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Cite as Knapp, in Bianca-Bonell Commentary on the International Sales Law, Giuffrè: Milan (1987) 538-548. Reproduced with permission of Dott. A Giuffrè Editore, S.p.A.

Article 74

Victor Knapp

1. History of the provision
2. Meaning and purpose of the provision
3. Problems concerning the provision

ARTICLE 74

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. Such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of contract.

1. History of the provision

     1.1. - Article 74 introduces the section containing the rules on damages in case of a claim under Articles 45(1)(b) and 61(1)(b) and must be interpreted in connection with those two articles as well as with Articles 75 to 80.

     1.2. - The concept of damages in Section II follows generally the concept in Section IV, Chapter IV and Chapter V of ULIS, with one important difference. ULIS strictly distinguished between damages when the contract was not avoided (sub-section A) and damages when the contract was avoided (sub-section B); this Convention does not.

     1.3. - Article 74 corresponds to Article 82 of ULIS, which read:

Where the contract is not avoided, damages for a breach of contract by one party shall consist of a sum equal to the loss, including loss of profit, suffered by the other party. Such damages shall not exceed the loss [page 538] which the party in breach ought to have foreseen at the time of the conclusion of the contract, in the light of the facts and matters which then were known or ought to have been known to him, as a possible consequence of the breach of the contract.

     1.4. - In contrast to Article 82 of ULIS, Article 74 of the Convention is not a rule to be applied only if the contract has been avoided but a general rule for the calculation of damages for every loss suffered as a consequence of a breach of contract. Thus, the mutual relationship between Article 74 on the one hand and Articles 75 and 76 of the Convention on the other is quite different from that between Articles 82 and 83 of ULIS and its Articles 84 to 87. Whereas Articles 75 and 76 apply only when the contract has been avoided, Article 74 applies whether or not the contract has been avoided. If the contract has been avoided it applies as a subsidiary rule concerning damages in addition to those which can be calculated under Article 75 or 76.

In summary, Articles 75 and 76 implement Article 74, the basic and general rule on damages, by providing the means of calculating damages in certain defined cases when the contract has been avoided. Article 74 provides the general rule for the calculation of damages whenever and to the extent that Articles 75 and 76 are not applicable, irrespective of whether the contract has been avoided.

     1.5. - The difference concerning the applicability of Article 74 versus Articles 75 and 76 depends on whether avoidance has occurred. In no way does it turn on whether the contract is avoidable.

2. Meaning and purpose of the provision

     2.1. - The claim for damages under Articles 74 et seq. is available to either party to the contract, seller or buyer, but only to them. No other person may claim damages under Articles 74 et seq. if he suffered a loss as a consequence of the breach of contract by the seller or by the buyer. A third person injured may claim damages only under the applicable domestic law. [page 539]

     2.2. - Article 74, as the introductory provision to Section IV, sets forth the basic rule for the calculation of damages (see § 1.4., supra). This is its principal, but not sole, purpose. At the same time, it implicitly sets forth the conditions under which the party in breach is liable for damages and the manner for compensation of the loss suffered by the injured party.

     2.3. - Several legal systems distinguish two ways of compensating the loss suffered by the injured party, namely damages as a monetary recovery for injuries suffered or restitution in integrum. Article 74 leaves no doubt that the only way of compensating losses under this Convention is the payment of the respective sum of money (see also Article 37).

     2.4. - Article 74 sets forth three conditions of liability:

(a) breach of contract by the seller or by the buyer,
(b) loss suffered by the other party; and
(c) causality between (a) and (b).

The party in breach is liable only for the loss suffered by the injured party as a consequence of that breach.

     2.5. - It follows that the liability under Article 74 is a strict liability, independent of any fraud or fault of the party in breach. This liability is, however, considerably limited by the conditions of foreseeability of the loss (see §§ 2.7. et seq., infra) and by the exemptions provided in Articles 79 and 80.

