The High Court has held that a party was not entitled to keep a contract alive indefinitely for the purpose of claiming ongoing liquidated damages for delayed performance following its counterparty’s repudiatory breach: MSC Mediterranean Shipping Company S.A. v Cottonex Anstalt [2015] EWHC 283 (Comm).

The court held that an innocent party’s decision whether to terminate or affirm a contract following a counterparty’s repudiatory breach must be exercised in good faith. This is essentially the same test as where a party exercises a contractual discretion.

Previous cases had established that an innocent party could not affirm a contract unless it had a “legitimate interest” in performing and claiming the contract price rather than claiming damages, but that was generally interpreted as setting a fairly low threshold. The present decision arguably goes further in applying good faith principles. If this approach is followed in other cases, it may mean that an innocent party’s options following an opponent’s repudiatory breach are subject to greater constraints than previously thought.

It is worth noting that the judge, Mr Justice Leggatt, also decided Yam Seng Pte Limited v International Trade Corporation Limited [2013] EWHC 111 (QB) (see post) which is generally seen as setting the high water mark for implied duties of good faith in commercial contracts. The decision is subject to an outstanding application for permission to appeal.

The decision is also of interest for the court’s comments regarding penalty clauses. If the court had concluded that the innocent party had an unfettered right to keep the contract alive and claim liquidated damages, it would have held that the liquidated damages clause was unenforceable as a penalty. Gregg Rowan and Rob Javin-Fisher, a partner and senior associate in our dispute resolution team, consider the decision further below.

Background

The claimant had contracted with the defendant to supply and ship containers of the defendant’s raw cotton to a customer in Bangladesh. Under the bills of lading the containers were to be returned to the claimant within 14 days of discharge from the vessel, failing which a daily tariff (demurrage) for late delivery was to apply.

The customer never collected the cotton due to a collapse in the market price. The containers remained in Bangladesh, where the customs authorities would not allow them to be unpacked without a court order (due to legal action taken by the customer).

After the 14 day period elapsed, the claimant sought to claim demurrage for each day that it was without use of the containers. The defendant refused to pay, arguing that it no longer had title to the goods and was unable to empty the containers and return them to the claimant.

Decision

The court held that the claimant was entitled to be paid demurrage after the 14 day period had elapsed, but only up to the point that the defendant had repudiated the bill of lading contracts.

Was the claimant required to mitigate?

The court rejected the defendant’s argument that the amount payable should be reduced because the claimant had failed to take reasonable steps to mitigate its loss. There is no obligation on a claimant to mitigate its losses when claiming liquidated damages, as the purpose of liquidated damages is to render any investigation of the claimant’s actual losses unnecessary.

The court concluded that this applied both to the rate of demurrage, which was payable irrespective of the amount of the claimant’s actual daily loss, and the period for which demurrage was payable – ie the defendant could not argue that the claimant was required to take reasonable steps to reduce the period of time for which it was deprived of the use of the containers.

Constraints on innocent party’s right to affirm

The court held that the defendant had repudiated the bill of lading contracts by reason of its inability or failure to collect the containers, which was clearly communicated to the claimant. It then went on to consider the effect of the repudiation.

The court noted that it is settled law that a repudiatory breach does not automatically bring a contract to an end. The innocent party has a choice whether to accept the repudiation as terminating the contract or whether to keep the contract alive.

However, the innocent party’s choice is subject to two limitations, referred to by the House of Lords in White & Carter (Councils) Ltd v McGregor [1962] AC 413, namely:

  • if the innocent party is not able to perform its obligations under the contract without the other’s cooperation then, unless it can get an order for specific performance to compel such cooperation, it may have no choice but to terminate; and
  • if the innocent party has “no legitimate interest, financial or otherwise” in performing the contract and claiming damages, it will not be allowed to affirm the contract.

In Isabella Shipowner SA v Shagang Shipping Co Ltd [2012] EWHC 1077 (Comm) Cooke J reviewed the authorities considering this “legitimate interest” principle and concluded that an innocent party could only be said to have no legitimate interest in affirming a contract if (a) damages are an adequate remedy and (b) maintaining the contract would be “wholly unreasonable”.

