Common law right to terminate and failure to pay
GRAND CHINA v SPAR SHIPPING (CA) [2016]
Whilst this case featured a shipping contract between a ship owner and some traders for the hire of some ships, some interesting points were made in relation to the rights of termination that apply to commercial contracts generally in the context of repeated late payment.
The Court of Appeal (“CA”) referred to the distinction between different types of contractual terms.
Classification of contractual terms
A contract term can be classified as a condition, a warranty or what is called an intermediate or innominate term and the classification affects the innocent party’s right to terminate. Generally, how a term will be classified depends on the intention of the parties and the interpretation of the contract:
- a condition is a major term of a contract, any breach of which (however small) justifies termination. A term may be a condition even if that label is not used if it is considered that the parties must have intended to confer a right of termination for any breach of that provision. If a deadline for performance is a condition, this can be expressed by agreeing that ‘time is of the essence’ so that even a small delay will entitle a party to terminate. Note that some terms implied by statute are expressly stated as being conditions such as the implied conditions of satisfactory quality and fitness for purpose under the Sale of Goods Act 1979;
- a warranty is a minor term. No breach of a warranty (however serious) will justify termination but only gives rise to a claim for damages;
- an intermediate or innominate term (the terms, rather confusingly, are interchangeable) is neither a condition nor a warranty. The remedy for the breach of an intermediate term will depend upon the consequences of the breach. To justify termination the consequences of the breach must deprive the aggrieved party of substantially all the benefit of the contract. Assuming the parties have not expressly stated in the contract that a particular term is a condition or a warranty (and even where they have, that will not necessarily decide the matter), if breach of that term may result in very different consequences depending upon the circumstances, then the term will generally be treated as intermediate.
Facts:
- Grand China (“GC”) hired some ships for a period of five years from Spar, a ship owner, (“S”) under three contracts which required periodic payment in advance and gave S an express right to withdraw the ships ‘failing punctual and regular payment’.
- GC was late in paying the hire charges under all three contracts. The average default was about $2 million and arose from GC being on average between one and four instalments late.
- S subsequently withdrew the ships and terminated the contracts. It claimed the balance of the hire charges due under the agreements and damages for loss of ‘bargain’ (ie the loss of the unexpired term of the contracts) on the basis that punctual payment was a ‘condition’.
- The High Court (“HC”) found that the persistent late payments were not breach of a condition but repudiatory breaches of an innominate term. A repudiatory breach of contract is one where the defaulting party indicates to the innocent party that it does not intend to perform the contract in a way which deprives the innocent party of substantially the whole benefit of the agreement. The judge said that looking at the history of broken promises, financial difficulties and trading conditions, GC had shown that it was “unwilling because it was unable” to pay the arrears and what would be due during the remainder of the contract terms. This therefore amounted to a repudiatory breach of the agreements giving S the right to terminate at common law and claim damages for loss of the contracts.
- Both parties appealed.
Decision:
Payment term not a condition
The CA interpreted the payment obligation as an intermediate term not a condition in line with the HC’s decision. It considered that:
- any failure to pay punctually in advance, no matter how trivial, would not derail S' performance under the contracts. It said the Court should not be “too ready” to treat contract terms as conditions and should only to do so if it was clear that the term was to be classified as such, even if it triggered the express termination clause;
- if the consequences of breach can vary from the trivial to the grave, a term is more likely to be intermediate than a condition; and
- even though it was commercially important to secure prompt payment, that did not mean the parties intended that any delay in payment would justify termination and give a right to damages for loss of the contract (which would be the effect of making the payment term a condition).
Was there a repudiatory breach?
- The CA went on to consider whether GC’s late payments were a repudiatory breach which justified termination and damages for loss of the contract at common law.
- The HC had referred to a summary of the applicable legal principles:
- conduct is repudiatory if it would lead a reasonable person to the conclusion that the party does not intend to perform its future obligations;
- indicating an intention to perform but in a manner which is substantially inconsistent with the contractual terms is showing an intention not to perform. Whether such conduct is repudiatory depends upon whether the threatened difference in performance deprives the innocent party of substantially the whole of the benefit it is intended to receive or is ‘radically different’ in nature;
- an inability to pay is effectively the same as an unwillingness to pay. As one judge put it, “saying ‘I would like to but I cannot’ negatives intent just as much as 'I will not' ”.
- The HC agreed that missing a few payments might not be repudiatory if it cast no doubt on the paying party’s willingness and ability to pay the arrears and pay promptly in future. However, GC’s conduct here showed an intention to turn each of the contracts into something radically different, namely from a contract for payment in advance to one for payment in arrears - in effect the performance of services by S on credit.
- Applying the above principles the CA agreed with the HC’s conclusion that there was a repudiatory breach of each of the contracts - GC had shown that it was “unwilling because it was unable” to pay for the arrears and for the balance of the contract terms.
Points to note:
- The payment clause in this case was held to be an intermediate term as most clauses will typically be these days. So breach of a payment clause will not necessarily give rise to a right to terminate at common law even if an express contractual right to terminate is triggered.
- Uncertainty over rights of termination for non-payment can be avoided by clearly stating that non-payment of a specified scale or duration gives rise to an express right to terminate. Relying upon establishing that a breach is ‘material’ is inherently uncertain.
- It is important for the parties to an agreement to understand the consequences of breach of a particular term of the contract and when they have the right to terminate. Contractual and common law rights to terminate are often considered to be one and the same thing. What is evident is that they will not necessarily always be and certainly the consequences of each may differ. A right to claim damages at common law can potentially be broader than a purely contractual remedy.
- The judgment seemed to assume that damages for the loss of the contract for the remainder of the agreed term cannot be recovered by the party terminating the contract unless the right to terminate arose at common law (from a repudiatory breach or a breach of condition). This seems inherently wrong and, indeed, in Gdynia v Gearbulk (CA) [2009] the CA held that the parties had intended the express contractual termination clause to identify, as between the parties and for that transaction, which breaches should justify both termination and a claim for damages for loss of the contract. That approach has to be sensible and it is a pity that the CA in this case did not perhaps take the opportunity to endorse that position but instead left some uncertainty.
- Contracting parties should be clear on whether they intend the rights and remedies provided under the agreement to:
- co-exist with any other rights and remedies available to them under the general or common law (a provision can be included to this effect - sometimes called a ‘Cumulative Remedies’ clause which states that the rights and remedies provided under the agreement are in addition to any rights or remedies provided by law); or
- be the sole remedy in place of any rights and remedies provided by law. If the common law right to terminate is to be excluded this needs to be clearly set out in the contract. Unless unambiguous wording is used to exclude common law rights, the Courts will be reluctant to rule that this is the case.
- When sending a termination notice, if the common law right to terminate is not excluded in the contract, ensure that you are clear which termination right you are exercising - under the terms of the contract or because there is a repudiatory breach at common law. If necessary, refer to both alternatives.
- The historic distinctions between conditions, warranties and intermediate terms should, in our view, be consigned to history (and thankfully that is the direction of travel). The incredibly complex and confusing multiplicity of terminology surrounding rights to terminate for ‘repudiatory’, ‘renunciatory’, ‘anticipatory’ and ‘material’ breaches not to mention the parallel universes of common law and express contractual termination rights bear little relevance to the real commercial world. Judges and other commercial lawyers would do well to recognise that most commercial clients would expect their rights to terminate and claim damages should be clear, understandable and set out in plain English in the contract without needing to have a law degree to make any sense of it!