Damage arising from Defect in Object of Contract to Creditor’s Absolute Legal Rights: Contractual or Delictual Liability?

Author:Karin Sein
Position:LL. M., Lecturer of Private International Law, Institute of Law, University of Tartu

1. Damage to creditor's absolute legal rights by defect in object of contract - 2. Preclusion of claims for compensation on grounds of force majeure? - 3. Preclusion of claims for compensation under the foreseeability rule (LOA § 127 (3))? - 4. Preclusion of claims for compensation through the purpose of breached obligation (LOA § 127 (2))? - 4.1. Functions of... (see full summary)


Karin Sein

LL. M., Lecturer of Private International Law, Institute of Law, University of Tartu

Damage arising from Defect in Object of Contract to Creditor's Absolute Legal Rights: Contractual or Delictual Liability?

1. Damage to creditor's absolute legal rights by defect in object of contract

During the performance of a contract, the creditor's interests can suffer damage in a number of ways. For example, the debtor can be late with a delivery of raw materials, which could obstruct the activities of the creditor's entire enterprise. Or, the debtor can fail to supply any raw material at all, and the creditor will have to procure it from other sources for a higher price. In such cases, the creditor will be entitled to claim compensation for damage from the debtor under § 115 of the Estonian Law of Obligations Act. Furthermore, damage can also be caused if the debtor sells to the purchaser a car with faulty brakes, repairs the brakes deficiently or provides a leased apartment in a condition which is hazardous to health. Such defects can damage creditors' absolute legal rights, and particularly their life, health or property. It would be traditional to assert that any such damage to the other party's absolute legal rights can also be covered by the creditor's contractual claim for compensation for damage1. Nonetheless, this article is aimed at demonstrating that such an assertion is no longer absolutely valid in the context of the Law of Obligations Act2 (LOA), which is presently applicable in Estonia. Rather, on the contrary: on the basis of the following examples we shall have to admit that as a rule, prevention of such damage is not the purpose of the debtor's contractual obligation (LOA § 127 (2)) and therefore, such damage is not compensable under the contract. Inasmuch as this regards legal rights that are absolute and are therefore protected by the law of delict, the debtor will be liable under LOA §§ 1043 et seqq.

In order to explain this conclusion, which may seem surprising at first sight, I should like to describe two hypothetical cases. Let us suppose that an appliance shop sells to a purchaser an extension lead for a price of 50 krooni, and a latent defect in the extension lead causes a short circuit, which results in a fire accident in the purchaser's house leading to a damage of 500,000 krooni. Should the shop compensate for the damage caused to the purchaser's property regardless of the fact that the defect in question was not detectable upon external inspection and it would be unreasonable to expect the shop to separately test or disassemble each item on sale?

Or, let us take another example in which an elderly lady lets out a house inherited from her sister. Unfortunately, substances which are poisonous and hazardous to health have been used in the construction of the house. The lessor is unaware, and even cannot be aware, of that since it is not reasonable to assume that an ordinary lessor would order, before letting out a house, a general technical expert analysis to make sure that the house has been built completely safely. The lessee moves in and suffers damage to health, and maybe even dies, because of the poisonous substances. Should the lessor compensate for the funeral expenses, pay support to the lessee's dependants (LOA § 129) and additionally satisfy the Health Insurance Fund's recourse claim to the extent of the medical treatment expenses under § 26 of the Health Insurance Act?

In both of these cases, the debtors have breached their contractual duty to deliver a thing which conforms to the contract3. Characteristically of both cases, the creditor's absolute legal rights have been damaged by a defective object of contract while the debtor was not, and did not have to be, aware of such defect. We also saw that such damage can be extremely large and, in the author's opinion, it is questionable in terms of legal policy whether a debtor can be expected to take such risks for e.g. a purchase price of 50 krooni or a monthly rent of 3000 krooni. This is particularly questionable in a situation in which all provisions regarding legal remedies available to the weaker party (i.e. the consumer or the lessee) are absolutely imperative: under Estonian law, neither the seller nor the lessor may contractually subject their liability to a condition of fault or limit their liability with regard to certain types of damage (LOA §§ 237 (1) and 275)4. It would also be unreasonable to expect lessors to insure their possible liabilities before concluding a residential lease contract - all the more so as, to the author's knowledge, conclusion of such insurance contracts in Estonia is presently not possible. But how then can such claims for compensation be avoided or limited?

