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A forensic approach

12 Feb 2020 / Justice Print

A forensic approach

The recent British judgment in Bajaj Healthcare Ltd v Fine Organics Ltd dealt with the matter of offsetting counterclaim damages against amounts owed to a plaintiff.

Breaches of contract and resulting losses are commonplace in today’s global economy. Disputes for unpaid invoices are also commonplace.

In a recent British case, Bajaj Healthcare Ltd v Fine Organics Ltd ([2019] EWHC 2316), the Chancery Court was asked to consider both issues in the same case. 

The case raises some interesting considerations for forensic accountants when asked to act as expert witnesses in such cases.

Bajaj Healthcare Ltd was a chemical manufacturing company based in India. It brought legal proceedings in Britain against Fine Organics Ltd for unpaid invoices totalling $513,946.23 plus interest. So far, straightforward.

Fine Organics Ltd, the defendant in the main proceedings, refused to pay the invoices and issued a counterclaim for damages, on the basis that a chemical supplied to it in 2014 by the plaintiff was contaminated by an unidentified substance and caused a financial loss.

This is where the case gets interesting from a forensic accountant’s perspective. All the elements seem to be present: outstanding invoices, counterclaim for losses, and quantification of those losses.

Issues to be considered

Michael Green QC, sitting as deputy judge of the Chancery Division, identified three issues for determination in this case, namely:

  • The terms of the contract between the parties,
  • Whether there was a breach of that contract by the plaintiff supplying a chemical with an unknown substance in it, and
  • If there was a breach of contract, what loss, if any, was caused by that breach?

Ultimately, Green found that there had been a breach of contract through the supply of a chemical with an unknown substance in it.

The focal point of the case, from a forensic accountant’s perspective, was how to calculate the loss and the judge’s determination of that loss?

Heads of loss

This case is very interesting in terms of how the claim for losses was calculated, and the expert evidence accepted by the trial judge.

Firstly, it is important to note that the defendant did not make a claim for loss of profits, which would typically be the starting point of any case involving a claim for breach of contract relating to the supply of goods or defective products.

Therefore, there was no claim in relation to lost sales or evidence required in support of any contracts that were unable to be fulfilled.

Instead, the defendant made its claim on the basis of additional costs that it incurred as a result of the contaminant in its manufacturing process.

The heads of loss, totalling Stg £671,283 were:

  • Loss of yield,
  • Increased production costs,
  • Extra technical support,
  • Extra disposal costs, and
  • Additional analyst costs.

Loss of yield: this head of claim was calculated by reference to the average yield of finished goods in the two years prior to the breach, and a cost per kilogram of the reduced yield was applied to the yield in the year following the breach.

The loss was calculated on the basis that the defective material led to 72kg less finished goods per batch – 63 batches were made. The evidence was not challenged and was accepted by the trial judge as an appropriate measure of the loss suffered under this head of claim.

Increased production costs: the increased production costs were calculated in this case, based on the total fixed costs and depreciation, which was calculated on a ‘vessel’ rate-per-hour basis. The trial judge accepted that the breach of contract meant that the vessels used in the conversion process were used for longer in 2014, compared with 2012 and 2013.

The methodology for calculating the loss was to evaluate the actual hourly ‘vessel’ rate, and apply that to the additional hours incurred due to the breach that should not have been incurred.

Wasted expenditure

The trial judge found this to be a “a reasonable and fair way” to calculate the wasted expenditure as a result of the breach.

Given that there was no claim for loss of profits, the trial judge rejected a counter-argument that the claimant was unable to point to a loss of contracts as a basis as to why they had not suffered a loss.

Breach of contract

Other additional costs: the trial judge accepted the other heads of claim for extra technical support, extra disposal costs, and additional analyst costs, and noted that there had been no challenge to the amounts claimed, or to the basis on which they were claimed.

The total award for damages as a result of the breach of contract was Stg£646,883.39, and the trial judge stated that this could be off-set in part against the outstanding invoices owed, which totalled $513,946. The judge awarded interest on the damages.

Accounting principles

This case, albeit a British case, reinforces a number of important accounting principles in the calculation of damages arising from a breach of contract, in circumstances where a claim for loss of profits is not evident, and indeed is not pleaded.

The use of fixed costs, including depreciation, converted to an hourly-rate basis, was accepted as a reasonable and fair way to measure the claimant’s losses. This judgment also reinforces the principle of being able to offset a claim for damages against outstanding invoices.

In Ireland, under High Court rules, it is necessary for an expert witness to act in an independent and unbiased manner, and to assist the court in their particular area of expertise.

Typically, this involves looking objectively at all the evidence to arrive at an independent assessment of the loss, which will then be submitted to court in the form of an expert report.

Expert evidence

Of note, there was no expert evidence provided, and the trial judge commented that, given that there were no submissions, these heads of loss were not claimable as a matter of principle.

This judgment is a useful guide as to how the judiciary in Ireland may decide on the calculation of damages in similar circumstances.

While this was not a conventional loss-of-profits case, it is nonetheless worth noting the approach taken, and the lack of submissions to counter the claim for damages.

Barry Robinson
Barry Robinson is a chartered accountant and director of forensic services in BDO Ireland