to consider whether on the facts of this case, the defendants had satisfied him that the prima facie measure was displaced by some other measure. This was to be resolved by asking the question, what loss to the plaintiffs is it reasonable to suppose would have been in the contemplation of the parties as a "serious possibility" or "a not unlikely result" had they had in mind the breach when they made their contract? The time of assessment is the time of making the contract. The learned judge both correctly defined the issue and expressed a proper approach to its resolution. Section 53(2) lays down a rule defining the measure of damages as a particular "loss" and section 53(3) is the exposition is how "such loss" is ordinarily calculated.

Leading counsel advanced the following propositions:

"1. In a case of sale of goods when a term as to quality is broken the court should resolve any issue as to the measure of damage by first recourse to section 53 SOGA 1979. In doing so the court is objectively ascertaining what loss would have been in the contemplation of the parties at the time of making the contract had they been made aware that a breach of the type which in fact occurred would occur.

2. The reference to "loss" in paragraph 1 does not involve the precise detail of the damage or the precise manner of its happening it is enough for the innocent party to show that loss of that kind is not unlikely or a serious possibility.

3. The parties are deemed to contemplate loss which directly and naturally results in the ordinary course of events. In the ordinary course of events when goods of defective quality are delivered such loss is prima facie the difference in value. This principle is of universal application and not confined to mercantile or trading conditions of the time when the predecessor of the Act appeared.

4. Additional actual or imputed knowledge proved by a party seeking to rely on it, may demonstrate that particular loss would have been in the contemplation of the parties either i) as a serious possibility of additional loss or, ii) (as in a chain sale proper) as the exclusive kind of loss that might be suffered. In i) the party suffering loss may confine his claim to the loss which the parties are deemed to contemplate as in para 3 above, or he may add a claim for additional loss in contemplation. In ii) he is confined to a claim for the exclusive loss so contemplated.

5. It is for the judge to resolve as a question of fact whether such additional knowledge as is relied on, demonstrates that some exclusive alternative loss was in contemplation."

I take as my starting point that section 53(3) lays down only a prima facie rule, from which the court may depart in appropriate circumstances. The burden of proof lies upon the person who seeks such a departure. The plaintiffs do not suggest that it is only open to a buyer to rebut the presumption. In my view, there is no reason in logic or principle why a seller cannot, in appropriate circumstances, seek to discharge the burden and displace the presumption (and see Biggin v Permanite supra at page 435-6).

The situation often arises where the buyer seeks to displace the presumption and recover losses other than the diminution in value. Where a seller knows that the buyer intended to re-sell the goods and ought reasonably to have contemplated that a breach of his undertaking as to the description or condition of goods would be not unlikely to cause the buyer to lose the profit he hoped to make on the re-sale, or potential sub-sale, the buyer may recover damages in respect of such loss of profits caused by a breach of the sellers undertaking (see Chitty on Contracts 27th Edition 41/315).

Situations arise where the court is satisfied and finds as a fact that it was within the contemplation of the parties, at the time of making the contract that:

"(a) the buyer intended to resell, or probably would do so, and that his sub-buyer would probably resell, and so on, so that there would be a series of sub-sales or 'string contracts' of the same goods; and

(b) that each contract in the series would, or probably would, contain the same, or a similar, contractual undertaking as to the description or condition of the goods; and

(c) that it was not unlikely that a breach of the seller's undertaking would cause the buyer and each sub-buyer in the series to be in breach of his undertaking to his own buyer; and

(d) that it was not unlikely that, in the case of such a breach, the ultimate buyers would recover damages from their sellers, so that liability would in turn be passed up the chain of sellers and buyers.

In these circumstances, the buyer who has paid to his sub-buyer damages and costs for breach of the undertaking in the first contract of sub-sale (which the sub-buyer claimed from the buyer, as the result of similar payments of compensation between successive sub-buyers down the chain) may recover the amount paid by him to the sub-buyer, together with his own reasonable costs in reasonably defending the sub-buyer's claim against him; the damages and costs paid or incurred by the buyer are taken as the measure of damages for the seller's breach of the original contract (see Hammond v Bussey (1887) 20 QBD 79, Kasler and Cohen v Slavouski [1928] 1 K.B. 78." [per Chitty (supra) 41 - 321].