2. Preclusion of claims for compensation on grounds of force majeure?

In the search for limits of contractual compensation for damage, the question of the existence of debtor's liability as such will inevitably come up: a distinction should be made between the question of the extent of the debtor's liability and the question of whether the debtor is liable at all5. Even in the above-described cases, the question of the debtor's liability in general will be the first to arise6. The sale of a defective thing or the delivery of a deficient work or defective object of lease may indeed be excusable by LOA § 103 but the question lies in whether the excusability can arise solely from the fact that the debtor was not, and did not have to be, aware of the defect in the object of contract.

In order to answer that question, the difference between fault-based liability and a stricter7, excusability-based type of liability must be explained in the first place. In Estonian legal literature, justified positions have been expressed that the practical difference between those concepts becomes apparent, first of all, in the case of 'result-oriented obligations' (i.e. obligations de résultat known in French law) referred to in LOA § 24 (1) (the first alternative)8. Both of our cases deal specifically with result-oriented obligations, in which the debtor can be exempted from liability only by proof that the defect in the object of contract was caused by force majeure. In order to decide when a defect in the object of contract may be regarded as due to force majeure, let us take a look at the practice of interpreting article 79 of the Vienna Convention on Contracts for the International Sale of Goods (CISG), as the concept of strict liability provided in Estonian LOA § 103 has its origins right there.

In creating the CISG, the common-law concept of seller's absolute liability was not incorporated into the convention9. However, at the same time, the principle of fault-based liability was also knowingly left aside10. Therefore, correct interpretations of LOA § 103 should not be based on the principle, prevailing in German law, whereunder a seller is not liable for damage caused by selling a defective item to a purchaser if the seller was unaware of the defect, had obtained the sold item from a trustworthy source and would not have detected that defect even by such methods of examination as could have been reasonably expected from the seller in such situation11. The general position regarding CISG art. 79 is that the seller is liable even for such a thing the defects of which are hidden from the seller, and that is the case both when the sold item has not been manufactured by the seller but, rather, purchased from a third party (e.g. importer)12 and (or particularly) when the sold goods have been manufactured by the seller13. A few exceptions, e.g. if the defect is caused by terrorist act, are conceivable but extremely rare in real life14.

As demonstrated above, a defect in a sold thing belongs to the risk sphere of the seller, who thus cannot use LOA § 103 as an excuse15. In the case of a residential lease contract, it must similarly be admitted that the lessor is practically always liable for damage caused by a defect in the object of lease under LOA §§ 276 (1), 115 and 10316.

3. Preclusion of claims for compensation under the foreseeability rule (LOA § 127 (3))?

Compensation for damage in the above-described cases could actually be precluded for the reason that the damage could not be reasonably foreseen by the debtor at the moment of concluding the contract (LOA § 127 (3)). It is often stressed in legal literature that strict liability and the foreseeability rule are closely or even inseparably interrelated17. However, upon closer analysis it can be noted that the foreseeability rule is not very suitable for application in the case of damaged absolute legal rights18. Namely, for the foreseeability of damage under LOA § 127 (3), it is not material whether or not the debtor foresaw or must have foreseen the breach of contract or, in other words, that the object of contract delivered by the debtor did not conform to the contract within the meaning of LOA § 217 (1) or § 276 (1). Hence the foreseeability of damage does not depend on whether the debtor was aware of the defect in the delivered thing: the only matter of relevance here is...

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