The decision of the Court of Appeal in this matter has prompted a flurry of articles with several criticising the decision on commercial grounds and others asserting that the decisions leaves the law in an uncertain state. In reality the decision affirms and reinforces two existing and well established principles of English law and provides a commercially sensible answer on an area of uncertainty created by a previous Court of Appeal decision and the decision of the First Instance Court in this matter.
The three issues considered and determined by the Court of Appeal were:
1. Whether the material contracts excluded an innocent party’s right to claim damages at common law;
2. Whether termination by the innocent party of two of the contracts by sole reference to a contractual right of termination could also be an effective termination of the subject contracts at common law;
3. Whether the exercise of contractual rights by the innocent party after termination could amount to an affirmation of the contracts such that the innocent party should lose any common law rights arising out of the termination.
Facts
The parties entered into six contracts for the construction of six bulkers for delivery on various dates between 2001 and 2004. All of the contracts were in the same, bespoke, form. The first three vessels were built and delivered but there was only minimal work carried out in respect of the fourth vessel and no work at all was carried out in respect of the fifth and sixth vessels. The dispute before the Court of Appeal concerned the last three contracts.
As is common under shipbuilding contracts, the Purchaser had made payment of predelivery instalments, by way of advances of the contract price, under each of the three contracts. The Seller (Builder), pursuant to its obligations under the contracts, caused its bank to provide the Purchaser with refund guarantees which secured the Seller’s obligation under each of the contracts to refund to the Purchaser these advances in event that the Purchaser exercised its rights to terminate each of the contracts pursuant to its rights under Article 10 of the shipbuilding contract. In the event, as a result of what amounted, in effect, to a complete failure by the Seller to build or deliver any of the last three contracts, the Purchaser terminated each of the contracts in turn. The notice of termination in respect of the fourth and fifth contracts referred solely to the Purchaser’s contractual right of termination. The notice of termination in respect of sixth and final contract referred both to the Purchaser’s contractual right of termination and to the Seller’s repudiatory breach.
Termination Clause
Article 10 in each contract provided as follows:
“Delay in Delivery and Deficiencies: Seller’s Default
The Contract Price of the Vessel shall be adjusted by way of reduction in the event of any of the contingencies set out in this Article ...any such reduction of the Contract Price shall be by way of liquidated damages and not by way of penalties.
The Purchaser shall not be entitled to claim any other compensation and the Seller shall not be liable for any other compensation for damages sustained by reason of events set out in this Article and/or direct or indirect consequences of such events other than liquidated damages specified in this Article.”
The Article then went on to specify the liquidated damages payable by reason of delay or deficiencies in the vessel and provide that the Purchaser would be entitled to terminate the contract in the event that construction or delivery was delayed beyond a specified point.
Article 10.7 then provided:
“Effect of Termination
Upon termination of this Contract by the Purchaser in accordance with the provisions of this Article 10 or any other provision of this Contract expressly entitling the Purchaser to terminate this Contract, the Seller shall forthwith repay to the Purchaser all sums previously paid to the Seller under this Contract ...
It is however further expressly understood and agreed upon by the parties hereto that if the Purchaser terminates this Contract under this Article the Purchaser shall not be entitled to any liquidated damages under (this Article)”
Refund Clause
Article 5.10 of each contract provided:
“Refund Guarantee
(a) The instalments of the Contract Price paid by the Purchaser prior to delivery of the Vessel ...shall be in the nature of advances to the Seller. In the event that the Purchaser shall exercise its right to terminate this Contract pursuant to any of the provisions hereof, the Seller shall forthwith refund to the Purchaser the aggregate amount of such instalments ...together with interest thereon at the rate of one month LIBOR per annum.
(b) It is a fundamental term of this Contract that the Seller’s obligations to make such refund of any of the predelivery instalments, with interest, shall be secured under and pursuant to the Refund Guarantee issued in favour of the Purchaser ...”
Exclusion of Purchasers’ Right to Recover Damages at Common Law
The primary argument advanced by the Seller was that the contractual wording excluded any liability that the Seller might have to pay any damages to the Purchaser for loss of bargain (or “damages at large”). The basis for this argument was the wording of Article 10 and in particular the paragraph quoted above, that the Purchaser should not be entitled to claim any other compensation and the Seller should not be liable for any other compensation other than liquidated damages.
The Seller then went on to argue that because Article 10.7 provided that the liquidated damages would not be payable in the event of cancellation pursuant to the provisions of the contract, the Purchaser was not entitled to any damages at all upon termination.
This argument was rejected by all those who heard the matter - the arbitrator (Sir Brian Neill, a retired Appellate Judge), the Commercial Court at first instance and the Court of Appeal. The basis for the decision in each instance was straight forward: that, pursuant to the general principles of English common law, where a party is in repudiatory breach (that is a breach that is sufficiently serious to go to the root of the contract) of its contractual obligations and the innocent party terminates the contract then the innocent party will be entitled to damages for loss of bargain and that it would require very clear wording in the contract to exclude liability for such loss of bargain.
The Court of Appeal put it this way:
“It is inherent in the nature of a legally binding contract that each party expects to obtain the benefit of the bargain into which he has entered or, if the contract is not performed, a right to recover compensation in the form of damages for the loss of that benefit.”
The Court then went on to rule:
“...any person approaching negotiations with a view to entering into a legally binding contract ...is to be taken to know that the law gives him a right to recover damages for loss of his bargain if the other party commits a breach which deprives him of substantially the whole benefit that it was intended that he should obtain from it.”
“The Court is unlikely to be satisfied that a party to a contract has abandoned valuable rights arising by operation of law unless the terms of the contract make it sufficiently clear that that was intended. The more valuable the right, the clearer the language will need to be.”
