Compensation measured by gains – Disgorgement of profit under the cisg?
If compensation is defined in a broader sense as a making good of the right to performance, this may open the way to another option to measure damages: Damages measured by the gains made by the contracting party as a result of the breach instead of the actual economic loss. Here a line must be drawn between (partial) disgorgement that is used to ease the evidentiary burden, where economic loss is indisputably caused but difficult to quantify, and full disgorgement of profit irrespective of economic loss. For the former the case at the beginning of this paper (goods produced under child labour conditions) may be an example. We have seen that the gains are a yardstick to measure the economic loss, therefore following the orthodox understanding of full compensation.
However, the more interesting question is if the CISG allows full disgorgement of profit. The consequence of such an award would be a preventive effect. Although disgorgement damages are awarded after breach of contract had already happened, the consequence of disgorgement is its influence on future behaviour. For the particular defendant the incentive to break a contract in the future is little, if he knows that ‘breach does not pay’. Likewise disgorgement has a general deterrence effect, as it warns other possible contract breakers of possible consequences.
The question whether the CISG provides for a claim of disgorgement of profit is not expressly stated in the CISG, nor expressly excluded as a possible calculation of damages. The drafting history of the CISG shows that the availability of “disgorgement” was not discussed. However, this is not surprising, because when the CISG was drafted in the 1980s the issue of disgorgement of profit in contract law had not yet emerged neither in civil law countries nor in common law countries. The CISG Advisory Council, which addresses from time to time emerging questions regarding the application and interpretation of the CISG, stated that the CISG does not provide for punitive damages, but did not mention the issue of disgorgement of profit. At this point it is worth mentioning that the concepts of the aforementioned consequences of breach of contract are different. Disgorgement is concerned to restore the breaching party in the same economic situation but for the breach, making the party indifferent between actual performance and breach. It does not go beyond this point. In contrast, the aim of punitive damages is to punish or make an example of the wrongdoer for “conduct which was outrageous in disregard of the plaintiff’s right” and could go beyond the actual gain. The study of the opinions of the most common commentators on the CISG reveals that there is still open disagreement on the issue of disgorgement of profit, so that the question still needs to be addressed.
Gap-filling pursuant to art 7
Art 7 as the ‘gap-filling’ provision of the CISG helps to cope with new developments or questions that have not been foreseen or have been overlooked during the drafting process. Art 7(2) states that matters covered by the Convention but not expressly settled must be tried to be filled with the general principles of the Convention, leaving the recourse to applicable domestic law as ultima ratio. Remedies after a breach of contract are “rights arising from the contract”, hence matters covered by the CISG according to art 4. While searching for general principles within the four corners of the CISG, attention must also be paid to the general aim to respect the international character of the Convention and to promote uniformity in the application.
As there is no enumeration of general principles in the CISG, general principles can be found in the explicit wording of provisions as well as in case law and literature where they are established progressively by judges and scholars interpreting the provisions of the CISG.
The following part will examine possible principles in order to find an answer whether the CISG covers disgorgement of profit.
Art 84 (2)
At first sight, one provision seems attractive regarding the disgorgement of profit as a legal consequence of a breach of contract: Article 84 (2). This rule applies in cases of avoidance of contract. It is a supplement to the general consequence of avoidance that parties have to restore what they have received as a consequence of performance of the contract. Concerning the buyer, his obligation to return the received goods does include any benefit that he has derived from the goods.
The problem with the application of that rule to an award of disgorgement of profits is that art 84 (2) concerns the restoration of the economical ex ante situation for both parties, because the duty to perform ceases to exist after avoidance. In contrast, damages concern the compensation for the non-performance of the contract.
Hence, no direct principal in regard to damages can be established from art 84 (2). However, it can be stated that at least the legal effect that a party is stripped of its actual profit is not totally unfamiliar to the CISG.
ii. Art 74
Disgorgement of profit in contract law constitutes a monetary award after the breach of a contract. Hence, it needs to be examined whether the principle of full compensation can serve as a gap-filling instrument. In the first part of the paper it was concluded that a broader conception of full compensation as a “making good” for the contractual right infringed could be derived from the general aim of remedies to establish an effective protection of the right to performance.