     2.6. - As to causality, it may be questioned whether the party in breach is liable only for the loss caused to the injured party by a direct causality or whether his liability extends to losses by indirect causality. There is no explicit answer to this question in the Convention. A working solution may be found by applying the criterion of foreseeability: the party in breach will be liable even for loss indirectly caused to the other party provided that this loss was foreseeable by the party in breach at the time of the conclusion of the contract.

     2.7. - The loss is foreseeable whenever the party in breach:

(a) foresaw or ought to have foreseen the loss; [page 540]
(b) in the light of the facts and matters which he knew or ought to have known; and
(c) at the time of the conclusion of the contract.

     2.8. - The wording «foresaw or ought to have foreseen» makes it clear that the party claiming damages need not prove that the party in breach really foresaw the loss. It will be enough if he proves that the party in breach was objectively in a position to foresee it. That means that the breaching party is not liable for all losses which are the consequence of the breach, but only for a foreseeable loss. This solution closely tracks the well-known theory of so-called adequate causality. In other words, Article 74 wishes to express affirmatively the idea which in some legal systems is expressed negatively (and perhaps more clearly) i.e., that having regard to all circumstances of the given case, the party in breach is not liable for a loss he could not foresee.

     2.9. - The question is: what is to be foreseen by the party in breach. Following the wording of Article 74 it seems that it is the amount of the loss suffered by the other party as a consequence of the breach of contract. This conclusion seems to flow from the provision that damages for breach of contract consist of a sum equal to the loss, that however this sum may not exceed the loss foreseeable by the party in breach. This conclusion is nevertheless ambiguous and may be understood either as a postulate of foreseeability by the party in breach of a sum certain of money equal to the possible loss suffered by the other party or simply as foreseeability of the extent of the possible loss. It seems that the latter interpretation corresponds more clearly to the ratio legis. Therefore, Article 74 should be interpreted so that the foreseeability as understood in it means the foreseeability by the party in breach of:

(a) the possibility of loss caused to the other party by the breach of contract; and
(b) the probable extent of the loss under (a).

     2.10. - The foreseeability by the party in breach of the possible loss suffered by the other party as a consequence of the breach is to be considered «in the light of the facts and matters [page 541] of which [the party in breach] ... knew or ought to have known». Thus foreseeability, as understood in Article 74, depends on the knowledge of facts and matters which enable the party concerned to foresee the results of the breach. It is, however, a presumed knowledge, and the party in breach will be considered as having been able to foresee the consequences of the breach even if he did not know the facts and matters enabling him to do so but objectively was in a position to know them.

     2.11. - The party in breach will be considered as knowing the facts and matters enabling to foresee the consequences of the breach of contract if such knowledge generally flows from the experience of a merchant or, in other words, if such knowledge can in the given case be expected of him having regard to his experience as a merchant.

     2.12. - The party in breach will also be considered as having known the facts and matters enabling him to foresee the possible consequences of the breach, and therefore, as having foreseen them, whenever the other party to the contract has drawn his attention to such possible consequences in due time. Should a party at the time of the conclusion of the contract consider that breach of contract by the other party would cause exceptionally heavy losses or losses of an unusual nature, he may make this known to the other party with the result that if such damages are actually suffered they may be recovered.

     2.13. - The relevant time for the foreseeability of the consequences of the breach of contract is the time of the conclusion of the contract. The negotiations leading to the conclusion of the contract may however last a certain period of time. The relevant time from the point of view of foreseeability is of course the time when the contract came into being. It follows that no subsequent foreseeability will have legal effects under Article 74. The party in breach will thus not be liable for losses he objectively could not foresee at the time of the conclusion of the contract even if he later (e.g., at the moment of the breach of contract) becomes able to foresee them.

     2.14. - In practice foreseeability is almost always examined ex post facto. That is to say that normally it will be only after the breach [page 542] of contract or, more exactly, after the loss which occurred as a consequence of the breach, that it is retrospectively examined whether the loss was foreseeable by the party in breach at the time of conclusion of the contract.