In the present case there was no series or "string" contracts. The same goods were not sold on. Even so the string contract cases illustrate graphically how the court is permitted to and will depart from the presumption in order to do justice between the parties based on a finding of fact of what the parties reasonably contemplated.

If the buyer uses the goods to make some product out of them the value of the goods is not taken. In Holden (Richard) Ltd v Bostock and Co Ltd (1902) 18 T.L.R. 317 where sugar was sold to brewers to be used for brewing beer and because of arsenic in the sugar the beer was rendered poisonous and was destroyed by the brewers the value of the beer at its market price in their cellars was allowed, inter alia as damages. Similarly in Bostock v Nicholson [1904] 1 KB 725 where commercial sulphuric acid warranted free from arsenic was used by the buyer for making brewers sugar, one of its ordinary uses, he recovered not only the price paid for the acid rendered worthless to him by the breach of warranty but the value of other ingredients spoilt by being mixed with the acid.

In McGregor on Damages 15th Edition paragraph 808 it is stated:

"In all these cases, it is once again vital that the use to which the goods have been put by the buyer is one that the seller either contemplated or must be taken to have contemplates: otherwise the damage will be too remote. If the buyer adopts the ordinary use of the goods, as where food sold for human consumption is eaten by him, or adopts one of the ordinary and well recognised uses although not the only one, as in Bostock v Nicholson , or adopts even a use which is not the predominant one provided it is a use which is sufficiently common, as in Hardwick Game Farm v Suffolk Agricultural Poultry Producers Association where contaminated groundnut extractions were supplied for compounding into poultry food and the compound was fed to pheasants and partridges, he will recover under the first rule in Hadley v Baxendale . If however he puts them to some special use, he will recover only if this intention is communicated to the seller, ie under the second rule in Hadley v Baxendale . Here, as elsewhere, the dividing line between the first and second rules is not always clear in the cases."

Mr Moran in argument invoked the principle that where the seller delivers defective goods but the buyer is nevertheless able to perform a sub-contract by delivering the goods to his sub-buyer, the buyers damages against the seller cannot be reduced by taking this into account. He relied upon the decision of the Court of Appeal in Slater v Hoyle and Smith Ltd [1920] 2 K.B. 11 where the buyer bought cotton cloth from the seller in order to fulfil another contract which the buyer had already made with a sub-buyer. The seller delivered cloth which was not up to the contractual quality, but the buyer was able to perform the sub-contract by delivering the same cloth. The sub-buyer paid the full price under the sub-contract. The buyer sued the seller for damages. The court awarded the buyer damages assessed at the normal measure, namely, the difference between the market price at the time and place of delivery of cloth up to the contractual quality and the market price, at the time and place of delivery of the cloth actually delivered. Scrutton LJ said that "if the buyer is lucky enough, for reasons with which the seller has nothing to do, to get his goods through on the sub-contract without a claim against him, this on principle cannot affect his claim against the seller any more than the fact that he had to pay very large damages on his sub-contract would affect his original seller."

In my judgment the decision in Slater can be narrowly distinguished from the instant case. In Slater's case the sub-sale was of the same goods albeit after bleaching; the seller did not know of the contemplated sub-sale. In the instant case the goods were substantially converted or processed by the buyer and the sellers were aware of the precise use to which the film was to be put at the time the contract was made. I recognise Auld LJ's reservations.

This last case must be considered in the light of the dicta of Devlin J in Biggin & Co Ltd v. Permanite Ltd [1951] 1 K.B. 422 at 435:

"Damages which arise under the so-called "second rule" in

Hadley v Baxendale (ii), are sometimes referred to as if they were an increased sum which the plaintiff could obtain if he could show "special circumstances", or as if the rule embodied a measure of damage specially beneficial to the plaintiff which he could invoke if he fulfilled the necessary conditions. It is, no doubt, true that it generally operates in favour of a plaintiff rather than against him, but I think that it is capable of doing either."

And later at 436:

"It has often been held that the profit actually made on a subsale which is outside the contemplation of the parties cannot be used to reduce the damages measured by a notional loss in market value. If, however, a subsale is within the contemplation of the parties, I think that the damages must be assessed by reference to it, whether the plaintiff likes it or not. Suppose that the only fault in the compound was its incompatibility with bitumen felt, the chance that it might produce bad results would certainly reduce its market value before use. But if it is the plaintiff's liability to the ultimate user that is contemplated as the measure of damage and if in fact it is used without injurious results so that no such liability arises, the plaintiff could not claim the difference in market value, and say that the subsale must be disregarded.