In the present case, Leggatt J said that the principle could be seen in the wider context of the increasing recognition of the need for good faith in contractual dealings. He referred to the established rule of English law that, in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith for the purpose for which it was conferred, and must not be exercised arbitrarily, capriciously or unreasonably.

He said he could not see any difference of principle between the exercise of a contractual discretion and a choice whether or not to terminate in response to a repudiatory breach. He added:

“In each case one party to the contract has a decision to make on a matter which affects the interests of the other party to the contract whose interests are not the same. The same reason exists in each case to imply some constraint on the decision-maker’s freedom to act purely in its own self-interest.”

Accordingly, he concluded that the tests were the same, ie whether the decision had been exercised in good faith.

Was the claimant entitled to keep the contract in force?

On the facts, Leggatt J held that the claimant had not acted in good faith in electing to affirm the contract. It had no legitimate interest in keeping the contract in force once it became clear that there was no realistic prospect that the defendant would be able to procure the return of the containers.

The claimant’s only interest in keeping the contract in force was to continue to claim demurrage. This would only be proper if there was some basis for supposing that the claimant’s inability to use the containers was causing it to suffer ongoing financial loss. In those circumstances, it would be legitimate to rely on the demurrage clause as a liquidated damages provision, avoiding the uncertainty and potential for dispute about the amount of damages the claimant would be entitled to claim on termination.

Here, however, there was no basis to suppose that the claimant was suffering any financial loss as a result of being deprived of the use of the containers. The election to affirm the contract was wholly unreasonable because it had not been invoked for a proper purpose, but rather to seek to generate a new revenue stream.

Was the demurrage provision a penalty clause?

The court also considered the defendant’s submission that the demurrage provision amounted to a penalty clause.

Leggatt J said that, if he had found that the claimant’s right to affirm the contract was unfettered such that demurrage would continue to accrue indefinitely, he would have found that the demurrage provisions were unenforceable as a penalty clause. It was, he said, impossible to justify on compensatory grounds a provision which could require payments without end for so long as the claimant chose to keep the contract in force. Such a clause could only be explained as serving the function of penalising breach of contract.

Comment

As with Leggatt J’s finding of a general implied duty of good faith in Yam Seng, it remains to be seen whether his decision to imply a duty of good faith in the context of the election to terminate for breach will be adopted in other similar cases.  If his approach takes hold, a further interesting question will be whether, in its practical application, the duty requires a higher standard than the “legitimate interest” principle, which was described by Leggatt J himself as setting only a weak constraint on the freedom of a party to choose whether or not to terminate.

This decision also raises the possibility of tension with the refusal of Mr Justice Akenhead in TSG Building Services PLC v South Anglia Housing Limited [2013] EWHC 1151 (see post) to imply a duty of good faith in relation to a right to terminate for convenience. It may seem surprising that a party’s election as to whether or not to terminate a contract for an opponent’s repudiatory breach must be exercised in good faith, whereas there is no such constraint on the exercise of a right to terminate for convenience. Advocates of a wider role for good faith in English law, and those who argue against such a role, may contend with equal force that there is no justification for this distinction and that similar principles should apply to any right to terminate – whether for breach or convenience.

In another recent High Court decision considering the possible implication of a good faith obligation (Myers v Kestrel Acquisitions Limited [2015] EWHC 916 (Ch)) Sir William Blackburne drew a distinction between the exercise of a contractual discretion, which involves a choice from a range of options, and a binary choice as to whether or not to exercise a contractual right. He concluded that good faith obligations only came into play in the former case, not the latter. It is interesting to consider the competing arguments that might be run if a similar analysis were applied to the MSC case where, on one view, the claimant was faced with a binary choice between terminating and affirming the agreement.

It seems unlikely that we have heard the last of these issues – not least given the outstanding application for permission to appeal in the MSC case. Whether or not permission is granted, it seems inevitable that we will see more authorities on the role of good faith in English law in the not too distant future.