Legal Briefing

The Court of Appeal drills deep into ‘the root of the contract’ and finds itself divided on whether there was a repudiatory breach for late payment

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Corporate and commercial | 01 June 2014

Many parties will require that certain aspects of a contract are to be performed in a timely manner. Indeed, written contracts will often include provisions that ‘time is of the essence’. The benefit of making time of essence is that this stipulation becomes a condition of the contract: if the performing party fails to perform the obligation within the required period, the other party can choose whether to terminate or affirm the agreement and also claim damages. A breach of a condition is a repudiatory breach, as it is considered to be an outright refusal to perform the contract. There is clearly a huge advantage to parties that are able to terminate commercial relations that have broken down immediately, rather than playing out a notice period and possibly incurring further loss or damage.


However, even if a term is not expressly stated to be a condition of a contract, it is possible that its breach could amount to a repudiatory breach if it deprives the aggrieved party of substantially all of the benefit that party should receive under the contract. This type of term is called an innominate term – the remedy for its breach depends on the effect of the breach at the time it happens. This assessment requires examination of the circumstances to determine what the ‘root of the contract’ is. Similarly, the nature and effect of the breach needs to be considered within the context of the contract as a whole.

Parties need to be careful if they wish to terminate a contract summarily on the basis that there has been a repudiatory breach where the contract is silent on whether the breached term is a condition of the contract. Falsely terminating on the basis of repudiatory breach could result in the terminating party being held liable to the other side for damages. This may be the case even if continuing the contract means that party will be suffering loss. The Court of Appeal case of Valilas v Januzaj [2014]demonstrates the breadth of analysis the courts will carry out when determining what goes to the ‘root of the contract’, as well as highlights the potential risks for terminating parties where there are no express provisions in the contract.

IOANNIS VALILAS V VALDET JANUZAJ


In an appeal against a decision of the Worcester County Court, the Court of Appeal had to consider whether the claimant’s deliberate failure to pay for services under a contract for three months amounted to a repudiatory breach and/or a renunciation of the contract. The court of first instance had found that while the claimant’s failure to pay would cause the defendant some loss, he would eventually recover the payments to which he was entitled. In the circumstances, it was held at first instance held that the defendant would not be deprived of substantially the whole of the benefit of the contract.

The Court of Appeal (Floyd LJ, Arden LJ, Underhill LJ sitting) were asked to consider the findings at first instance on repudiation and renunciation of the contract.

THE FACTS

Both parties were dentists. The defendant was the principal of a practice in Droitwich Spa (known as DSDP). The claimant practised at the DSDP under an oral agreement that in return for the right to make use of the premises, equipment and the services of the practice staff, he would pay the defendant 50% of his monthly receipts (‘the Agreement’).

The majority of the claimant’s earnings 
from his DSDP practice came from his contract with the Primary Care Trust 
(PCT). Under this contract, he was obliged to carry out a specified number of ‘units of dental activity’ per year for a fixed price per unit. In return, the claimant was paid, in advance, equal monthly instalments of £16,260. Approximately £12,000 of this sum was paid directly to the claimant, the remainder directly to the DSDP for administrative reasons.

If, by the end of the accounting year, the claimant had not carried out the full 
number of units required under the PCT contract, he was obliged to refund the overpayment to the PCT. The claimant alleged that had this occurred, he would have clawed back the consequent overpayment from the defendant.

This agreement worked well for three years, with the claimant carrying out the requisite number of units per year – consequently, there was never an issue between the parties as to payment. However, in 2010 the relationship began to deteriorate. The defendant had asked the claimant to sign a standard form ‘associate agreement’, which the claimant had refused. In a letter to the claimant, the defendant wrote that he hoped the claimant would reconsider signing, failing which the claimant should:

‘… consider this letter as an intention to give [him] notice to complete [his] undergoing treatments before leaving’.

The claimant wrote back stating he would be happy to continue working at the DSDP if the defendant wrote an apology, but if not, the letter should be treated as final notice. He ended the letter by adding that if his conditions were not acceptable, he had been advised to stop further monthly payments to the defendant, as he was running behind in the PCT units as a result of the stress of the dispute, and so would likely need to refund the PCT for their overpayment throughout the year. At the time of writing that letter, the claimant did in fact stop making payments.

Further letters ensued, and the parties were unable to resolve their disagreements. Finally, in November, after three months of non-payment by the claimant, the defendant terminated the Agreement 
and excluded the claimant from the premises. The claimant issued proceedings for breach of the Agreement by its 
summary termination. The defendant’s position was that he had given adequate notice of termination (by his first letter), alternatively that he was entitled to terminate the Agreement summarily by reason of various breaches, including the claimant’s failure to pay. The defendant also lodged a counterclaim for the outstanding monthly payments.

FIRST INSTANCE DECISION

The judge at first instance was unconvinced by the defendant’s proposition that notice had been given.

He then considered whether the claimant had renounced the contract or was in repudiatory breach. He found that the claimant had not renounced the Agreement, stating that renunciation could only apply where total non-performance was asserted – the claimant’s letters demonstrated he intended to carry on working through the PCT units.

Turning to the question of whether there was a repudiatory breach as a result of late payment, while finding that there was a breach of contract, the judge held that the defendant should have realised that (in the context of his explanation) the claimant could have completed the PCT units had the relationship continued and that the defendant would therefore receive everything he was entitled to, albeit late. Essentially, therefore, he held it was a breach of an innominate term that did not give rise to a claim of renunciation or repudiation. As a consequence, the defendant was not entitled to summarily terminate the agreement. Furthermore, the judge found the termination had led to the claimant’s loss of the PCT contract, ordering an interim payment of £100,000 damages.