I say this so as to make it clear, that although I have come to the conclusion that, if the plaintiffs' basic claim fails, they can to some extent rely on the alternative of difference in market value, it is not because I think the plaintiffs have an option in the matter."

Lord Pearce in Koufos v Czarnikow (supra) made a similar point

when he said at page 46:

"Of course the extension of the horizon need not always increase the damage; it might introduce a knowledge of particular circumstances, eg a sub-contract, which show that the plaintiff would in fact suffer less damage than a more limited view of the circumstances might lead one to expect." (his emphasis)

In my judgment, once the goods had been converted in a manner which was contemplated by the parties, Slater has no application, the damages must be assessed by reference to the sub-sale "whether the plaintiff likes it or not". Thus the plaintiff does not have the option to choose which outcome is most favourable to him. It is for the court to determine the correct measure of damage, not the aggrieved party. Where the court determines the proper measure the effect of the choice may reduce the amount of damages claimed or increase it.

With this analysis I address the issue as to what was within the contemplation of the parties. The evidence showed that there was a close and protracted business relationship between the parties from which it can be readily inferred that the defendants had detailed knowledge of the plaintiffs' business. The end use of the film was exclusively for container decals. The defendants knew that the plaintiffs then supplied the decals to container manufacturers and the manufacturers subsequently supplied the containers (suitably marked by the decals) to subsequent purchasers. The sellers knew that the plaintiffs' customers demanded five-year durability of their product.

Moreover, the sellers would have known that any defect in the film would not have been detected on delivery or in the process of manufacture. The defect, ie the breach, would have caused deterioration of decals in service with the result that the ultimate users of the containers (lessees of the owners) would complain to and claim damages against the container owners who would in turn make claims against the container manufacturers. The manufacturers in turn would make claims for damages against the plaintiffs which the plaintiffs would be 'not unlikely' obliged to meet. Moreover the defendants would expect to be liable for the value of unmerchantable film processed by the plaintiff and of unsaleable raw materials supplied by the defendants.

These factors, to my mind, point indubitably against a loss of value basis and towards a measure of damage based upon the plaintiff's liability to the subsequent or ultimate users of the plaintiffs product in which the defendants' goods were an integral part and in the event of a breach of the warranty as to quality the plaintiffs' liability to those others would be triggered.

It is not without significance that after the breach had been discovered the remedy sought by the plaintiffs in correspondence was one of indemnity and not the difference of value of the goods. However, when the statement of claim was served in 1988 it was solely for the difference in value. The obvious inference to draw is that by that time the plaintiffs had realised that the claim for indemnity and the peripheral claims were of lesser value than a claim for the market value. It is true that the statement of claim was amended in 1991 to include, in the alternative, an indemnity against all claims by customers of the plaintiff. However, at trial they pressed for relief under the section 53(3) presumption.

Thus, in my view, at the time of making their contract the parties were aware of facts which indicated to both that the loss would not be the difference between the value of the goods delivered and the market value and accordingly the prima facie measure ceased to be appropriate.

Finally, the judge in rejecting the defendant's case at trial said:

"Mr Heaton's submission is that the measure of damages recoverable by the plaintiff is in effect an indemnity in respect of claims by their customers made against them. The weakness of the Heaton submission is demonstrated by nebulousness of what Mr Heaton called an indemnity. Was it unlimited in amount? The purpose for which the vinyl was made was for processing into decals. A degraded decal, that is not having the 5 year durability quality, could result in the loss of a container and the goods within it, the value of which could be large or small. It could also result in a container and its goods going to a wrong destination. Did the indemnity cover such losses which might well be of a magnitude out of all proportion to the price of the vinyl when sold to the plaintiffs or the price of the decal, the vinyl processed by the defendants when sold on to their customers? Did the indemnity only cover claims the defendants were legally obliged to satisfy or did it cover claims which could be defeated by reason of the Limitation Act but which would be commercially suicidal not to satisfy? Did the indemnity cover claims successfully defended in respect of costs of successfully defending claims arising out of the breach of warranty. Did it cover the costs of processing and investigating complaints?"

