Debt v damages: why should I care?

Debt v damages: why should I care?

Financial management advice for SMEs worried about post-pandemic debt

In the banking universe, it is important that the key amounts due under loan agreements are “debts”. But why does that matter? What would they be if they weren’t debt? And how can we tell that they are debt?

At the heart of the matter is the ease of enforcement: a debt claim is almost always easier to enforce than a claim for unliquidated damages. This is because the claimant (in our banking universe, the lender) does not have to prove that it has lost anything, or that the borrower has breached an obligation or agreement which in turn caused the amount to be due, or show the steps that it has taken to reduce the amount due. The lender recovers simply because the borrower agreed to pay a specific amount and has not done so. Debts may usually be assigned freely, which is important to lenders who may want to sell their loans in the future. By contrast, the assignment of a claim to damages is more difficult (as law seeks to ensure that litigation is not undertaken by parties without a proper interest in the case).

To complicate matters slightly, a claim for a “liquidated” (or specified) amount enjoys many of the same advantages as a debt. A party might therefore seek a more advantageous remedy for breach of contract by negotiating a liquidated damages clause which contains a formula or specified sum instead of its right to (unspecified) damages.

English law has grappled with the distinction between debt from damages, and liquidated from unliquidated, producing at times conflicting case law in different contexts. An amount cannot be both debt and damages, and it cannot be liquidated and unliquidated, but it can move between the categories.

There are three tests established by case law to differentiate between debt and damages. We summarise the first two below, and leave the third for anyone who would like to discuss with us in person!

  • Does the agreement provide for a specified sum of money to be payable?
  • What caused the amount to be due – is it a primary or secondary obligation?
  • Would it have been a debt claim in pre-1873 forms of action?

Specified sum of money

If a party is contractually bound to pay a specified sum of money, this will likely result in a debt. This arises where there is a fixed price or amount, interest, or a formula with easily ascertainable values. Where the value is difficult to ascertain, a payment claim may be treated as a claim for damages. So, a principal repayment or interest payment due under a loan agreement or loan note would be a debt.

Primary or secondary duty

A duty may be primary or secondary, depending on the contractual obligation. A primary obligation comprises a party’s main duty under a contract, such as to manufacture or supply goods. If a party does not perform its primary obligation, a secondary obligation to pay damages arises from the initial breach. It does not matter how a party has labelled its contractual obligation – whether it is primary or secondary is determined on the facts of the case. Debts are always primary, but, confusingly, not all primary obligations are debts, and it can be difficult to pin down the nature of the obligation. An example of this is in relation to indemnities, which the courts have held to be both debt and damages – a topic for another day!

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