Legal Briefing

Contractual certainty: does Court of Appeal decision signal new approach?

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Corporate & Commercial | 01 July 2010

In Durham Tees Valley Airport LTD v BMI Baby Ltd & anor [2010], the Court of Appeal overturned a ruling that a contractual term was void for uncertainty and instead looked at the factual circumstances surrounding the contract. In doing so it found that one party had failed to perform its obligations, even though those obligations were not clearly outlined in the contract.

Introduction

While freedom of contract is a fundamental principle of English contract law, the same law requires certainty and precision in the terms of those contracts. Such precision can often be at odds with the commercial reality of the deal that the parties have struck, such that the document finally produced may have left a degree of flexibility, which one side or both felt was desirable at the time. However, when a good deal goes bad, flexibility in the eyes of the law becomes uncertainty, and uncertainty can be a major threat to enforceability.

It is in this context that the recent Court of Appeal decision in Durham Tees is considered. The Court of Appeal overturned the High Court’s ruling that a contract between the parties was void for lack of certainty. The Court of Appeal judgment provides some comfort to those who, for practical purposes, eschew the rigidity of the law in favour of a commercially practical agreement.

Facts

Under a contract (the contract) between Durham Tees Airport Ltd (the airport) and BMI Baby Ltd (BMI), BMI agreed to ‘support the establishment of a minimum x2-based aircraft operation’ within a year, to be sustained over ten years. The airport provided substantial initial funding to assist the launch of BMI’s operation, the cost of which was to be recouped by escalating passenger rates over the ten-year period.

In the first year, BMI established only a single aircraft at the airport. The airport took the view that BMI was in breach of contract. The parties entered into a variation agreement that provided BMI with another four months to set up a second operation and expressly provided that the parties would ‘consult diligently in order for them to agree the [initial season’s] flying programmes’.

BMI suffered substantial losses in operating from the airport and removed its aircraft two years after entering into the contract. The airport sued for damages on the grounds of breach by BMI of its obligations to base and fly two aircraft at the airport for the full ten-year term. As the contract did not contain any specific details regarding minimum passenger movement and/or flights, the airport accepted that to quantify damages, it would be necessary to imply a term requiring BMI to operate the two aircraft in a manner that was reasonable. As part of its defence, BMI argued that the proposed term was too vague and imprecise to be workable or enforceable.

High Court decision

The judge at first instance held that the contract did impose a positive obligation on BMI to both establish and operate (in the sense of flying commercially) a two-aircraft operation at the airport within the first year. Despite this, the judge ruled in favour of BMI as it was held that the terms relied on were too vague and uncertain to be enforceable. The judge held that it was not possible to imply such a term as it failed to resolve the question of how many flights BMI was required to operate to comply with the contract. It therefore lacked the necessary certainty to be enforceable. To imply the term would effectively require the contract (and subsequent variation) to do something it was not designed to do. The judge’s view was that there were simply:

‘… too many uncertain factors as between parties with competing interests and the defect cannot be met by an implication of reasonableness.’

It was held that while a criterion of reasonableness might remove uncertainty in some cases, these were generally those in which objective criteria existed to enable the court to decide what would be reasonable in terms of quantity or price (such as a tenancy under which the tenant agrees to pay a reasonable rent). In Durham Tees it was found that there were no such criteria. Similarly, it would be impossible to assess damages as the court would not be able to specify what level of performance was necessary to constitute compliance with the contract.

Appeal

The airport appealed on two grounds. The first was that, even without the implied term, the contract, as construed by the judge, was enforceable and damages could therefore be assessed. The second was that the judge was wrong to find that it was not possible by law to imply such a term.

Court of Appeal decision

The court first considered whether the judge at first instance was right to find that the terms concerning BMI’s obligations under the contract were void for uncertainty. Patten LJ considered the test set out in G Scammell and Nephew Ltd v HC and JG Ouston [1941], which states that for a contract to be binding, its terms must be:

‘… sufficiently definite to enable the court to give it a practical meaning. Its terms must be so definite, or capable of being made definite without further agreement of the parties, that the promises and performances to be rendered by each party are reasonably certain.’

Patten LJ noted, however, that courts had, over the years, when applying the test, shown an established reluctance to strike down what were obviously intended to be legally enforceable commercial agreements.

Toulson LJ took the view that:

‘The proper test is not whether a court would have been able to determine on, say, an application for specific performance what would be the minimum number of flights required in order to constitute a x2 aircraft-based operation… but whether the court would be able to determine on a set of facts which had occurred… whether the airline had, or had not, maintained a x2-based aircraft operation at the airport.’

Toulson LJ went on to explain that in reaching that decision a court would have to take into account the factual circumstances.

Contrary to the lower court, the Court of Appeal concluded that the contract did contain sufficient terms to enable it to determine whether BMI’s obligations had been met by taking into account the known facts. Its conclusion was that BMI had failed to meet its obligations, had breached the contract and was liable to the airport in damages. As a result of this finding the need for the airport to rely on an implied term of reasonableness fell away.

As the judge at first instance had not considered an assessment of damages given the finding of no liability, it fell to the Court of Appeal to address this. Patten LJ held that in cases where the defaulting party has been given a discretion in the performance of its contractual obligations, a court will conduct a factual inquiry as to how the contract in question would have been performed had it not been repudiated. This involves considering the factual circumstances prevailing at the time and the assumption that the defaulting party would operate within the terms of the agreement, but with its own interests in mind. The inquiry into damages itself was left to be dealt with at a later date.

Conclusion

Durham Tees arguably provides some reassurance to commercial parties that the courts will endeavour to give effect to formal agreements that were clearly intended to have a legal effect, but where vague drafting threatens successful enforcement. It is clear that the Court of Appeal was influenced by business efficacy and an understanding of the reality of commercial agreements.

For commercial parties this may be particularly significant in deals where one side holds the majority of the commercial bargaining power (perhaps because it is a market leader) and for that reason does not consider that it needs to be more specific about certain terms of the contract if it feels it is in its own interest for those terms to remain vague.

However, this reassurance comes with a warning. First, it should never be assumed that the court will fill in the contractual gaps left by the parties. Businesses and their advisers must remain aware that, by leaving certain terms open and flexible, parties expose themselves to the risk that their agreement will prove to be unenforceable in the event of a dispute.

One way of overcoming this would be for the parties to provide for ongoing variations within the terms of their agreement, but this may add yet another level of uncertainty that might prove to be commercially unworkable.

It is likely, particularly in light of Durham Tees, that this will be an area which continues to exercise the courts, and therefore should remain at the forefront of the minds of contracting parties and their legal advisers when crystallising terms and drafting contracts.

 

at-a-glance guide

  • A contract will not necessarily be unenforceable for lack of certainty provided that it is possible for the courts to determine whether the alleged contractual obligations have been performed by taking into account all the factual circumstances.
  • When assessing damages in such a case (ie one that awards a discretion to one party in how they perform) because a party has failed to perform, the court will conduct a factual inquiry as to how the contract would have been performed had it not been repudiated.
  • In conducting a damages enquiry of this kind the parties will be assumed to have acted in good faith but with their own commercial interests in mind.