I do not see any "nebulousness" of what Mr Heaton called an indemnity. The defendants will only be liable to indemnify the plaintiffs in respect of any liability which they may be held to have incurred to third parties. The difficulties posed by the trial judge are, to my mind, more apparent than real and would be a matter for determination in any subsequent action by third parties and in third party proceedings against the defendants.

I accept Mr Grime's submission that the learned judge attached weight to the supposed difficulties in assessment that adoption of the measure of damages contended for by the defendant would create when such difficulties as may exist were irrelevant to the issue which the learned judge had to decide.

It follows that, with respect to the learned judge, I consider his reasoning and conclusion cannot be sustained. If the plaintiff had sought to rebut the presumption they would have succeeded with ease. Any argument by the defendants that the correct measure of damage was the difference in value would have been doomed to failure. I am satisfied therefore that the learned judge erred in law in holding that the prima facie measure of damages for breach of warranty of quality provided for by section 53(3) SOGA (1979) was not displaced.

Accordingly I would allow the appeal, substitute a judgment for £22,000 with any appropriate interest and direct that the case be remitted for assessment of damages.

LORD JUSTICE AULD: I agree with the conclusion of Otton LJ and his general reasoning, but wish to add some words on the effect of section 53(3) of the 1979 Act and on mercantile contracts where the parties obviously contemplate that the buyer will sell on the subject matter of the contract in its existing or in an altered form or as part of some other thing.

As to section 53(3), there is, in my view, a danger of giving it a primacy in the code of section 53 that it does not deserve. The starting point in a claim for breach of a warranty of quality is not to determine whether one or other party has "displaced" the prima facie test in that sub-section. The starting point is the Hadley v. Baxendale principle reproduced in section 53(2) applicable to a breach of any warranty, namely an estimation on the evidence, of "the ... loss directly and naturally resulting in the ordinary course of events from the breach of warranty". The evidence may be such that the prima facie test in section 53(2) never comes into play at all.

The Hadley v. Baxendale principle is recovery of true loss and no more (or less), namely to put the complaining party, so far as money can do it, in the position he would have been if the contract been performed. Where there is evidence showing the nature of the loss that the parties must be taken to have contemplated in the event of breach, it is not to be set aside by applying the prima facie test in section 53(3) simply because calculation of such contemplated loss would be difficult. Equally, it should not be set aside in that way so as to produce a result where the claimant will clearly recover more than his true loss.

Where, as here, the contract of sale is between two merchants both of whom contemplate that the subject matter of the sale is to be sold on in whatever form, it offends the Hadley v. Baxendale principle to rule out mutual contemplation by them of damage arising from the buyer's onward sale simply because the subject matter is to be altered or incorporated in another product, or because the terms of the sub-sale may not be identical to those in the sale. It is equally offensive to that principle to describe the subject matter, as Mr Moran did, as "worthless" or of "no value" to the buyer at the time of delivery if it appeared then to be of the contract quality and he was able to incorporate it in his product and sell it on without claim or provable prospective claim. Put shortly, and drawing on the analysis of Scarman LJ in H. Parsons (Livestock Ltd. v. Uttley Ingham & Co. Ltd . [1978] 1 Q.B. 791, CA, at 807F-H, the sort of question the judge should have asked is "What would the parties have thought about the probable loss to the buyer in the event of a latent defect in film at the time of delivery later causing causing trouble?".

Those observations run contrary to the judgments of this Court in Slater v. Hoyle & Smith Ltd . [1920] 2 K.B. 11, though they are of a piece with the approach of Devlin J in Biggin v. Permanite [1951] 2 All ER 191. In my view, the time has come for the former case to be reconsidered at least in the context of claims by a buyer for damages for breach of warranty where he has successfully sold on the subject matter of the contract in its original or modified form without claims from his buyers. With respect to Otton LJ, I do not think that the case is materially distinguishable from the present on the two bases that he suggests.

As to the first, the seller's knowledge of the buyer's intended use of the goods, the report in Slater states that the seller did not know of the buyer's onward sale contracts. However, that must simply mean that he did not know of the specific contracts; for there can be no doubt that, in contracting to sell 3,000 pieces of unbleached cloth of a certain quality, the seller knew that he was dealing with a commercial buyer who would sell them on either unprocessed or processed to some degree, and must be taken to have contemplated that loss could result from such onward sales if the cloth was not of the required quality. The fact that the seller in this case had more detailed knowledge of the use to which the buyer would put the film is not a material distinction in determining the measure of damages as distinct from their precise calculation.