In fact, there is an international trend questioning if the economic approach to receive full compensation is always an effective protection of the right to performance. As art 7(1) guides us that every interpretation needs to bear in mind the international character of the CISG and its aim to create a uniform set of rules, any gap-filling should be guided by the search for a common understanding acceptable in all jurisdictions. The following comparative analysis aims at finding an internationally acceptable approach.
National tendencies and comparative analysis
a. Common Law jurisdictions
England has a pioneering role in the international trend to allow disgorgement of profit as a remedy in contract law. Originally English law provided for disgorgement of profit only in particular types of contract, as the breach of fiduciary duty, breach of confidence and some proprietary torts. Disgorgement of profit for a ‘pure’ breach of contract was first awarded in Attorney-General v Blake. Blake was a Soviet spy, who worked for the British Secret Intelligence Service. Under his terminated employment contract he undertook to not disclose any information gained as a result of his employment, during as well as after his time as an informant. He breached the contract by publishing an autobiography about his time as an agent. The House of Lords awarded an account of all the profit of the book that Blake had not yet received from the publisher and based the award on the breach of the employment contract. Lord Nicholls acknowledged that this was a new step in English contract law and concluded that an account for profit should only be awarded “exceptionally”. Although he stated that all circumstances need to be taken into account, he gave some guidance on what constitutes an exceptional case. Firstly, disgorgement is a remedy of last resort, when other remedies as damages measured by the economic loss are inadequate. Secondly the aggrieved party has to have a “legitimate interest” in preventing the party in breach from profit making. Although Lord Hobhouse noted in his dissenting speech to the judgement that “to extend that exceptional case to commercial situations ... will require careful consideration” disgorgement damages were discussed and partly awarded shortly afterwards in several commercial cases. Especially cases concerning a breach of a negative covenant which appear to be difficult as to find clear reasons whether an award of full disgorgement or only partial disgorgement is adequate. Likewise the doctrinal basis of an award of disgorgement of profit is controversially discussed in the literature.
Australia has not yet followed the English example and has not extended the availability of disgorgement of profit in contract law. This has, to a large part, to do with present resistance of courts to detach availability of disgorgement of profit from its historic roots. Courts tend to adhere to the strict division between common law and equity, disgorgement of profit available only in the latter case. However, a number of Australian academics suggest a more flexible and modern approach of disgorgement of profit in private law.
In regard to New Zealand Attorney-General for England and Wales v R was the parallel case to the English Blake case. However, the facts were slightly different, because the parties had expressively agreed on disgorgement as a remedy through a contractual provision. Until now New Zealand’s courts have not been required to decide about a general availability of disgorgement of profit in contract law and its possible requirements. Nonetheless, a hint towards a more flexible approach to disgorgement of profit is implied by the judgement of Paper Reclaim Ltd v Aotearoa International Ltd. Although the judgment concerned the availability of punitive damages for a breach of contract, its reasoning is of relevance. One argument why punitive damages were considered as generally not necessary in contract law, was the fact that remedies exist which already fulfill some of the objectives of punitive damages: Disgorgement of profit in contract with reference to Blake was explicitly named in the list of contract remedies.
b. Civil Law jurisdictions
Similar to Common Law countries there is yet no general concept for the availability of disgorgement of profit in German law. Rather it is narrowly tied to specific cases in commercial law where there is a particular fiduciary relationship between the parties, for example between employees and business owners, partners of a commercial business or directors and administrators of a stock company. In those relationships disgorgement is provided explicitly for the prohibition of competition. Apart from these provisions disgorgement often requires infringement of an absolute right rather than a contractual obligation.
However, it was recently discussed at the 66th German Jurists’ Forum whether deriving from the existence of s 687 (2) German Civil Code (Bürgerliches Gesetzbuch), a general provision should be adopted, allowing to claim for disgorgement of profit in case of an intentional breach of a person’s right. Consequently such a provision would include contractual rights. At the moment s 687 (2) BGB has a very little scope of application, because the wording requires a benefit from an intentional management of another person’s affairs without the person ́s knowledge. The prevailing view in literature and case law interprets ‘management of another person ́s affairs’ in a narrow way, hence, not including contractual situations.