The Court of Appeal then went on to hold (in exactly the same way as both the arbitrator and the Court at first instance had held) that the regime set out in Article 10 was determinative of the damages to which the Purchaser would be entitled in the event that the vessels’ delivery was delayed or the vessels’ technical characteristics suffered from one of the deficiencies identified in Article 10 but did not cover or determine the Purchaser’s entitlement to damages in the event of non-delivery of the vessels. Accordingly the contract did not contain any exclusion of the Purchaser’s right to damages for loss of bargain and, therefore, all other things being equal, the Purchaser would be entitled to claim under each contract damages for loss of bargain.
In short, all that the Court of Appeal was doing on this issue was to restate what should at least be a well known principle of English law: that if a party wishes to exclude its liability for damages in the event that it breaches its contractual obligations then it must ensure that included within the contractual wording is clear language which unequivocally excludes that liability.
Termination Terminology
As an alternative argument in respect of the first two (ie fourth and fifth) contracts, the Seller’s argued that, because the Purchaser had terminated those contracts by reference to their contractual termination rights, they could not, subsequently, argue either that they had also terminated by reason of repudiatory breach or that they could subsequently terminate for repudiatory breach. As the Seller put it, you cannot “kill a dead man twice” . The Seller then went on to argue that since the Purchaser would only be entitled to damages for loss of bargain where the contract had been terminated for repudiatory breach, it must then follow that Purchaser was not entitled to damages for loss of bargain in respect of these two contracts.
Once more the Seller’s argument that the Purchaser had “failed” to exercise their right to terminate for repudiatory breach in respect of the first two contracts was rejected at every stage. Each of the arbitrator, the Court at first instance and the Court of Appeal reaffirmed the principle that in order to terminate a contract for repudiatory breach all that a party had to do was make it clear that they were terminating the contract. It made no difference if, when doing so, they made express reference to a contractual right of termination. The key was simply that it was clear that the contract was terminated.
Indeed, Lord Justice Moore-Bick in the Court of Appeal expressed the point in the following terms:
“In my view it is wrong to treat the right to terminate in accordance with the terms of the contract as different in substance from the right to treat the contract as discharged by reason of repudiation at common law. In those cases where the contract gives a right of termination they are in effect one and the same.”
In practical terms, the significance of this decision is to reinforce the principle that, as a matter of English law, the key, when a party is seeking to terminate a contract, is simply to make it clear that they are terminating the contract without there being a need for the party to worry about the exact terminology that it uses.
Affirmation
The Seller’s final argument was that the Purchaser, by reason of claiming under the refund guarantees after it had terminated each of the contracts, had thereby affirmed each of the shipbuilding contracts and, as a consequence, were not entitled to claim damages for repudiatory breach. This argument was rejected by the arbitrator but was accepted by the Court at first instance. The judgment of the Court at first instance was, however, then reversed by the Court of Appeal.
Prospectively the decision of the Court at first instance gave rise to quite serious consequences for a party when faced with a repudiatory breach which also gave rise to a contractual right of termination: in this context the effect of the judgment was that the Court found that the Purchaser had a choice: either to repayment of the predelivery instalments under the refund guarantees OR to claim damages at large (which the Court accepted would include the predelivery instalments) but not both. In other words, the Purchaser had a stark choice of either recovering its money under the refund guarantees but nothing more or pursuing an unsecured claim against the Seller for damages at large.
It was suggested by the Seller in argument that what the Purchaser was doing was wanting “to have its cake and eat it”. In other words, it was wanting to have both the benefit of the security in respect of the predelivery instalments represented by the refund guarantees and to be entitled to claim damages at large. This argument was rejected by the Court of Appeal and, despite it being supported in at least one article written on the decision, is an argument that proceeds on a fundamental misconception of the commercial realities: the predelivery instalments were simply (and expressly) advances made by the Purchaser, using its own money, to Seller. In claiming repayment of those instalments all that the Purchaser was doing was claiming the return of its own money for which it had received no consideration. The claim for loss of bargain, in contrast, was a claim for the losses that the Purchaser had suffered by reason of the complete failure of the Seller to perform its side of the bargain.
The flaw in the legal argument underlying the Seller’s submissions, as was recognised and accepted by the Court of Appeal, was that the contractual right upon which the Purchaser was relying, which the Court at first instance said amounted to an affirmation of the contract, was a right which could only arise AFTER the termination of the contract.
Lord Justice Moore-Bick, in his judgment in the Court of Appeal, dealt with the point as follows:
“...I am quite unable to accept that the exercise by Gearbulk of its right to recover instalments of the Contract Price under Articles 5 and 10 involved an election on its part to affirm the Contract. ...the right to recover the instalments of the price, together with the right to obtain payment under the bank guarantees, arose only on and by reason of the termination of the Contract. I think it is clear therefore that the parties intended it to survive the termination of the Contract just as, for example, they intended the arbitration clause to survive. Reliance on that obligation could not, therefore, amount to an election to keep the Contract in being.”
Summary
The Court of Appeal decision in Gearbulk v Stocznia therefore applies simple and commercially sensible principles:
1. If a party wishes to exclude its liability for a complete failure to perform its contractual obligations then it will require very clear contractual language to do so.
2. No magic wording is required in order for a party to terminate a contract and to rely upon any right of termination (whether contractual or common law) that it may have. All that it has to do is make it clear that it is terminating the contract.
3. A party, by relying upon a right which arises upon termination of a contract and is intended to survive a termination of a contract, cannot thereby affirm the contract.
With thanks to Michael Stockwood of Ince & Co (Solicitors for Gearbulk Holdings Ltd)