Second, as to what happened to the goods, the buyer in Slater did in fact process them before selling them on; he bleached the unbleached pieces of cloth. That does not seem to me to be materially different for this purpose from incorporating the goods in a manufactured product for onward sale.

The Court of Appeal in Slater had to reason around two decisions to the effect that where there has been delivery of goods to the buyer his onward sale may be taken into account in the assessment of damages. The first was a decision of the Privy Council, Wertheim v. Chicoutimi Pulp Co . [1911] A.C.301, where their Lordships held that the damages for late delivery should take account of the price actually obtained by the buyer in his onward sale. Lord Atkinson, giving the judgment of the Board, said at 307-308:

"... it is the general intention of the law that, in giving damages for breach of contract, the party complaining should, so far as it can be done by money, be placed in the same position as he would have been in if the contract had been performed ... That is a ruling principle. It is a just principle. The rule which prescribes as a measure of damages the difference in market prices at the respective times above mentioned is merely designed to apply this principle and ... it generally secures a complete indemnity to the purchaser. But it is intended to secure only an indemnity. The market value is taken because it is presumed to be the true value of the goods to the purchaser. In the case of non-delivery, where the purchaser does not get the goods he purchased, it is assumed that these would be worth to him, if he had them, what they would fetch in the open market; and that, if he wanted to get others in their stead, he could obtain them in that market at that price. In such a case, the price at which the purchaser might in anticipation of delivery have resold the goods is properly treated, where no question of loss of profit arises, as an irrelevant matter: Rodocanachi v. Milburn ... The purchaser not having got his goods should receive by way of damages enough to enable him to buy similar goods in the open market. Similarly, when the delivery of goods purchased is delayed, the goods are presumed to have been at the time they should have been delivered worth to the purchaser what he could then sell them for, or buy others like them for, in the open market, and when they are in fact delivered they are similarly presumed to be, for the same reason, worth to the purchaser what he could then sell for in that market, but if in fact the purchaser, when he obtains possession of the goods, sells them at a price greatly in advance of the then market value, that presumption is rebutted and the real value of the goods to him is proved by the very fact of this sale to be more than market value, and the loss he sustains must be measured by that price, unless he is, against all justice, to be permitted to make a profit by the breach of contract, be compensated for a loss he never suffered, and be put, as far as money can do it, not in the same position in which he would have been if the contract had been performed, but in a much better position."

Lord Atkinson's reasoning in that case, in particular the distinction between cases of non-delivery and late delivery and the relevance of the onward sale price in the latter case, was approved and re-stated by Lord Dunedin in the House of Lords in Williams Bros. v. Ed. T. Agius Ltd [1914] AC 510, a case of non-delivery. He said, at 522:

"... It is certain that Lord Atkinson, who delivered the judgment in that case, did not think that he was going against Rodocanachi's Case, for he says so in terms. Nor, in my mind, is there any discrepancy between the two judgments. Wertheim's Case was a case, not of delivery withheld, but of delivery delayed. The buyer, therefore, got the goods, and the only damage he had suffered was in delay. Now, delay might have prejudiced him; but the amount of prejudice was no longer a matter of speculation, it had been put to the test by the goods being actually sold; and he was rightly, as I think, only held entitled to recover the difference between the market price at the date of due delivery and the price he actually got. But when there is no delivery of the goods the position is quite a different one. The buyer never gets them, and he is entitled to be put in the position in which he would have stood if he had got them at the due date. That position is the position of a man who has goods at the market price of the day - and barring special circumstances, the defaulting seller is neither mulct in damages for the extra profit which the buyer would have got owing to a forward resale at over the market price ..., nor can he take benefit of the fact that the buyer has made a forward resale at under the market price."

See also per Lord Atkinson at 529, and the unusual case of Pagnan & Fratelli v. Corbisa Industrial Agropacyarua Limitada [1970] 1 W.L.R. 1306, CA, where a buyer, having initially rejected goods because of their defective quality, later accepted them after negotiating a reduced price which was less than the market price for similar goods at the date of the seller's breach. The Court of Appeal held that the prima facie market price rule in section 53(3) did not apply because the buyer had suffered no loss.

