Apr 24

Can we claim for loss of profits in our business dispute?

Written by Jonathan Mortimer
Partner

DDI: 01423 726608
M: 07850 993952
E: jonathan.mortimer@raworths.co.uk

Can we claim for loss of profits in our business dispute?

The answer may be yes depending upon the nature of the business dispute, your contract with the business partner and the financial ramifications of the problem for you.

Jonathan Mortimer, partner in the Dispute Resolution team at Raworths, looks at an example.

The example

If you are say a manufacturer of machines and you are claiming a breach of contract by a supplier whose parts were not fit for purpose, or not supplied at all you may have a claim for losses arising from the issue. An alternative supplier may have been found, causing a delay in production and a consequent delay in sales, and an important order could not be fulfilled in time which has affected your profits.

It will be necessary at the outset to establish that the supplier has acted in breach of the contract and also to check on the terms of the contract between you and the supplier to see what it says about what losses can be recovered.  However, for these purposes we can presume that loss of profits can be claimed.

So how do we go about calculating such profits that our missing from the bottom line?

The calculation

It is important to say at the outset that when a court awards damages, the sum determined is intended to compensate you, rather than to punish your opponent, and the objective is to place you in the same position as if the contract had not been breached.

To calculate actual losses, the starting point will be to compare actual profits made, compared to what the company believes would have been the profit figure had the breach not occurred.   In doing so, it is usually necessary to consider anticipated losses by preparing a forecast based on expected revenue and expected costs.

In very simple terms ‘profit’ is the difference between the price you achieve for the sale of your goods less the amount it cost to provide those goods. Of course, many factors lie beneath these figures which need to be considered to calculate the actual profit, and therefore the actual loss, that would have been achieved if a breach had not occurred.

The court will look at a variety of factors, including:

• direct and indirect costs;
• production capacity and whether parts could be sourced elsewhere;
• mitigation of loss;
• taxation; and
• external market factors.

If a considerable loss is at stake and the calculation involves a number of variables, to ensure that the figure is as accurate as possible it may be appropriate for us to work with a forensic accountant on your behalf.

It is for you to prove your loss, but the court will bear in mind that this is not an exact science.

The variables

Key issues to take into account include:

• Relevant period – The start of the period of the loss is usually the date on which the breach first occurred, but the end of the period is harder to establish. For example, it may end when the breach is rectified, or when the contract terminates, or when a replacement is found that allows for the profit potential to resume.
• Production capacity – One of the factors the court will take into account is the usual production capability of the company which dictates what the company can and does usually produce. It is possible that a company may have decided to expand their production with the supply that they are missing, and if so there must be an element attributed to this loss too. Were you intending to expand and have been prevented from doing this by the breach?
• Sales price – Determining what the sales price would reasonably be for this product in this market is easier to establish if you have already been selling products at a particular price. If not, you will need to prove what a realistic sales price would be for your products, based on factors such as previous invoices, market information, whether there is a current contract for sale that might set out the sale price, and what are your competitors selling for.
• Costs – If replacement parts were not found and the loss of profit is wholescale, those losses may be offset by the fact that you require less staff or less equipment or premises. This may have a knock-on effect on other expenses, such as insurance.
• Mitigation – If it is possible to mitigate your loss, for example by obtaining a supply elsewhere, or making a reduction in staffing levels, you will be expected to do so. For example, if you managed to source a supply of parts elsewhere then the loss in profit may simply be a reduction rather than full loss. Alternatively, if you were not able to produce the machines at all, you may claim full loss of profit. Once you have mitigated to the extent that you are able to move back to making profits, the period of loss will usually end.
• Taxes – Against any loss of sales and loss of profit, it is necessary to take into account the gain made by not incurring any tax on those profits.
• External factors – There may be other factors that contributed to your loss apart from the breach, and the court will look at these when assessing the level of damages. For example, if the market has crashed and your machines are unlikely to make the anticipated level of profit. Alternatively, a lack of supply by competitors could mean profits might have been set to increase.
• Cash flow benefit – Depending on the timing, the court is also likely to adjust the award to take into account that you will be getting a guaranteed fixed sum, and you may benefit from the fact that this money will be received earlier than usual.

It is important to remember that you can only claim damages to be put back into the position you would have been in had the breach not occurred.

The key considerations

It can be appreciated from the above discussion that claims for loss of profit are complex.  They require legal and accountancy considerations in equal measure.

It is important before embarking on such a detailed analysis to take an overview of the financial implications of the dispute for your business, does it look likely that you have a claim for appreciable loss of profits?

Some business may have a claim on paper but in effect been able to mitigate their potential loss by making other arrangements.  Some businesses may actually be only breaking even or making a loss on the product line in question so that there is no actual loss of profit.

Finally, the timing of making such a claim is also a factor.  It can help to let some time pass (subject to any legal or contract deadlines for bringing such a claim) to allow matters to settle down, mitigate your loss and potentially work on actual rather than projected figures.

Jonathan Mortimer can be contacted by email at jonathan.mortimer@raworths.co.uk or telephone 01423 566666.  Raworths is based in Harrogate, North Yorkshire.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.

Published on 25 April 2024