The proposal for a general provision based on s 687 (2) BGB was finally rejected, presumably in part because of the very general wording that had only required an intentional infringement. However, there was a widespread agreement that disgorgement, with its absolute deterrent effect, is a preferable solution for the intentional infringement of another person’s right. That fact implies that German scholars see at least partly a lack of effective protection of legal rights and a need for development. One might not exclude that this also applies to contract law, irrespective of what the requirements for disgorgement might be.
France, likewise, has so far a ‘sectoral’ approach towards disgorgement of profit that concentrates on tort law. Disgorgement of profit is explicitly named in the legislation concerning the protection of intellectual property rights. In the past the infringement of personality rights through the press led to judgements allowing disgorgement of profits, even if the legal basis is unclear, because judges referred to a flexible way of calculating non-pecuniary loss. Scholars support the idea of a legal comprehensive framework for the availability of disgorgement of illicit profit. Even if the discussion seems to focus on a solution in the area of tort law, influences on contract law are shown by the preliminary draft bill for a reform of contract law proposed by a group of scholars led by Professor Terré in 2009. Art 120 provided for a partial or full disgorgement in cases of ‘lucrative fraud’, “i.e. where a party willfully fails to comply with the law, preferring to risk a conviction and damages so as to be able, for example, to conclude contracts elsewhere, in more advantageous conditions”. It has to be noted that this provision is more likely to be characterized as a proposal of punitive damages in contract law, as it merely requires a deliberate breach.
c. Mixed jurisdictions
Israel granted disgorgement of profit long before Blake. In fact Israeli law provides for an extensive set of remedies after a breach of contract; ones deriving from the law of contracts as well as ones deriving from the law of unjust enrichment. Disgorgement as a remedy under unjust enrichment law is therefore generally available in contract law irrespective of any loss. Interestingly, the landmark decision for disgorgement in contract Adras Building Material v Harlow & Jones GmbH concerned an international commercial sales contract. In 1973 the defendant, a German company, contracted to sell the plaintiff, an Israeli company, iron for a pre-determined price. Due to political instability in the buyer’s region, the delivery was delayed. A few months later after a partial delivery the seller informed the buyer that he had to sell the iron to a third party due to high storage costs. In fact the market price for iron had spiked in the meantime and the seller was able to sell the iron to a third party for a profitable price. The buyer had not made a cover purchase and had not avoided the contract but claimed for damages consisting of the seller’s profit under the Convention related to a Uniform law for the International Sale of Goods (ULIS, the predecessor of the CISG). The Court initially dismissed the claim under art 82 ULIS (equivalent to art 74 CISG), because the price for iron had dropped again at the time of the proceedings, so there was no loss, and under 84 ULIS because the provision required the avoidance of the contract which had not taken place. However, the Court applied the national law of unjust enrichment and argued that:
The injured party has a right not only to compensation for breach of contract, but also to specific performance . . . Therefore, under Israeli law, a buyer in a contract of sale is entitled to receive the subject-matter of the sale, and an enrichment of the seller which infringes this right is an unjust enrichment at the buyer’s expense.
Contrary to the wide approach in Israel an analysis of current developments in South Africa shows that even if some scholars favor a development towards disgorgement of profit, yet only in exceptional circumstances, they struggle to place disgorgement in South Africa’s existing set of private law. Within the law of contract South Africa follows a strict rule of compensation for patrimonial loss, so that any gain based approach to calculate damages is unknown. It is argued that the law of unjust could provide a further doctrinal basis for disgorgement of profit, however, a condition is that the enrichment is unjustified which is prima facie questionable due to the existence of a valid contract. Nevertheless there are some local commentators who favor a development towards disgorgement of profit in contract law as an exceptional remedy.
As a summary the comparative analysis shows that at this point there is no international ‘one-fits all solution’ under which circumstances disgorgement of profit is necessary in contract law. Notwithstanding, irrespective of the stage of ‘development’ the national jurisdictions are – reaching from scholar writing on one hand to existing case law on the other –, one fact can be stated: Jurisdictions all over the world discuss the issue of disgorgement in contract law. That implies that to a certain degree they see a deficiency in their existing set of remedies after a breach of contract.