In Slater all the members of the Court were disinclined to extend the decision in Wertheim to a claim for breach of warranty of quality. Bankes LJ, at 15, confined it in any event to a sub-sale of the identical goods, relying on reasoning of Lord Dunedin in that case at 523 about the difficulty of establishing damages based on the terms of a sub-sale in a non-delivery case. Warrington LJ, at 17-18, appears to have been of the view - though he did not explain why - that section 53(3) of the 1893 Act [corresponding to section 53(3) of the 1979 Act] was the right principle governing delivery of inferior goods to those provided for by the contract and that what the buyer did with the goods was irrelevant. Scrutton LJ, at 22, expressed the view that the Rodocanachi principle as to non-delivery applied equally to delivery of inferior goods, because if the buyer fulfils his sub-contract by buying in the market, he is left with the inferior goods at their market value against the market value of sound goods. Alternatively, if he applies the inferior goods to a sub-sale the damages he may have to pay to his buyer may be calculable differently from those in the contract with his seller. He acknowledged that, on this approach, the buyer may recover more than his true loss, but he cited examples of the same principle resulting in a recovery of less than the true loss.

With respect to the Court of Appeal in that case, and to the authors of the supporting comments in McGregor on Damages, 15th ed., para. 774, at p [502] and Chitty on Contracts, 27th ed. Vol. 2, para. 41-300, note 91, it seems to me that they wrongly:

1. overlooked the basic rule in section 53(2) as to what would have been in the ordinary and natural contemplation of the parties in a commercial contract such as it was, namely, that the buyer could well be prejudiced in his onward dealing with the goods if they were defective;

2. disregarded the reasoning of the Privy Council in Wertheim as approved and re-stated by Lords Dunedin and Atkinson in Williams v. Agius that where there has been delivery in a mercantile contract and it can be seen what the buyer has done with the goods, it is possible and proper to measure his actual loss by reference to that outcome;

3. had too much regard to practicality at the expense of principle in relying on possible difficulties of estabishing causation and assessment where the goods sold have been subjected to some process or where the terms of the contract and sub-contract may for that or some other reason be different; and

4. were seemingly content to award a buyer more than the evidence clearly showed he had lost.

As Devlin J made plain in his consideration in Biggin v. Permanite , [1951] 1 KB 422, at 436, of the supposed two rules in Hadley v. Baxendale , the critical matter in determining the earlier question as to the applicability or not of the prima facie rule in section 53(3) is the contemplation of the parties:

"... there is only one area of indemnity to be explored, and that is what is within the prevision of the defendant as a reasonable man in the light of the knowledge, actual or implied, which he has at the time of the contract. It has often been held ... that the profit actually made on a subsale which is outside the contemplation of the parties cannot be used to reduce the damages measured by a notional loss in market value. If, however, a subsale is within the contemplation of the parties I think that the damages must be assessed by reference to it, whether the plaintiff likes it or not. ...if it is the plaintiff's liability to the ultimate user that is contemplated as the measure of damage and if in fact it is used without injurious results so that no such liability arises, the plaintiff could not claim the difference in market value, and say that the subsale must be disregarded."

The judge, at page 6E of the transcript of his judgment, directed himself broadly to the question of the notional contemplation of the parties in the event of a latent defect in the film putting the buyer in breach of his contract to the container manufacturers. However, apart from a brief summary, at page 11C-E, of the relevant circumstances and, at pages 16F-17D, posing a series of unanswered questions about uncertainties as to the extent of the damages if calculated on that basis, he has not made a reasoned finding as to their notional contemplation. His approach, at pages 17E-18D, was a paraphrase of a passage in paragraph 264 of McGregor, op cit, relating to contracting parties' knowledge of "special circumstances". He asked whether there were "special circumstances" known at the time to the buyer which he should be taken as having accepted so as to restrict his claim "(by reduction from the prima facie measure)" or by which the seller should have contemplated exposing himself to an "open-ended liability" of indemnity.

In my view, that was a wrong approach. This was not a "special circumstances" case or one where the possible damages were so remote or open-ended as not to have been within the parties' contemplation. It was eminently a case in which they would have contemplated that, in the event of a breach by the seller discovered only after the decals had been in use, the buyer might wish to pass on to it claims for damages from dissatisfied customers.