     2.15. - In some legal systems the limitation of damages to those «which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract» is not applicable if the non-performance of the contract was due to the fraud of the non-performing party. No such rule exists in this Convenion. That means that even when the loss was due to a fraud of the party in breach the latter will be liable only for the consequences of a breach which he could have foreseen at the moment of conclusion of the contract.

3. Problems concerning the provision

     3.1. - The main problem concerning Article 74 is that of how to establish the extent of damages due from the party in breach to the other party. Article 74 limits itself to stating that the injured party may, as a rule, recover as damages «a sum equal to the loss, including loss of profit, suffered ... as a consequence of the breach». This wording makes it clear that the basic aim of Article 74 is, as far as possible, to place the injured party in the same economic position he would have been had the contract been performed. However, Article 74 permits compensation of damages only by recovering a certain sum of money. It does not permit a restitution in integrum (see § 2.3., supra). Thus, the injured party will sometimes not be placed completely in his original economic position.

     3.2. - Article 74 is based on the principle of full compensation. Under this principle damages consist in compensation of:

(a) the so-called effective loss, i.e., the diminution of the injured party's property (damnum emergens); and
(b) the loss of profit (lucrum cessans).

     3.3. - The specific reference to the loss of profit is made because in some legal systems the concept of «loss» standing alone does not include the loss of profit. The question is how to calculate [page 543] the loss of profit under this Convention. This question involves several problems well known to lawyers from different countries. It may be questioned, for example, whether the injured party is entitled to recover the loss of profit he in fact suffered, could expect, or average profit to be expected at a certain place at a certain time, or for which period of time the injured party is authorized to claim recovery of the loss of profit.

     3.4. - Because the Convention does not provide specific rules for these questions, it should be assumed that the injured party may recover the loss of profit he in fact suffered or could expect and that the period of time for which the injured party may recover the loss of profit is not limited. He should be able to demand compensation of any profit lost as a consequence of the breach of contract by the other party, to the extent and under the condition that the loss was foreseeable by the other party in breach as provided in Article 74.

     3.5. - Another question raised is whether the injured party may ask only for the loss of profit already incurred or also for loss of expected profit. The Convention does not give any explicit answer to this question nor does it provide for calculation of the loss of future profit by a lump-sum or in a similar way. It seems that the court or the arbitration tribunal may adjudicate to the injured party only the loss of profit which has been incurred at the time of the taking of the judicial or arbitral decision. This conclusion would not exclude the injured party later claim for profit lost after the first decision if other conditions justifying such a claim under Article 74 are present.

     3.6. - As to interest, Article 78 provides that if a party fails to pay the price of any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under Article 74. Lost interest as a consequence of the breach of contract is part of the loss of profit.

     3.7. - Article 74 does not provide for punitive damages. It does not, however, exclude an agreement in this respect.

     3.8. - If follows from Article 45(2) and, when applicable, from Article 61(2) that, provided that the injured party did not [page 544] declare the contract avoided, the claim for damages which might have accrued in the meantime does not prevent the party injured from resorting to other remedies for breach of contract available to him under Articles 45 et seq. and 61 et seq. As to the consistency of these remedies with the claim for damages under Article 74, see commentary on Articles 45(2) and 61(2), infra.

     3.9. - Since Article 74 is applicable to claims for damages by both the buyer and the seller and these claims might arise out of a wide range of situations, including claims for damages ancillary to a request that the party in breach perform the contract or to a declaration of avoidance of the contract, no specific rules have been set forth in Article 74 describing the appropriate method of determining «the loss ... suffered ... as a consequence of the breach». The court or arbitral tribunal must calculate this loss in the manner best suited to the circumstances.

     3.10. - Where the breach by the buyer occurs before the seller has manufactured or procured the goods, Article 74 would permit the seller to recover the profit which he would have made on the contract plus any expenses which he has incurred in the performance of the contract. The profit lost because of the buyer's breach includes any contribution to overhead which would have resulted from the performance of the contract.

     3.11. - The following three examples are from the Secretariat's Commentary (Official Records, I, 59).

