Contracts can be terminated both at common law and in reliance on specific contractual provisions. If a breach of contract deprives the innocent party of substantially the whole benefit of the contract (see Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962]), the common law recognises the right to treat the contract as discharged and to recover damages. Such breaches are described as repudiatory.
It is often difficult to predict whether a breach of contract is sufficiently serious to permit an innocent party to treat the contract as discharged. The question depends on a review of the nature of the breach and the terms of the contract as a whole. Making a wrong choice can be disastrous. If the innocent party wrongfully brings a contract to an end, it will be in breach of contract and liable for damages.
It is common in commercial contracts for parties to depart from the common law position and agree specific termination provisions, which for example specify with precision the circumstances in which a contract may be terminated.
Termination for breach at common law is not automatic, and the position is usually the same under a contract. The innocent party can choose to terminate or to affirm the contract. Affirmation can be express, or it can be implied from conduct, for example by the innocent party continuing to perform the contract despite knowledge of the breach. While, following breach, innocent parties are usually given some time to decide whether to affirm the contract or treat it as discharged, they should also not delay too long.
The recent Court of Appeal decision of Stocznia Gdynia SA v Gearbulk Holdings Ltd [2009] considered whether a contractual termination clause excludes the common law right to treat the contract as discharged and the right to seek damages.
Facts of the Case
The claimant buyer entered into three ship-building contracts with the defendant shipyard. Each contract contained the following provisions regarding late delivery and termination:
- a liquidated damages clause reducing the purchase price for late delivery, and permitting termination if delivery of the ship was delayed for more than 150 days;
- a separate right to terminate if the ship was not delivered, for whatever reason, by a stated ‘drop-dead date’;
- the right to terminate for delay in construction which, in the buyer’s reasonable opinion, would prevent delivery by the ‘drop-dead date’; and
- following termination under the above provisions, the seller was required to refund instalments of the purchase price made by the buyer.
None of the three ships were delivered. The buyer served a notice under each contract exercising its contractual right to terminate, and requested a refund of the payments it had made. The third notice also stated that the seller was in repudiatory breach of the contract at common law, accepted that breach and reserved the right to claim damages.
The seller argued that it had not repudiated the contracts, that further in relation to two of the contracts common law rights had not been exercised as the termination notices had simply relied on the contractual right to terminate, and that in any event in choosing to rely on the contractual right to terminate and reclaim pre-payments the buyer was prevented from treating the contract as discharged at common law. Further, it was said that termination under the contract excluded any claim for damages at common law.
The consequence was that the buyer’s remedies following termination would have been confined to liquidated damages for delay, and the right to recover pre-payments with interest.
arbitral and first instance decisions
The arbitrator rejected the seller’s submissions. He decided that at the time each of the contracts was terminated the seller was unable and unwilling to perform them, and had repudiated them. The contractual termination clauses did not exclude the common law right to treat the contracts as discharged on the grounds of repudiatory breach by the seller, or the right to recover damages. He also rejected a submission that the buyer had affirmed the contracts by seeking the return of the pre-payments.
Permission was granted to the seller to appeal the arbitrator’s award under s69 of the Arbitration Act 1996. At first instance the judge rejected the argument that the contractual termination provisions operated as a complete code that excluded the common law right to treat the contract as repudiated and claim damages. However, the judge decided that the buyer had affirmed each of the contracts. The fact that the buyer had enforced the contractual provision forcing a refund of pre-payments was said to be conclusive.
Court of Appeal judgment
The Court of Appeal reinstated the arbitrator’s decision. First, it rejected the argument that the contractual provisions excluded the common law right to treat the contract as repudiated and to recover damages. These common law rights were described as valuable, and it was said that a court would be unlikely to be satisfied that the rights had been abandoned unless the terms of the contract made it sufficiently clear that that was intended. The more valuable the right, the clearer the language will need to be.
Here, the Court of Appeal said that the parties had instead simply specified the circumstances in which a breach of contract had become sufficiently serious to permit the buyer to treat the contract as discharged. In the case of delay, that was after a ship remained undelivered 151 days after it was due, among other events. The right to terminate in accordance with terms of the contract in these circumstances was no different in substance from the common law right to treat the contract as discharged by reason of repudiation at common law.
That left the question of affirmation. It is settled that it is impossible for a party faced with a breach of contract to both terminate the contract, and to treat it as continuing. These two actions are inconsistent, whether a contract is terminated in reliance on specific contractual provisions or by accepting a repudiatory breach at common law. This, the seller argued, was what the buyer was seeking to do.
The Court of Appeal rejected that argument. For the reasons stated above, the termination of the contract by the buyer was intended to and did operate to discharge the contract with the same consequences as if it had been discharged by the acceptance of a repudiatory breach at common law.
The termination notices were wholly inconsistent with an election by the innocent party to affirm the contract. Further, the parties had clearly intended that the clauses requiring a refund of pre-payments would survive termination, just like a clause allowing for arbitration of disputes. The claimant could therefore terminate and rely on the repayment clause.
The first and second notices had not specifically referred to the buyer’s common law right to treat the contracts as discharged. This was irrelevant. All that is required for acceptance of a repudiation at common law is for the innocent party to communicate clearly and unequivocally his intention to treat the contract as discharged (see Vitol SA v Norelf Ltd [1996]). Here, the contract provided for a right to terminate that corresponded with the common law right, and it was therefore unnecessary to specifically rely on the latter. It was sufficient simply to make clear that the contract was being discharged. The position could be different if the contract and common law provide the innocent party with alternative rights with different consequences, in which case an election may be necessary (Dalkia Utilities Services plc v Celtech International Ltd [2006]).
Conclusion
This case confirms that the starting position is that a contractual termination clause, however detailed, will not exclude an innocent party’s common law right to treat a contract as discharged and seek damages, following a sufficiently serious breach. Typically, the circumstances in which termination is permitted under the contract will be regarded as events that the parties have decided correspond with breaches that the common law would recognise as giving rise to similar rights.
Clear words are needed to exclude the common law rights. However, they are capable of exclusion, for example by a clause stating that the remedies specified in the contract displace any rights or remedies in law (provided that the clause satisfies statutory reasonableness tests, if applicable).
Where termination under the contract and treating a contract as discharged at common law give rise to identical consequences, a termination notice will not necessarily have to specify which is relied upon. An election may, however, be necessary where the contract and common law give rise to alternative rights and different consequences.
By James Maton, partner, and Jonathan McDonald, trainee.
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Dalkia Utilities Services plc v Celtech International Ltd [2006] EWHC 63 (Comm)
Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26
Stocznia Gdynia SA v Gearbulk Holdings Ltd [2009] EWCA Civ 75
Vitol SA v Norelf Ltd [1996] AC 800
At-a-glance guide
- At common law, an innocent party faced with a sufficiently serious breach can treat the contract as discharged and seek damages.
- Contracts often contain detailed termination clauses specifying the circumstances in which termination is permitted.
- Common law rights will only be restricted or excluded if a contractual termination clause makes it sufficiently clear that this is what was intended (subject to statute).
- For example, that can be achieved by stating that contractual remedies displace rights and remedies existing in law.
- Relying on contractual termination clauses, for example to recover pre-payments, should not constitute an affirmation at common law of a contract.
- At common law, all that is required for acceptance of a breach is for the innocent party to communicate clearly and unequivocally its intention to treat the contract as discharged.
- If the contract and common law provide alternative rights on termination with different consequences, the innocent party should specify which is relied upon.