I add a few words about chain contracts. In Dexters Ltd. v. Hill Crest Oil Co. (Bradford) Ltd . [1926] 1 K.B. 348, CA, Bankes, Warrington and Scrutton LJJ expressed the view, obiter, that all the contracts in a chain must be the same if recoverable damages are to be passed along the chain. However, as the editors of Chitty, op cit, Vol. 2, at para. 815, observe, that approach is "a little too strict". The matter was considered by Devlin J in Biggin v. Permanite . He said, at 433, that he agreed with the reasoning that lay behind the view, namely that material variations in contracts down the line could lead to contractual claims for damages not contemplated by the original seller. However, he clearly regarded the matter as one of fact for determination in each case, not as a rigid principle of law that all contracts in the chain must be in the same terms. He said, at 433-434:

" I respectfully adopt this principle, but I have still to determine how it should be applied in this case, and also what degree of variation in descriptions breaks the chain. ... To understand the application of the principle it is necessary to understand its basis. Like every principle in this branch of the law, it stems from the broad rule that the damage is to be measured by those consequences of the breach which the parties as reasonable men would, if they had thought about it, have foreseen and accepted as natural and probable. If the variation to a description is such that it is impossible to say whether the injury that ultimately results would have flowed from the breach of the original warranty, the parties must as reasonable men be presumed to have put the liability for the injury outside their contemplation as a measure of compensation. If this is, as I believe, the nature of the principle, it must be applied very differently according to whether the injury for which the defendant is being asked to pay is a market loss or physical damage. In the former case (which I think is what the Lords Justices were considering in Dexters ...) any variation that is more than a matter of words is likely to be fatal, because there is no way of telling its effect on the market value. In the latter case the nature of the physical damage will show whether the variation was material or not."

As Mr Stephen Grime QC submitted on behalf of the seller, the point is essentially one of causation, namely whether there is sufficient similarity between the sale contract and the subsequent contract(s) to enable a finding that breach by the seller of the sale contract has in fact caused the breach of the subsequent contract(s). Clearly, as he also submitted, a substantial change to goods sold as a result of the buyer subjecting them to a manufacturing process may break the chain of causation between the breach of the contract sued upon and any claim arising under a subsequent contract. However, that is unlikely on the facts of this case - a five-year film life without deterioration was stipulated by the container owner, the container manufacturer and the decal manufacturer, the buyer, in the contracts into which they respectively entered along the chain.

I, therefore, conclude, as Otton LJ has done, that this is plainly a case in which the parties must be taken as having contemplated that any latent defect in the vinyl film at the time of delivery or at the time of conversion by the buyer into the decals might when later discovered render the buyer vulnerable to claims for damages which it would wish to pass back to the seller. On the material before the judge, there appears to have been no material differences between the contracts in the chain which would have put damage claimed at any point in the chain outside the imputed contemplation of the buyer and seller, given their knowledge that the vinyl film and the decals into which it was converted were required to serve their purpose for a minimum of five years. I am accordingly of the view that the appeal should be allowed and that there should be an order in the terms stated by Otton LJ.

LORD JUSTICE THORPE: Where a contract is breached the natural objective of the legal system is to compensate the injured party fairly. Where a manufacturer supplies a defective product to his customers as a consequence of the use within the process of a raw material that did not possess the qualities warranted by the supplier the manufacturer is fairly compensated by recovering from the supplier the cost of settling claims made by his customers together with the profit lost on those sales, and perhaps prospective sales. Compensation so calculated would in the vast majority of cases considerably exceed the price that the manufacturer paid for the raw materials. I make those generalisations to illustrate the conclusion that the facts underlying this appeal are exceptional.

The condition governing the supply of the product to the plaintiff dealt with liability under paragraph 11 in these terms:

"(c) The seller's aggregate liability to the purchaser whether for negligence breach of contract misrepresentation or otherwise shall in no circumstances exceed the cost of the defective, damaged or undelivered goods determined by net price invoiced to the buyer in respect of any occurrence or series of occurrences.

(d) The seller's prices are determined on the basis of the limits of liability set out in this condition. The purchaser may by written notice to the seller request the seller to agree a higher limit of liability provided insurance cover can be obtained therefore."

Thus the parties must be taken to have contemplated the consequence of possible future breach within the terms of those sub paragraphs.

