Wrongful termination for ‘substantial breach’
PBS Energo v Bester (High Court) [2020]
If a contracting party wrongly purports to terminate a contract when they do not have sufficient grounds for doing so, there is a clear danger that they will themselves be committing what is known as a ‘repudiatory breach’. Such a breach will entitle the other contracting party to ‘accept’ that repudiation and terminate themselves, thereby completely turning the tables. This could render the party who originally purported to terminate liable for damages as well as substantially reducing or even eliminating any claim for damages that they might have had relating to the breach(es) which formed the basis of the original purported termination. Termination is therefore a very high-risk option unless you are on very firm ground.
Facts:
Bester engaged PBS to design and construct a biomass fired energy generating plant. Payment of the contract price was to be made by way of milestone payments. Ultimately, the plant was never completed as the parties fell out. Both parties purported to terminate the contract and claim damages.
PBS alleged that Bester: Failed to pay a milestone payment when it was due under the contract and also committed substantial failures to comply with its obligations under the contract. Clause 16.2(b) of the contract entitled PBS to terminate if "Bester substantially fails to perform his obligations under the contract". The alleged failures included:-
- Wrongly rejecting a number of PBS’ claims for an extension of time and additional payment.
- Preventing PBS from fulfilling its obligations under the contract.
Bester alleged that PBS:
- Were guilty of not proceeding with the project diligently and of unlawfully suspending work;
- Abandoned the project or demonstrated an intention not to perform, and failed to comply with a "notice to correct", both of which gave rise to a contractual right to terminate.
PBS maintained that it had been locked off the site by Bester. It argued that to allow Bester to terminate on this ground would be contrary to what is known as the ‘prevention principle’, a principle which prevents a contracting party from taking action in respect of a breach which it has itself caused.
Finally, the parties disagreed as to Bester's right to claim liquidated damages for the delay in completion given that the contract had been terminated.
Decision:
The judge found in favour of Bester.
Bester was held not to be in breach of contract in relation to the claims for an extension of time and additional payment. Bester's rejection of the extension of time claims was not a "material breach" justifying termination, at least in circumstances where adjudication (effectively an appeal of their decision) was available under the terms of the contract.
The PBS claim based on the alleged failure to make milestone payments also failed. Quite apart from doubt as to whether the relevant milestones had actually been achieved, PBS was found not to have complied with the contractual payment mechanism in that it had not provided the necessary ‘statement’ which set time running for the payment of the milestone in question and neither did it ever issue any invoice for the milestone. PBS could not therefore exercise its contractual right to terminate under clause 16.2(a) for late payment.
PBS had also sought to argue that it was entitled to terminate under clause 16.2 (b). In order to do so the court had to consider what the term ‘substantially fails’ means and, in particular does it (a) mean the same as a ‘repudiatory breach’ (which entitles a party to terminate a contract under the common law)? or (b) does it mean the same as the commonly used phrase ‘material breach’? The judge concluded that ‘substantial’ did not mean only breaches that the common law regarded as repudiatory. It would have been odd for the parties to include express wording that simply repeated their common law rights (see the earlier case of Dalkia Utilities Services plc v Celtech which said much the same thing). The judge also concluded that ‘substantial’ should not be equated with "material breach". In doing so, the judge distinguished a previous case from 2006 (Fitzroy House Epworth Steet v Financial Times) in which the Court of Appeal stated that "the words 'substantial' and 'material' depending on the context, are interchangeable".
The judge recognised that there may be situations in which non-payment justified termination on the basis of ‘substantial failures’, such as repeated failure to pay or failing to pay a particularly large amount. However, this case concerned failure to pay a single instalment representing [only] 5% of the contract price (in the region of £700,000). The judge pointed to the fact that the contract contained entitlements to interest for late payments and rights to potentially suspend work. The judge concluded that “on the true construction of the contract a failure to pay this sum would not constitute ‘substantially failing to perform the obligations under the contract’ so as to entitle termination”.
Bester was entitled to terminate and had not offended the prevention principle. PBS argued that it was unable to return to the site and recommence the works because it had been locked out from the site. The judge rejected that argument, commenting that this was "a classic example of the prevention principle being invoked in inapposite circumstances". She pointed out that, on the evidence PBS had itself locked the site “There can be no prevention where the exclusion relied on is one which lies at PBS's own door”. Work on the site had been abandoned for some time and no attempt had been made to resume it. Even had the position been different, the locking of the site could certainly not assist PBS in relation to those elements of the project that it had abandoned that did not require access to the site, such as offsite preparation or submission of documents. It had not resumed those elements and remained in breach, justifying termination under the contract.
On the liquidated damages point, PBS relied on the Court of Appeal's judgment in Triple Point Technology v PTT. The judge accepted that the case "makes clear that what is perhaps the orthodox [position] is that the [liquidated damages] clause applies until the termination of the first contract - and also the case is authority for the proposition that in deciding which of three outcomes ((i) LDs have no application; (ii) LDs apply only up until termination of the contract, or (iii) LDs continue to apply beyond termination until physical completion) is correct in any given case will turn on the wording of the clause in each case."
The judge said there were clear differences from the liquidated damages wording in Triple Point and also pointed to clause 29.1 - a pretty standard clause providing that termination does not affect accrued rights and obligations as at termination.
Points to Note:
- The finding that Bester was not in material breach by rejecting claims for extensions of time because it was open to PBS to refer the claims for adjudication does seem a somewhat strange conclusion although the adjudication process is built upon the ‘fix first, argue later’ principle so that may have had a bearing on the decision.
- The right to terminate for failure to pay needs to be drafted in the clearest of terms in a contract. Terminology such as ‘substantial breach’ or ‘material breach’ is open to interpretation and is always likely to give rise to disputes. Much better to be very specific as to how much needs to be unpaid and for how long to justify termination or to qualify as a ‘material breach’.
- The judge provided no guidance on where ‘material’ and ‘substantial’ stand in relation to each other which was not particularly helpful.
- Make sure that if terminating for non-payment you have correctly followed the contractual provisions under which payment is due.
- The prevention principle is “a focused principle of narrow application”. To be successful a party needs to demonstrate on the facts that prevention [by the other party] occurred.
- In relation to any liquidated damages clause it would seem sensible for the contract to be very explicit as to the impact, if any, of the contract being terminated on the right to claim the liquidated damages that have accrued up to that point.
- The Triple Point case is being appealed to the Supreme Court and so it is likely that in the relatively near future we will have further guidance on the liquidated damages point.