Example A: The contract provided for the sale for 50,000 U.S. Dollars F.O.B. of one hundred tools which were to be manufactured by Seller. Buyer repudiated the contract prior to the commencement of manufacture of the tools. If the contract had been performed, Seller's total costs would have been 45,000, of which 40,000 would have represented costs incurred only because of the existence of this contract (e.g., materials, energy and labour hired for the contract or paid by the unit of production) and 5,000 would have represented an allocation to this contract of the overhead of the firm (cost of borrowed capital, general administrative expense, depreciation of plant and equipment). Because Buyer repudiated the contract, Seller did not [page 545] expend the 40,000 in costs which would have been incurred by reason of the existence of this contract. However, the 5,000 of overhead which was allocated to this contract was for expenses of the business which were not dependent on the existence of the contract. Therefore, those expenses could not be reduced and, unless the Seller has made other contracts which have used his entire productive capacity during the period of time in question, as a result of Buyer's breach Seller has lost the allocation of 5,000 to overhead which he would have received if the contract had been performed. Thus, the loss Buyer was able to foresee at the time of the conclusion of the contract and for which he is therefore liable in this example amounts to 10,000:

CONTRACT PRICE:   50,000  
Expenses of performance which could be saved:        40,000  
Loss arising out of breach:   10,000  

Example B: If, prior to Buyer's repudiation of the contract in Example A, Seller had already incurred 15,000 in non-recoverable expenses in part-performance of the contract, the total foreseeable damages would equal 25,000.

Example C: If the product of the part-performance in example B could be sold as salvage to a third party for 5,000, Seller's loss would be reduced to 20,000.

     3.12. - Where the seller delivers and the buyer retains defective goods, the loss suffered by the buyer might be measured in a number of different ways. The buyer is authorized to claim damages equal to the difference of the value of the goods as contracted and the value of the defective goods received. He may also claim loss of profit. If the buyer is able to cure the defect, his loss would often equal the cost of the repairs. If the goods delivered were machine tools, the buyer's loss might also include the loss resulting from lowered production during the period the tools could not be used.

     3.13. - If, however, the delivery of the defective goods constituted a fundamental breach of contract, the buyer could avoid the contract. In such a case he would compute his damages under Article 75 or 76 to the extent that those articles were applicable. [page 546]

     3.14. - If the goods delivered had a recognized value which f1uctuated, the loss to the buyer would be equal to the difference between the value of the goods as they exist and the value the goods would have had if they had been as stipulated in the contract. Since this formula is intended to restore the buyer to the economic position he would have had if the contract had been performed properly, the contract price of the goods is not an element in the calculation of the damages. To the amount as calculated above there may be additional damages, such as those arising out of additional expenses incurred as a result of the breach. These additional elements of the buyer's damages will however often be limited by the requirement of foreseeability discussed at §§ 2.7. et seq., supra.

     3.15. - The situation mentioned under § 3.14., supra, is best illustrated by the following example from the Secretariat's Commentary (Official Records, I, 59).

The contract provided for the sale of one hundred tons of grain at a total price of 50,000 F.O.B. When delivered the grain had more moisture in it than allowable under the contract description and, as a result of the moisture, there had been some deterioration in quality. The extra cost to Buyer of drying the grain was 1,500. If the grain had been as contracted, its value would have been 55,000, but because of the deterioration caused by the moisture, after it was dried the grain was worth only 51,000.

CONTRACT PRICE:   50,000  
=======
Value the grain would have had if as contracted:     55,000  
Value of grain delivered:   51,000  
    4,000    
Extra expenses of drying the grain:     1,500    
Loss arising out of breach:     5,500    

     3.16. - Article 74 gives no indication of the time and place at which «the loss» to the injured party should be measured. Presumably it should be at the place the seller delivered the [page 547] goods and at an appropriate time, sush as the moment the goods were delivered, the moment the buyer learned of non-conformity of the goods or the moment that it became clear that the non-conformity would not be remedied by the seller under Articles 37, 46, 47 or 48. [page 548]


Pace Law School Institute of International Commercial Law - Last updated February 9, 2005
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