When problems of discolouration and disintegration of the decals arose in the summer of 1985 the plaintiffs did not know the cause but the defendants did. The defendants took steps to remedy the deficiency in future supplies, concealing its realisation and its reaction from the plaintiff. When the plaintiffs subsequently asserted the true cause of the defect the defendants refuted the assertion by spurious reliance on test results that were not germane. Despite this unmeritorious history the defendants vigorously contested the issue of liability. The plaintiffs' managing director gave lengthy evidence. On the sixth day the defendants made substantial admissions. On the seventh day they added the admission that all the material supplied to the plaintiff between 1980-1985 inclusive was defective in that by reason of its lack of ultra violet stabiliser it had a tendency to discolour or degrade within the five year period for which it was warranted durable. The defendants were therefore left with the issue of quantum of the resultant damage. The statement of claim sought the return of the contract price of £564,328.54. By subsequent amendment it sought an indemnity in respect of all claims made or to be made against the plaintiffs caused by or attributable to the supply by the defendants of defective film. But the defendants' endeavour to persuade the judge to assess damages on the alternative basis pleaded by amendment had to be weighed not only in the light of the concessions but also upon the evidence of the plaintiff alone, since the defendant elected to call no evidence. In the course of his evidence Mr Bence for the plaintiffs had asserted that the defective film supplied was worthless, since it lacked the essential durability, and that accordingly the plaintiffs were entitled to the return of the price paid.

Of course the reality was that he had had no conception that the material was defective until 1985 and had processed it to supply decals to manufacturers whose ultimate dissatisfaction had only given rise to modest claims. Despite that reality the judge was entitled to find that the product was worthless for want of durability and that finding has always been accepted by the defendants. But that is simply an unusual feature of the developments post the defendants' breach and it is the consequence of the latent character of the defect.

The issue fought by the defendant following the concessions on the sixth and seventh days had to be resolved by the application of sections 53 and 54 of the Sale of Goods Act 1979 to the contract from formation to breach. By the terms of section 53(3) the plaintiff had a prima facie entitlement to the return of the contract price. At trial Mr Heaton mounted an argument under section 54 or the second limb in Hadley v Baxendale . Throughout this appeal Mr Grime has contended under the first limb and section 53 that the plaintiff's prima facie entitlement is displaced by the party's exclusive contemplation of an alternative measure of damages. Mr Grime criticises with justification the use of the word 'remedy' at page 6e of the judgment. But in the end the judge made a finding which in my judgment is decisive of this appeal. His ultimate conclusion at 18c was in these terms:

"The defendants have failed to satisfy me on the balance of probabilities that having regard to all the circumstances in which the contract was made the parties must be taken to have contemplated that the section 53(3) measure of damages was displaced."

That was a finding of fact made on the evidence of the plaintiffs. I accept Mr Moran's submission that that finding is unassailable in this court. The consequence of the finding was judgment for damages equivalent to the price paid for the defective goods. The plaintiffs accepts that the judgment is comprehensive of all claims arising from the breach and that should they face future claims from those they supplied they cannot look to the defendants for indemnity or any other contribution.

Before reaching his essential contribution Morland J reviewed the relevant authorities at some length. As the sophisticated argument in this appeal demonstrates this is not an easy field of case law to summarise or to reconcile. But in my judgment Mr Moran is right to emphasise the distinction between authorities which determine cases involving a string of contracts and cases involving the supply of a raw material to a manufacturer or processor who converts the material to, or incorporates it within, some other product for supply to his customers. As Mr Moran submits, in the former class of case the buyer changes role and becomes himself the seller, the self same goods passing along a conduit of contracting parties on identical terms save as to price. In such cases (exemplified by Hall v Pim (Junior) & Co (1928) 30 Ll l Reps 159) the exclusive contemplation of the parties is very different in the event of breach of a quality warranty. In the latter type of case the contemplation of the supplier and the manufacturer is less confined and will depend upon all the circumstances of the case. Here the judge decided the contemplation of the parties on the evidence of the plaintiff alone.

Although the arguments have ranged wide over authority which as my lord, Auld L.J. demonstrates is difficult if not impossible to reconcile, I would dismiss this appeal on the simple ground that the judge's conclusion was justified on the evidence and no sufficiently substantial misdirection in law has been demonstrated.

Order: Appeal allowed with costs; case be dealt with in Mercantile Court, Manchester, for assessment of further damages and costs plus interest of hearing below.

Further proceedings stayed until repayment of £800,000 (excluding order as to costs); payment to be made within 28 days.

Balance of judgment sum plus interest accrued be paid to defendant's solicitors.

Leave to appeal to the House of Lords allowed.