THE CASE BEFORE THE COURT OF APPEAL

The oral submissions before the Court of Appeal were fairly focused. The defendant (as the appellant) argued as his primary point that the claimant’s letter in which he wrote that he was stopping his payments was a repudiatory breach and a renunciation of the contract. He argued that an obligation to make a monthly payment on the due date should be a condition of the Agreement.

However, in any event, the defendant argued, the breaches were plainly repudiatory in character as they involved a deliberate and persistent refusal to perform the claimant’s primary obligations under the Agreement. The claimant argued in response that the late payments were a breach, but were simply that – late payments. Furthermore, as the claimant pointed out, time of payment is not a condition to a contract unless time is expressly agreed to be of the essence, which was not the case in the oral agreement between the parties. Lastly, the claimant pointed to the explanation for non-payment (stress of the dispute) and the fact that the judge had held the defendant would be paid in full in due course.

CASE LAW ON REPUDIATORY BREACH

The Court of Appeal was divided in its conclusions on whether there had been a repudiatory breach, although ultimately found in favour for the claimant, with Underhill LJ dissenting.

All were agreed however that time was not of the essence in the contract – or, put another way, that the timely monthly payments by the claimant were not a condition of the Agreement that would permit summary termination. In absence of express or necessarily implied agreement that time should be of the essence, a requirement to pay on time would simply remain an ‘innominate term’ (per Diplock LJ in Hongkong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962]).

However, a breach (or threatened breach) of an innominate term could still amount to repudiatory breach in certain circumstances. While approving Lord Wilberforce’s test in Federal Commerce & Navigation Co Ltd v Molena Alpha Inc (The Nanfri) [1979] that in order to amount to a repudiation a breach must go to ‘the root of the contract’, Underhill LJ also accepted that it was not the most helpful formulation. It was essential, he said, to have regard to all the circumstances. Thus in Decro-Wall International SA v Practitioners in Marketing Ltd [1971] the series of late payments by purchasers to suppliers that were very short and caused minimal (and recoverable losses), and which the suppliers knew they would recover, were held not to be repudiatory, whereas the late payments in Alan Auld Associates Ltd v Rick Pollard Associates [2008] were described by Tuckey LJ as ‘substantial, persistent and cynical’ and were held to amount to repudiatory breach.

Underhill LJ found that the late payments by the claimant, taken cumulatively, should have constituted a repudiatory breach. Of particular importance was the fact that the payments had not been missed by mistake or by some venial reason (ie illness); instead, the claimant had taken a deliberate decision to withhold payment and depart from the agreement. Furthermore, Underhill LJ considered the fact that the claimant would still receive the PCT payments until final accounting for the year end, following which the defendant would likely receive a lower amount (possibly even nothing) as a result of the anticipated repayment to the PCT (and the consequent ‘claw back’). In the meantime, the defendant would have to go on bearing the running costs of the practice.

Arden and Floyd LJ disagreed. Both accepted that the claimant’s actions might mean that the defendant would find himself out of pocket, his cash flow affected, and perhaps needing to borrow money to cover the lost payments. However, they did not consider that this amounted to a repudiatory breach, as the defendant would in the end obtain what he was entitled to – this, they said, could be contrasted with a position where the claimant refused to pay at all. Floyd LJ did not consider the defendant was deprived of ‘substantially the whole benefit’ of the Agreement. Arden LJ emphasised the need to consider the knowledge of the victim of the likely consequences of the breach, holding in this case that the defendant was aware that the likely effect of the breach was a delayed payment, not a refusal to make payment entirely.

Noting the findings in Decro-Wall, Floyd LJ saw it as equally important to look at the practical results of the breach in order to decide whether it went to the root of the contract. While the Court of Appeal did not hear any evidence on the effect of the late payments on the defendant, Floyd LJ considered it clear that the defendant had failed to establish the serious consequences for him and his practice.

COMMENT

As is well established, if parties wish to avoid uncertainty about whether a contract can be summarily terminated for failure to fulfil one aspect on time (for example, the payment terms), it is crucial that they expressly agree that time is of the essence in respect of that clause. If a contract is an oral one, this should also be expressly agreed, preferably in writing to avoid dispute. Similarly, if a party considers one term or obligation under a contract to be of particular importance, that term should be expressly agreed to be a condition of the contract so that the contract can be terminated immediately if it is breached.

Failure to do so will mean that a party wishing to terminate immediately will need either to assert that the breach is repudiatory (and run the risk that it is not, in which case that party will itself have committed a repudiatory breach by terminating), or simply terminate for breach under the requisite notice period and then claim damages.

When contractual relationships break down it may be far more preferable to terminate immediately and halt any further loss, rather than playing out a notice period. However, the case of Valilas v Januzaj demonstrates how high the bar is to prove repudiatory breach if there is no express agreement as to the conditions in a contract. Even where a party is deprived of payment and is suffering loss, this still may not amount to a repudiatory breach (for example, where the terminating party might eventually receive payment if the contract were to continue). While every case turns on its facts, it is clear that the burden is firmly on the terminating party to show why the circumstances justify a finding of repudiatory breach.

For this reason, unless the circumstances show that the breach clearly goes to the ‘root of the contract’ and deprives the terminating party of the benefit of the contract, parties would be advised to 
simply terminate for breach and then 
claim for damages at the end of the notice period. Or, better still, ensure that the contract agreed at the outset of the commercial relationship clearly designates which terms are most important to the parties and allow immediate termination if they are breached.